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


                                    FORM 10-K

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

                     For the fiscal year ended June 30, 1998

                         Commission file number 0-27802


                       ARTERIAL VASCULAR ENGINEERING, INC.
              (Exact name of Company as specified in its charter)

              Delaware                                  94-3144218
    (State or other jurisdiction of         (I.R.S. Employer Identification No.)
     incorporation or organization)

3576 Unocal Place, Santa Rosa, California                 95403
(Address of principal executive offices)                (Zip code)

                                 (707) 525-0111
                (Company's telephone number, including area code)

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

           Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $0.001 Par Value

Indicate by check mark whether the Company (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 periods as the Company 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 Company'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 10-K. [ ]

   
As of July 31, 1998, there were 64,186,371  shares of Common Stock  outstanding.
The aggregate market value of voting stock held by non-affiliates of the Company
was  approximately  $2,056,140,000  based upon the  closing  price of the Common
Stock on July 31, 1998 on the Nasdaq  National  Market tier of The Nasdaq  Stock
Market. Shares of Common Stock held by each officer, director and holder of five
percent or more of the Common  Stock  outstanding  as of July 31, 1998 have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily conclusive.
    

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

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions  of the Proxy  Statement  of  Company  for the 1998  Annual  Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K.

================================================================================

<PAGE>

                                     PART I

   
         The following  trademarks of Arterial  Vascular  Engineering,  Inc. are
used in this Form 10-K: Arterial Vascular Engineering(TM), Micro Stent(R), Micro
Stent(R)  II, Micro  Stent(R) II XL, Micro  Stent(R)  2.5,  GFX(R),  GFX(R) 2.5,
GFX(R) XL, GFX(R) XP, GFX(R) 2,  Bridge(TM),  LTX(TM),  Peak(TM),  Elite(TM) and
Nike(TM).
    

ITEM 1.  BUSINESS

   
         The statements  contained in this Form 10-K that are not historical are
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,  including
statements  regarding  the  Company's  expectations,   beliefs,   intentions  or
strategies regarding the future.  Forward-looking statements and risk factors in
this Item 1 include,  without  limitation,  statements  regarding  the Company's
industry, products and strategy under "Company Strategy", "AVE Stent Technology"
and "Additional  Business Risks",  statements regarding the extent and timing of
product development,  future revenues,  customer demand,  competitive  products,
pricing   pressure,   the  intellectual   property   positions  of  competitors,
reimbursement and future  technological  change under "Products,"  "Research and
Development  Programs,"  "Distribution,  Sales  and  Marketing,"  "Competition,"
"Third-Party  Reimbursement  and "Patents and  Proprietary  Rights,"  statements
regarding   expected  clinical  trial  results  and  regulatory   approvals  and
compliance  under "Clinical Trial  Activities" and "Government  Regulation," and
statements   regarding   expected   acquisitions   under   "Recent   Acquisition
Agreements." All forward-looking  information included in this document is based
on information  available to the Company as of the date hereof,  and the Company
assumes no  obligation  to update  any such  forward-looking  statements.  It is
important to note that the Company's actual results could differ materially from
those in such forward-looking statements.  Additional forward-looking statements
and risk factors include those discussed in the sections entitled "Item 3. Legal
Proceedings,"  "Item 5. Market for the  Registrant's  Common  Equity and Related
Stockholder Matters," "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of  Operations,"  and "Item 8.  Financial  Statements  and
Supplementary Data," as well as those that may be set forth in the reports filed
by the Company from time to time on Forms 10-Q and 8-K.
    

General

         Arterial Vascular  Engineering,  Inc. ("AVE" or the "Company") designs,
develops, manufactures and markets a variety of highly specialized stent systems
and percutaneous  transluminal  coronary angioplasty ("PTCA") balloon catheters.
The Company's  stents are used as arterial  support  devices in connection  with
balloon  angioplasty or other minimally  invasive  treatments of atherosclerosis
(the  formation of deposits in the  arteries) and to prevent  abrupt  closure of
vessels in higher-risk angioplasty  procedures.  The Company believes that it is
currently one of the leading  providers of coronary stent  systems.  The Company
commenced  operations in 1991 and began marketing its PTCA balloon  catheters in
October 1993,  its coronary  stent systems in October 1994,  and its  peripheral
stent  systems in December  1996.  To date,  the  Company has sold over  500,000
coronary  stent  systems and over 50,000 PTCA balloon  catheters in more than 40
countries,  including the United  States with respect to the Company's  coronary
stent  systems.  In June  1997,  the  Company's  Japanese  distributor  received
regulatory  approval  for the  sale in  Japan of the  Company's  coronary  stent
systems,  and in January  1998 the Company  received  the related  reimbursement
approval.  In December 1997, the Company received a pre-market  approval ("PMA")
from the United  States Food and Drug  Administration  (the "FDA") in connection
with its  commencement of commercial  sales of its coronary stent systems in the
United  States.   Prior  to  that  time,   international   sales  accounted  for
substantially all of the Company's revenues.

   
         In April 1998,  the Company  entered into an agreement to acquire World
Medical  Manufacturing  Corporation  ("World  Medical"),  a leading  independent
developer,  manufacturer  and marketer of medical  devices for the  treatment of
abdominal aortic aneurysms, for stock and stock options of the Company valued at
approximately $62 million (the "World Medical  Acquisition").  In July 1998, the
Company entered into an agreement to acquire the coronary  catheter lab business
of C.R. Bard, Inc. ("Bard"),  as well as rights to the supply by Bard of certain
materials,  for approximately  $550 million in cash,  subject to adjustment (the
"Bard Cath Lab  Acquisition").  Consummation  of each of these  acquisitions  is
subject  to a  number  of  conditions.  Bard's  broad  range  of  catheter-based
technologies includes PTCA balloon catheters (including perfusion rapid exchange
catheters),  guidewires,  guide  catheters,  coronary  diagnostic  catheters and
guidewires, introducers and vessel closure devices, coronary stents, and various
other components and accessories.  When closed,  these acquisitions are expected
to  substantially  increase  the  Company's  personnel,  facilities  and product
offerings   and  to  enable  the  Company  to   participate   in  new  areas  of
interventional  cardiology  through a wider product  portfolio and access to new
markets  and  customers.   However,   there  can  be  no  assurance  that  these
acquisitions  will be  successfully  consummated  or, if  consummated,  that the
Company will  successfully  participate in such new product  areas.  The Company
expects to enter into a bank credit agreement for $600 million in senior secured
credit facilities in order to, among other things,  finance substantially all of
the Bard Cath Lab Acquisition.  See "--Recent Acquisition  Agreements" and "Item
7.  Management's  Discussion and Analysis of Financial  Condition and Results of
Operations -- Liquidity and Capital Resources."
    


                                       1
<PAGE>


AVE Stent Technology

   
         The Company  believes  that its line of coronary and  peripheral  stent
systems  incorporates a number of unique and  proprietary  design  features that
enable the Company to address  effectively a variety of lesion and vessel types.
The Company's stents are constructed of seamless,  medical grade stainless steel
rings  that  are  precision-formed  into  sinusoidal  shaped  elements.  In  the
Company's  coronary  stents,  these  elements are  polished  and  connected in a
helical pattern utilizing a proprietary manufacturing process in order to form a
fully connected, yet flexible, stent device. The Company believes that its stent
design  provides  more  consistent  vessel  support and radial force than coiled
stent  designs as well as more  flexibility  and easier  delivery  than  tubular
slotted or mesh stent designs.  The Company's  stent products are available in a
variety  of  diameters  and  lengths  and  are  provided   pre-mounted  on  both
over-the-wire  and rapid exchange  delivery  systems  (currently  available only
outside the United  States) with the same  advanced  technology as the Company's
PTCA  balloon  catheters.  The  Company's  coronary  stents  have been used in a
variety of applications,  including vessels in which other stent procedures have
failed,  as well as in the  treatment of lesions in curved or tortuous  vessels.
The Company  also sells stent  systems for use in the  peripheral  vessels.  The
Company  believes the  following  technical  features of its  proprietary  stent
systems provide the Company with a number of competitive advantages:

         Smooth Edge Design and  Sheathless  Deployment  System.  The  Company's
stent products consist of highly polished,  rounded,  sinusoidal-shaped elements
at either end of the stent  (unlike mesh  stents,  which have flat edges at each
end). The Company believes that the smooth edges of its stent products  optimize
their  ability  to be moved  through a vessel by  minimizing  resistance  to and
friction of the stent and its  delivery  system,  thereby  minimizing  trauma to
treated  vessels.  The smooth edges of the stent and the  Company's  proprietary
attachment method permit the stent to be delivered without the protective sheath
necessary for use of certain competing stent products. The Company believes that
eliminating the need to monitor and remove a protective sheath enhances the ease
of use of its products.
    

         High Stent Flexibility and System Trackability.  The Company's products
consist of  sinusoidal-shaped  elements that are connected in a helical  pattern
designed to provide a highly flexible stent.  Increased stent flexibility allows
the Company's stent products to be more easily maneuvered and placed at the site
of a lesion,  particularly  through  curved or tortuous  vessels or around other
deployed stents.  In addition,  flexible stent design allows the use of a single
stent in the  treatment  of a lesion in a curved  vessel,  as  compared  to more
inflexible  designs that may require the use of multiple stents to treat a long,
curved lesion.  The Company believes that the ease of use and enhanced  handling
characteristics  of its stent delivery  systems,  coupled with stent flexibility
and  smooth  edge  design,  allow  it  to  provide  a  stent  system  with  high
trackability.  The  ability  to  easily  access  or  "track  to" a lesion  is an
important  stent  system  characteristic  in the  treatment of a distant site or
tortuous vessel. The Company currently offers coronary stents in lengths as long
as 40mm for use in the treatment of long, diffuse lesions.

   
         Improved  Stent  Strength and  Stability.  The advanced  designs of the
Company's GFX 2, GFX and Micro Stent II families of stent products combines high
radial  strength,  which minimizes  vessel recoil,  and axial  stability,  which
provides  consistent  vessel  support along the entire length of the stent.  The
Company believes these features allow a physician to better control and optimize
final minimal lumen diameter ("MLD"). Studies have indicated that optimizing the
MLD  of a  vessel  following  use  of a  stent  product  generally  reduces  the
likelihood of subsequent restenosis.
    

         Moderate   Radiopacity.   The  Company   believes   that  the  moderate
radiopacity  of its  devices  optimizes  angiographic  identification  of  stent
position and enhances  post-procedure stent assessment.  Physicians commonly use
low level x-rays to accurately  monitor the placement and deployment of a stent,
including final expansion using a high pressure  balloon,  as well as to conduct
post-operative assessment of MLD. As a result, a lack of radiopacity,  which may
prevent  illumination  of a  stent,  or an  excess  of  radiopacity,  which  may
overilluminate  the stent and impede its visual  identification,  may affect the
outcome of stent procedures and subsequent diagnosis of treated vessels.

         Proprietary, Pre-Mounted Delivery Systems. Unlike certain other stents,
which may require the  physician to hand-crimp  the stent on a balloon  delivery
device,  the Company's  stents are  pre-mounted  onto its  proprietary  delivery
systems.  The Company believes that  pre-mounting its stents on balloon delivery
systems helps ensure more consistent and accurate stent delivery and deployment,
particularly  as stents are used by a broader group of  physicians  with varying
levels of experience  with stents.  In addition,  the Company  believes that the
ease of use of its product has promoted physician acceptance.

         Adaptable Design Characteristics.  The Company believes that the design
features  of its  stents  allow  it to  modify  one or  more  stent  performance
characteristics,  such  as mass or  flexibility,  as  necessary  to  produce  an
effective device for a particular application. To date, the Company has utilized
its stent  technologies  to develop  families  of more than ten  distinct  stent
products.  Each product  also is offered in a variety of lengths and  diameters,
allowing  the  physician  to choose  the  device  that best suits the needs of a
patient based on lesion  characteristics.  The Company believes the adaptability
of its stent  designs  will allow  their use as  platform  technologies  for the
development  of a variety  of other  coronary  and  non-coronary  products.  For
example, the stents introduced by the Company in selected  international markets
designed for use in the peripheral renal and iliac vessels are based on the same
platform technology used in the Company's coronary stents. See "-- Products."


                                       2
<PAGE>

   
         Despite such advantages, due to the number of clinical applications for
stent  systems  and the  variety of  available  products,  the  Company's  stent
products may not be superior to  competitive  products in all  applications.  In
addition,  many of the Company's  competitors have substantially greater capital
resources,  name recognition and expertise in research and product  development,
manufacturing,   marketing  and  product  approval,   which  factors  provide  a
competitive  advantage to such  companies,  in connection with the sale of these
stent products.  The medical  indications that can be treated by stents can also
be treated by surgery,  minimally  invasive  bypass  procedures,  drugs or other
medical devices, including stand-alone balloon catheters, atherectomy catheters,
irradiated  devices and lasers.  Many of the  alternative  treatments are widely
accepted in the medical community and have a long history of use.
    

Company Strategy

   
         The  Company's  goal is to expand its  position  as one of the  leading
worldwide  providers of coronary stent systems  toward  becoming a major medical
device provider for less invasive treatment of cardiovascular  disease.  The key
elements of its strategy are as follows:
    

         Introducing   New   Products  for  Both   Coronary   and   Non-Coronary
Applications.  The Company  intends to build on its stent designs to broaden the
coronary and non-coronary  applications for its stents.  For example,  the GFX 2
stent system  released by the Company in selected  international  markets in May
1998 was  designed to have a lower  profile  (outside  diameter)  to provide for
increased  trackability,  with  a  goal  of  increasing  the  types  of  medical
indications  that may be treated  with  stents.  The Company  believes  that the
inherent  adaptability  and  flexibility  of the  Company's  stent  designs will
augment its ability to meet  specialized  coronary  needs, as well as to provide
stents  for  use  in  peripheral  vessels,   saphenous  vein  grafts  and  other
applications.

   
         Continuing  Integration of Research and Development  and  Manufacturing
Operations.   The   Company   believes   that  the   design  of   products   for
manufacturability and the rapid manufacture of products to satisfy market demand
are key  success  factors  in new  product  development  in the  medical  device
industry. To support these capabilities,  the Company has designed and developed
internally  the  technology   necessary  to  perform  a  number  of  proprietary
production  processes  and has developed the expertise to fabricate the majority
of the components of its stent and PTCA balloon catheter  products.  The Company
also completed in fiscal 1998 the construction of a 130,000 square foot building
in Santa Rosa, California which is largely devoted to manufacturing  activities.
The design of the new facility is intended to allow continued integration of the
Company's  research and  development and  manufacturing  operations as well as a
significant  expansion of the  Company's  production  capabilities.  The Company
intends  to  leverage  its  vertically   integrated   product   development  and
manufacturing approach to rapidly introduce innovative products and to similarly
take such an approach in  connection  with the  facilities to be acquired in the
Bard Cath Lab Acquisition.

         Continuing  to  Expand  Sales  and  Marketing   Efforts.   The  Company
continually  seeks to increase its market share and build  product  awareness in
each of the over 40 countries in which its  products are  marketed.  The Company
has direct  sales  operations  in certain  principal  target  markets -- Canada,
France, Germany, the Netherlands (to service the Benelux countries),  Singapore,
Switzerland, the United Kingdom and the United States -- and expects to initiate
direct sales operations in certain other countries in fiscal 1999,  primarily as
a result of the Bard Cath Lab Acquisition.  In other countries  internationally,
the Company operates  through  unaffiliated  distributors.  The Company believes
that its direct  sales  presence  allows it to focus  greater  attention on such
countries'  physician  communities,  which it  believes  helps to  increase  the
advocacy base for the Company's  products in Europe and other  countries as well
as facilitating more direct feedback to the Company on its products. The Company
also believes  that,  in addition to building  stronger  relationships  with its
customers,  this direct sales  strategy  provides the Company with more complete
control of the  distribution  and growth of the Company's  full product line, as
well as allowing it to better manage the pricing and regulatory approval process
for its products.  The Company may continue to establish direct sales operations
in selected  markets  where it believes  that such an approach  will benefit its
competitive position. The Company has also centralized its distribution services
by  contracting  with a provider  in the  Netherlands  to support  direct  sales
operations and independent  distributors  throughout  Europe.

         Broadening   Product   Offerings  to  Provide  More  Complete   Therapy
Solutions. The Company believes that an ability to offer a more complete line of
therapeutic products may enhance the Company's ability to compete effectively in
the interventional  marketplace.  For example,  the Company believes its current
line of PTCA  balloon  catheters  has  provided  the Company  with  expertise in
balloon  delivery  and  deployment.  The Company  continually  reviews  possible
strategic  acquisitions,  third  party  technology  licenses  and  marketing  or
distribution  relationships with companies that have medical products in certain
complementary product areas. The World Medical Acquisition and the Bard Cath Lab
Acquisition,  for example,  are expected to enable the Company to participate in
new areas of  interventional  cardiology  through a wider product  portfolio and
access to new markets and  customers.  However,  there can be no assurance  that
these acquisitions will be successfully consummated or, if consummated, that the
Company will successfully participate in such new product areas.


                                       3
<PAGE>


         Pursuing   Regulatory   Approval  in  the  United  States  and  Abroad;
Conducting  Clinical  Trials  to  Promote  Market  Acceptance  of the  Company's
Products.  In  December  1997,  the  Company  received  a PMA  from  the  FDA in
connection with the  commencement of commercial sales of certain of its coronary
stent systems in the United  States.  Some of the other  coronary  stent systems
that the Company currently markets  internationally will require clinical trials
conducted  under  an  investigational  device  exemption  (an  "IDE")  or a  PMA
supplement  before  such  products  can be marketed  in the United  States.  The
clinical trials  necessary to obtain such marketing  clearances from the FDA are
currently being sponsored by the Company and are ongoing;  however, there can be
no assurance that such clinical trials will result in FDA approvals or as to the
timing of any such approvals. In addition to its United States clinical program,
the Company is sponsoring  several ongoing clinical studies in several countries
outside the United States.  The Company intends to use data from these trials to
obtain regulatory  approvals in various  applicable  markets,  to promote market
acceptance of its products and to expand clinical  applications of the Company's
products.

         Developing and Maintaining  Relationships with Leading Physicians.  AVE
develops and maintains relationships with leading physicians worldwide.  Through
these  relationships,  the Company  seeks to work with  opinion  leaders who can
foster market  awareness of the Company's  products.  The Company supports these
efforts  through  group  training  programs   designed  to  increase   physician
familiarity  with the  Company's  products,  and  utilizes  a staff of  clinical
specialists to expand its physician  training,  service and support  activities.
The Company also has an active  marketing  program that  provides a  significant
presence  at industry  trade shows and  produces  marketing  materials  targeted
toward  physicians.  In addition,  the Company  maintains  an active  program of
collaborating with key physicians and medical centers to obtain feedback for new
product development.
    

Products
<TABLE>

         The Company  currently markets its coronary stent systems in the United
States, in most countries in Europe,  including  Germany,  France and the United
Kingdom, and in other countries.  In addition, the Company offers a line of PTCA
balloon catheters and peripheral stent systems outside of the United States. The
following  table  identifies the Company's  current  products,  their  principal
clinical application and their current commercialization status:
<CAPTION>

CURRENT PRODUCTS
------------------------------------------------------------------------------------------------------------------------

CORONARY STENT SYSTEMS
                                                                   Initial
                                                                   Release
     Product                 Description/Application                 Date                       Status
     -------                 -----------------------                 ----                       ------

<S>                  <C>                                        <C>             <C>    
GFX Stent Systems
   GFX 2             Improved  advanced  coronary stent system    June 1998     Available    for   sale   in   selected
                     designed  to provide  15% lower  profile,                  international  markets.  PMA supplement
                     and utilizing a delivery  system  capable                  expected  to  be  submitted  in  autumn
                     of  higher  balloon  pressures,  than the                  1998.
                     GFX.

   GFX               Advanced  coronary stent system  designed  September 1996  Available   for   sale   in   over   40
                     to  provide  lower  profile  (most  sizes                  countries,  including the United States
                     capable of being  used in 6 French  guide                  since December 1997.
                     catheters)  and greater  radial  strength
                     and flexibility than Micro Stent II.

   GFX XP            Coronary  stent  system  being  developed       N/A        PMA supplement expected to be submitted
                     for   the   U.S.   market.   Utilizes   a                  in autumn 1998.
                     delivery   system   capable   of   higher
                     balloon pressures than the GFX.

   
   GFX 2.5           Coronary   stent   designed  for  use  in    June 1997     Available   for   sale   in   over   40
                     vessels as small as 2.5mm in diameter.                     countries outside the United States. IDE
                                                                                clinical  studies   commenced  in  April
                                                                                1998.  PMA  application  expected  to be
                                                                                submitted in autumn 1998.
    

   GFX XL            Coronary  stent  designed  for use in the    June 1997     Available   for   sale   in   over   40
                     treatment of long and diffuse lesions.                     countries  outside  the United  States.
                                                                                PMA supplement  expected to be submitted
                                                                                in autumn  1998.  
Micro Stent II Systems

   Micro Stent II    Coronary stent system featuring helical     October 1995   Being replaced  by the  GFX.  
                     connections  and enhanced radial  strength.  
                     Designed for use in a variety of coronary
                     applications.

   Micro Stent 2.5   Coronary stent designed for use in          December 1995  Being replaced by the GFX 2.5.
                     vessels as small as 2.5mm in diameter.

   Micro Stent II    Coronary  stent  designed for use in the    December  1995 Being replaced by the GFX XL. 
   XL                treatment of long and diffuse lesions.
-------------------- ------------------------------------------ --------------- ----------------------------------------



                                       4
<PAGE>

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

PERIPHERAL STENT SYSTEMS
                                                                   Initial
                                                                   Release
      Product                 Description/Application                Date                       Status

Bridge Renal Stent   Peripheral  stent designed for use in the  December 1996   Limited     release     in     selected
  -- Extra           renal arteries.                                            international  markets. IDE application
Support                                                                         for  new  product  version submitted in
                                                                                June 1998.

Bridge Iliac Stent   Peripheral  stent designed for use in the  December 1996   Being  replaced  by  the iliac flexible
  -- Extra Support   iliac vessels.                                             stent.

Bridge Iliac Stent   Peripheral  stent  designed  for  use  in    July 1997     Limited     release     in     selected
  -- Flexible        more tortuous iliac vessels.                               international markets.

   
Bridge Biliary       Peripheral  stent designed for use in the       N/A        510(k) for new product version expected
Stent                biliary tract.                                             to be  submitted  to the FDA in  autumn
                                                                                1998.
    
PTCA BALLOON CATHETERS
                                                                   Initial
                                                                   Release
      Product                 Description/Application                Date                       Status
      -------                 -----------------------                ----                       ------

LTX                  Lower    profile,     higher    pressure,  September 1997  Available   for   sale   in   over   40
                     minimally    compliant    PTCA    balloon                  countries outside the United States.
                     catheter  with  hydrophilic  coating  for
                     improved   performance,   in  both  rapid
                     exchange and over-the-wire models.

Elite                Rapid   exchange,   semi-compliant   PTCA  November 1994   Approved   for   use   in   Japan   and
                     catheter,  incorporating stiffer proximal                  available    for   sale   in   selected
                     shaft.                                                     international markets.

   
Peak                 Over-the-wire,     semi-compliant    PTCA    July 1995     Approved   for   use   in   Japan   and
                     catheter.                                                  available    for   sale   in   selected
    
                                                                                international markets.

Nike                 Rapid   exchange,   semi-compliant   PTCA   October 1994   Approved   for   use   in   Japan   and
                     catheter,  featuring a flexible  proximal                  available    for   sale   in   selected
                     shaft.                                                     international markets.

-------------------- ------------------------------------------ --------------- ----------------------------------------
</TABLE>
Coronary Stent Systems

         The Company currently markets the following  families of coronary stent
products, all of which are pre-mounted on a catheter and balloon delivery system
produced by the Company:

     GFX Stent Systems

         GFX 2. The GFX 2 coronary stent system  improves on the basic design of
the GFX product to allow for improved  stent  trackability  and  deliverability.
Like the GFX, the GFX 2 utilizes a six-crown sinusoidal configuration with stent
components  of 2mm in  length.  The GFX 2 is  designed  to improve on the GFX by
providing  lower  profile  (outer  diameter)  and by  utilizing a more  advanced
delivery  system  that is  capable  of higher  balloon  pressures.  The GFX 2 is
offered in lengths of 8, 12, 18, 24 and 30 mm with diameters of 3.0, 3.5 and 4.0
mm.

         GFX. The GFX stent has a modified,  six crown sinusoidal  configuration
and  utilizes a stent  component  of 2mm in length.  The  product is designed to
allow improved stent flexibility and  trackability,  vessel coverage and support
while  providing the capability of using most sizes with guiding  catheters with
outer diameters as small as 6 French (approximately 2.0mm), which may be helpful
in certain applications. The GFX is offered in lengths of 8, 12, 18, 24 and 30mm
with diameters of 3.0, 3.5 and 4.0 mm.

         GFX XP. The GFX XP is a GFX coronary stent  utilizing the more advanced
delivery  system  that is  incorporated  into the GFX 2. This  product  would be
marketed in the United States,  if and when  regulatory  approvals are obtained,
and has  not yet  been  released  for  commercial  sale  in any  country.  A PMA
supplement is expected to be submitted in autumn 1998.

   
         GFX 2.5. The GFX 2.5 generally incorporates the same design features as
the GFX (although it utilizes a four-crown  configuration),  but is designed for
application in vessels as small as 2.5mm in diameter.  The GFX 2.5 is offered in
8, 12, 18 and 24mm lengths with a diameter of 2.5mm.
    

                                       5
<PAGE>

   
         GFX  XL.  The  GFX XL is a  longer  stent  made  up of  multiple  stent
components that is designed to be used in treating  diffuse arterial disease and
longer lesions with a single stent.  Because the GFX XL retains the  flexibility
of the Company's GFX stent design, the Company believes it enables physicians to
treat longer lesions with a single stent, thereby potentially reducing procedure
time and cost. The product  incorporates the same design features as the GFX. It
is offered in a length 40mm with diameters of 3.0, 3.5 and 4.0mm.
    

     Micro Stent II Systems

         Micro Stent II. The Micro Stent II utilizes a stent component of 3mm in
length.  The helical  connection  and reduced length of the stent elements allow
for increased  flexibility,  thereby enhancing the handling  characteristics and
trackability  of  the  stent  system.  The  Micro  Stent  II  also  incorporates
engineering  advances  related  to  radial  strength  and  materials  processing
designed to allow greater control of minimal lumen diameter.  The Micro Stent II
is being replaced by the GFX.

         Micro  Stent 2.5.  The Micro  Stent 2.5  incorporates  the same  design
features as the Micro Stent II, but is designed  for  application  in vessels as
small as 2.5mm in  diameter.  The Micro  Stent 2.5 is being  replaced by the GFX
2.5.

         Micro Stent XL. The Micro Stent II XL is a longer stent  designed to be
used in  treating  diffuse  arterial  disease and longer  lesions  with a single
stent. The Micro Stent II XL is being replaced by the GFX XL.

Peripheral Stent Systems

         In addition to the Company's  coronary stent systems,  the Company also
offers a line of stent systems designed for the treatment of  atherosclerosis in
peripheral vessels of the body.

         Bridge Extra Support Renal Stent.  The Bridge extra support renal stent
is designed to be used in the renal  arteries  and is offered in diameters of 5,
6, and 7mm and  lengths of 16mm.  Initial  release of the  product  occurred  in
December  1996. An IDE  application  for a new product  version was submitted in
June 1998.

         Bridge Extra Support Iliac Stent.  The Bridge extra support iliac stent
is designed to be used in the iliac vessels and is offered in diameters of 6, 7,
8, 9 and 10mm  and  lengths  of 40 and  60mm.  Initial  release  of the  product
occurred  in  December  1996.  The Bridge  extra  support  iliac  stent is being
replaced by the Bridge flexible iliac stent.

         Bridge Flexible Iliac Stent. The Bridge flexible iliac stent is a lower
profile,  more flexible peripheral stent designed for use in more tortuous iliac
vessels and is offered in diameters of 6, 7, 8, 9 and 10mm and lengths of 20, 40
and 60mm. Initial release of the product occurred in May 1997.

   
         Bridge Biliary  Stent.  The Bridge biliary stent is designed to be used
in the biliary tract. A 510(k) application for a redesigned Bridge biliary stent
is expected to be submitted with the FDA by autumn 1998, but the product has not
yet been released for commercial sale in any country.
    

PTCA Balloon Catheters

         In  addition  to the balloon  catheters  sold as part of the  Company's
stent systems, the Company also offers a broad line of balloon catheters for use
in PTCA balloon  procedures.  The Company offers PTCA catheters with balloons in
lengths  of 20,  30 and  40mm  and  diameters  ranging  from  1.5mm  to 4.0mm as
discussed below.

         LTX.  The LTX  utilizes a lower  profile,  higher  pressure,  minimally
compliant  PTCA balloon  rated at 14  atmospheres.  Among other  things,  higher
pressure  PTCA  balloons are useful in  follow-up  dilatation  treatment,  since
higher pressure balloons  generally more fully expand implanted stents.  Initial
release of the product occurred in selected markets in September 1997.

         Peak. The over-the-wire  Peak catheter  incorporates a stiffer proximal
(nearer to the  operator)  shaft for  enhanced  control  and a  flexible  distal
(further from the operator)  shaft for ease of access to more tortuous  vessels.
It was designed for the Japanese  market,  which at least in the past  generally
favored over-the-wire catheters, although it is also sold in other countries.

         Elite.  The Elite is a rapid exchange  catheter with a smaller proximal
shaft  diameter.  It  incorporates  the Nike distal  shaft design with a stiffer
metallic type of proximal shaft construction  designed to allow greater operator
control in maneuvering the balloon catheter while enhancing vessel imaging.

         Nike.  The Nike is a rapid exchange  catheter with a flexible  proximal
shaft design  coupled with a low profile  distal shaft.  It is designed to allow
greater access to smaller or more tortuous vessels.


                                       6
<PAGE>

Research and Development Program

         The  Company  maintains  an active  research  and  development  program
designed to exploit its core technical expertise in stent systems,  PTCA balloon
catheters and related medical  technologies.  The Company has made a significant
investment in developing its  proprietary  stent  technologies  and believes its
research and development  commitment in this area is critical to its competitive
position.  During fiscal 1998, the Company significantly  increased its research
and development  expenditures and personnel.  Research and development  expenses
for fiscal 1998, 1997 and 1996 were approximately $37,208,000,  $11,422,000, and
$6,480,000  ($3,880,000  after  excluding  a one-time  charge of  $2,600,000  in
connection  with  the  termination  of  certain  patent  royalty   obligations),
respectively.

         The Company is reviewing potential products in several areas, including
stent use in carotid and  neurological  applications,  radiation  and the use of
alternative stent materials.  There can be no assurance that any of the products
above will be successfully  developed,  commercially released or accepted by the
market  or  that  regulatory  clearance  will be  obtained  from  the  necessary
international or United States regulatory agencies.

Clinical Trial Activities

   
         Clinical  trials have not been required in most European  markets prior
to the initiation of commercial  sales.  By contrast,  certain other  countries,
including the United States and Japan,  require government  pre-market approval,
rigorous in vitro and/or pre-clinical data and the completion of clinical trials
prior to commercialization of new products.  In Japan,  following the submission
of the  results of  clinical  trials to Japanese  regulators  in late 1996,  the
Company's Japanese distributor received in June 1997 government approval for the
sale in Japan of the  Company's  coronary  stent  systems,  and in January  1998
received the related  reimbursement  approval. In the United States, in December
1997 the Company received a PMA from the FDA in connection with its commencement
of  commercial  sales of certain  of its  coronary  stent  systems in the United
States. The PMA was based on a 661-patient,  multi-center,  randomized  clinical
study in the  United  States  with the  Company's  Micro  Stent II and GFX stent
systems under an IDE. Some of the other  coronary stent systems that the Company
currently markets  internationally  will require clinical trials conducted under
an IDE or a PMA  supplement  before such  products can be marketed in the United
States.  The clinical trials necessary to obtain such marketing  clearances from
the FDA are currently being  sponsored by the Company and are ongoing;  however,
there can be no assurance that such clinical trials will result in FDA approvals
or as to the timing of any such approvals. The Company has incurred, and expects
to  continue  to  incur,  substantial  clinical  research  and  other  costs  in
connection  with  obtaining  regulatory  approvals  for its stent systems in the
United States and other countries.
    

         In  addition  to its United  States  clinical  program,  the Company is
sponsoring  several ongoing  clinical studies in several  countries  outside the
United States.  In addition to fulfilling the  regulatory  requirements  for the
sale of its products in certain countries,  the Company intends to use data from
these trials to promote market acceptance of its products and to expand clinical
applications  of the Company's  products.  In sponsoring  clinical  trials,  the
Company  generally  is involved in the design of the  protocol  for such trials,
makes its stents  available  to the trials'  investigators  free of charge or at
discounted  rates,  and aids with the patient  enrollment  procedures  and other
ministerial  aspects  of  the  trial  as  necessary,   but  otherwise  does  not
participate in the performance of the trials.

         Clinical results are inherently unpredictable and are influenced by the
indications and endpoints chosen and the procedures used.  Results from clinical
trials sponsored by the Company, its competitors or a third party could delay or
prevent regulatory approvals, reduce market demand and therefore have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.   In  addition,  there  can  be  no  assurance  that  the  Company's
interpretation  of data from its clinical  trials will be accepted by the FDA or
other regulatory authorities or the medical community at large.

Distribution, Sales and Marketing

   
         The Company markets its GFX family of coronary stent systems in over 40
countries,  including  the United  States and Japan.  It also  markets  its PTCA
catheters and its GFX 2.5 and GFX XL stent systems in over 40 countries  outside
the United States,  and its peripheral stent systems and its next generation GFX
2 coronary stent system in selected international markets.

         Until  April 1996,  substantially  all of the  Company's  sales were to
international  distributors  who  resell  products  to  health  care  providers.
Beginning  in April  1996,  the  Company  from time to time has  terminated  its
relationship with  distributors  where it believes such an approach will benefit
its competitive  position.  In those countries where the Company has established
and  maintained  direct sales  forces,  the change has,  over time,  resulted in
increased revenues and market share in the applicable  territories.  The Company
believes  that its direct sales  operations  have  enabled it to build  stronger
relationships  with customers,  more  completely  control the  distribution  and
growth of the Company's  full product line, and to better manage the pricing and
regulatory approval process for its products.  The establishment and maintenance
of direct sales forces has  required  and will  continue to require  significant
ongoing expenditures,  additional management resources and has resulted, and may
continue  to result,  in  additional  costs to  eliminate  existing  distributor
relationships  (including  litigation  by former  distributors).  Certain of the
Company's 


                                       7
<PAGE>

former distributors, including those in Belgium and France, have commenced legal
action  against  the  Company  in  connection   with  the   termination  of  the
distribution  relationships in those countries. See "Item 3. Legal Proceedings."
The Company has also centralized its distribution services by contracting with a
provider in the  Netherlands to support direct sales  operations and independent
distributors   throughout   Europe.

         In all other  countries,  the  Company  currently  sells  its  products
through independent  distributors.  Such distributors  generally are granted the
right  to sell  the  Company's  products  within  a  defined  territory  and are
typically permitted to sell other non-competing  medical products.  All sales to
distributors are denominated in U.S.  dollars,  while sales effected through the
Company's  direct sales  operations are denominated in the local  currency.  The
Company's distributors purchase the Company's products at discounts that vary by
product  and  market.  The  distributors  resell  the  products  to health  care
providers  such as hospitals at prices that are  determined by the  distributor.
The  Company's  use of  distributors  in  certain  countries  does not allow the
Company to control  end-market  prices charged for its products in those markets
and may not result in the same level of sales and marketing efforts as would the
use of a direct  sales  force by the Company in those  markets.  The Company has
written agreements with most of its more significant distributors, including the
Company's Japanese  distributor.  Approximately 20% of the Company's fiscal 1998
revenues   were  derived  from  export   sales  to   independent   international
distributors.  The Company's  Japanese  distributor,  Japan  Lifeline Co., Ltd.,
accounted  for  approximately  11% of the  Company's  net sales in fiscal  1998.
International  sales are subject to certain  risks,  including  foreign  medical
regulations,  export/import licenses, foreign currency fluctuations, economic or
political  instability,  shipping  delays and  tariffs and other  various  trade
restrictions,  all of which  could have a  significant  impact on the  Company's
ability to deliver  products on a competitive  and timely basis.  As the Company
continues to develop an international sales force it expects to be more directly
subject to foreign currency  fluctuations to the extent such direct sales may be
denominated in foreign currency.  Since the third fiscal quarter of fiscal 1997,
when the  Company  incurred  losses of  approximately  $550,000  due to  foreign
currency  fluctuations,  the Company has from time to time  entered into certain
currency hedging transactions in the form of forward exchange contracts that the
Company believes should limit its exposure to such currency fluctuations.  There
can be no  assurance,  however,  that the Company  will not incur  losses due to
foreign  currency  fluctuations  in the  future.  As of June 30,  1998,  no such
currency hedging transactions were outstanding.
    

         The Company has  implemented  a marketing  and  development  program to
support its sales as well as to increase its visibility with leading physicians.
The Company has  implemented a series of marketing  programs to help  coordinate
clinical trials, work directly in the training of physicians and certain aspects
of patient  care,  provide an  increased  presence  at industry  tradeshows  and
produce marketing material targeted toward physicians.  The Company  anticipates
that,  because of the diverse needs of the market for peripheral stents and some
of the other  markets  for which the  Company is  developing  products,  it will
develop separate clinical support and sales forces to take advantage of clinical
and technical expertise specific to those markets.

         The Company has entered into agreements with certain hospital groups in
the United  States  qualifying  the  Company as a qualified  supplier  for those
groups. The Company anticipates that its various sales forces,  particularly its
U.S.  sales  force,  will need to actively  pursue  additional  approvals of the
Company as a  qualified  supplier  for  similar  affiliated  groups,  as well as
independent  hospital group  purchasing  organizations,  each of which negotiate
contracts  with  suppliers of medical  products.  Qualification  with such group
purchasing organizations, which exist on both a national and regional level, has
become  increasingly  important in recent years in response to cost  containment
pressures and health care reform, and there can be no assurance that the Company
will continue to be successful in obtaining such qualifications.

Manufacturing

   
         The Company  performs most of the steps for  fabrication  of its stents
internally,   including  machining,   forming,  connecting  through  proprietary
attachment processes and  electropolishing  high quality medical grade stainless
steel. To support this capability,  the Company has designed  manufacturing  and
testing  equipment that has enabled the development and execution of proprietary
processes not  currently  available  from outside  suppliers.  For example,  the
Company has its own balloon and catheter extrusion  equipment,  which allows for
rapid  prototyping  and  adherence to strict design  specifications  and quality
standards in manufacturing.

         In addition to the technological  advantages of its stent designs,  the
Company believes that its vertically  integrated  manufacturing and research and
development operations provide a competitive advantage in quickly developing and
bringing to market  sophisticated stent and catheter products.  This integration
allowed  the  Company to develop  and bring to market  several  new  products in
fiscal  1998,  including  its LTX PTCA  balloon  catheter and its GFX 2 coronary
stent system. The Company's  manufacturing  engineers participate in the product
design  process so as to insure the Company's  ability to achieve rapid and cost
effective manufacturing  capabilities for its products. The Company is committed
to  manufacturing   internally  as  many  of  its  products  and  components  as
practicable  and believes that such a process better enables it to set,  achieve
and  control  high  standards  for the  quality of its  devices,  reduce time

                                       8
<PAGE>

to market,  manage costs,  maintain  control over proprietary  information,  and
execute improvements in design and manufacturing  processes. In spring 1998, the
Company  moved  a  significant  portion  of  its  United  States   manufacturing
operations  to a new  130,000  square  foot  facility  that  is now  part of its
headquarters in Santa Rosa, California.
    

         The design,  manufacture and assembly of certain proprietary components
and materials  used in the Company's  PTCA balloon  catheters and stent delivery
systems take place in the  Company's  facilities in Santa Rosa,  California  and
those of Arterial Vascular  Engineering Canada,  Inc. ("AVEC"),  a subsidiary of
the  Company  located in  Richmond,  British  Columbia.  Prior to the  Company's
receipt of FDA approval for certain of its  coronary  stent  systems in December
1997, all of the Company's products sold commercially were finished and packaged
in the Canadian facility, with the Company's finished medical devices then being
shipped from Canada to  distributors or direct sales  operations  outside of the
United States.  However, once such FDA approval was obtained,  the Company began
supplying the United States market directly from its manufacturing facilities in
Santa  Rosa,  and the  Canadian  facility  has since  been  used to  supply  the
Company's  international  markets.  The Company  executes all critical  assembly
operations  in  controlled  environment  rooms in which  bacterial  and airborne
particulate levels are monitored.

   
         The Company has obtained the right to affix CE  (Conformite  Europeene)
marking to all of its coronary stent systems and certain of its peripheral stent
systems  and  PTCA  balloon  catheters  sold in all  countries  of the  European
Economic Area and Switzerland. CE marking is a European symbol of conformance to
strict product  manufacturing  and quality system  standards.  As part of the CE
marking process,  the Company also received ISO 9001/EN46001  certification with
respect to the manufacturing of all of its coronary stent products. With respect
to the United States,  in autumn 1997 the FDA inspected the Company's Santa Rosa
manufacturing  facilities  and processes for  compliance  with the FDA's quality
system regulation,  at which time the Company demonstrated the compliance of its
facilities and processes with such regulation.  Additional  manufacturing  sites
(such as those that may be acquired in the World Medical Acquisition or the Bard
Cath Lab  Acquisition)  and  changes  in  manufacturing  processes  will also be
subject  to  regulatory   inspection  for  compliance  with  United  States  and
international  regulations.  There can be no assurance  that the Company will be
able to demonstrate or continue to demonstrate the compliance of its existing or
future facilities with any such regulations. See "-- Government Regulation."

         The Company relies on some outside sources for catheter  components and
from time to time the  Company has  experienced  shortages  of certain  supplied
materials that have significantly affected its ability to produce enough product
to satisfy market demand. The Company currently relies upon a single supplier of
the medical grade stainless steel from which the Company's  stents are machined.
The Company is continually  reviewing its own  capabilities and the capabilities
of other potential suppliers of medical grade stainless steel,  although to date
no such  other  suppliers  have  been  able to  produce  materials  meeting  the
Company's  quality  standards.  The Company has also agreed to indemnify certain
suppliers   against  certain   potential   product   liability   exposure.   The
establishment of additional or replacement  suppliers for certain  components or
materials cannot be accomplished quickly, largely due to the FDA approval system
and the complex nature of  manufacturing  processes  employed by many suppliers.
The  failure  to  obtain  sufficient   quantities  of  component   materials  on
commercially  reasonable  terms  could  have a  material  adverse  effect on the
Company's business, financial condition and results of operations.

         From time to time, particularly since the Company's entry into the U.S.
coronary stent market,  the Company has  encountered  difficulties in increasing
production to a level sufficient to satisfy demand, including problems involving
production  yields,  adequate  supplies  of  components,   quality  control  and
assurance and shortages of qualified  personnel.  The commencement of commercial
sales of the Company's  coronary  stent  systems in the United States  increased
production  requirements  to a level not previously  experienced by the Company,
and consequent difficulties resulted in a significant back log during the second
half of fiscal 1998. In addition,  in May 1998 the Company experienced a quality
control issue that resulted in a voluntary  recall of two  production  lots (170
units) of its GFX coronary stent systems that had been distributed in the United
States. There can be no assurance that the Company will be successful in scaling
up its  manufacturing  operations or that it will not  experience  manufacturing
difficulties or recalls or safety alerts in the future. Difficulties experienced
by the Company in manufacturing  scale-up,  including  recalls or safety alerts,
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations.
    

         The Company believes that, with the addition of its recently  completed
130,000  square  foot  facility  at its Santa  Rosa  headquarters,  its  current
manufacturing  space  will be  sufficient  to serve its needs  through  at least
mid-1999.  Additional manufacturing sites (such as those that may be acquired in
the potential  acquisitions  of World Medical or the Bard coronary  catheter lab
business)  may require  facility  work-outs or  redevelopment  in  manufacturing
processes.  There  can  be no  assurance  that  such  re-worked  or  redeveloped
manufacturing  facilities  will be  timely  completed  or will  pass  regulatory
inspection for compliance with United States and international regulations.

Competition

   
         Competition in the market for the treatment of  cardiovascular  disease
is intense and is expected to  increase.  The Company  competes  primarily  with
Boston Scientific Corporation, C.R. Bard, Inc., Cook, Inc., Guidant Corporation,
Cordis Corporation (Johnson & Johnson),  Medtronic, Inc. and Pfizer, Inc., among
others,  in the 

                                       9
<PAGE>
development,  production and marketing of stents and PTCA/stent technology.  The
Company  believes  that,  as of the fourth  quarter of fiscal  1998,  it was the
worldwide  market leader in sales of coronary  stent  systems,  although  Boston
Scientific  had at that time not yet received  FDA  approval for the  commercial
sale of its coronary stent systems in the United States.  As of the date of this
report, Boston Scientific, Cordis, Cook, Medtronic, Guidant and the Company have
the only  coronary  stent systems that have been approved by the FDA for sale in
the United  States.  The Company  believes  that its principal  competitors  are
Guidant  and Boston  Scientific.  The  Company  expects  that other  potentially
significant  competitors  will receive  marketing  clearance from the FDA in the
near future.  Many of the Company's  competitors and potential  competitors have
substantially  greater name  recognition  and financial and other resources with
which to improve and aggressively market their products.
    
         The Company believes that the primary competitive factors in the market
for stent  technology  include product safety,  quality,  ease of use,  clinical
performance (radial strength, flexibility,  radiopacity, low thrombosis risk and
long term efficacy), delivery system characteristics (flexibility,  reliability,
ease  of  use),  price,   customer  service  and  availability  of  third  party
reimbursement.  In  addition,  the length of time  required  for  products to be
developed and to receive regulatory approval is an important competitive factor.
The Company  believes  it  competes  favorably  with  respect to these  factors,
although there can be no assurance that it will be able to continue to do so.

         An additional competitive factor is the current healthcare environment.
Particularly in the United States,  this environment has  increasingly  centered
around managed care  organizations,  group  purchasing  organizations,  hospital
consolidations  and  other  factors  resulting  in  increased  cost  containment
pressures  for  medical  procedures  generally,   including  the  less  invasive
procedures  for which the Company  markets its  products.  Many of the Company's
competitors  have a greater  strategic  mass and offer broader  product lines in
minimally invasive procedures generally than does the Company,  allowing them to
market their stent systems and PTCA balloon catheters to medical  specialists as
part of a broad  package of other needed  minimally  invasive  medical  devices.
Although the acquisition of Bard's coronary catheter lab business,  when closed,
is  expected  to allow the  Company to  participate  in  competitive  situations
requiring  such  packaging  arrangements,  there  can be no  assurance  that the
Company's  competitors  will not succeed in developing more effective  marketing
programs than the Company in such an environment.

         The increasing number of devices in the international  stent market and
the desire of companies to obtain  market share has resulted in increased  price
competition,  which has caused the Company from to time to reduce  prices on its
stent  systems.  The  Company  expects  that,  as the stent  industry  develops,
competition  and pricing  pressures will increase,  and that similar  conditions
will exist in the United States as more competitors  receive marketing clearance
from  the  FDA.  Moreover,  it is  likely  that  the  FDA  will  begin  to use a
streamlined  PMA process  once a  sufficient  number of similar  coronary  stent
products have been cleared for commercial  sale in the United  States,  and will
permit  coronary  stent  manufacturers  to utilize a simplified  clinical  trial
structure in obtaining  marketing  approval here as sufficient stent performance
data enters the public domain.  Thus,  the  regulatory  barriers to entry in the
United States coronary stent market that currently exist may, in the future,  be
lowered  significantly with respect to both new market entrants and new products
introduced  by  existing  U.S.  competitors.  If the Company is forced to effect
further price  reductions in connection  with such increased  competition,  such
reductions  would reduce net sales in future  periods if not offset by increased
unit sales or other  factors.  Price  reductions  by the  Company in response to
competitive  pressure  could have a  material  adverse  affect on the  Company's
business, financial condition and results of operations.

         In addition,  the ability to use patents or other proprietary rights to
prevent sales by  competitors  is an important  competitive  tool in the medical
device  industry.  Since the commencement of sales of its coronary stent systems
in the United  States,  several of the Company's  competitors  have filed claims
against  the  Company  alleging,  among other  things,  that such stent  systems
infringe on certain patents of such competitors. See "-- Patents and Proprietary
Rights."

         The stent market is  characterized  by rapid technical  innovation.  In
many  countries in which the Company  markets its products,  neither  pre-market
approval nor clinical  studies are  required  prior to marketing a product,  and
accordingly competitive products have been and continue to be quickly introduced
in these markets.  Moreover, earlier entrants in a particular therapeutic market
often obtain and maintain  significant  market share relative to later entrants.
Although  the  use of  stents  is  increasingly  supported  by the  professional
community, there is no assurance that clinical research will continue to support
the use of stents.  The  medical  indications  that can be treated by stents can
also be treated by surgery,  minimally  invasive  bypass  procedures,  drugs, or
other medical  devices  including  stand-alone  balloon  catheters,  atherectomy
catheters  and  lasers,  many  of  which  are  widely  accepted  in the  medical
community.  Additionally,  new  surgical  procedures  and  medications  could be
developed that replace or reduce the importance of current  procedures  that use
the Company's products. There can be no assurance that the Company's competitors
and potential competitors will not succeed in developing and marketing stents or
stent systems, competing technologies,  therapeutic drugs or other products that
are more effective or more  effectively  marketed than products  marketed by the
Company or that would render the Company's  technology and products  obsolete or
noncompetitive.

                                       10
<PAGE>
Patents and Proprietary Rights

         The Company has filed U.S. and foreign patent  applications  to protect
its proprietary  position in stents and stent delivery systems. The Company also
relies on trade  secrets,  technical  know-how and  technological  innovation to
maintain  its  competitive  position.  The  Company's  policy is to protect  and
enforce its patent and other intellectual property rights by appropriate action.

   
         The  Company  holds two issued  United  States  patents,  has  received
notices of allowance on five of its United  States patent  applications  and has
numerous United States patent applications pending. It also holds two Australian
patents,  one  European  patent  and  has  numerous  additional  foreign  patent
applications  filed.  The Company's issued United States patents relate to stent
technology used in the Company's  current stent systems.  The Company also has a
license  to make  and  sell  stent  delivery  systems  and  balloon  angioplasty
catheters using technology covered by patents and patent applications of a third
party.  The application for a stent patent that resulted in one of the Company's
issued United States patents was acquired from Endothelial Support Systems, Inc.
(subsequently  known as Endovascular  Support  Systems,  Inc.) ("ESS").  In June
1996, two former  shareholders  of ESS, each of whom  currently  holds shares of
Common Stock of the Company,  filed an action against the Company seeking, among
other  things,  to  rescind  the  transfer  of such  technology  from ESS and to
transfer  such patent to ESS. No assurance can be given as to the outcome of any
such  litigation.  Loss or impairment of the right to produce  products based on
such patents could have a material  adverse  effect on the  Company's  business,
financial condition and results of operations. See "Item 3. Legal Proceedings."
    

         A number of  medical  device  and  other  companies,  universities  and
research institutions have filed patent applications or have been issued patents
relating  to  catheters,   stents  and  delivery  systems  and  there  has  been
substantial  litigation in this area.  The Company's  success will depend on its
products  not  infringing  patents  issued  to  competitors.   Portions  of  the
technology  used in the Company's  current  stent  systems are  currently  being
challenged by each of Cordis Corporation (a subsidiary of Johnson & Johnson) and
Advanced  Cardiovascular  Systems, Inc. (a subsidiary of Guidant Corporation) as
being in conflict with certain United States patents held by those  competitors.
These  competitors  are  larger  and have more  substantial  resources  than the
Company,  and can be  expected  to expend  significant  resources  to attempt to
enforce  and/or  defend  the  validity  of their  patents.  See  "Item 3.  Legal
Proceedings." In the event that such litigation is resolved unfavorably from the
Company's  perspective,  the Company may be  precluded  from selling its current
stent products in the United States for the life of the applicable  patent if it
cannot obtain a license on commercially  reasonable  terms.  Modification of the
Company's  products or  development of new products to avoid  infringement,  the
success of which there can be no  assurance,  may require the Company to conduct
additional  clinical trials for such new or modified products in connection with
United  States  regulatory  approval  and to revise its filings  with the FDA or
other  regulatory  agencies.  Therefore,  if the Company is  determined  to have
infringed  a patent  held by one of its  competitors,  such  event  could have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

         The Company is  continually  reviewing  the scope of United  States and
foreign  patents  and the status of any  litigation  with  respect to patents of
interest of which it is aware.  The question of infringement and of the validity
and breadth of patent claims  involves  complex legal and factual  issues and is
highly uncertain.  There can be no assurance that any conclusion  reached by the
Company  regarding  infringement  will be consistent with the resolution of such
issue by a court. In any event,  there can be no assurance that the Company will
not be obliged to defend itself in court against  allegations of infringement of
third party patents.  Patent  litigation is very expensive and could subject the
Company to significant liabilities,  require disputed rights to be licensed from
third parties or require the Company to cease selling its products.

         No  assurance  can be given that any  patents  based on pending  patent
applications  or any future patent  applications  of the Company will be issued,
that the scope of any patent  protection  will  exclude  competitors  or provide
competitive  advantages  to the Company,  that any of the  Company's  patents or
patents  to which it has  licensed  rights  will be held  valid if  subsequently
challenged  or that others will not claim  rights in or ownership of the patents
and other proprietary rights held or licensed by the Company. Furthermore, there
can be no assurance  that others have not developed or will not develop  similar
products,  duplicate any of the Company's  products or design around any patents
issued to or  licensed by the Company or that may be issued in the future to the
Company.  Since  patent  applications  in the United  States are  maintained  in
secrecy until patent  issue,  the Company also cannot be certain that others did
not first file  applications  for  inventions  covered by the Company's  pending
patent  applications,  nor can the Company be certain  that it will not infringe
any patents that may be issued to others on such applications.

         The Company relies upon trade secret  protection for certain aspects of
its proprietary  technology.  The Company's  policy is to have each employee and
consultant  enter  into  a  confidentiality   agreement  containing   provisions
prohibiting  the  disclosure of  confidential  information to anyone outside the
Company  and  requiring  disclosure  to  the  Company  of  ideas,  developments,
discoveries  or  inventions   conceived  during   employment  or  service  as  a
consultant,  and assignment to the Company of proprietary rights to such matters
related  to  the  business  and  technology  of  the  Company.  There  can be no
assurance,  however, that these agreements will provide meaningful protection or
adequate  remedies for the Company's  trade secrets in the event of unauthorized
use or  disclosure  of such  information  or that

                                       11
<PAGE>

others  will not  independently  develop  substantially  equivalent  proprietary
information  and  techniques  or otherwise  gain access to the  Company's  trade
secrets and proprietary know-how.

Government Regulation

         International  sales of  medical  devices  are  subject  to  regulatory
requirements  in many  countries.  The regulatory  review  process  required for
commercial  sales  varies from  country to country.  In certain  countries,  the
Company  may also be subject to  regulations  governing  clinical  trials of its
products.  The Company or its distributors have received pre-market approvals in
those  countries  that  require  them and in which  the  Company  currently  has
commercial  sales.  Currently,  pre-market  approvals from particular  countries
within the European  Economic  Area (the 15 countries of the European  Union and
Norway and Iceland) and  Switzerland  are no longer  required for those products
with respect to which the Company has achieved  compliance with the requirements
of  the  Medical  Devices  Directive  (the  "MDD")  discussed  below.   However,
legislation  has been  proposed in France that would  require  manufacturers  to
declare their intent to market  certain  devices in France three months prior to
launching  such  devices,   even  though  the  manufacturer  may  have  achieved
compliance with the MDD requirements.

         The Company takes an active role in the receipt of pre-market approvals
and compliance with clinical trial  requirements in those countries that require
them,  particularly  in those  countries  where it has direct sales  operations.
However,  to some extent the Company  continues to rely on distributors in those
countries  where it continues to use  distributors.  The Company has in the past
discovered instances of regulatory  noncompliance by its distributors,  and has,
in response,  caused the  applicable  distributor  to file revised  governmental
notifications,  ceased  to sell  commercially  its  products  in the  applicable
countries or  otherwise  acted so as to halt any ongoing  noncompliance  in such
countries.  While  the  Company  is not  aware  of  any  pending  or  threatened
governmental action against it in any country in which it has done business, any
enforcement action by regulatory  authorities with respect to past or any future
regulatory  noncompliance  could have a material adverse effect on the Company's
business, financial condition and results of operations.

   
         Generally,  in  order to  continue  selling  its  products  within  the
European  Economic  Area and  Switzerland,  the  Company is  required to achieve
compliance with the requirements of the MDD and affix CE marking on its products
to attest to such  compliance.  Products  that have  already  been  delivered to
distributors will be able to continue to be sold by such  distributors  during a
subsequent  three-year  transition period. To achieve compliance,  the Company's
products must meet the  "essential  requirements"  of the MDD relating to safety
and performance and the Company must  successfully  undergo  verification of its
regulatory  compliance  ("conformity  assessment") by a qualified third party (a
"Notified  Body") selected by the Company.  The Company  currently  utilizes TUV
Product  Service  of  Munich,  Germany  as its  Notified  Body.  The nature of a
Notified Body's assessment  depends on the regulatory class of the product.  The
Company's  coronary  stent  systems are currently in Class III, the highest risk
class, and therefore subject to the most rigorous controls, while its peripheral
stent  systems are  currently  in Class IIb and are  subject to somewhat  lesser
controls.

         The  Company  has  received  ISO  9001/EN46001  certification  from its
Notified  Body with respect to the  manufacturing  of all of its coronary  stent
systems and certain of its peripheral stent systems.  This certification applies
to the  manufacturing  operations in each of the Company's Santa Rosa facilities
and  AVEC's  facility  in Canada.  The  Company  obtained  the right to affix CE
marking to all of its coronary stent systems and certain of its peripheral stent
systems  and  PTCA  balloon  catheters  sold in all  countries  of the  European
Economic Area and Switzerland.  The Company is subject to continued  supervision
by its  Notified  Body  and will be  required  to  report  any  serious  adverse
incidents to the appropriate  authorities.  The Company also will be required to
comply with additional  national  requirements  that are beyond the scope of the
MDD.  With  respect to any  products  not already  cleared  for CE marking,  the
Company  will in the future need to comply with the CE marking  requirements  or
else it will be unable to sell such  products in the European  Economic  Area or
Switzerland  unless and until compliance is achieved.  There can be no assurance
that the Company will be able to achieve or maintain  compliance required for CE
marking  on all or any of its  products  or that it will be able to  timely  and
profitably produce its products while complying with the requirements of the MDD
and other regulatory requirements. Failure to achieve such compliance could have
a material adverse effect upon the Company's  business,  financial condition and
results of operations.

         In the United States, the Company is subject to extensive regulation of
medical devices by the FDA as well as state and local authorities, including the
California  Department of Health  Services.  Generally,  unless a medical device
manufacturer  can  establish to the FDA's  satisfaction  that a newly  developed
device is "substantially  equivalent" to a legally marketed device that does not
itself require pre-market approval, the Federal Food, Drug and Cosmetic requires
that the manufacturer  submit a PMA for the device and obtain the FDA's approval
of the PMA prior to marketing  the device in the United  States.  It is expected
that all of the Company's  coronary  stent systems and certain of its peripheral
stent  systems  will be  subject to the PMA  process.  The first step in the PMA
approval  process  is  usually  the  submission  to the  FDA of the  results  of
laboratory  and  pre-clinical  studies,  which  typically  must be  conducted in
compliance with the FDA's regulations governing good laboratory practices, and a
request for permission to clinically evaluate the device in humans under an IDE.
Initiation  of  the  study   requires  the  approval  of  the  FDA  and  of  the
institutional  review 


                                       12
<PAGE>

board of the hospital or clinic  participating in the clinical trial and written
informed consent from all participating patients.  Furthermore,  FDA regulations
subject sponsors of IDEs to certain requirements  including proper monitoring of
clinical investigations,  selection of qualified  investigators,  recordkeeping,
reporting of  unanticipated  adverse  device  events and  submission of periodic
progress  reports.  In  addition,  a sponsor is  prohibited  from  promoting  or
commercializing  a device prior to PMA  approval.  The PMA must  contain,  among
other things,  the results of the clinical  trials,  the results of all relevant
bench tests,  laboratory and pre clinical studies, a complete description of the
device and its components, and a detailed description of the methods, facilities
and controls used for  manufacture,  including the method of  sterilization.  In
addition,  the  submission  must  include  the  proposed  labeling,  advertising
literature and physician training methods (if required).  In general,  data from
adequate and well-controlled  independent,  statistically  significant  clinical
trials must  demonstrate the safety and  effectiveness of the device in order to
obtain approval of the PMA.

         After  completion of the FDA's  preliminary  review,  the submission is
ordinarily  sent  to an  FDA-selected  scientific  advisory  panel  composed  of
physicians  and scientists  with expertise in the particular  field which (after
holding any public hearings it deems necessary) then issues a recommendation  to
the FDA that may include  conditions  for approval.  The FDA is not bound by the
recommendations of the advisory panel. Toward the end of the PMA review process,
the FDA will conduct an  inspection of the  manufacturer's  facilities to ensure
that the facilities are in compliance with applicable  quality system regulation
("QSR") requirements. If the FDA evaluations of both the PMA application and the
manufacturing facilities are favorable, the FDA will issue an approvable letter,
which  usually  contains  a number of  conditions  which must be met in order to
secure final approval of the PMA. When those  conditions  have been fulfilled to
the  satisfaction  of the FDA,  the  agency  will  issue a PMA  approval  order,
authorizing  commercial  marketing  of the device for certain  indications.  The
sponsor  may not promote  the device for uses not  approved by the FDA.  The FDA
also has the authority to impose  certain  post-approval  requirements  in a PMA
approval order, including post-approval  surveillance studies further evaluating
the safety, efficacy and reliability of the device. Additional post-approval FDA
requirements  include  Medical Device  Reporting  ("MDR")  requirements,  device
tracking  requirements and long-term data study requirements.  Failure to comply
with - any  post-approval  requirements  may lead to withdrawal of FDA approval.
The PMA review and approval process generally takes more than a year to complete
from the date of  acceptance by the FDA for filing,  and may take  substantially
longer.  In response to public  concerns,  the FDA has recently  made efforts to
reduce the time required to clear PMAs and PMA supplements, but review times for
products  such as the Company's  remain long and there can be no assurance  that
the  Company's PMA will receive any kind of expedited  review.  The FDA may also
determine that additional  clinical trials are necessary,  in which case the PMA
may be delayed for several years while additional  clinical trials are conducted
and  submitted  in an  amendment to the PMA.  Certain  modifications  to medical
devices require FDA clearance, either under the IDE or in a PMA supplement. Such
IDE and PMA supplements relating to product modifications require the submission
of the same type of information required for an initial application, but because
such subsequent filings need only contain sufficient  information to support the
change,  they  are  generally  more  brief.  The FDA  generally  does not use an
advisory panel review for PMA supplements.
    

         The Company has incurred, and expects to continue to incur, substantial
clinical  research  and other  costs in  connection  with  obtaining  regulatory
approvals for its stent systems in the United States and other countries.

   
         The  Company  supplies  the  United  States  market  directly  from its
manufacturing  facilities in Santa Rosa, California.  Under current law, as long
as the Company manufactures  finished devices in the United States or imports or
offers  finished  devices  for import into the United  States  (except as may be
covered by an IDE), the QSR requirements will apply and the Company expects that
the FDA will inspect the Company's  manufacturing  facilities on a regular basis
for compliance with applicable FDA regulations,  including the QSR requirements.
The QSR  requirements  mandate  that the Company  manufacture  its  products and
maintain its  documents in a  prescribed  manner with respect to  manufacturing,
testing and  control  activities.  The  Company is also  required to comply with
various FDA requirements for labeling. Furthermore, in accordance with the FDA's
MDR  requirements  the Company is required to provide  information to the FDA on
death or serious  injuries  alleged to have been  associated with the use of its
medical  devices,  as well as product  malfunctions  that would  likely cause or
contribute  to death or  serious  injury if the  malfunction  were to recur.  In
addition,  the  FDA  prohibits  an  approved  device  from  being  marketed  for
unapproved applications. If the FDA believes that a company is not in compliance
with the law, it can institute proceedings to detain or seize products,  issue a
recall,  enjoin future  violations,  assess civil and criminal penalties against
the  Company,  its  officers  and its  employees  or require the Company to make
substantial changes to its manufacturing  operations.  Any of such actions could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

         The Company is also subject to environmental  laws and regulations both
in the United States and abroad.  The  operations of the Company,  like those of
other medical device  companies,  involve the use of substances  regulated under
environmental  laws,  primarily in manufacturing  and  sterilization  processes.
There can be no assurance that a violation of such laws will not occur,  or that
any such  violations  will not have a material  adverse  effect on the Company's
business, financial condition or results of operations.
    


                                       13
<PAGE>

Third-Party Reimbursement

         Sales  volumes  and  prices  of  the  Company's  products  are  heavily
dependent on the availability of reimbursement from third party payors,  such as
government and private  insurance plans,  health  maintenance  organizations and
other sources of  reimbursement  for health care costs  ("Third-Party  Payors").
Individuals are seldom,  if ever,  willing or able to pay directly for the costs
associated  with  the  use  of  the  Company's  products.  In  foreign  markets,
reimbursement  is  obtained  from a variety of sources,  including  governmental
authorities,  private health insurance plans and labor unions. The market in the
United  States is moving  rapidly in the  direction  of managed  care,  in which
Third-Party  Payors attempt to shift  financial risk to providers of health care
through  mechanisms  that,  among other  things,  involve  fixed  payments for a
defined treatment or episode of care. In addition, Third-Party Payors attempt to
contain health care costs by influencing the clinical  decision making of health
care providers in the direction of what is deemed to be "cost  effective  care."
Some  Third-Party  Payors may also contract on an exclusive  basis with a single
provider of an ancillary  service or product to obtain the lowest possible price
and  then  induce  providers  or  insured  individuals  to deal  only  with  the
contracted source by limiting routine insurance coverage to services or supplies
obtained from that source.

         The federal Medicare program and other major Third-Party  Payors in the
United  States  generally  reimburse  most acute,  general  care  hospitals  for
inpatient  medical  treatment,  including all operating  costs and all furnished
items or services,  including devices such as the Company's,  at a prospectively
fixed  rate  based on the  diagnosis-related  group  ("DRG")  that  covers  such
treatment,  as established  by the federal Health Care Financing  Administration
("HCFA").  For  interventional  procedures,  the fixed rate of  reimbursement is
based on the procedure or procedures  performed and is unrelated to the specific
devices used in that procedure.  In addition, each interventional DRG payment is
calculated  to reflect the costs of a specific  procedure or type of  procedure.
Effective  October 1, 1997, HCFA assigned the procedure code associated with the
implantation  of a  coronary  stent to DRG 116 (a code  which  includes  cardiac
pacemaker   implants).   The  Company  believes  that  the  reimbursement   rate
established in connection with such new DRG code generally  reflects the current
costs associated with the use of the Company's coronary stent systems. There can
be no assurance,  however,  that any new  reimbursement  rates will sufficiently
reflect the current or future  costs  associated  with the use of the  Company's
stent systems.

         Third-Party  Payors  that  do  not  use  prospectively  fixed  payments
increasingly  use other  cost  containment  devices,  such as  having  exclusive
suppliers  or  approved  lists of  devices  deemed to be "cost  effective,"  and
requiring  discretionary,  prior  authorization  for  exceptions.  In  addition,
Third-Party Payors may deny reimbursement if they determine that the device used
in a  treatment  was not a  covered  device or was  unnecessary,  inappropriate,
experimental,  used for a nonapproved indication or not cost effective. In other
situations,  Third-Party Payor cost containment efforts may pose barriers to the
use of the  Company's  products  if,  for  example,  the  products  are not on a
Third-Party  Payor's  approved  list of  devices.  Accordingly,  providers  must
determine that the clinical  benefits of stents  justify the additional  cost or
the additional effort required to obtain prior authorization or coverage and the
uncertainty of actually obtaining such authorization or coverage.

         While the Company  believes  that the use of stents may  continue to be
cost  effective  for  many  medical  indications,   the  Company  believes  that
reimbursement in the future is becoming subject to increased  restrictions  such
as those described above, both in the United States and in foreign markets.  The
Company  believes  that the  overall  escalating  cost of medical  products  and
services  has led to and will  continue to lead to  increased  pressures  on the
health care industry,  both foreign and domestic, to reduce the cost of products
and  services,  including  products  offered  by the  Company.  There  can be no
assurance  as to either  United  States or  foreign  markets  that  third  party
reimbursement  and  coverage  will  be  available  and  adequate,  that  current
reimbursement  amounts  will  not be  decreased  in the  future  or that  future
legislation, regulation or reimbursement policies of Third-Party Payors will not
otherwise  adversely affect the demand for the Company's products or its ability
to sell its products on a profitable basis, particularly if the Company's stents
are more expensive  than competing  stents.  The  unavailability  of Third-Party
Payor coverage or the inadequacy of reimbursement  could have a material adverse
effect on the Company's business, financial condition and results of operations.

Recent Acquisition Agreements

   
         On April 10, 1998, the Company  entered into a definitive  agreement to
acquire  World  Medical  Manufacturing  Corporation.  Under  the  terms  of  the
agreement,  World  Medical's  outstanding  stock will be exchanged  for, and its
outstanding stock options converted into, stock and stock options of the Company
valued at approximately  $62 million,  in a transaction to be accounted for as a
purchase.  The exchange  ratio will be determined  in accordance  with a formula
based on the average price of Company  common stock during a period prior to the
closing of the acquisition,  subject to certain adjustments. The Company expects
to incur a significant  one-time charge related to the  acquisition,  largely in
connection  with the  write-off  of  in-process  research and  development.  The
acquisition  is  expected to be  completed  in autumn 1998 and is subject to the
approval of shareholders of World Medical and certain other conditions.

         On July 9, 1998, the Company  entered into a definitive  agreement with
respect to the Bard Coronary Cath Lab business. The transaction is structured as
an acquisition of the assets and certain liabilities of Bard related to, and

                                       14
<PAGE>

the   acquisition  of  stock  of  certain   subsidiaries   of  Bard  (the  "Bard
Subsidiaries")  engaged  in the  coronary  catheter  lab  business  of Bard (the
"Business"),  and  is to  be  accounted  for  as a  purchase.  Pursuant  to  the
agreement,  the Company will not acquire any cash or accounts  receivable of the
Business in  consideration of the $550 million purchase price, but will purchase
the trade accounts  receivable of the Bard  Subsidiaries  for an amount equal to
95% of the book value of such  receivables as of the closing of the  transaction
after deducting  reserves for doubtful  accounts.  The product  offerings of the
Business  include  coronary PTCA balloon  catheters  (including  perfusion rapid
exchange catheters),  guidewires, guide catheters, coronary diagnostic catheters
and guidewires;  introducers and vessel closure devices;  coronary  stents;  and
various other coronary  components and accessories.  For the year ended December
31,  1997,   Bard's  coronary   catheter  lab  business   reported  revenues  of
approximately $215 million.  The Company expects to incur a significant one-time
charge related to the  acquisition,  largely in connection with the write-off of
in-process research and development. The acquisition is expected to be completed
in the  autumn  of  1998.  When  closed,  these  acquisitions  are  expected  to
substantially increase the Company's personnel, facilities and product offerings
and to  enable  the  Company  to  participate  in new  areas  of  interventional
cardiology  through a wider  product  portfolio  and access to new  markets  and
customers.  However,  there can be no assurance that these  acquisitions will be
successfully consummated or, if consummated,  that the Company will successfully
participate  in new product  areas subject to obtaining  antitrust  clearance in
Ireland and certain other closing conditions.

         The  Company  expects to enter into a bank  credit  agreement  for $600
million in senior secured  credit  facilities in order,  among other things,  to
finance  substantially  all of the Bard Cath Lab  Acquisition.  The financing is
expected to be subject to conditions  customary for transactions of this nature.
See "Item 7.  Management's  Discussion  and Analysis of Financial  Condition and
Results of Operations -- Liquidity and Capital  Resources."  The Company's  high
degree of leverage could have important  consequences to the stockholders of the
Company, including the following: (i) the Company's ability to obtain additional
financing  for working  capital,  capital  expenditures,  acquisitions,  general
corporate  purposes or other  purposes  may be  impaired  in the future;  (ii) a
substantial portion of the Company's cash flow from operations must be dedicated
to the payment of principal and interest on its  indebtedness,  thereby reducing
the funds  available  to the Company  for other  purposes;  (iii) the  Company's
borrowings under such senior secured credit facilities will be at variable rates
of  interest,  which will expose the Company to the risk of  increased  interest
rates;  (iv) the  indebtedness  outstanding  under  the  senior  secured  credit
facilities will be secured;  (v) the Company may be substantially more leveraged
than certain of its  competitors,  which may place the Company at a  competitive
disadvantage;  and (vi) the Company's  substantial  degree of leverage may limit
its flexibility to adjust to changing market  conditions,  reduce its ability to
withstand  competitive  pressures  and make it more  vulnerable to a downturn in
general economic conditions or businesses.

         The Company may continue to choose to expand its  operations  or market
presence  through  business  combinations,   acquisitions,   investments,  joint
ventures or other strategic alliances with third parties.  The World Medical and
Bard transactions,  and any similar transactions, are and will be accompanied by
the risks commonly associated with such transactions,  such as the difficulty of
assimilating the operations, technology and personnel of the combined companies,
the potential disruption of the Company's ongoing business, the diversion of the
attention of  management,  the inability to retain key technical and  managerial
personnel,  the  inability of management to maximize the financial and strategic
position  of  the  Company  through  the  successful   integration  of  acquired
businesses,   additional  expenses  associated  with  amortization  of  acquired
intangible assets,  the maintenance of uniform standards,  controls and policies
and the impairment of relationships with existing employees and customers. There
can be no assurance  that the Company would be  successful  in overcoming  these
risks or any  other  potential  problems  encountered  in  connection  with such
business  combinations,  acquisitions,  investments,  joint  ventures  or  other
strategic alliances, or that such transactions would not have a material adverse
effect on the Company's business, financial condition and results of operations.
    

         The  Company  intends  to expand its  operations  by  promoting  new or
complementary  products  and by  expanding  the breadth and depth of its product
offerings,  through  the World  Medical  and Bard  transactions  and  otherwise.
Expansion of the Company's  operations  in this manner will require  significant
additional expense as well as substantial managerial,  financial and operational
resources.  Furthermore, gross margins attributable to new business areas may be
lower than those  associated with the Company's  existing  business  activities.
There can be no assurance that the Company will be able to expand its operations
in a cost-effective or timely manner.  Furthermore,  any new product or business
launched by the Company that is not  favorably  received by customers may damage
the Company's reputation or the AVE brand. The lack of market acceptance of such
efforts or the Company's inability to generate  satisfactory  revenues from such
expanded  product  offerings  to offset its costs could have a material  adverse
effect on the Company's business, financial condition and results of operations.

Product Liability and Insurance

         The design,  manufacture  and marketing of medical devices of the types
produced by the Company  entail an inherent risk of product  liability and other
liability claims in the event that the use of the Company's  products results in
personal injury claims.  The Company's  products are designed to be implanted in
the human body indefinitely,  and are used in life-threatening  situations where
there is a high risk of serious  injury or death.  From time to time the Company

                                       15
<PAGE>

has received  inquiries  regarding  particular  medical  procedures in which its
products  were used,  but to date the  Company has not  experienced  any product
liability  claims.  Any such claims could have a material  adverse effect on the
Company's business,  financial condition and results of operations.  The Company
maintains  liability  insurance with coverage of $20 million both per occurrence
and in the aggregate.  There can be no assurance that product liability or other
claims will not exceed such insurance  coverage  limits,  or that such insurance
will continue to be available on commercially acceptable terms or at all.

Environmental Matters

         The  Company  is  subject  to  federal,  state and local  laws,  rules,
regulations and policies governing the use,  generation,  manufacture,  storage,
air emission, effluent discharge, handling and disposal of certain hazardous and
potentially   hazardous   substances  used  in  connection  with  the  Company's
operations.  Although the Company  believes that it has complied with these laws
and  regulations  in all material  respects and to date has not been required to
take any action to correct any noncompliance, there can be no assurance that the
Company  will  not be  required  to  incur  significant  costs  to  comply  with
environmental regulations in the future.

Additional Business Risks

         The Company has recently experienced rapid growth in its facilities and
the number of its  employees,  the number of  products  under  development,  the
number and amount of products  manufactured and sold and the geographic scope of
its sales.  This situation is compounded by the expected  acquisitions  of World
Medical  and Bard's  coronary  catheter  lab  business.  While the  Company  has
commenced the  implementation of improved financial and management  systems,  is
increasing personnel and expects to increase  substantially its efforts in these
areas,  there  can be no  assurance  that such  systems  and  personnel  will be
efficiently  integrated or will be adequate for the  management of the Company's
current or future  operations,  or that the Company  will be able to manage such
growth effectively.

   
         The Company has recently  experienced an unsustainable level of growth,
and there can be no assurance that the Company's future  financial  results will
be comparable to its recent  results.  Future  operating  results will depend on
many  factors,  including the demand for the  Company's  products,  the level of
product and price  competition,  the levels of  third-party  reimbursement,  the
Company's  success in  integrating  acquisitions  and expanding its direct sales
force and distribution  channels, and whether the Company can develop and market
new products and control costs. In addition, the Company's future prospects must
be  considered  in light of the  risks,  expenses  and  difficulties  frequently
encountered in the medical device  industry,  which is  characterized by intense
competition, rapid technological change and significant regulation.
    

         Substantially  all of the Company's  revenues are derived from sales of
its coronary stent systems.  The success of these products depends,  among other
things,  on the nature of the  technological  advances inherent in the products'
design,  clinical  trial  results,  market  acceptance of the products,  and the
Company's  receipt of regulatory  approvals for the products.  The life cycle of
the Company's products is difficult to predict. To the extent that unit sales or
pricing  for any of the  Company's  products  declines  or the  Company's  newly
introduced  products are not  commercially  accepted,  in each case whether as a
result of technological change,  competition or any other factors, such declines
or lack of acceptance  could have a material  adverse  effect upon the Company's
business, financial condition and results of operations.

         The medical device industry is  characterized  by rapid and significant
technological  change. The Company's future success will depend in large part on
whether the Company can continue to respond to such changes,  and whether it can
expand the indications and applications for which its products are used, through
the timely development and successful  introduction of enhanced and new versions
of its stents systems and balloon  catheters.  Product  research and development
will require  substantial  expenditures and has inherent risks, and there can be
no assurance  that the Company will be  successful in  identifying  products for
which  demand  exists,  in  developing  products  that have the  characteristics
necessary to treat particular  applications,  or that any new product introduced
will receive regulatory approval or be commercially successful.

         The Company is dependent  upon a limited  number of key  management and
technical  personnel.  The  loss of the  services  of one or  more  of such  key
employees  could have a material  adverse effect on the Company's  business.  In
addition,  the  Company's  success  will be dependent on whether the Company can
attract and retain additional highly qualified sales, management,  manufacturing
and research and development personnel. The Company faces intense competition in
its recruiting activities and there can be no assurance that the Company will be
able to attract and/or retain qualified personnel.

   
         The Company  believes that its existing  computer  programs will not be
adversely  affected  by the "Year  2000"  problem,  and is  currently  assessing
whether any of its major  customers,  suppliers or service  providers will be so
affected. The Company believes that the computer programs to be acquired as part
of the Bard Cath Lab  Acquisition are not Year 2000 compliant and the Company is
currently  evaluating  the steps  necessary to assure that such acquired  assets
will not be adversely  affected by the Year 2000  problem.  The Company plans to
devote the necessary  resources


                                       16
<PAGE>

to resolve all significant Year 2000 issues in a timely manner. Costs associated
with the Year 2000  assessment  and  correction  of  problems  are  expensed  as
incurred. Based on management's current assessment, the Company does not believe
that  the  cost of such  actions  will be  material.  Failure  of the  Company's
computer systems or that of its customers,  suppliers or service providers could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

         The Company  anticipates  that its results of operations  may fluctuate
for the  foreseeable  future due to several  factors,  including  variations  in
operating  expenses,  the costs and the  outcome of  litigation,  the  Company's
ability to manufacture its products efficiently,  competition (including pricing
pressures),  the  timing of new  product  introductions  or  transitions  to new
products,  the costs of  establishing  direct  sales  operations,  the timing of
research  and   development   expenses   (including   clinical   trial   related
expenditures), timing of regulatory and third party reimbursement approvals, the
level of  third-party  reimbursement,  sales by  distributors,  the mix of sales
among  distributors  and the Company's  direct sales force,  the fluctuations in
international currency exchange rates, and seasonal factors impacting the number
of elective angioplasty or stent procedures.  In addition, the Company's results
of operations  could be affected by the timing of orders from its  distributors,
changes in the Company's  distributor  network (including expenses in connection
with  termination of former  distributors),  the ability of the Company's direct
sales force and independent  distributors  to effectively  promote the Company's
products,  the ability of the Company to quickly and cost-effectively  establish
an  effective  direct sales force in targeted  countries  and the ability of the
Company to successfully  integrate acquisitions and to realize expected benefits
from such  acquisitions.  The Company's limited operating history makes accurate
prediction of future  operating  results  difficult or impossible.  Although the
Company has  experienced  growth in recent years and  substantial  growth in the
most recent  quarter,  there can be no assurance  that in the future the Company
will sustain  revenue or earnings  growth on a quarterly or annual basis or that
its growth will be consistent with predictions made by securities analysts.  The
Company has  experienced,  and may  experience  in one or more future  quarters,
operating  results that are below the expectations of public market analysts and
investors.  In such event, the price of the Company's common stock has been, and
would likely be, materially and adversely affected.

         The Company's Amended and Restated Certificate of Incorporation and the
Delaware  General  Corporation  Law contain  certain  provisions,  including the
requirements of Section 203 of the Delaware  General  Corporation  Law, that may
delay or prevent an attempt by a third party to acquire  control of the Company.
In addition,  the Company's Board of Directors has adopted a stockholder  rights
plan, commonly referred to as a "poison pill," that is intended to deter hostile
or coercive attempts to acquire the Company and which was amended in May 1998 to
account for the recent  increase  in the market  price of the  Company's  common
stock. The stockholder rights plan enables stockholders to acquire shares of the
Company's  common  stock,  or the common stock of an acquiror,  at a substantial
discount to the public market price should any person or group acquire more than
15% of the Company's common stock without the approval of the Board of Directors
under certain circumstances. The Company has reserved 1,000,000 shares of Series
A Junior  Participating  Preferred  Stock for  issuance in  connection  with the
stockholder  rights  plan.  The  Company is  authorized  to issue an  additional
4,000,000 shares of preferred stock in one or more series with terms to be fixed
by the  Board of  Directors  without  a  stockholder  vote.  While  the Board of
Directors  has no  current  intentions  or plans to issue any  preferred  stock,
issuance of these shares could also be used as an anti-takeover device.
    

Employees

         At June 30, 1998,  the Company and its  subsidiaries  had 2,177 regular
and  temporary  employees  worldwide of which 181 were  involved in research and
development,  1,569 in manufacturing and manufacturing support, 167 in sales and
marketing,  180 in quality  assurance and regulatory and clinical affairs and 80
in finance and  administration.  None of the  Company's  employees  is currently
covered by a collective bargaining  agreement,  but certain employees of Bard in
Japan and  Ireland who the Company  would  acquire  upon the closing of the Bard
Cath Lab Acquisition are covered by such an agreement. The Company believes that
its relationship with its employees is good.

                                       17
<PAGE>

Executive Officers of the Company

         The  executive  officers of the Company and their ages and positions as
of June 30, 1998 are as follows:

Name                       Age              Position

Scott J. Solano            41    President, Chief Executive Officer and 
                                 Chairman of the Board of Directors
John D. Miller             41    Chief Financial Officer, Treasurer and Director
W. Kevin Bedsole           38    Vice President of International Sales
Gregory M. French          37    Vice President of Manufacturing
John A. Schiek             43    Vice President of Compliance
Creg W. Dance              44    Vice President of International Operations
Lawrence J. Fassler        38    Vice President of Legal Affairs, General 
                                 Counsel and Secretary
Mark C. Brister            36    Vice President of Research and Development
Glenn S. Foley             41    Vice President of Sales, North America
Azin Parhizgar             38    Vice President of Quality, Clinical and 
                                 Regulatory Affairs
Andrew P. Rasdal           40    Vice President of Marketing
Robert L. Harris           33    Vice President of Finance and Controller
W. Scott Wade              41    Vice President of Operations
Richard L. Klein           38    Vice President and Chief Patent Counsel

         Scott J. Solano has served as President,  Chief Executive Officer and a
Director of the Company since August 1997,  after serving as the Company's Chief
Operating  Officer since February 1997, and became the Chairman of the Company's
Board of Directors in January  1998.  Prior to joining the Company,  Mr.  Solano
served as Vice  President  of Research  and  Development  at the Ohmeda  medical
device division of The BOC Group from February 1995 to February 1997. Mr. Solano
also served as Vice President of New Product  Development  and Operations at the
interventional   vascular   division  of  Medtronic,   Inc.,  a  medical  device
manufacturer,  from  September  1994 to  February  1995,  and as Director of New
Product  Development there from March 1991 to September 1994. Mr. Solano holds a
B.S.  degree from the State  University of New York at Albany and a M.S.  degree
from Rensselaer Polytechnic Institute.

         John D.  Miller is a founder  of the  Company  and has  served as Chief
Financial Officer,  Treasurer and a Director since the Company's inception.  Mr.
Miller also served as Vice President of Finance from January 1996 to March 1998,
as Secretary  from May 1995 to December 1996 and as Director of Finance from the
Company's  inception to January  1996.  Mr.  Miller  performed his duties to the
Company as a consultant from the Company's inception until January 1995, when he
began devoting his full working time to the Company. Mr. Miller was a partner in
a New York accounting firm until 1990, when he went into private  practice.  Mr.
Miller holds a B.B.A. from Hofstra University.

         W. Kevin Bedsole has served as Vice  President of  International  Sales
and  Marketing  since  March 1998 and  previously  served as Vice  President  of
Worldwide  Sales and  Marketing  from January 1996 to March 1998 and Director of
Worldwide Sales and Marketing from March 1993 to January 1996.  Prior to joining
the Company,  Mr. Bedsole spent seven years in interventional  cardiology device
sales with Cordis Corporation, a medical device manufacturer.  Mr. Bedsole holds
a B.S. degree from Florida State University.

         Gregory M. French has served as Vice President of  Manufacturing  since
January 1996 and  previously  served as Director of  Manufacturing  from October
1992 to January  1996.  From January 1989 to October 1992,  Mr.  French  managed
Northern  California  manufacturing  operations for Peripheral  Systems Group, a
medical device  manufacturing  division of Eli Lilly  ("PSG"),  and also managed
PSG's  Advanced  Development  Group.  Mr.  French has also served with  Advanced
Cardiovascular  Systems,  Inc.,  a  medical  device  manufacturer  that is now a
subsidiary of Guidant Corporation  ("ACS").  Mr. French holds a B.S. degree from
California Polytechnic State University, San Luis Obispo.

   
         John A.  Schiek  has  served as Vice  President  of  Compliance  of the
Company since March 1998,  and  previously  served as Vice President of Quality,
Regulatory and Clinical  Affairs of the Company from January 1996 to March 1998.
Mr. Schiek also served as Director of Regulatory  Affairs and Quality  Assurance
of the Company from  February 1993 to January  1996.  Mr. Schiek had  previously
served as the Quality and  Reliability  Engineering  Department head of PSG from
January  1989 to  February  1993  and  from  1992 to 1993  was a  member  of the
executive  staff in charge of Quality  Assurance and Regulatory  Affairs at PSG.
Mr. Schiek has also worked for ACS as a Quality  Engineering  Specialist and has
worked in the fields of  quality  assurance,  product  development  and  program
evaluation  since 1979.  Mr. Schiek holds a B.A.  degree from the  University of
Wisconsin -- Milwaukee and an M.S. degree from San Jose State University.
    

         Creg W. Dance has served as Vice President of International  Operations
since December 1996 and previously served as Director of Canadian  Operations at
AVEC since joining the Company in January 1995.  From 1989 to January 1995,  Mr.
Dance was Director of Research  and  Development  and Clinical  Research at Lake
Region  Manufacturing  Co., Inc., a medical device  manufacturer.  Mr. Dance has
also served as Manager of Research and

                                       18
<PAGE>

Development  and  Manufacturing  -- Catheter  Division with  Medtronic,  Inc., a
medical device  manufacturer,  and as Manufacturing  Engineering Manager of ACS.
Mr. Dance holds a B.S. degree from Southern Illinois University.

         Lawrence J.  Fassler  has served as Vice  President  of Legal  Affairs,
General Counsel and Secretary since March 1998 and previously  served as General
Counsel since October 1996 and Secretary  since December 1996.  Prior to joining
the Company,  Mr.  Fassler  served as an attorney  with Cooley  Godward LLP from
August 1995 to October 1996 and with Shearman & Sterling from March 1991 to June
1995.  Mr.  Fassler  holds a B.S.  degree from the  University  of California at
Berkeley and a J.D./M.B.A. degree from Columbia University.

   
         Mark  C.  Brister  has  served  as  Vice   President  of  Research  and
Development of the Company since January 1998 and previously  served as a Senior
Manufacturing  Engineer since November 1993.  Prior to joining the Company,  Mr.
Brister served as an engineer with PSG. Mr. Brister studied at the University of
California at Riverside.
    

         Glenn S. Foley has served as Vice President of Sales,  North America of
the Company since March 1998 and previously  served as Director of Sales,  North
America of the Company since  February 1997.  Prior to joining the Company,  Mr.
Foley served as Price  Strategist  of Managed Care and National  Accounts at the
Vascular  Intervention  division  of  Guidant  Corporation,   a  medical  device
manufacturer, from November 1996 to February 1997. Prior to that time, Mr. Foley
served as a sales representative at ACS from January 1992 to November 1996. From
March 1989 to January  1992,  Mr. Foley served as the Western Area Sales Manager
at Baxter Healthcare Corp. and held various other positions at Baxter Healthcare
Corp.  from 1982 through  March 1989.  Mr.  Foley holds a B.A.  degree from East
Stroudsburg University.

         Azin  Parhizgar  has served as Vice  President  of  Clinical  Research,
Regulatory  Affairs and Quality  Assurance  of the Company  since March 1998 and
previously served as Director of Clinical  Research and Regulatory  Affairs from
November 1996 to March 1998. Prior to joining the Company,  Ms. Parhizgar served
as  the  Director  of  Corporate  Regulatory  and  Clinical  Affairs  at  Summit
Technology,  Inc., a medical device  manufacturer,  from August 1995 to November
1996. Ms. Parhizgar also served as the Regulatory Affairs Program Manager in the
Vascular Systems division of C.R. Bard, Inc. from February 1994 to July 1995 and
as a senior  regulatory  affairs  specialist at Johnson & Johnson  Professional,
Inc. from December 1992 to January 1994. Ms.  Parhizgar holds a B.S. degree from
Boston College and Sc.M. and Ph.D. degrees from Brown University.

         Andrew P.  Rasdal  has served as Vice  President  of  Marketing  of the
Company since March 1998 and  previously  served as Director of Marketing of the
Company since February 1997. Prior to joining the Company, Mr. Rasdal held sales
and marketing  positions for EP  Technologies,  a division of Boston  Scientific
Corporation,  from March 1993 to February 1997.  From May 1992 through  February
1993, Mr. Rasdal served as a sales  representative for SCIMED Lifesystems,  Inc.
Mr. Rasdal also served as a sales  representative and as a business analyst with
ACS from June 1990 to May 1992.  Mr.  Rasdal  holds a B.S.  degree from San Jose
State University and an M.M. degree from the Kellogg Graduate School of Business
at Northwestern University.

         Robert L. Harris has served as Vice President of Finance and Controller
of the Company  since March 1998 and as  Controller  from November 1995 to March
1998.  Prior to  joining  the  Company,  Mr.  Harris  spent  six years in public
accounting with Coopers & Lybrand.

   
         W. Scott Wade has served as Vice President of Operations of the Company
since May 1998 and  previously  served as Director of  Operations of the Company
since January 1998. Prior to joining the Company, Mr. Wade served as Director of
Operations at the Ohmeda Medical Device  Division of the BOC Group from February
1994 to  December  1997.  From July 1992 to January  1994,  Mr. Wade served as a
Texas Instruments' Loaned Executive to the Agile Manufacturing  Enterprise Forum
at Lehigh  University,  and  prior to that was an  Operations  Manager  at Texas
Instruments' Defense Systems and Electronics Group. Mr. Wade holds a B.S. degree
from Virginia Polytechnic and State University.

         Richard L. Klein has served as Vice  President and Chief Patent Counsel
of the  Company  since June 1998 and Patent  Counsel of the  Company  since June
1996. Prior to joining the Company, Mr. Klein served as an attorney with the law
firm of Fischbach,  Perlstein,  Lieberman & Yanny from May 1994 to May 1996. Mr.
Klein also served as Assistant  Patent  Counsel at the  California  Institute of
Technology and Jet Propulsion  Laboratory  from January 1989 through April 1994.
Prior to that,  Mr. Klein served as an examiner  with the United  States  Patent
Trademark Office from June 1982 to September 1988. Mr. Klein holds a B.S. degree
from  the  State  University  of New  York at  Buffalo  and a J.D.  degree  from
Southwestern University School of Law.
    

ITEM 2.  PROPERTIES

   
         The Company owns two buildings aggregating 195,000 square feet in Santa
Rosa,  California that serve as the Company's  corporate  headquarters and house
most of its  administrative  offices,  research  laboratories and  manufacturing
facilities.  The Company also leases or subleases  approximately  59,000  square
feet in Santa Rosa,  California,  or nearby  communities  which house additional
administrative offices and manufacturing and warehouse 


                                       19
<PAGE>

facilities,  as well as a sales  office in  Atlanta,  Georgia.  Such  leases and
subleases expire at various times from February 1999 to July 2002. The Company's
wholly  owned  subsidiary,  AVEC,  leases  approximately  45,000  square feet in
Richmond,  British Columbia,  which house AVEC's offices and assembly  facility.
The lease for such facility expires in August 2001. The Company's  international
subsidiaries  maintain  international  sales  offices  in France,  Germany,  the
Netherlands  (to  service the Benelux  countries),  Switzerland,  and the United
Kingdom. The Company's European  subsidiaries  collectively lease administrative
offices and warehouse space of approximately 6,500 square feet under leases that
expire  at  various  times  between  September  1997 and May 2006.  The  Company
believes that its facilities are adequate to meet its space requirements through
at least mid-1999. As part of the Bard Cath Lab Acquisition, the Company expects
to obtain an aggregate of over 275,000  additional  square feet of manufacturing
and administrative office space in Billerica, Massachusetts and Galway, Ireland,
as well as significant office and warehouse space in Japan.
    

ITEM 3.  LEGAL PROCEEDINGS

         The statements  contained in this Form 10-K that are not historical are
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,  including
statements  regarding  the  Company's  expectations,   beliefs,   intentions  or
strategies regarding the future.  Forward-looking statements and risk factors in
this Item 3 include,  without limitation,  statements  regarding the anticipated
outcome of litigation. All forward-looking statements in this document are based
on information  available to the Company as of the date hereof,  and the Company
assumes  no  obligation  to update  any such  forward-looking  statement.  It is
important to note that the Company's actual results could differ materially from
those in such forward-looking statements.  Additional forward-looking statements
and risk factors  include  those  discussed in the  sections  entitled  "Item 1.
Business,"  "Item 5.  Market for the  Registrant's  Common  Equity  and  Related
Stockholders,"  "Item 7.  Management's  Discussion  and  Analysis  of  Financial
Condition and Results of  Operations,"  and "Item 8.  Financial  Statements  and
Supplementary Data," as well as those that may be set forth in the reports filed
by the Company from time to time on Forms 10-Q and 8-K.

         ESS  Litigation.  Effective as of October  1992,  a  subsidiary  of the
Company purchased  substantially all the assets of Endothelial  Support Systems,
Inc.  (subsequently  known as  Endovascular  Support  Systems,  Inc.) ("ESS") in
consideration  of certain royalty  payments  payable by the Company based on the
net sales of  products  using or  adapted  from such  assets.  The  Company  was
informed that the  shareholders of ESS ratified the transaction on May 27, 1993.
The purchased  assets  included an application for a stent patent which resulted
in a patent owned by the Company.  Following such asset  purchase,  the Company,
between June 1993 and March 1995,  purchased in several transactions 100% of the
shares of capital stock of ESS from its  shareholders in consideration of shares
of common stock of the Company and, in certain instances,  other  consideration,
and ESS was merged into the Company.

         On or about May 28, 1996,  Dr. Azam Anwar and Benito  Hidalgo,  each of
whom is a former  shareholder  of ESS (who  together held  approximately  48% of
ESS's  outstanding  shares of common  stock)  and each of whom  currently  holds
shares of common stock of the Company,  filed a lawsuit in the District Court of
Dallas County,  Texas. The suit names as defendants the Company, John D. Miller,
a  director,  officer  and  principal  stockholder  of the  Company,  Bradly  A.
Jendersee,  a principal  stockholder  and a former  director  and officer of the
Company,  Dr.  Simon H.  Stertzer,  a  stockholder  and former  director  of the
Company,  and Dr. Gerald Dorros,  a stockholder  of the Company.  The plaintiffs
allege  multiple  claims for relief,  including  (but not limited to) common law
fraud,  negligent  misrepresentation,  securities  fraud  pursuant  to the Texas
Securities  Act,  fraud  pursuant to the Texas  Business  and  Commercial  Code,
control  person  liability,  aider  and  abetter  liability  of  the  individual
defendants,  civil conspiracy,  breach of fiduciary duty, and constructive fraud
in  connection  with  the  Company's   acquisition  of  ESS  and  the  Company's
acquisition of shares of ESS capital stock from the  plaintiffs.  The plaintiffs
seek $395 million in damages, rescission of the Company's acquisition of the ESS
assets and its subsequent  acquisition of the ESS stock,  reconstitution of ESS,
punitive damages, interest and attorneys' fees and other relief.

   
         The defendants, including the Company, have filed counterclaims against
the  plaintiffs.  The  defendants  allege claims  against Mr. Hidalgo for, among
other things,  specific performance,  breach of contract,  breach of the implied
covenant  of good  faith  and fair  dealing,  and  declaratory  relief  based on
comparative indemnity,  contribution and absence of fraud. The defendants allege
claims  against  Dr.  Anwar for  intentional  and  negligent  interference  with
contract,  breach of contract,  defamation  and business  disparagement,  fraud,
equitable  estoppel  and  declaratory  relief  based on  comparative  indemnity,
contribution,  and absence of fraud.  The  defendants  also added Mrs. Anwar and
Mrs.  Hidalgo as involuntary  plaintiffs,  seeking a declaration of Mrs. Anwar's
ownership  interest in Dr.  Anwar's  shares and Mrs.  Hidalgo's  interest in Mr.
Hidalgo's shares. A trial date has been set for October 19, 1998.
    

         The Company believes it has meritorious  defenses to the claims alleged
by the plaintiffs, and that it has meritorious claims against the plaintiffs, in
the action.  However, no assurance can be given as to the outcome of the action.
The  inability  of the Company to prevail in the action,  including  the loss or
impairment  of the  right to  produce  products  based on the  Company's  issued
patents,  could  have a  material  adverse  effect  on the  Company's  business,
financial condition and results of operations.

                                       20
<PAGE>

         The Company has agreed to indemnify  each of the  individuals  named as
defendants in the lawsuits against the Company relating to the ESS transaction.

         U.S. Patent  Litigation.  Two of the Company's  competitors  have filed
claims against the Company with respect to their alleged  intellectual  property
rights.  The  Company  has  filed  for  declaratory  and  injunctive  relief  in
connection with one of the  competitors'  claims and for damages and declaratory
and injunctive relief in connection with the other competitor's claim.

   
         On October 21, 1997, the Company received notice that it had been named
as an additional defendant,  along with Boston Scientific Corporation and SCIMED
Life  Systems,  Inc.,  in a  lawsuit  originally  filed  by  Cordis  Corporation
("Cordis") against Guidant Corporation and Advanced Cardiovascular Systems, Inc.
in federal district court in Delaware.  Cordis alleges, among other things, that
the sale by the  Company of its stents in the United  States  would  infringe on
certain  patents  licensed  by  Cordis.  The  complaint  seeks  declaratory  and
injunctive  relief,  unspecified  damages,  attorneys' fees and other relief. On
November 6, 1997, the Company filed a motion to dismiss  Cordis'  complaint.  On
December 29, 1997, Cordis filed a motion for preliminary  injunctive relief, but
on July 20, 1998, Cordis withdrew such motion.
    

         On December  24,  1997,  the  Company  received  notice  that  Advanced
Cardiovascular  Systems, Inc. ("ACS"), a subsidiary of Guidant Corporation,  had
filed a lawsuit  against  the  Company  in federal  district  court in San Jose,
California.  ACS alleges, among other things, that the Company is selling in the
United States stents that infringe on certain patents of ACS. On April 10, 1998,
ACS filed a second lawsuit against the Company alleging infringement of a patent
that was granted  subsequent to the filing of the initial  lawsuit.  This second
lawsuit,  also filed in federal district court in San Jose,  involves a division
application  that is within the family of  patents  that are the  subject of the
initial lawsuit.  Each of the complaints seeks  injunctive  relief,  unspecified
damages, attorneys' fees and other relief. On June 1, 1998, the federal district
court in San Jose granted the Company's  motion to transfer each of the lawsuits
to the federal district court in Delaware.

         On December 26, 1997,  the Company  filed an action  against  Johnson &
Johnson,  Cordis and Expandable Grafts  Partnership in federal district court in
Delaware.  The action seeks (i) a declaration  that certain patents are invalid,
void,  unenforceable and not infringed by the Company's  activities with respect
to its stent systems in the United States,  (ii) an injunction  prohibiting  the
defendants  from asserting  infringement of such patents against the Company and
(iii) a declaration that the defendants have violated certain antitrust laws.

         On  February  18,  1998,  the  Company  filed a lawsuit  against ACS in
federal district court in Delaware,  alleging infringement of two patents of the
Company,   breach  of  contract,   misappropriation  of  trade  secrets,  unfair
competition, and conversion. The complaint seeks unspecified damages, attorney's
fees and other relief,  as well as a declaration that certain patents of ACS are
invalid, void and unenforceable.

         On April 24, 1998,  Johnson & Johnson and Expandable Grafts Partnership
filed an action  against  the  Company in the  Federal  Court of  Canada,  Trial
Division  in Toronto.  The claim  alleges  that the  Company is selling  certain
stents in Canada that infringe a Canadian  patent of the  plaintiffs.  The claim
seeks declaratory and injunctive relief,  unspecified  damages,  attorney's fees
and other relief.

   
         On June 15, 1998,  C.R.  Bard,  Inc.  ("Bard")  filed a writ of summons
against the Company in the District  Court of The Hague,  the  Netherlands.  The
writ  alleges  that the  Company  is  selling in the  Netherlands  certain  PTCA
catheters  that infringe a European  patent of Bard.  The writ seeks  injunctive
relief, civil fines,  unspecified damages and costs. The patent in question will
be transferred to the Company if the Bard Cath Lab Acquisition is consummated.
    

         On  August  13,  1998,  the  Company  filed a  lawsuit  against  Boston
Scientific  Corporation and its subsidiary SCIMED Life Systems,  Inc. in federal
district court in Delaware, alleging infringement of two patents of the Company.
The complaint seeks injunctive relief, unspecified damages,  attorneys' fees and
other relief.

         The Company  believes  that it has  meritorious  defenses to the claims
alleged by the plaintiffs, and meritorious claims against the defendants, in the
aforementioned actions.  However, no assurance can be given as to the outcome of
the actions.  The inability of the Company to prevail in the actions,  including
the loss or  impairment of the right to produce  products in the United  States,
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations. In the patent suits that have been and from
time to time will be filed by the Company against its competitors, counterclaims
by the  defendants  with  respect  to the  validity  and  enforceability  of the
Company's patents are likely and, if successful, such counterclaims could have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

         Claims of Terminated  Distributors.  In  connection  with the Company's
termination of certain distributor  relationships,  several of such distributors
have filed claims against the Company with respect to such terminations.

         In November 1996, in connection  with the Company's  termination of its
distribution  relationship with  Alfatec-Medicor  N.V.  ("Alfatec-Medicor")  and
Medicor  Nederland B.V.  ("Medicor  Nederland") in Belgium and The  Netherlands,
respectively,  effective  September 30, 1996, the Company  received  notice of a
lawsuit filed by  Alfatec-

                                       21
<PAGE>

Medicor in the Second  Chamber of the  Commercial  Court of  Brussels,  Belgium,
alleging insufficient notice of termination of a distribution  agreement between
the parties,  promotion  costs,  personnel  restructuring  claims and additional
compensation. Alfatec-Medicor seeks compensation of BF189,389,135 (approximately
$5.2 million using current exchange rates), of which BF30,000,000 (approximately
$825,000) is sought as a provisional  payment.  A pleadings hearing is scheduled
for October 5, 1998.

         In  connection  with  the  Company's  termination  of its  distribution
relationship  in France with Medi  Service,  S.A.R.L./Fournitures  Hospitalieres
S.A.  effective  September  30,  1996,  the  Company  received  notice from such
distributor  that it had filed an action before the Tribunal de Grande  Instance
of Mulhouse in France seeking  compensation  for breach of an alleged  exclusive
distribution  agreement for an  indeterminate  period  between the parties.  The
action  included  a claim  for  compensation  equal to the  total  value of such
distributor's   business,   which  the  distributor   valued  at   FF400,000,000
(approximately   $67  million  using  current  exchange   rates).   The  Company
counterclaimed for unpaid accounts  receivable of approximately $1.8 million and
for damages for abusive legal  proceedings.  On September 23, 1996, the Tribunal
rejected the distributor's  claims for damages for unlawful  termination as well
as the  Company's  counterclaim  for abusive legal  proceedings.  On February 2,
1998, the Tribunal ordered the distributor to pay the accounts receivable sought
by the Company and also  ordered the  Company to  repurchase  the  distributor's
remaining inventory,  tentatively valued at $921,500.  On February 10, 1997, the
distributor  filed an appeal of the  Tribunal's  decision of September  23, 1996
with the Court of Appeals of Colmar,  and the parties have  exchanged  briefs in
the appellate proceeding.  A final procedural hearing is scheduled for September
18, 1998.

         The Company has consulted  with local counsel in Belgium and France and
believes  that the  termination  of each of the  distributor  relationships  was
lawful.  The Company  understands that under the laws of Belgium,  under certain
circumstances,   certain   indemnities  may  be  claimed  by  distributors   for
insufficient  notice of termination and/or goodwill  compensation.  No assurance
can be given as to the outcome of any pending or threatened litigation.

         From time to time,  the Company is involved in other legal  proceedings
arising in the  ordinary  course of its  business.  As of the date  hereof,  the
Company is not a party to any other legal  proceedings  with respect to which an
adverse outcome would, in management's  opinion,  have a material adverse effect
on the Company's business, financial condition or results of operations.

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

         Not applicable.


                                       22
<PAGE>

                                     PART II

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

         The statements  contained in this Form 10-K that are not historical are
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,  including
statements  regarding  the  Company's  expectations,   beliefs,   intentions  or
strategies regarding the future.  Forward-looking statements and risk factors in
this Item 5 include,  without limitation,  statements regarding factors that may
affect the market  price of the  Company's  common  stock.  All  forward-looking
statements in this document are based on information available to the Company as
of the date hereof,  and the Company  assumes no  obligation  to update any such
forward-looking  statement.  It is important to note that the  Company's  actual
results could differ materially from those in such  forward-looking  statements.
Additional  forward-looking  statements and risk factors include those discussed
in the sections entitled "Item 1. Business," "Item 3. Legal  Proceedings," "Item
7.  Management's  Discussion and Analysis of Financial  Condition and Results of
Operations," and "Item 8. Financial  Statements and Supplementary Data," as well
as those that may be set forth in the reports  filed by the Company from time to
time on Forms 10-Q and 8-K.

Market Information

   
         The Company's common stock trades on the Nasdaq National Market tier of
The Nasdaq Stock Market  ("Nasdaq") under the symbol "AVEI." The following table
sets forth the high and low closing sales prices for the Company's  common stock
since public  trading  commenced on April 3, 1996, as furnished by Nasdaq and as
adjusted for the Company's  two-for-one  stock split,  effected in the form of a
100% stock  dividend,  that occurred in the third quarter of fiscal 1998.  These
prices reflect  prices between  dealers,  without retail  markups,  markdowns or
commissions, and may not represent actual transactions.
    

                                                    High            Low
Year ended June 30, 1998
   
         Fourth Quarter                            $39.500        $28.250
         Third Quarter                             $44.063        $25.625
         Second Quarter                            $32.500        $22.938
         First Quarter                             $28.313        $15.375
    

Year ended June 30, 1997
   
         Fourth Quarter                            $16.125       $  6.125
         Third Quarter                             $ 9.625       $  5.750
         Second Quarter                            $14.563       $  4.500
         First Quarter                             $18.125       $  9.125
    

Year ended June 30, 1996
   
         Fourth Quarter (beginning April 3)        $24.750        $14.750

         As of July 31,  1998,  there were  approximately  289  stockholders  of
record  (which number does not include the number of  stockholders  whose shares
are held of record by a brokerage house or clearing agency but does include such
brokerage house or clearing agency as one record holder).  The Company  believes
it has in excess of 25,000 beneficial holders of the Company's Common Stock. The
Company's  stock price has been and may  continue  to be subject to  significant
volatility,  particularly  on a quarterly  basis.  Any  shortfall  in revenue or
earnings from levels expected by securities analysts could have an immediate and
significant adverse effect on the trading price of the Company's Common Stock in
any given period.  Additionally,  the Company  participates  in a highly dynamic
industry,  which has and may continue to result in significant volatility of the
price of the Company's common stock.  Announcements of technological innovations
or new products by the Company or its competitors  (including future competitors
with  alternative  technologies),  release of reports  by  securities  analysts,
developments or disputes  concerning patents or proprietary  rights,  regulatory
developments,  changes in regulatory or medical reimbursement policies, economic
and other external  factors,  as well as  period-to-period  fluctuations  in the
Company's  financial results,  may have a significant impact on the market price
of the Common Stock. In addition,  the securities markets have from time to time
experienced  significant price and volume fluctuations that are unrelated to the
operating performance of particular companies or industries.
    

                                       23
<PAGE>

Dividend Policy
<TABLE>

   
         The Company has not  historically  paid cash  dividends  and  currently
intends  to  retain  any  future  earnings  for  use in  its  business  for  the
foreseeable  future. The bank credit agreement to be entered into by the Company
in  connection  with the  Bard  Cath  Lab  Acquisition  is  expected  to  impose
restrictions on the ability of the Company to pay cash dividends.
    

<CAPTION>
ITEM 6.  SELECTED FINANCIAL DATA
                                                                               Fiscal Year Ended June 30,
                                                                  -----------------------------------------------------
                                                                   1998        1997       1996        1995       1994
                                                                   ----        ----       ----        ----       ----
                                                                         (in thousands, except per share data)
<S>                                                               <C>         <C>        <C>        <C>         <C>   
Consolidated Statements of Operations Data:
Net sales                                                         $387,645    $79,420    $55,228    $17,141     $2,897
Cost of sales                                                       72,690     16,217     10,565      4,515      1,631
                                                                  --------    -------    -------    -------     ------
Gross profit                                                       314,955     63,203     44,663     12,626      1,266
Operating expenses:
         Research and development                                   37,208     11,422      6,480        987        594
         Selling, general and administrative                        96,964     22,510      8,437      1,807        870
         Settlement costs                                              --          --         --        425        358
                                                                  --------    -------    -------    -------     ------
Operating income (loss)                                            180,783     29,271     29,746      9,407       (556)
Interest and other income                                            5,463      4,190      1,460        237         21
                                                                  --------    -------    -------    -------     ------
Income (loss) before provision for income taxes                    186,246     33,461     31,206      9,644       (535)
Provision for income taxes                                          71,126     11,711     10,766      3,004          3
                                                                  --------    -------    -------    -------     ------
Net income (loss)                                                 $115,120    $21,750    $20,440    $ 6,640     $ (538)
                                                                  ========    =======    =======    =======     ======
   
Net income (loss) per share - basic                               $   1.86    $  0.37    $  0.44    $  0.18     $(0.02)
    
Net income (loss) per share - diluted                             $   1.76    $  0.34    $  0.36    $  0.13     $(0.02)
   
Shares used in per share calculation - basic                        61,989     58,447     46,926     36,081     35,317
Shares used in per share calculation - diluted                      65,228     63,289     56,617     49,300     35,317
    

                                                                                        June 30,
                                                                 ------------------------------------------------------
                                                                    1998       1997       1996       1995       1994
                                                                    ----       ----       ----       ----       ----
                                                                                      (in thousands)
Consolidated Balance Sheet Data:
   
Cash and cash equivalents                                         $ 48,282   $ 25,036   $ 59,238    $ 2,533    $ 1,882
Working capital                                                    204,510    114,486    106,925      4,413        415
Total assets                                                       387,469    147,979    122,157     13,089      3,086
Retained earnings (accumulated deficit)                            162,022     46,902     25,152      4,712     (1,928)
Total stockholders' equity                                         276,978    138,200    116,571      8,129      1,004
    
</TABLE>

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

         The statements  contained in this Form 10-K that are not historical are
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,  including
statements  regarding  the  Company's  expectations,   beliefs,   intentions  or
strategies regarding the future.  Forward-looking statements and risk factors in
this Item 7 include,  without  limitation,  statements  regarding the extent and
timing  of  new  product  introductions,   competition,   regulatory  approvals,
expenditures and margin levels,  and the establishment of direct sales forces in
targeted countries. All forward-looking statements in this document are based on
information  available  to the  Company as of the date  hereof,  and the Company
assumes  no  obligation  to update  any such  forward-looking  statement.  It is
important to note that the Company's actual results could differ materially from
those in such forward-looking statements.  Additional forward-looking statements
risk  factors  include  those  discussed  in  the  sections  entitled  "Item  1.
Business,"  "Item 3. Legal  Proceedings,"  "Item 5. Market for the  Registrant's
Common Equity and Related  Stockholders," and "Item 8. Financial  Statements and
Supplementary  Data" as well as those that may be set forth in the reports filed
by the Company from time to time on Forms 10-Q and 8-K.

                                       24
<PAGE>

Overview

         The Company is engaged in the design,  development,  manufacturing  and
marketing of stent systems and PTCA balloon catheters designed to be utilized in
connection with less invasive treatment of atherosclerosis. The Company believes
that it is currently one of the leading providers of coronary stent systems. The
Company  began  commercial  sales of its PTCA  catheters  in October  1993,  its
coronary  stent systems in October  1994,  and its  peripheral  stent systems in
December  1996.  In June  1997,  the  Company's  Japanese  distributor  received
regulatory  approval  for the  sale in  Japan of the  Company's  coronary  stent
systems,  and in January  1998 the Company  received  the related  reimbursement
approval.  In  December  1997,  the  Company  received  a PMA  from  the  FDA in
connection  with its  commencement  of  commercial  sales of its coronary  stent
systems in the United States. Prior to that time,  international sales accounted
for substantially all of the Company's revenues.

         The increase in the Company's  sales to date has primarily  been due to
greater demand for the Company's  coronary  stent  systems.  In order to support
increased levels of sales in the future and to augment its long-term competitive
position,  the Company  anticipates  that it will be required to make continuing
significant additional  expenditures in manufacturing,  research and development
(including  clinical  study and  regulatory  costs),  sales and  marketing,  and
administration,  both in absolute  dollars and as a percentage of net sales. The
Company also expects to incur  significant  legal  expenses  relating to ongoing
litigation, including patent litigation.

         Generally, the Company manufactures and ships product shortly after the
receipt of orders,  and anticipates that it will do so in the future.  From time
to time,  however,  the Company develops  short-term backlogs in connection with
the scale-up of manufacturing  of its stent products.  There can be no assurance
that the Company will be  successful in scaling up production of new or modified
products or that it will not experience  manufacturing  difficulties  or develop
backlogs in the future,  particularly with respect to the significant demands of
the U.S. market.  The Company has recently  completed  construction of a 130,000
square  foot  building  at its  corporate  headquarters  campus  in Santa  Rosa,
California, which is largely devoted to manufacturing activities. However, there
can be no assurance that such new manufacturing  facility is sufficient to allow
the Company to adequately supply the significant demands of the U.S. market on a
long-term basis.

         The Company has a limited  history of  operations.  The increase in the
Company's  sales to date has been due to greater demand for the Company's  stent
systems and, to a much lesser degree,  its PTCA balloon  catheter  systems.  The
Company  believes  that it is  currently  one of the leading  providers of stent
systems  internationally.  In order to support  increased levels of sales in the
future  and  to  augment  its  long-term  competitive   position,   the  Company
anticipates that it will be required to make continuing  significant  additional
expenditures  in  manufacturing,  research and development  (including  clinical
study and regulatory  costs),  sales and marketing and  administration,  both in
absolute dollars and as a percentage of net sales.

         Since the  commencement  of sales of its coronary  stent systems in the
United States,  several of the Company's  competitors  have filed claims against
the Company  alleging,  among other things,  that such stent systems infringe on
certain patents of such competitors.  Although the Company  continually  reviews
the scope of relevant  U.S.  and foreign  patents  and related  litigation,  the
question of infringement involves complex legal and factual issues and is highly
uncertain.  There can be no assurance that any conclusion reached by the Company
regarding infringement will be consistent with the resolution of such issue by a
court. If the Company's  products are determined to infringe such patents and it
cannot obtain a license on commercially  reasonable  terms or modify its current
technology or develop new products to avoid  infringement,  the Company would be
required to cease its sales of the affected products in the United States, which
could  have a  material  adverse  affect on the  Company's  business,  financial
condition and results of operations.

         The increasing number of devices in the international  stent market and
the desire of companies to obtain  market share has resulted in increased  price
competition,  particularly in the second and third quarters of fiscal 1997. Such
competition  has, in the past,  caused the Company to reduce prices on its stent
systems.  The Company expects that, as the stent industry develops,  competition
and pricing  pressures  will increase.  In particular,  it is likely that in the
United  States  the FDA  will  begin to use a  streamlined  PMA  process  once a
sufficient  number of similar  coronary  stent  products  have been  cleared for
commercial   sale  in  the  United  States,   and  will  permit  coronary  stent
manufacturers  to utilize a  simplified  clinical  trial  structure in obtaining
marketing  approval here as sufficient stent  performance data enters the public
domain.  Thus,  the regulatory  barriers to entry in the United States  coronary
stent market that currently exist may, in the future,  be lowered  significantly
with respect to both new market entrants and new products introduced by existing
U.S. competitors. If the Company is forced to effect further price reductions in
connection with such increased  competition,  such  reductions  would reduce net
sales in future periods if not offset by increased unit sales or other factors.
   
         The Company  anticipates  that its results of operations  may fluctuate
for the  foreseeable  future due to several  factors,  including  variations  in
operating  expenses,  the costs and the outcome of litigation,  costs associated
with  integration of  acquisitions,  the Company's  ability to  manufacture  its
products efficiently,  competition (including pricing pressures),  the timing of
new  product  introductions  or  transitions  to  new  products,  the  costs  of
establishing  direct sales  operations,  the timing of research and  development
expenses (including clinical trial related  expenditures),

                                       25
<PAGE>

timing of  regulatory  and third  party  reimbursement  approvals,  the level of
third-party  reimbursement,  sales  by  distributors,  the  mix of  sales  among
distributors   and  the  Company's  direct  sales  force,  the  fluctuations  in
international currency exchange rates, and seasonal factors impacting the number
of elective angioplasty or stent procedures.  In addition, the Company's results
of operations  could be affected by the timing of orders from its  distributors,
changes in the Company's  distributor  network (including expenses in connection
with  termination of former  distributors),  the ability of the Company's direct
sales force and independent  distributors  to effectively  promote the Company's
products  and  the  ability  of the  Company  to  quickly  and  cost-effectively
establish an effective direct sales force in targeted  countries.  The Company's
limited operating history makes accurate  prediction of future operating results
difficult or impossible.  Although the Company has experienced  growth in recent
years  and  substantial  growth  in the most  recent  quarter,  there  can be no
assurance that, in the future, the Company will sustain revenue growth or remain
profitable  on a quarterly or annual basis or that its growth will be consistent
with predictions made by securities analysts.  The Company has experienced,  and
may experience in one or more future quarters,  operating results that are below
the  expectations  of public market analysts and investors.  In such event,  the
price of the Company's  common stock has been,  and would likely be,  materially
and adversely affected.
    

         The Company  believes that its existing  computer  programs will not be
adversely  affected  by the "Year  2000"  problem,  and is  currently  assessing
whether any of its major  customers,  suppliers or service  providers will be so
affected. The Company believes that the computer programs to be acquired as part
of the Bard Cath Lab  Acquisition are not Year 2000 compliant and the Company is
currently  evaluating  the steps  necessary to assure that such acquired  assets
will not be adversely  affected by the Year 2000  problem.  The Company plans to
devote the necessary  resources to resolve all significant Year 2000 issues in a
timely manner.  Costs associated with the Year 2000 assessment and correction of
problems are expensed as incurred. Based on management's current assessment, the
Company does not believe that the cost of such actions will be material. Failure
of the Company's computer systems or that of its customers, suppliers or service
providers  could  have a  material  adverse  effect on the  Company's  business,
financial condition and results of operations.

Results of Operations - Years Ended June 30, 1998 and 1997

         Net sales.  For the fiscal  year  ended June 30,  1998,  net sales were
$387.6  million,  an increase  of 388% from $79.4  million in fiscal  1997.  The
increase in net sales was primarily due to significant increases in net sales of
the Company's Micro Stent II and GFX coronary stent systems in the United States
and of GFX coronary stent systems in Japan. The Company first began sales of its
Micro Stent II coronary stent systems in the United States in late December 1997
and of its GFX  coronary  stent  systems in late March 1998.  The Company  first
began sales of its GFX coronary stent systems in Japan in July 1997.  Outside of
the United States,  the GFX family of coronary stent systems was responsible for
a  substantial  majority of the  Company's  net sales.  The GFX was  released in
certain countries internationally in September 1996, and the GFX 2.5 and the GFX
XL were released in certain countries  internationally in June 1997. The Company
expects that coronary stent system sales,  particularly of the Company's GFX(TM)
family of products,  will constitute the vast majority of total net sales in the
near future,  and that the United  States will continue to produce a significant
portion of the Company's total net sales.

         The Company  experienced  sales growth during the fiscal year in all of
its major markets,  including the United States, Europe, and Japan. Sales in the
United  States,  Europe and Asia  represented  approximately  65%,  19% and 12%,
respectively,  of the  Company's  total  net sales  during  fiscal  1998.  Japan
Lifeline  Co.,  Ltd.,  the  Company's   Japanese   distributor,   accounted  for
approximately  11% of the Company's  total net sales for the year ended June 30,
1998.

   
         In certain  international  territories,  including Europe,  the Company
suffered price  reductions  during the fiscal year.  These price reductions were
attributable  both to competitive  pressures and, in those countries  outside of
the United States where the Company has direct sales  operations,  exchange rate
fluctuations.  If the Company is forced to effect further price reductions, such
reductions  would reduce net sales in future  periods if not offset by increased
unit sales or other factors.

         Cost of Sales.  Cost of sales  increased  to $72.7  million in the year
ended  June 30,  1998 from $16.2  million in fiscal  1997,  and  decreased  as a
percentage  of net sales to 18.8% in fiscal 1998 from 20.4% in fiscal 1997.  The
increase in absolute  dollars  during the fiscal year was  primarily a result of
the  increased  volume of products  sold and, to a lesser  extent,  the costs of
additional  manufacturing  capacity and personnel necessary to support increased
sales  volume and $20.9  million in special  general  employee  bonuses  paid or
accrued  during the period.  The  decrease as a  percentage  of net sales during
fiscal 1998 was  primarily  the result of increased  aggregate  average  selling
prices (primarily due to U.S. sales), leveraging certain fixed overhead expenses
across a higher base of sales and, to a lesser  extent,  decreased  average unit
manufacturing  costs  (excluding  the  effect of the  special  general  employee
bonuses).
    
       The Company  expects cost of sales  (excluding  the effect of the special
general  employee  bonuses) to  continue to increase in absolute  dollars as the
Company increases the volume of products sold and adds additional  manufacturing
capacity and  personnel.  If the Company is successful in continuing to leverage
certain  fixed  overhead  expenses  across a higher  base of sales and to reduce
average  unit  manufacturing  costs,  the  Company  expects  cost of  sales as a
percentage  of net  sales  to  remain  at a  level  generally  similar  to  that
experienced in fiscal 1998.

                                       26
<PAGE>

   
         Research and  Development.  Research and  development  expenses,  which
include clinical study and regulatory  costs,  increased to $37.2 million in the
year ended June 30, 1998 from $11.4  million in fiscal 1997,  and decreased as a
percentage  of net sales to 9.6% in fiscal 1998 from 14.4% in fiscal  1997.  The
increase in absolute  dollars  during the fiscal year was  primarily  due to the
addition of research and development personnel,  increased levels of spending in
connection  with  clinical  studies  relating  to the GFX,  GFX 2.5,  and GFX XL
coronary stent systems and costs incurred in connection  with the development of
additional  products.  In addition,  during the fiscal year the Company incurred
approximately  $4.6  million  in  legal  expenses  relating  to  ongoing  patent
litigation and $4.5 million in special general  employee bonuses paid or accrued
during the period.  The decrease as a percentage  of net sales during the fiscal
year was primarily the result of leveraging  research and  development  expenses
across a higher base of sales.
    

         The Company expects  research and development  expenses  (excluding the
effect of the  special  general  employee  bonuses)  to  continue to increase in
absolute dollars as the Company increases clinical trial activities, pursues the
development of new products and incurs  increased  legal costs related to patent
litigation.  If the Company is successful in continuing to leverage research and
development  expenses  across a higher base of sales,  the Company  expects such
expenses as a percentage of net sales to remain at a level generally  similar to
that experienced in fiscal 1998.

   
         Selling,    General   and   Administrative.    Selling,   general   and
administrative  expenses  increased in absolute  dollars to $97.0 million in the
year ended June 30, 1998 from $22.5 million in the  comparable  period in fiscal
1997,  and  decreased as a percentage  of net sales to 25.0% in fiscal 1998 from
28.3% in fiscal 1997.  The increase  during the fiscal year in absolute  dollars
primarily  reflected  additional  costs of sales,  marketing and other personnel
necessary to support the  Company's  higher level of  operations,  including the
commencement  of direct sales  operations  in the United States in late December
1997,  as well as sales  and  marketing  assistance  to the  Company's  Japanese
distributor and increased reserves against,  among other things, unpaid accounts
receivable balances attributable to former European distributors of the Company.
Additionally,  during fiscal 1998, the Company  incurred a $9.8 million  special
general  employee bonus expense and increased legal costs relating  primarily to
litigation  with former  shareholders  of  Endothelial  Support  Systems,  Inc.,
subsequently known as Endovascular  Support Systems,  Inc. ("ESS"),  and certain
distributor  terminations,  which together resulted in related legal expenses of
$7.4 million for the period.  The decrease in percentage of sales for the fiscal
year was primarily the result of leveraging selling,  general and administrative
expenses across a higher base of sales.
    

         The  Company  expects  selling,   general  and   administrative   costs
(excluding the effect of the special  general  employee  bonuses) to continue to
increase in absolute  dollars in the future primarily due to increased levels of
sales,  product support and  manufacturing  operations,  as well as increases in
finance,  legal and  administrative  costs.  If the  Company  is  successful  in
continuing to leverage  selling,  general and  administrative  expenses across a
higher base of sales,  the Company  expects such expenses as a percentage of net
sales to remain at a level generally similar to that experienced in fiscal 1998.

   
         Interest and Other Income. The Company had interest and other income of
$5.5 million in the year ended June 30, 1998, compared to $4.2 million in fiscal
1997. The increase during the fiscal year was primarily due to higher cash, cash
equivalents and short-term investments balances.
    

         Provision  for Income Taxes.  The Company's  provision for income taxes
was $71.1 million in the year ended June 30, 1998,  compared to $11.7 million in
fiscal 1997. The increase in this provision was a result of the Company's higher
earnings during fiscal 1998.

         The  income  tax rate on sales in the  United  States has been and will
likely  continue to be higher than that related to the  Company's  international
sales, which receive a benefit from the Company's foreign sales corporation.

         Net Income.  The Company had net income of $115.1 million,  or 29.7% of
net  sales,  in the year  ended June 30,  1998  compared  to net income of $21.7
million, or 27.4% of net sales, in fiscal 1997.

Results of Operations - Years Ended June 30, 1997 and 1996

         Net sales.  For the year ended June 30,  1997,  net sales  increased to
$79.4  million,  an increase of 43.8% from $55.2  million for fiscal  1996.  The
increase in net sales was due to significant increases in sales of the Company's
stent systems,  particularly  the GFX and the Micro Stent II family of products.
The GFX was released in certain countries internationally in September 1996, and
the Micro Stent II was released in certain countries  internationally in October
1995.

         Cost of Sales.  Cost of sales increased to $16.2 million in fiscal 1997
from $10.6 million in fiscal 1996, and increased as a percentage of net sales to
20% in fiscal 1997 from 19% in fiscal  1996.  The  increase in absolute  dollars
during fiscal 1997 was  primarily a result of the  increased  volume of products
sold and, to a lesser extent, the costs of additional manufacturing capacity and
personnel  necessary  to support  increased  sales  volume.  The  increase  as a
percentage  of net sales during  fiscal 1997 was  primarily  the result of lower
unit pricing compared to fiscal 1996.

                                       27
<PAGE>

         Research and  Development.  Research and  development  expenses,  which
include clinical study and regulatory costs increased to $11.4 million in fiscal
1997 from $6.5 million in fiscal 1996 and increased as a percentage of net sales
to 14% in fiscal 1997 from 12% in fiscal 1996. A one-time charge of $2.6 million
was included in fiscal 1996 in connection with the termination of certain patent
royalty  obligations.   Excluding  the  effect  of  this  charge,  research  and
development  expenses  increased from $3.9 million or 7% of net sales for fiscal
1996.  The increase in absolute  dollars and as a percentage of net sales during
fiscal  1997 was  primarily  due to the  addition of  research  and  development
personnel,  increased  levels of spending in connection  with  clinical  studies
relating  to the GFX,  Micro  Stent II and Micro  Stent II XL systems  and costs
incurred in connection with the development of additional products.

         Selling,    General   and   Administrative.    Selling,   general   and
administrative expenses increased in absolute dollars to $22.5 million in fiscal
1997 from $8.4 million in fiscal  1996,  and  increased  as a percentage  of net
sales to 28% in fiscal 1997 from 15% in fiscal 1996.  A one-time  charge of $2.6
million was  included  in fiscal  1996 in  connection  with the  termination  of
certain  patent  royalty  obligations.  Excluding  the  effect  of this  charge,
selling,  general and administrative expenses increased from $5.8 million or 11%
of net sales for fiscal  1996.  The  increase  during  fiscal  1997 in  absolute
dollars and as a percentage of sales  primarily  reflected  additional  costs of
marketing and other personnel necessary to support the Company's higher level of
operations,  including the  commencement  of direct sales  operations in France,
Germany, the Netherlands (to service the Benelux countries), Switzerland and the
United  Kingdom.  Additionally,  the  increase  reflects  increased  legal costs
relating primarily to litigation with former shareholders of ESS, which resulted
in related legal expenses of $3.4 million during fiscal 1997.

         Interest and Other Income. The Company had interest and other income of
$4.2  million  in fiscal  1997  compared  to $1.5  million in fiscal  1996.  The
increase was primarily due to additional interest income earned on the Company's
increased cash and cash equivalents and short-term  investment  balances arising
from the  utilization of proceeds from the Company's  initial public offering in
April 1996.

         Provision  for Income Taxes.  The Company's  provision for income taxes
was $11.7 million in fiscal 1997,  compared to $10.8 million in fiscal 1996. The
increase in this  provision  during  fiscal  1997 was a result of the  Company's
higher earnings during fiscal 1997.

         Net  Income.  The  Company  had net income of $21.8  million for fiscal
1997,  compared to $20.4 million for fiscal 1996 ($23.9  million if the one-time
charge is excluded).

Liquidity and Capital Resources

   
         Net cash provided by operating  activities was $71.7 million for fiscal
1998.  Net cash used in operating  activities in fiscal 1997 was $20.0  million,
and net cash used by  operating  activities  in fiscal  1996 was $20.5  million.
Excluding the effect of transactions in short-term investments,  the Company had
net cash provided by operating  activities of $136.4 million for fiscal 1998 and
$9.9  million in fiscal  1997,  principally  arising as a result of positive net
income for the period. Cash, cash equivalents and short-term investments totaled
$175.1  million at June 30, 1998 as compared to $87.2  million at June 30, 1997.
Working  capital  increased  to $204.5  million at June 30,  1998 as compared to
$114.5 million at June 30, 1997.  Inventories  increased to $9.5 million at June
30, 1998 from $7.3 million at June 30, 1997,  primarily  due to increased  sales
activity. The Company expects accounts receivable and inventories to increase in
absolute dollar amounts as sales increase.
    

         In connection with the construction of a new manufacturing facility, in
August 1997 the Company  entered  into a bank credit  agreement  for a revolving
credit  facility of $20 million.  The interest  rate on such  facility was LIBOR
plus  one-half  of one  percent.  Such  facility  was  secured by certain of the
Company's short-term investments and was due and payable on August 31, 1998. The
bank credit agreement contained no material restrictive covenants and was repaid
in full during the fourth  quarter of fiscal 1998.  The Company  incurred  $53.2
million in capital  expenditures  during fiscal 1998,  primarily relating to the
construction  of such new  manufacturing  facility  and the  purchase of related
manufacturing equipment.
   
         During  the  third  quarter  of fiscal  1998,  the  Company's  Board of
Directors  declared a two-for-one stock split that was effected in the form of a
100% stock dividend.  The stock split resulted in the issuance of  approximately
32 million additional shares of common stock.

         A significant  portion of the Company's  revenues are currently derived
from sales outside of the United States.  As a result,  the Company's  financial
results will be affected by changes in foreign  currency  exchange  rates to the
extent that such sales may be  denominated in foreign  currency.  The Company is
currently  exposed  to  fluctuations  in  currencies  in  western  Europe and in
Singapore.  During fiscal 1997, the Company began a program of from time to time
entering into derivative  financial  instruments in the form of forward exchange
contracts in order to reduce the  uncertainty of foreign  exchange rate movement
on inter-Company  sales denominated in foreign  currencies.  These contracts are
designed to  specifically  hedge against  gains or losses  incurred from foreign
currency  transactions  and are not used for  trading or  speculative  purposes.
Forward    exchange    contracts   are   used   to   hedge   material    foreign
currency-denominated  receivables  and  payables.  They  are  generally  settled
between three to six months with gains or losses  recorded in "Selling,  general
and  administrative"  expenses  to offset  gains or losses on  foreign  currency
receivables and payables.  As of June 30, 1998, however, the Company had no such
currency hedging instruments outstanding.

                                       28
<PAGE>

         In connection with the Bard Cath Lab  Acquisition,  the Company expects
to enter into a bank credit  agreement for $600 million in senior secured credit
facilities,  of which $200 million  would be  five-year  term loans (the "Term A
Loans"),  $350 million would be six-year term loans (the "Term B Loans") and $50
million would be a five-year  revolving credit facility (the "Revolving Loans").
The term loans are expected to amortize and be prepayable  at any time,  subject
to customary breakage  provisions.  Initial interest rates are expected to be at
the higher of the  London  InterBank  Offered  Rate  ("LIBOR")  plus 2.00% or an
agreed pricing grid for the Term A Loans and the Revolving Facilities and at the
higher of LIBOR plus 2.25% or an agreed  pricing grid for the Term B Loans.  The
Term A Loans,  the Term B Loans and the  Revolving  Loans  outstanding  would be
reduced by certain mandatory prepayments, including (i) 100% of the net proceeds
from  debt  issuances,  subject  to  certain  exceptions,  (ii)  100% of the net
proceeds from extraordinary asset sales,  subject to certain  exceptions,  (iii)
50% of the first $200  million of the net cash  proceeds  from any  issuances of
equity  securities  of the Company and 50% of any further net cash proceeds from
issuances  of equity  securities  of the Company if the  Company's  then current
leverage  ratio exceeds 2.5, and (iv) 50% of the Company's  consolidated  annual
excess cash flow if the Company's  then current  leverage ratio exceeds 2.5. The
bank credit  agreement is expected to contain  restrictive  financial  covenants
relating to a maximum leverage ratio, a minimum fixed charge coverage ratio, and
a minimum net worth of the Company. The bank credit agreement would also contain
customary negative  covenants,  including  restrictions on (i) the incurrence of
additional debt, (ii) payment of restricted payments, (iii) liens, (iv) sales of
assets, (v) acquisitions,  mergers or similar  combinations,  (vii) transactions
with  affiliates,  and (viii)  capital  expenditures.  The senior secured credit
facilities are expected to be secured by substantially  all the operating assets
of the Company  and its  subsidiaries  and a pledge of the capital  stock of the
Company's material  subsidiaries,  including a subsidiary to be formed that will
hold a substantial portion of the assets acquired from Bard.
    

         The Company's high degree of leverage could have important consequences
to the stockholders of the Company,  including the following:  (i) the Company's
ability  to  obtain   additional   financing   for  working   capital,   capital
expenditures,  acquisitions, general corporate purposes or other purposes may be
impaired in the future;  (ii) a substantial  portion of the Company's  cash flow
from  operations  must be dedicated to the payment of principal  and interest on
its indebtedness,  thereby reducing the funds available to the Company for other
purposes;  (iii) the  Company's  borrowings  under such  senior  secured  credit
facilities will be at variable rates of interest,  which will expose the Company
to the risk of increased interest rates; (iv) the indebtedness outstanding under
the senior secured  credit  facilities  will be secured;  (v) the Company may be
substantially  more leveraged than certain of its  competitors,  which may place
the Company at a competitive  disadvantage;  and (vi) the Company's  substantial
degree of  leverage  may  limit its  flexibility  to adjust to  changing  market
conditions,  reduce its ability to withstand  competitive  pressures and make it
more vulnerable to a downturn in general economic conditions or businesses.

         The  Company  is  expected  to  incur  substantial   additional  costs,
including  costs relating to capital  equipment and other costs  associated with
expansion  of the  Company's  manufacturing  capabilities,  increased  sales and
marketing  activities  (including  the  establishment  of  direct  sales  forces
internationally),   and  increased  research  and  development  expenditures  in
connection with seeking regulatory approvals and conducting  additional clinical
trials.  The Company also intends to expand its  operations  by promoting new or
complementary  products  and by  expanding  the breadth and depth of its product
offerings,  and may do so by entering into business combinations,  acquisitions,
investments, joint ventures or other strategic alliances with third parties. The
Company may require  additional  equity or debt financing to address its working
capital needs, to provide  funding for capital  expenditures in the future or to
finance  any  such  acquisitions  or  strategic  alliances.   Furthermore,   any
additional equity financing may be dilutive to stockholders, and debt financing,
if available,  may involve restrictive  covenants and may increase the Company's
leverage.  There can be no assurance  that events in the future will not require
the  Company to seek  additional  capital  or, if so  required,  that it will be
available on terms acceptable to the Company.

   
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         See  "Item 7.  Management's  Discussion  and  Analysis  of  Results  of
Operations  and Financial  Condition  --Liquidity  and Financial  Condition" for
information  related to quantitative  and qualitative  disclosures  about market
risk.
    

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         See Item  14(a) for an index to the  Company's  consolidated  financial
statements  as of June 30,  1998 and 1997 and for each of the three years in the
period ended June 30, 1998.

         The statements  contained in this Form 10-K that are not historical are
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,  including
statements  regarding  the  Company's  expectations,   beliefs,   intentions  or
strategies regarding the future.  Forward-looking statements and risk factors in
this Item 8 include,  without limitation,  statements regarding factors that may
affect the Company's results of operations.  All  forward-looking  statements in
this document are based on  information  available to the Company as of the date
hereof, and the Company assumes no obligation to update any such forward-looking
statement.  It is  important to note that the  Company's  actual  results  could
differ  materially  from those in such  

                                       29
<PAGE>

forward-looking  statements.  Additional  forward-looking  statements  and  risk
factors  include those  discussed in the sections  entitled "Item 1.  Business,"
"Item 3. Legal  Proceedings," "Item 5. Market for the Registrant's Common Equity
and Related Stockholders," and "Item 7. Management's  Discussion and Analysis of
Financial Condition and Results of Operations," as well as those that may be set
forth in the reports  filed by the  Company  from time to time on Forms 10-Q and
8-K.

Quarterly Results of Operations
<TABLE>

         The following table sets forth certain unaudited  consolidated  results
of  operations  for the  fiscal  years  ended  June  30,  1998  and  1997.  This
information has been derived from unaudited  consolidated  financial  statements
that, in the opinion of management,  reflect all adjustments (consisting only of
normally  recurring  adjustments)  necessary to fairly present this information.
The results of operations for any quarter are not necessarily  indicative of the
results to be expected for any future period.
<CAPTION>

                                                     First             Second             Third            Fourth
                                                    Quarter            Quarter           Quarter           Quarter
                                                    -------            -------           -------           -------
                                                                (in thousands, except per share data)
<S>                                                <C>                <C>             <C>                <C>     
Year  ended June 30, 1998
   
Net sales                                          $26,263            $38,303         $141,203           $181,877
Gross profit                                        20,774             30,647          113,657            149,878
Operating income                                     7,779             10,830           66,789             95,387
Net income                                           5,710              7,754           42,242             59,415
Net income per share - basic                          0.10               0.12             0.67               0.95
Net income per share - diluted                        0.09               0.12             0.64               0.90
    

Year  ended June 30, 1997
   
Net sales                                          $18,568            $18,228        $  20,402          $  22,222
Gross profit                                        15,657             14,495           15,806             17,245
Operating income                                    10,670              6,032            6,257              6,311
Net income                                           7,765              4,606            4,633              4,746
Net income per share - basic                          0.13               0.08             0.07               0.08
Net income per share - diluted                        0.12               0.07             0.07               0.07
    
</TABLE>

         Results of the Company's  operations may fluctuate  significantly  from
quarter to quarter and will depend on numerous factors, including (i) variations
in  operating  expenses,  (ii)  the  costs  and  outcome  of  litigation,  (iii)
competition  (including  pricing  pressures),  (iv) the timing of  research  and
development expenses (including clinical trial related  expenditures),  (vi) the
timing of new product  introductions  or transitions  to new products,  (vi) the
timing of regulatory and third party  reimbursement  approvals,  (vii) the costs
and the timing of establishing direct sales operations,  (viii) the mix of sales
among distributors and the Company's direct sales force, (ix) the level of third
party  reimbursement,  (x) the  Company's  ability to  manufacture  its products
efficiently,   and  (x)  seasonal  factors  impacting  the  number  of  elective
angioplasty  procedures.  Announcements or expected announcements by the Company
or its  competitors  of new products or  technologies  could cause  customers to
defer  purchases  of  existing  products  of the  Company  and  alter the mix of
products  sold by the  Company,  which  could  materially  adversely  affect the
Company's business,  financial condition and results of operations. There can be
no assurance that future  products or product  enhancements  can be successfully
introduced or that such  introductions  will not adversely affect the demand for
existing products. Since the Company believes there are typically fewer elective
interventional  procedures during the summer months due to vacation schedules of
patients and health care providers, especially in Europe, sales of the Company's
products may slow during the  Company's  first fiscal  quarter of each year (the
quarter ending  September 30). The Company expects that its quarterly  operating
results will fluctuate in the future as a result of these and other factors. Due
to  such  quarterly  fluctuations  in  operating  results,  quarter  to  quarter
comparisons of the Company's  operating  results are not necessarily  meaningful
and should not be relied upon as  indicators  of likely  future  performance  or
annual operating results.

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

          None.

                                       30
<PAGE>

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Information  regarding  the Company's  directors and the  compliance of
certain reporting  persons with Section 16(a) of the Securities  Exchange Act of
1934 will be set forth under the caption "Election of Directors" and "Compliance
with the  Reporting  Requirements  of  Section  16(a)"  in the  Company's  proxy
statement for use in connection  with the Annual Meeting of  Stockholders  to be
held on  November  12,  1998 (the "1998 Proxy  Statement")  and is  incorporated
herein by reference.  The 1998 Proxy Statement will be filed with the Securities
and Exchange  Commission  within 120 days after the end of the Company's  fiscal
year.

         Information regarding Company's executive officers is set forth in this
Form 10-K in Part I, Item 1.

ITEM 11.  EXECUTIVE COMPENSATION

         The  information  required  by this  item  is  incorporated  herein  by
reference  from  the  information  set  forth  under  the  caption  "  Executive
Compensation" in the Company's 1998 Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   
         The  information  required  by this  item  is  incorporated  herein  by
reference from the information set forth under the caption  "Security  Ownership
of  Certain  Beneficial  Owners  and  Management"  in the  Company's  1998 Proxy
Statement.
    

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The  information  required  by this  item  is  incorporated  herein  by
reference   from  the   information   set  forth  under  the  caption   "Certain
Transactions" in the Company's 1998 Proxy Statement.


                                       31
<PAGE>

                                     PART IV

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

(a) The following documents are filed as part of this Form 10-K:

                                                                           Page
                                                                           ----
      (1)  Consolidated Financial Statements

   
           Report of Ernst & Young LLP, Independent Auditors                38
           Consolidated Balance Sheets at June 30, 1998 and 1997            39
           Consolidated Statements of Operations for the three 
           years ended June 30, 1998                                        40
           Consolidated Statements of Stockholders' Equity for the 
           three years ended June 30, 1998                                  41
           Consolidated Statements of Cash Flows for the three 
           years ended June 30, 1998                                        42
           Notes to Consolidated Financial Statements                       43
    

      (2)  Financial Statement Schedules

           Schedule II     Valuation and Qualifying Accounts                59

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

      (3)  Exhibits

Exhibit
 Number                          Description of Document
 ------                          -----------------------

 3.1     Amended  and  Restated  Certificate  of  Incorporation  of the  Company
         (incorporated by reference to Exhibit 3.1 to the Company's Registration
         Statement on Form S-1 No. 333-00824, filed February 1, 1996).

 3.2     Amended  By-laws of the Company  (incorporated  by reference to Exhibit
         3.2 to the Company's  Registration  Statement on Form S-1 No 333-00824,
         filed February 1, 1996).

 3.3     Certificate  of  Amendment  of  Amended  and  Restated  Certificate  of
         Incorporation  (incorporated  by  reference to Exhibit 3.3 to Amendment
         No.  1  to  the  Company's  Registration  Statement  on  Form  S-1  No.
         333-00824, filed March 7, 1996).

 3.4     Certificate of Designation of Series A Junior  Participating  Preferred
         Stock of the Company  (incorporated  by  reference  to Exhibit 2 to the
         Company's Current Report on Form 8-K, filed February 27, 1997).

 4.1     Specimen stock certificate (incorporated by reference to Exhibit 4.1 to
         Amendment No. 1 to the Company's Registration Statement on Form S-1 No.
         333-00824, filed March 7, 1996).

 10.1    Company's  1996 Equity  Incentive  Plan,  as amended  (incorporated  by
         reference to Exhibit 10.1 to the  Company's  annual Report on Form 10-K
         for the fiscal year ended June 30, 1997, filed September 16, 1997).

 10.2    Company's 1996 Non-Employee  Directors' Stock Option Plan (incorporated
         by  reference to Exhibit 10.2 of the  Company's  Annual  Report on Form
         10-K for the fiscal  year  ended June 30,  1996,  filed  September  26,
         1996).

 10.3    Company's 1997 Employee Stock Purchase Plan  (incorporated by reference
         to Exhibit  10.3 to the  Company's  annual  Report on Form 10-K for the
         fiscal year ended June 30, 1997, filed September 16, 1997).

 10.4    Distribution  Agreement  dated July 17,  1993  between  the Company and
         Century Medical, Inc. (incorporated by reference to Exhibit 10.3 to the
         Company's  Registration  Statement  on Form  S-1 No.  333-00824,  filed
         February 1, 1996).

 10.5    Importing and Distribution Agreement dated December 2, 1993 between the
         Company and Japan  Lifeline  Co.,  Ltd  (incorporated  by  reference to
         Exhibit 10.4 to the  Company's  Registration  Statement on Form S-1 No.
         333-00824, filed February 1, 1996).

 10.6    Termination  Agreement  dated  August 11, 1995  between the Company and
         Century  Medical,  Inc.  (incorporated by reference to Exhibit 10. 5 to
         the Company's Registration  Statement on Form S-1 No. 333-00824,  filed
         February 1, 1996).

 10.7    International  Distribution  Agreement,  dated as of January 22,  1997,
         between  Japan  Lifeline  Co.,  Ltd. and the Company  (incorporated  by
         reference to Exhibit  10.26 to the Company's  Quarterly  Report on Form
         10-Q for the period ended December 31, 1996,  filed February 14, 1997).
         (Confidential  treatment  applies to certain  information  contained in
         this  document  pursuant  to an order of the  Securities  and  Exchange
         Commission. Such information has been omitted and filed separately with
         the  Securities and Exchange  Commission  pursuant to Rule 24b-2 of the
         Securities Exchange Act of 1934, as amended.)


                                       32
<PAGE>

 10.8    Amendment,  dated as of July 9, 1997, to the International Distribution
         Agreement dated as of January 22, 1997 between Japan Lifeline Co., Ltd.
         and the  Company  (incorporated  by  reference  to Exhibit  10.8 to the
         Company's Annual Report on Form 10-K for the fiscal year ended June 30,
         1997,  filed  September  16,  1997).  (Confidential  treatment has been
         requested  for certain  information  contained in this  document.  Such
         information  has been omitted and filed  separately with the Securities
         and  Exchange  Commission  pursuant  to Rule  24b-2  of the  Securities
         Exchange Act of 1934, as amended).

 10.9    Amendment  No. 2, dated as of August  22,  1997,  to the  International
         Distribution  Agreement  dated as of January  22,  1997  between  Japan
         Lifeline  Co.,  Ltd.  and the Company  (incorporated  by  reference  to
         Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal
         year ended June 30, 1997,  filed  September  16,  1997).  (Confidential
         treatment has been requested for certain information  contained in this
         document.  Such  information has been omitted and filed separately with
         the  Securities and Exchange  Commission  pursuant to Rule 24b-2 of the
         Securities Exchange Act of 1934, as amended).

 10.10   Amendment  No. 3, dated as of December 22, 1997,  to the  International
         Distribution  Agreement  dated as of January  22,  1997  between  Japan
         Lifeline  Co.,  Ltd.  and the Company  (incorporated  by  reference  to
         Exhibit  10.33 to the Company's  Quarterly  Report on Form 10-Q for the
         period ended December 31, 1997, filed January 16, 1998).  (Confidential
         treatment has been requested for certain information  contained in this
         document.  Such  information has been omitted and filed separately with
         the  Securities and Exchange  Commission  pursuant to Rule 24b-2 of the
         Securities Exchange Act of 1934, as amended).

 10.11   Employment  Agreement,  dated as of March 17, 1995, between the Company
         and Bradly A. Jendersee  (incorporated  by reference to Exhibit 10.6 to
         the Company's Registration  Statement on Form S-1 No. 333-00824,  filed
         February 1, 1996).

 10.12   Employment  Agreement  Amendment  between  the  Company  and  Bradly A.
         Jendersee (incorporated by reference to Exhibit 10.7 to Amendment No. 1
         to the  Company's  Registration  Statement  on Form S-1 No.  333-00824,
         filed March 7, 1996).

 10.13   Employment  Agreement,  dated as of March 17, 1995, between the Company
         and Robert D. Lashinski  (incorporated  by reference to Exhibit 10.8 to
         the Company's Registration  Statement on Form S-1 No. 333-00824,  filed
         February 1, 1996).

 10.14   Employment  Agreement  Amendment  between  the  Company  and  Robert D.
         Lashinski (incorporated by reference to Exhibit 10.9 to Amendment No. 1
         to the  Company's  Registration  Statement  on Form S-1 No.  333-00824,
         filed March 7, 1996).

 10.15   Employment  Agreement,  dated as of March 17, 1995, between the Company
         and John D. Miller  (incorporated  by reference to Exhibit 10.10 to the
         Company's  Registration  Statement  on Form  S-1 No.  333-00824,  filed
         February 1, 1996).

 10.16   Employment  Agreement,  dated as of March 17, 1995, between the Company
         and W. Kevin Bedsole (incorporated by reference to Exhibit 10.11 to the
         Company's  Registration  Statement  on Form  S-1 No.  333-00824,  filed
         February 1, 1996).

 10.17   Employment  Agreement,  dated as of March 17, 1995, between the Company
         and Gregory M. French.  (incorporated  by reference to Exhibit 10.12 to
         the Company's Registration  Statement on Form S-1 No. 333-00824,  filed
         February 1, 1996).

 10.18   Employment  Agreement,  dated as of March 17, 1995, between the Company
         and John A. Schiek  (incorporated  by reference to Exhibit 10.13 to the
         Company's  Registration  Statement  on Form  S-1 No.  333-00824,  filed
         February 1, 1996).

 10.19   Employment Agreement, dated as of February 3, 1997, between the Company
         and Scott J. Solano  (incorporated by reference to Exhibit 10.28 to the
         Company's  Quarterly  Report on Form 10-Q for the period ended December
         31, 1996, filed February 14, 1997).

 10.20   Form of Change in Control Option Vesting Acceleration Agreement between
         the Company and Lawrence J. Fassler,  Glenn S. Foley, Andrew P. Rasdal,
         and certain other employees (incorporated by reference to Exhibit 10.27
         to the  Company's  Quarterly  Report on Form 10-Q for the period  ended
         December 31, 1996, filed February 14, 1997).

 10.21   Form of  Indemnification  Agreement between the Company and each of its
         executive officers and directors  (incorporated by reference to Exhibit
         10.25 to the  Company's  Quarterly  Report on Form 10-Q for the  period
         ended September 30, 1996, filed November 13, 1996).

 10.22   Rights  Agreement,  dated as of February 26, 1997,  between the Company
         and The First  National  Bank of Boston  (incorporated  by reference to
         Exhibit 1 to the Company's  Current  Report on Form 8-K, filed February
         27, 1997).

 10.23   Amendment to Rights  Agreement,  effective  May 28,  1998,  between the
         Company and BankBoston, N.A. (formerly known as The First National Bank
         of Boston)  (incorporated  by reference  to Exhibit 1 to the  Company's
         Current Report on Form 8-K, filed June 9, 1998).

 10.24   Stock Exchange  Agreement,  dated as of December 22, 1994,  between the
         Company and Benito Hidalgo  (incorporated by reference to Exhibit 10.14
         to the  Company's  Registration  Statement  on Form S-1 No.  333-00824,
         filed February 1, 1996).


                                       33
<PAGE>

 10.25   Stock  Exchange  Agreement,  dated as of March 27,  1995,  between  the
         Company and Michael D.  Bonneau  (incorporated  by reference to Exhibit
         10.15  to  the  Company's   Registration  Statement  on  Form  S-1  No.
         333-00824, filed February 1, 1996).

 10.26   Lease, dated August 5, 1996, and First Amendment thereto,  between Ruth
         Waltenspiel, Dixie Walker and the Company, concerning the facilities at
         5341,  5343, 5345 and 5347 Skylane  Boulevard,  Santa Rosa,  California
         (incorporated by reference to Exhibit 10.24 to the Company's  Quarterly
         Report on Form 10-Q for the period  ended  September  30,  1996,  filed
         November 13, 1996).

 10.27   Second  Amendment to Lease,  dated May 5, 1997,  to that certain  Lease
         dated August 5, 1996 between Dixie  Walker,  Ruth  Waltenspiel  and the
         Company, as amended  (incorporated by reference to Exhibit 10.30 to the
         Company's  Quarterly Report on Form 10-Q for the period ended March 31,
         1997, filed May 15, 1997).

 10.28   Lease,  dated as of April 28, 1997,  between Bruce and Sandra Rocco and
         the Company  concerning the facility at 5355 Skylane  Boulevard,  Santa
         Rosa,  California  (incorporated  by reference to Exhibit  10.26 to the
         Company's 1997 Annual Report on Form 10-K, filed September 16, 1997).

 10.29*  Sublease,  dated as of June 30, 1997, between the Company and Verticom,
         Inc.  concerning the facility at 1201 Corporate  Center Parkway,  Santa
         Rosa, California.

 10.30   Lease,  dated  as  of  May  19,  1997,  between  the  Company  and  SBR
         Development  concerning  the  facility at 7975  Cameron  Center  Drive,
         Buildings  100  and  300,  Santa  Rosa,  California   (incorporated  by
         reference to Exhibit 10.28 to the Company's  1997 Annual Report on Form
         10-K, filed September 16, 1997).

 10.31   Lease,   dated  August  10,  1994,   between  Bentall  Properties  Ltd,
         Westminster  Management  Corporation and Arterial Vascular  Engineering
         Canada,  Inc.,  concerning the facility at 13155 Delf Place,  Richmond,
         British  Columbia  (incorporated  by reference to Exhibit  10.29 to the
         Company's 1997 Annual Report on Form 10-K, filed September 16, 1997).

 10.32   Addendum to Lease and Lease  Amending  Agreement,  dated as of July 21,
         1997, between Arterial Vascular  Engineering  Canada,  Inc. and Bentall
         Properties Ltd. concerning 13140 Delf Place Richmond,  British Columbia
         (incorporated  by  reference  to Exhibit  10.30 to the  Company's  1997
         Annual Report on Form 10-K, filed September 16, 1997).

 10.33   Lease,  dated as of October  29,  1997,  between  the  Company  and SBR
         Development  concerning  the  facility at 7975  Cameron  Center  Drive,
         Building 200, Windsor, California (incorporated by reference to Exhibit
         10.31 to the Company's 1997 Annual Report on Form 10-K, filed September
         16, 1997).

 16.1    Letter,  dated March 5, 1996, from Anthony Capeci  regarding  change in
         certifying  accountant  (incorporated  by  reference to Exhibit 16.1 to
         Amendment No. 1 to the Company's Registration Statement on Form S-1 No.
         333-00824, filed March 7, 1996).

 16.2    Letter,  dated May 10, 1996,  from Coopers & Lybrand  L.L.P.  regarding
         change in certifying  accountant  (incorporated by reference to Exhibit
         16.2 to the Company's Form 8-K, filed May 10, 1996).

 21.1*   Subsidiaries of the Company.

 23.1*   Consent of Ernst & Young LLP, Independent Auditors.

 24.1*   Power of Attorney (reference is made to the signature page of this Form
         10-K). 27* Financial Data Schedule.

-------------
*        Filed herewith.


                                       34
<PAGE>


(b)      Reports on Form 8-K

                  On May 22, 1998,  the Company filed a Form 8-K with respect to
         its  restatement  of  earnings  per share  information  pursuant to the
         Financial   Accounting   Standards   Board's   Statement  of  Financial
         Accounting  Standards No. 128, which  replaced the previously  reported
         primary  and fully  diluted  earnings  per share with basic and diluted
         earnings per share.

         Report Date:        May 21, 1998
         Filing Date:        May 22, 1998
         Item 5 -- Other Events
         Item 7 -- Exhibits

                  On June 9, 1998,  the Company filed a Form 8-K with respect to
         an  amendment  to the Rights  Agreement  dated as of February  26, 1997
         between the Company and BankBoston,  N.A.  (formerly known as The First
         National  Bank of Boston).  The  amendment  provides  that the purchase
         price under the Rights  Agreement for one  one-hundredth  of a share of
         the Company's Series A Junior Participating  Preferred Stock, par value
         $.001 per share, is changed from $75.00 to $175.00 (taking into account
         the stock dividend previously distributed by the Company).

         Report Date:        May 28, 1998
         Filing Date:        June 9, 1998
         Item 5 -- Other Events
         Item 7 -- Exhibits

(c)      See Exhibits listed under Item 14(a)(3).

(d)      The  financial  statement  schedules  required  by this Item are listed
         under Item 14(a)(2).


                                       35
<PAGE>

                                   SIGNATURES

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

                       ARTERIAL VASCULAR ENGINEERING, INC.



Date:  September 4, 1998                  /s/ Scott J. Solano
                                          -------------------------------------
                                          Scott J. Solano
                                          President, Chief Executive Officer and
                                          Chairman of the Board of Directors


         KNOW ALL PERSONS BY THESE  PRESENTS,  that each person whose  signature
appears below  constitutes and appoints Scott J. Solano and John D. Miller,  and
each of them,  as his true and lawful  attorneys-in-fact  and agents,  with full
power of substitution and  resubstitution,  for him and in his name,  place, and
stead, in any and all capacities,  to sign any and all amendments to this Report
on Form  10-K,  and to file the  same,  with all  exhibits  thereto,  and  other
documents in connection therewith,  with the Securities and Exchange Commission,
granting unto said  attorneys-in-fact  and agents,  and each of them, full power
and  authority  to do and  perform  each and every act and thing  requisite  and
necessary  to be done in  connection  therewith,  as  fully to all  intents  and
purposes as he might or could do in person, hereby ratifying and confirming that
all said attorneys-in-fact and agents, or any of them or their or his substitute
or substituted, may lawfully do or cause to be done by virtue hereof.

         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
Company and in the capacities and on the dates indicated.



Date:  September 4, 1998            /s/ Scott J. Solano
                                    -------------------------------------------
                                    Scott J. Solano
                                    President, Chief Executive Officer and
                                    Chairman of the Board of Directors
                                    (Principal Executive Officer)



Date:  September 4, 1998            /s/ John D. Miller
                                    -------------------------------------------
                                    John D. Miller
                                    Chief Financial Officer, Treasurer
                                    and Director
                                    (Principal Financial and Accounting Officer)



Date:  September 4, 1998            /s/ Craig E. Dauchy
                                    -------------------------------------------
                                    Craig E. Dauchy
                                    Director



Date:  September 4, 1998            /s/ George B. Borkow
                                    -------------------------------------------
                                    George B. Borkow
                                    Director

                                       36
<PAGE>


              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                    YEARS ENDED JUNE 30, 1998, 1997 AND 1996

                                      with

                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS



                                       37
<PAGE>



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS



Board of Directors and Stockholders
Arterial Vascular Engineering, Inc. and Subsidiaries

We have  audited  the  accompanying  consolidated  balance  sheets  of  Arterial
Vascular  Engineering,  Inc. and  Subsidiaries as of June 30, 1998 and 1997, and
the related  consolidated  statements of operations,  stockholders'  equity, and
cash flows for each of the three years in the period ended June 30, 1998.  These
consolidated  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 consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Arterial Vascular Engineering,  Inc. and Subsidiaries at June 30, 1998 and 1997,
and the consolidated statements of its operations and its cash flows for each of
the three years in the period ended June 30, 1998 in conformity  with  generally
accepted accounting principles.



                                                               ERNST & YOUNG LLP

Palo Alto, California
July 17, 1998


                                       38
<PAGE>

<TABLE>
                              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                                          CONSOLIDATED BALANCE SHEETS
                                     (In thousands, except per share data)
<CAPTION>
                                                                                            June 30,
                                                                                ---------------------------------
                                                                                       1998              1997
                                                                                ---------------    --------------
<S>                                                                                   <C>               <C>
                                   ASSETS
Current assets:
     Cash and cash equivalents                                                        $ 48,282          $ 25,036
     Short-term investments                                                            126,843            62,192
     Accounts receivable, net of allowance for doubtful accounts of                    109,851            22,850
          $9,687 and $1,080 at June 30, 1998 and 1997
     Inventories                                                                         9,524             7,302
     Deferred income tax                                                                14,687             2,413
     Prepaid expenses and other current assets                                           5,814             4,472
                                                                                ---------------    --------------
         Total current assets                                                          315,001           124,265

Property, plant and equipment, net                                                      71,095            21,759
Deferred income tax                                                                        896             1,598
Other assets                                                                               477               357
                                                                                ---------------    --------------
         Total assets                                                                 $387,469          $147,979
                                                                                ===============    ==============

                                LIABILITIES
Current liabilities:
   
     Accounts payable                                                                 $ 13,894         $   4,035
     Accrued employee bonus                                                             25,585               387
     Accrued expenses                                                                   27,530             5,357
     Income taxes payable                                                               43,482                 -
    
                                                                                ---------------    --------------
         Total current liabilities                                                     110,491             9,779
                                                                                ---------------    --------------

Commitments and contingencies (Note 7)

                            STOCKHOLDERS' EQUITY
Preferred Stock, $0.001 par value
     Authorized: 5,000 shares
     Issued and outstanding: None                                                            -                 -
Common Stock, $0.001 par value
     Authorized: 100,000 shares
     Issued and outstanding, including shares in treasury:  
         63,974 and 62,094 shares at June 30, 1998 and 1997                                 64                62
Additional paid-in capital                                                             117,281            92,990
Deferred compensation                                                                     (268)                -
Treasury Stock, at cost; 60 shares at June 30, 1998 and 1997                              (390)             (390)
Cumulative translation adjustment                                                       (1,731)           (1,364)
Retained earnings                                                                      162,022            46,902
                                                                                ---------------    --------------
     Total stockholders' equity                                                        276,978           138,200
                                                                                ---------------    --------------
     Total liabilities and stockholders' equity                                       $387,469          $147,979
                                                                                ===============    ==============

<FN>
               The accompanying notes are an integral part of these consolidated financial statements
</FN>
</TABLE>

                                       39
<PAGE>


<TABLE>
                         ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                                CONSOLIDATED STATEMENTS OF OPERATIONS
                                (In thousands, except per share data)
<CAPTION>
                                                                      Year Ended June 30,
                                                          ---------------------------------------------
                                                               1998             1997            1996
                                                          ------------    -------------    ------------

<S>                                                          <C>               <C>             <C>
Net sales                                                    $387,645          $79,420         $55,228
Cost of sales                                                  72,690           16,217          10,565
                                                          ------------    -------------    ------------
Gross profit                                                  314,955           63,203          44,663
                                                          ------------    -------------    ------------

Operating expenses:
   Research and development                                    37,208           11,422           6,480
   Selling, general and administrative                         96,964           22,510           8,437
                                                          ------------    -------------    ------------
     Total operating expenses                                 134,172           33,932          14,917
                                                          ------------    -------------    ------------

Operating income                                              180,783           29,271          29,746
Interest and other income                                       5,463            4,190           1,460
                                                          ------------    -------------    ------------
Income before provision for income taxes                      186,246           33,461          31,206
Provision for income taxes                                     71,126           11,711          10,766
                                                          ------------    -------------    ------------
Net income                                                   $115,120          $21,750         $20,440
                                                          ============    =============    ============

Net income per share - basic                                   $ 1.86           $ 0.37          $ 0.44

Net income per share - diluted                                 $ 1.76           $ 0.34          $ 0.36

Shares used to calculate net income per share:
   Basic                                                       61,989           58,447          46,926
   Diluted                                                     65,228           63,289          56,617



<FN>
               The accompanying notes are an integral part of these consolidated financial statements
</FN>
</TABLE>
                                       40
<PAGE>


<TABLE>
                                        ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                                           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                                           (In thousands)

<CAPTION>
                                                            Notes                                           Retained
                           Common Stock       Additional Receivable For                       Cumulative    Earnings
                           ----------------    Paid-in     Common      Deferred   Treasury    Translation (Accumulated
                            Shares    Amount   Capital      Stock     Compensation  Stock     Adjustment    Deficit)       Total
                           --------   -----   ----------   ---------   --------    -------    ----------    --------     ----------
<S>                         <C>       <C>       <C>        <C>          <C>        <C>        <C>           <C>          <C>
Balances, June 30, 1995     43,362    $ 43      $ 6,799    $ (3,126)    $ (299)    $    -     $      -      $   4,712    $    8,129

Issuance of common stock       220       -        1,321           -          -          -            -             -          1,321
Issuance of common stock     9,643      10           25           -          -          -            -             -             35
  upon exercise of stock
  options
    
Common stock offering        8,500       9       81,306           -          -          -            -             -         81,315
(Note 8)
Amortization of deferred         -       -            -           -        212          -            -             -            212
  compensation
Income tax reduction             -       -        2,294           -          -          -            -             -          2,294
  relating to stock
plans
Repayment of notes               -       -            -       2,825          -          -            -             -          2,825
receivable
Net income                       -       -            -           -          -          -            -        20,440         20,440
    
                           --------   -----   ----------   ---------   --------    -------    ---------    ----------     ----------
Balances, June 30, 1996     61,725      62       91,745        (301)       (87)         -            -        25,152        116,571
Issuance of common stock       369       -          204           -          -          -            -             -            204
  upon exercise of stock
  options
Treasury stock purchased         -       -            -           -          -       (390)           -             -           (390)
Amortization of deferred         -       -            -           -         87          -            -             -             87
  compensation
Income tax reduction             -       -        1,041           -          -          -            -             -          1,041
  relating to stock
  plans
Repayment of notes               -       -            -         301          -          -            -             -            301
receivable
Translation adjustment           -       -            -           -          -          -       (1,364)            -         (1,364)
Net income                       -       -            -           -          -          -            -        21,750         21,750
                           --------   -----   ----------   ---------   --------    -------    ---------    ----------     ----------
Balances, June 30, 1997     62,094      62       92,990           -          -       (390)      (1,364)       46,902        138,200
Issuance of common stock     1,880       2        4,764           -          -          -            -             -          4,766
  upon exercise of stock
  options and Employee
  Stock Purchase Plan
Deferred compensation            -       -          302           -       (302)         -            -             -              -
Amortization of deferred         -       -            -           -         34          -            -             -             34
  compensation
Income tax reduction             -       -       19,225           -          -          -            -             -         19,225
  relating to stock
  plans
Translation adjustment           -       -            -           -          -          -         (367)            -           (367)
Net income                       -       -            -           -          -          -            -       115,120        115,120
                           ========   =====   ==========   =========   ========    =======    =========    ==========     ==========
Balances, June 30, 1998     63,974    $ 64     $117,281    $      -    $ (268)     $ (390)    $ (1,731)    $ 162,022      $ 276,978
                           ========   =====   ==========   =========   ========    =======    =========    ==========     ==========


<FN>
               The accompanying notes are an integral part of these consolidated financial statements
</FN>
</TABLE>

                                                                 41
<PAGE>


<TABLE>

                         ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                                CONSOLIDATED STATEMENTS OF CASH FLOWS
                                            (In thousands)
<CAPTION>
                                                                   Year Ended June 30,
                                                          ------------------------------------
                                                            1998          1997          1996
                                                          --------     ---------     ---------
<S>                                                      <C>           <C>           <C> 
Cash flows from operating activities:
   Net income                                            $ 115,120     $  21,750     $  20,440
   Adjustments to reconcile net income to net cash
     provided by (used in) operating activities:
        Depreciation and amortization                        3,650         1,706           817
        Provision for doubtful accounts                      8,618           804           186
        Provision for obsolete inventory                     2,429           317           261
        Amortization of deferred compensation                   34            87           212
        Income tax reduction relating to stock plans        19,225         1,041         2,294
        Deferred income taxes                              (11,572)       (1,823)       (1,100)
        Changes in assets and liabilities:              
                                                        
        Short-term investments                             (64,651)      (29,838)      (31,054)
        Accounts receivable                                (95,927)      (11,348)       (8,422)
        Inventories                                         (5,111)       (4,912)       (2,693)
        Prepaid expenses and other current assets           (1,671)       (1,904)       (2,068)
        Accounts payable                                     9,884         2,405         1,319
        Accrued employee bonus                              25,280            56           183
        Accrued expenses                                    22,254         3,336         1,132
        Customer deposits                                     --            --          (1,405)
        Income taxes payable                                44,141        (1,633)         (603)
                                                        
                                                         ---------     ---------     ---------
            Net cash provided by (used in) operating        71,703       (19,956)      (20,501)
activities
                                                         ---------     ---------     ---------

Cash flows from investing activities:
   Proceeds of investments                                    --            --             100
   Acquisition of property, plant and equipment            (53,177)      (14,379)       (8,390)
                                                         ---------     ---------     ---------
            Net cash used in investing activities          (53,177)      (14,379)       (8,290)
                                                         ---------     ---------     ---------

Cash flows from financing activities:
   Increase in short-term borrowings                        17,471          --            --
   Repayment of short-term borrowings                      (17,471)         --            --
   Proceeds from issuance of common stock                    4,766           204        82,671
   Treasury stock purchased                                   --            (390)         --
   Repayment of notes receivable                              --             301         2,825
                                                         ---------     ---------     ---------
            Net cash provided by financing activities        4,766           115        85,496
                                                         ---------     ---------     ---------

Effect of exchange rate changes on cash and cash               (46)           18          --
   equivalents

Net increase (decrease) in cash and cash equivalents        23,246       (34,202)       56,705
Cash and cash equivalents, at beginning of period           25,036        59,238         2,533
                                                         ---------     ---------     ---------
Cash and cash equivalents, at end of period              $  48,282     $  25,036     $  59,238
                                                         =========     =========     =========

Supplemental cash flow information:
   Income taxes paid                                     $  19,701     $  14,206     $  10,175
Supplemental disclosures of non-cash investing and
financing activities:
     Transfer of available-for-sale investments to       $    --       $    --       $   1,300
trading


<FN>
               The accompanying notes are an integral part of these consolidated financial statements
</FN>
</TABLE>
                                       42
<PAGE>



              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Formation and Business of the Company

     Arterial  Vascular  Engineering,  Inc., (the "Company") was incorporated in
     Delaware  in  July  1991  to  address  the  rapidly  expanding  market  for
     angioplasty  products.  The Company  designs,  develops,  manufactures  and
     markets a variety of highly  specialized  stent  systems  and  percutaneous
     transluminal coronary angioplasty ("PTCA") balloon catheters. The Company's
     stents are used as arterial  support  devices in  connection  with  balloon
     angioplasty or other minimally invasive treatments of atherosclerosis  (the
     formation of deposits in the  arteries)  and to prevent  abrupt  closure of
     vessels  in  higher-risk  angioplasty  procedures.  The  Company  commenced
     operations  in 1991 and  began  marketing  its PTCA  balloon  catheters  in
     October  1993,  its  coronary  stent  systems  in  October  1994,  and  its
     peripheral stent systems in December 1996. In April 1996, the Company began
     its first  direct  sales  operation  in Europe and in  December  1997 began
     selling  directly in the United States.  Currently,  the Company has direct
     operations  in each of France,  Germany,  the  Netherlands  (to service the
     Benelux countries),  Switzerland, the United Kingdom and Singapore. In June
     1997, the Company's Japanese  distributor  received regulatory approval for
     the sale in Japan of the Company's  coronary stent systems,  and in January
     1998 the Company received the related reimbursement approval.

2.   Summary of Significant Accounting Policies

     Basis of Presentation

     The consolidated  financial  statements include the accounts of the Company
     and its wholly owned subsidiaries.  All significant  intercompany  accounts
     and transactions have been eliminated in consolidation.

     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 reported amounts of assets and liabilities and
     disclosure  of  contingent  assets  and  liabilities  at  the  date  of the
     financial  statements  and the  reported  amounts of revenues  and expenses
     during  the  reporting  period.  Actual  results  could  differ  from those
     estimates.

     Cash and Cash Equivalents

     The Company  considers  all highly  liquid  investments  purchased  with an
     original maturity of three months or less to be cash equivalents.  Cash and
     cash  equivalents are maintained with financial  institutions in the United
     States, Canada and Europe. Deposits in these banks may exceed the amount of
     insurance  provided on such  deposits.  These deposits may be redeemed upon
     demand and,  therefore,  bear minimal risk. The Company has not experienced
     any losses on its deposits of cash and cash equivalents.

     Investments

     The Company  classifies all investments as trading securities in accordance
     with Statement of Financial  Accounting  Standards No. 115, "Accounting for
     Certain  Investments  in Debt and Equity  Securities  (SFAS No. 115)." Such
     investments  are recorded at market value and unrealized  holding gains and
     losses are  reflected in earnings.  Market value is  determined by the most
     recent traded price of the security at the balance sheet date. Net realized
     gains or losses are determined on the specific identification cost method.

     During  the  year  ended  June  30,  1996,  the  Company  re-evaluated  its
     investment  policies and  reclassified  all investments  previously held as
     available-for-sale  to trading  securities.  The  reclassification  did not
     result in any unrealized gains or losses being included in net income.

     Accounts Receivable

     Accounts  receivable  consists of trade  receivables  arising from sales of
     product to  customers.  The  Company  does not require  collateral  for its
     receivables.  Reserves are maintained for potential  credit losses.  Actual
     losses may differ from the Company's  estimates which could have a material
     impact on the Company's future results of operations.

     Inventories

     Inventories are stated at the lower of cost (using the first-in,  first-out
     method) or market value. Provisions are made in each year for the estimated
     effects of excess and  obsolete  inventories.  Actual  excess and  obsolete
     inventories  may differ from the Company's  estimates and such  differences
     could be material to the consolidated financial statements.




                                       43
<PAGE>
              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

2.   Summary of Significant Accounting Policies (continued)

     Property, Plant and Equipment

     Property,   plant  and  equipment  are  stated  at  cost  less  accumulated
     depreciation and  amortization.  Depreciation and amortization of property,
     plant and  equipment is computed  using the  straight-line  method over the
     estimated useful lives of the respective  assets (three to forty years), or
     over  the  shorter  of the  lease  term  or the  estimated  useful  life of
     leasehold improvements.

     Construction  in  progress  consists  of  expenditures   incurred  for  the
     expansion of the Company's existing facilities.  Depreciation  commences as
     these assets are placed in service.

     Purchased Technology

     Purchased   technology   is   capitalized   at  cost  and  amortized  on  a
     straight-line basis over its useful life.

     Research and Development

     Research and development costs are expensed as incurred.

     Revenue Recognition

     The  Company  recognizes  revenue  upon  shipment  of product to  customers
     provided there is no conditional payment upon sale by the customer to other
     third  parties  and  provided  there  is  no  right  of  return  on  unsold
     merchandise.

     Income Taxes

     Income  taxes are  accounted  for under the asset and  liability  method of
     Statement of Financial Accounting Standards No. 109, "Accounting for Income
     Taxes  (SFAS No.  109)."  Under  SFAS No.  109,  deferred  tax  assets  and
     liabilities are recognized for the future tax consequences  attributable to
     differences  between the financial  statement  carrying amounts of existing
     assets and liabilities and their respective tax bases.  Deferred tax assets
     and liabilities are measured using enacted tax rates in effect for the year
     in which the differences  are expected to affect taxable income.  Valuation
     allowances are established  when necessary to reduce deferred tax assets to
     the amounts expected to be realized.

     Foreign Currency Translation

     The assets and  liabilities,  capital  accounts  and  revenue  and  expense
     accounts of the Company's  foreign  subsidiaries have been translated using
     the exchange rates at the balance sheet date,  historical  exchange  rates,
     and the  weighted  average  exchange  rates for the  period,  respectively.
     Adjustments  arising from the  translation of assets and  liabilities  held
     outside the United  States are  recorded as a  component  of  stockholders'
     equity.

     Key Suppliers

     The Company relies on some outside sources for catheter components and from
     time to time the  Company has  experienced  shortages  of certain  supplied
     materials  that have  significantly  affected its ability to produce enough
     product to satisfy  market  demand.  The  Company  currently  relies upon a
     single  supplier  of the  medical  grade  stainless  steel  from  which the
     Company's stents are machined. The Company is continually reviewing its own
     capabilities and the  capabilities of other potential  suppliers of medical
     grade stainless  steel,  although to date no such other suppliers have been
     able to produce  materials  meeting the Company's  quality  standards.  The
     Company has also agreed to  indemnify  certain  suppliers  against  certain
     potential  product liability  exposure.  The establishment of additional or
     replacement  suppliers  for  certain  components  or  materials  cannot  be
     accomplished  quickly,  largely  due to the  FDA  approval  system  and the
     complex nature of manufacturing  processes employed by many suppliers.  The
     failure  to  obtain  sufficient   quantities  of  component   materials  on
     commercially  reasonable  terms could have a material adverse effect on the
     Company's business, financial condition and results of operations.

     Net Income Per Share

     In 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
     Financial  Accounting  Standards  No.  128,  "Earnings  per Share (SFAS No.
     128)".  SFAS No. 128 replaced the  calculation of primary and fully diluted
     earnings  per share  with basic and  diluted  earnings  per  share.  Unlike
     primary earnings per share,  basic earnings per share excludes any dilutive
     effects of options and warrants. Diluted earnings per share is very similar
     to the previously reported fully diluted earnings per share. Net income per
     share - diluted, as reported, includes the effect of dilutive stock options
     (using  the  treasury  stock  method).  All net  income  per share  amounts
     presented have been restated to conform to SFAS No. 128 requirements, where
     appropriate.
                                       44
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

2.   Summary of Significant Accounting Policies (continued)
<TABLE>
     The table below sets forth the  computation of basic and diluted net income
     per share (in thousands, except per share data):
<CAPTION>
                                                                                Year Ended June 30,
                                                                        -------------------------------------
                                                                           1998         1997         1996
                                                                        -----------  -----------  -----------
<S>                                                                       <C>           <C>          <C>  
      Numerator:
           Net income                                                     $115,120      $21,750      $20,440
                                                                        -----------  -----------  -----------

      Denominator for net income per share - basic:
           Weighted average common shares outstanding                       61,989       58,447       46,926
      Denominator for net income per share - diluted:
           Effect of dilutive securities:
               Employee stock options                                        2,270        1,395        4,582
               Other dilutive securities                                       969        3,447        5,109
           Weighted average common shares and dilutive
                                                                        -----------  -----------  -----------
               securities outstanding                                       65,228       63,289       56,617
                                                                        -----------  -----------  -----------

      Net income per share - basic                                        $   1.86      $  0.37      $  0.44
      Net income per share - diluted                                      $   1.76      $  0.34      $  0.36
</TABLE>


     Stock Split

     On  February  4,  1998,  the  Company's  Board  of  Directors   declared  a
     two-for-one stock split to be effected in the form of a 100% stock dividend
     payable to  stockholders of record at the close of business on February 17,
     1998.  Distribution of the additional shares resulting from the stock split
     occurred  on March 2, 1998.  The stock split  resulted  in the  issuance of
     approximately  32  million   additional   shares.  All  references  in  the
     accompanying   consolidated  financial  statements  to  common  shares  and
     per-share  amounts for the current and prior  periods have been restated to
     reflect the stock split.

     Stock-Based Compensation

     Statement  of  Financial  Accounting  Standards  No. 123,  "Accounting  for
     Stock-Based  Compensation  (SFAS No. 123)," encourages but does not require
     companies to record compensation cost for stock-based compensation plans at
     fair  value.  The Company  elected to  continue to account for  stock-based
     compensation  using the  intrinsic  value method  prescribed  in Accounting
     Principles Board Opinion No. 25,  "Accounting for Stock Issued to Employees
     (APB No. 25)" and related Interpretations.

     Recent Accounting Pronouncements

     In June 1997, the Financial  Accounting Standards Board issued Statement of
     Financial  Accounting  Standards No. 130, "Reporting  Comprehensive  Income
     (SFAS No. 130)",  and Statement No. 131,  "Disclosure  about Segments of an
     Enterprise and Related Information (SFAS No. 131)." The Company is required
     to adopt these statements in fiscal year 1999. SFAS No. 130 establishes new
     standards  for  reporting  and  displaying  comprehensive  income  and  its
     components.  SFAS  No.  131  requires  disclosure  of  certain  information
     regarding  operating segments,  products and services,  geographic areas of
     operation and major customers.  Adoption of these statements is expected to
     have no impact on the Company's consolidated financial position, results of
     operations or cash flows.

3.   Financial Instruments

     Revolving Credit Agreement

     In August 1997,  the Company  signed a revolving  credit  agreement  with a
     financial  institution  under  which  the  Company  could  borrow up to $20
     million  for  the  construction  of  new  manufacturing  facilities  at its
     headquarters in Santa Rosa, California, with an interest rate of LIBOR plus
     one-half of one percent.  In April 1998, the entire outstanding balance was
     repaid,  and the credit  agreement was terminated.  The credit facility was
     secured by certain of the Company's short-term investments.




                                       45
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
   
3.   Financial Instruments (continued)
    

     Foreign Currency Instruments

     A substantial  element of the Company's revenues are currently derived from
     sales outside of the United States.  As a result,  the Company's  financial
     results will be affected by changes in foreign  currency  exchange rates to
     the extent  that such sales may be  denominated  in foreign  currency.  The
     Company is exposed to fluctuations in currencies in western Europe.

     During  the year  ended  June 30,  1997,  the  Company  began a program  of
     entering  into  derivative  financial  instruments  in the form of  forward
     exchange  contracts  ("forwards")  in order to reduce  the  uncertainty  of
     foreign  exchange  rate  movement on  inter-Company  sales  denominated  in
     foreign  currencies.  These  contracts are designed to  specifically  hedge
     against gains or losses incurred from foreign currency transactions and are
     not used for trading or speculative purposes. The Company has established a
     control   environment  that  includes  policies  and  procedures  for  risk
     assessment and the approval,  reporting and monitoring of foreign  currency
     hedging  activities.  Forwards are used to hedge material  foreign currency
     denominated  receivables and payables.  They are generally  settled between
     three to six months with gains or losses recorded in "Selling,  general and
     administrative"  expenses,  to offset  gains or losses on foreign  currency
     receivables  and  payables.  As of June 30,  1998,  the Company had no such
     currency hedging and instruments outstanding.

4.   Inventories

     Inventories comprise (in thousands):

   
                                                           June 30,
                                                    ------------------------
                                                        1998          1997
                                                    -----------   ----------
                      Raw materials                    $3,346      $   925
                      Work in process                   2,554        3,044
                      Finished goods                    3,624        3,333
                                                    -----------   ----------
                                                       $9,524       $7,302
                                                    ===========   ==========
    



5.   Property, Plant and Equipment

     Property, plant and equipment comprise (in thousands):

<TABLE>
<CAPTION>
   
                                                                                  June 30,
                                                                           ------------------------
                                                                              1998         1997
                                                                           -----------   ----------
<S>                                                                          <C>         <C>
                      Land                                                   $11,232     $  2,891
                      Buildings and improvements                              34,104        8,590
                      Manufacturing equipment                                 15,425        5,486
                      Computers and equipment                                  4,582        2,218
                      Furniture and fixtures                                   3,146        1,737
                      Leasehold improvements                                   3,342          872
                                                                           -----------   ----------
                                                                              71,831       21,794
                      Less accumulated depreciation and amortization          (6,311)      (2,575)
                                                                           -----------   ----------
                                                                              65,520       19,219
                      Construction in progress                                 5,575        2,540
                                                                           -----------   ----------
                                                                             $71,095      $21,759
                                                                           ===========   ==========
</TABLE>
    



                                       46
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

6.   Accrued Expenses

     Accrued expenses comprise (in thousands):


   
                                                             June 30,
                                                      ------------------------
                                                         1998         1997
                                                      -----------  -----------
                      Payroll and related benefits       $14,451       $1,874
                      Professional and other fees          5,377        1,089
                      Clinical trial costs                 3,792          432
                      Sales taxes                          2,463        1,160
                      Other accrued expenses               1,447          802
                                                      -----------  -----------
                                                         $27,530       $5,357
                                                      ===========  ===========
    

7.   Commitments and Contingencies

     Commitments

     The Company leases its facilities under operating lease agreements expiring
     in 1998 through 2007.  Total rent expense  under all  operating  leases was
     $369,000,  $898,000 and $1,345,000 for the years ended June 30, 1996,  1997
     and 1998,  respectively.  In  addition,  the Company  leases  vehicles  for
     certain of its European staff.

     The  future  minimum  annual  lease  payments  as of June  30,  1998  under
     operating leases are as follows:


                       Year Ending June 30,                (In thousands)
                       --------------------                              
                       1999                                        $1,385
                       2000                                         1,086
                       2001                                           733
                       2002                                           363
                       2003                                           194
                       Thereafter                                     254
                                                                ==========
                                                                   $4,015
                                                                ==========


   
The  Company has  commitments  under  various  construction  contracts  totaling
approximately $19.6 million.
    


                                       47
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
   
7.   Commitments and Contingencies (continued)
    
     Contingencies

     ESS  Litigation.  Effective as of October 1992, a subsidiary of the Company
     purchased substantially all the assets of Endothelial Support Systems, Inc.
     (subsequently  known as  Endovascular  Support  Systems,  Inc.)  ("ESS") in
     consideration  of certain royalty  payments payable by the Company based on
     the net sales of products  using or adapted from such  assets.  The Company
     was informed that the  shareholders  of ESS ratified the transaction on May
     27, 1993. The purchased  assets  included an application for a stent patent
     which  resulted  in a patent  owned by the  Company.  Following  such asset
     purchase,  the  Company,  between  June 1993 and March 1995,  purchased  in
     several  transactions  100% of the shares of capital  stock of ESS from its
     shareholders in consideration of shares of common stock of the Company and,
     in certain  instances,  other  consideration,  and ESS was merged  into the
     Company.

     On or about May 28, 1996, Dr. Azam Anwar and Benito  Hidalgo,  each of whom
     is a former  shareholder  of ESS (who  together held  approximately  48% of
     ESS's outstanding  shares of common stock) and each of whom currently holds
     shares of common  stock of the  Company,  filed a lawsuit  in the  District
     Court of Dallas  County,  Texas.  The suit names as defendants the Company,
     John D.  Miller,  a director,  officer  and  principal  stockholder  of the
     Company, Bradly A. Jendersee, a principal stockholder and a former director
     and officer of the Company, Dr. Simon H. Stertzer, a stockholder and former
     director of the  Company,  and Dr.  Gerald  Dorros,  a  stockholder  of the
     Company.  The plaintiffs allege multiple claims for relief,  including (but
     not limited to) common law fraud, negligent  misrepresentation,  securities
     fraud  pursuant to the Texas  Securities  Act,  fraud pursuant to the Texas
     Business and Commercial Code,  control person liability,  aider and abetter
     liability  of  the  individual  defendants,  civil  conspiracy,  breach  of
     fiduciary  duty, and  constructive  fraud in connection  with the Company's
     acquisition  of ESS and the Company's  acquisition of shares of ESS capital
     stock from the  plaintiffs.  The  plaintiffs  seek $395 million in damages,
     rescission  of  the  Company's  acquisition  of  the  ESS  assets  and  its
     subsequent  acquisition of the ESS stock,  reconstitution  of ESS, punitive
     damages, interest and attorneys' fees and other relief.

     The defendants, including the Company, have filed counterclaims against the
     plaintiffs.  The  defendants  allege claims  against Mr. Hidalgo for, among
     other  things,  specific  performance,  breach of  contract,  breach of the
     implied  covenant of good faith and fair dealing,  and  declaratory  relief
     based on  comparative  indemnity,  contribution  and absence of fraud.  The
     defendants  allege claims against Dr. Anwar for  intentional  and negligent
     interference  with  contract,  breach of contract,  defamation and business
     disparagement,  fraud,  equitable  estoppel and declaratory relief based on
     comparative indemnity,  contribution,  and absence of fraud. The defendants
     also added Mrs. Anwar and Mrs. Hidalgo as involuntary plaintiffs, seeking a
     declaration of Mrs.  Anwar's  ownership  interest in Dr. Anwar's shares and
     Mrs.  Hidalgo's interest in Mr. Hidalgo's shares. A trial date has been set
     for October 19, 1998.

     The Company  believes it has meritorious  defenses to the claims alleged by
     the plaintiffs,  and that it has meritorious claims against the plaintiffs,
     in the action.  However, no assurance can be given as to the outcome of the
     action.  The  inability of the Company to prevail in the action,  including
     the loss or  impairment  of the  right  to  produce  products  based on the
     Company's  issued  patents,  could  have a material  adverse  effect on the
     Company's business, financial condition and results of operations.

     The  Company  has  agreed to  indemnify  each of the  individuals  named as
     defendants  in the  lawsuits  against  the  Company  relating  to  the  ESS
     transaction.

     U.S. Patent Litigation.  Two of the Company's competitors have filed claims
     against the Company with  respect to their  alleged  intellectual  property
     rights.  The Company has filed for  declaratory  and  injunctive  relief in
     connection  with  one  of the  competitors'  claims  and  for  damages  and
     declaratory and injunctive relief in connection with the other competitor's
     claim.

     On October 21, 1997, the Company  received notice that it had been named as
     an  additional  defendant,  along with Boston  Scientific  Corporation  and
     SCIMED  Life  Systems,  Inc.,  in a  lawsuit  originally  filed  by  Cordis
     Corporation   ("Cordis")   against   Guidant   Corporation   and   Advanced
     Cardiovascular Systems, Inc. in federal district court in Delaware.  Cordis
     alleges,  among other things, that the sale by the Company of its stents in
     the United States would infringe on certain patents licensed by Cordis. The
     complaint seeks  declaratory and injunctive  relief,  unspecified  damages,
     attorneys' fees and other relief.  On November 6, 1997, the Company filed a
     motion to dismiss Cordis'  complaint.  On December 29, 1997, Cordis filed a
     motion for  preliminary  injunctive  relief,  but on July 20, 1998,  Cordis
     withdrew such motion.

                                       48
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

7.   Commitments and Contingencies (continued)

     On  December  24,  1997,   the  Company   received   notice  that  Advanced
     Cardiovascular  Systems, Inc. ("ACS"), a subsidiary of Guidant Corporation,
     had filed a lawsuit  against the Company in federal  district  court in San
     Jose,  California.  ACS alleges,  among other  things,  that the Company is
     selling in the United  States  stents that  infringe on certain  patents of
     ACS.  On April 10,  1998,  ACS filed a second  lawsuit  against the Company
     alleging infringement of a patent that was granted subsequent to the filing
     of the initial lawsuit. This second lawsuit, also filed in federal district
     court in San Jose,  involves  a  division  application  that is within  the
     family of patents that are the subject of the initial lawsuit.  Each of the
     complaints seeks injunctive relief,  unspecified  damages,  attorneys' fees
     and other relief.  On June 1, 1998, the federal  district court in San Jose
     granted  the  Company's  motion to  transfer  each of the  lawsuits  to the
     federal district court in Delaware.

     On  December  26,  1997,  the  Company  filed an action  against  Johnson &
     Johnson, Cordis and Expandable Grafts Partnership in federal district court
     in Delaware.  The action seeks (i) a declaration  that certain  patents are
     invalid, void,  unenforceable and not infringed by the Company's activities
     with respect to its stent systems in the United States,  (ii) an injunction
     prohibiting  the  defendants  from asserting  infringement  of such patents
     against  the  Company  and (iii) a  declaration  that the  defendants  have
     violated certain antitrust laws.

     On February 18, 1998,  the Company  filed a lawsuit  against ACS in federal
     district  court in Delaware,  alleging  infringement  of two patents of the
     Company,  breach of contract,  misappropriation  of trade  secrets,  unfair
     competition,  and  conversion.  The complaint  seeks  unspecified  damages,
     attorney's  fees and other relief,  as well as a  declaration  that certain
     patents of ACS are invalid, void and unenforceable.

     On April 24, 1998, Johnson & Johnson Inc. and Expandable Grafts Partnership
     filed an action  against the Company in the Federal Court of Canada,  Trial
     Division in Toronto.  The claim alleges that the Company is selling certain
     stents in Canada that  infringe a Canadian  patent of the  plaintiffs.  The
     claim  seeks  declaratory  and  injunctive  relief,   unspecified  damages,
     attorney's fees and other relief.

     On June 15, 1998, C.R. Bard, Inc.  ("Bard") filed a writ of summons against
     the Company in the District Court of The Hague, the  Netherlands.  The writ
     alleges  that the  Company  is  selling  in the  Netherlands  certain  PTCA
     catheters  that  infringe  a  European  patent  of  Bard.  The  writ  seeks
     injunctive relief,  civil fines,  unspecified damages and costs. The patent
     in  question  will be  transferred  to the  Company  if the  Bard  Cath Lab
     Acquisition is consummated.

     On August 13, 1998, the Company filed a lawsuit  against Boston  Scientific
     Corporation  and its  subsidiary  SCIMED  Life  Systems,  Inc.  in  federal
     district  court in Delaware,  alleging  infringement  of two patents of the
     Company.  The  complaint  seeks  injunctive  relief,  unspecified  damages,
     attorneys' fees and other relief.

     The Company believes that it has meritorious defenses to the claims alleged
     by the plaintiffs,  and meritorious  claims against the defendants,  in the
     aforementioned  actions.  However,  no  assurance  can be  given  as to the
     outcome of the  actions.  The  inability  of the  Company to prevail in the
     actions,  including the loss or impairment of the right to produce products
     in the United States, could have a material adverse effect on the Company's
     business,  financial  condition  and results of  operations.  In the patent
     suits  that have  been and from  time to time will be filed by the  Company
     against its  competitors,  counterclaims  by the defendants with respect to
     the validity and enforceability of the Company's patents are likely and, if
     successful,  such counterclaims could have a material adverse effect on the
     Company's business, financial condition and results of operations.

     Claims  of  Terminated  Distributors.  In  connection  with  the  Company's
     termination  of  certain   distributor   relationships,   several  of  such
     distributors  have filed  claims  against the Company  with respect to such
     terminations.

     In November  1996, in  connection  with the  Company's  termination  of its
     distribution relationship with Alfatec-Medicor N.V. ("Alfatec-Medicor") and
     Medicor   Nederland   B.V.   ("Medicor   Nederland")  in  Belgium  and  The
     Netherlands,  respectively,  effective  September  30,  1996,  the  Company
     received notice of a lawsuit filed by Alfatec-Medicor in the Second Chamber
     of the Commercial Court of Brussels,  Belgium, alleging insufficient notice
     of termination of a distribution  agreement between the parties,  promotion
     costs,   personnel   restructuring  claims  and  additional   compensation.
     Alfatec-Medicor  seeks  compensation of BF189,389,135  (approximately  $5.2
     million using current exchange rates), of which BF30,000,000 (approximately
     $825,000)  is sought as a  provisional  payment.  A  pleadings  hearing  is
     scheduled for October 5, 1998.

     In  connection   with  the  Company's   termination  of  its   distribution
     relationship   in   France   with   Medi   Service,    S.A.R.L./Fournitures
     Hospitalieres  S.A.  effective  September  30, 1996,  the Company  received
     notice  from  such  distributor  that it had  filed an  action  before  the
     Tribunal de Grande Instance of Mulhouse in France seeking



                                       49
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

7.   Commitments and Contingencies (continued)

     compensation for breach of an alleged exclusive  distribution agreement for
     an  indeterminate  period between the parties.  The action included a claim
     for compensation equal to the total value of such  distributor's  business,
     which the distributor  valued at FF400,000,000  (approximately  $67 million
     using  current  exchange  rates).  The  Company  counterclaimed  for unpaid
     accounts  receivable  of  approximately  $1.8  million  and for damages for
     abusive legal proceedings. On September 23, 1996, the Tribunal rejected the
     distributor's  claims for damages for unlawful  termination  as well as the
     Company's counterclaim for abusive legal proceedings.  On February 2, 1998,
     the Tribunal ordered the distributor to pay the accounts  receivable sought
     by the Company and also ordered the Company to repurchase the distributor's
     remaining inventory,  tentatively valued at $921,500. On February 10, 1997,
     the distributor filed an appeal of the Tribunal's decision of September 23,
     1996 with the Court of Appeals of Colmar,  and the parties  have  exchanged
     briefs in the appellate proceeding. A final procedural hearing is scheduled
     for September 18, 1998.

     The  Company  has  consulted  with local  counsel in Belgium and France and
     believes that the termination of each of the distributor  relationships was
     lawful.  The  Company  understands  that under the laws of  Belgium,  under
     certain  circumstances,  certain indemnities may be claimed by distributors
     for insufficient  notice of termination  and/or goodwill  compensation.  No
     assurance  can be given as to the  outcome  of any  pending  or  threatened
     litigation.

     From time to time,  the  Company is  involved  in other  legal  proceedings
     arising in the ordinary course of its business.  As of the date hereof, the
     Company is not a party to any other legal proceedings with respect to which
     an adverse outcome would, in management's  opinion, have a material adverse
     effect  on the  Company's  business,  financial  condition  or  results  of
     operations.

8.   Stockholders' Equity

     Common and Preferred Stock

     During the year ended June 30, 1995, the Company  entered into a Restricted
     Stock Purchase  Agreement with certain directors and other  individuals.  A
     total of  6,877,000  shares  were  issued at fair  market  value under this
     agreement at $0.4545 per share.  All  purchases  of stock were  financed by
     issuance of notes  accumulating  interest at 8% per annum until repaid. The
     notes  were  fully  repaid at June 30,  1997.  All  shares  are  subject to
     repurchase by the Company pursuant to vesting over periods ranging from one
     to five  years  or upon  termination  of  employment.  At  June  30,  1998,
     1,183,000 shares were subject to repurchase.

     In January 1996, the Board of Directors  approved the Company's Amended and
     Restated  Certificate of  Incorporation  increasing the authorized  capital
     stock of the  Company  to  50,500,000  and  reducing  the par  value of the
     capital stock to $0.001 from $0.01.

     In February 1996, the Company amended its Certificate of  Incorporation  to
     increase the authorized capital stock of the Company to 105,000,000 shares.
     One hundred million (100,000,000) shares are designated common stock with a
     par value of $0.001,  and five million  (5,000,000)  shares are  designated
     preferred stock with a par value of $0.001.

     In April 1996, the Company  completed an initial public offering and issued
     8,500,000 shares of common stock, raising net proceeds of approximately $81
     million.

     In February  1997 the  Company's  Board of Directors  adopted a stockholder
     rights plan,  commonly  referred to as a "poison pill," that is intended to
     deter hostile or coercive attempts to acquire the Company.  In May 1998 the
     stockholder  rights plan was amended to account for the recent  increase in
     the market price of the Company's common stock. The stockholder rights plan
     enables  stockholders  to acquire shares of the Company's  common stock, or
     the common stock of an acquiror,  at a  substantial  discount to the public
     market  price  should  any  person  or group  acquire  more than 15% of the
     Company's common stock without the approval of the Board of Directors under
     certain circumstances.  The Company has reserved 1,000,000 shares of Series
     A Junior Participating  Preferred Stock for issuance in connection with the
     stockholder  rights plan.  The Company is authorized to issue an additional
     4,000,000  shares of preferred stock in one or more series with terms to be
     fixed by the Board of Directors without a stockholder vote.

     Stock Repurchase Program

     During the first quarter of fiscal 1997, the Board of Directors  authorized
     a stock  repurchase  program  pursuant to which the Company may  repurchase
     shares of its common stock with an aggregate value of up to $10 million.


                                       50
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

8.   Stockholders' Equity (continued)

     The  repurchases  were  made  from  time  to  time on the  open  market  at
     prevailing  market prices. In November 1997 the program was discontinued by
     the Board of Directors.  As of the termination of the program,  the Company
     had  repurchased  60,000 shares of its common stock at an aggregate cost of
     $390,000.

     Employee Stock Purchase Plan
     In July  1997,  the Board of  Directors  adopted  the 1997  Employee  Stock
     Purchase Plan (the "ESPP") under which 3,000,000 shares of common stock are
     reserved  for  issuance  under  the  terms of the  ESPP.  The ESPP  permits
     eligible  employees to purchase  common stock  through  payroll  deductions
     (which cannot exceed 20% of the employees eligible  compensation) at 85% of
     its fair market value on specified  dates.  Each offering under the ESPP is
     for a period of twenty-four  months,  and each offering  period consists of
     four purchase periods.  Approximately 70% of eligible  employees  currently
     participate  in the ESPP.  At June 30, 1998,  a total of 73,000  shares had
     been issued at an aggregate  purchase  price of  $1,222,000  and  2,927,000
     shares remain reserved for future issuance under the ESPP.

     Stock Option Plans

     From  1991 to 1996,  the Board of  Directors  granted  non-statutory  stock
     options allowing  employees,  directors,  and consultants of the Company to
     purchase  shares of the Company's  common  stock.  Stock option grants were
     awarded at the discretion of the Board of Directors and generally vest over
     a period of three years from the date of the grant, and unexercised options
     expire  upon  termination  of  employment  with the  Company  or after  the
     expiration  of five years  from the date of the grant.  No shares of common
     stock  under  stock  options  granted  from  1991 to 1996  are  subject  to
     repurchase. The difference between the exercise price and fair market value
     of the  Company's  common  stock at the date of issue of  certain  of these
     non-statutory  stock  options,  totaling  $902,000  has  been  recorded  as
     deferred  compensation and a component of stockholders'  equity. The entire
     compensation of $902,000 has been recognized as an expense through June 30,
     1997.

     In January 1996,  the Company  adopted the 1996 Equity  Incentive Plan (the
     "Incentive Plan") under which 1,600,000 shares of common stock are reserved
     for issuance  upon exercise of options  granted to employees,  officers and
     consultants of the Company.  In December  1996, the Company's  stockholders
     approved an increase in the number of shares of common  stock  reserved for
     issue under the  Incentive  Plan from  1,600,000 to  3,000,000.  In October
     1997,  the  Company's  stockholders  approved  an increase in the number of
     shares of common  stock  reserved for issue under the  Incentive  Plan from
     3,000,000 to 5,000,000. If any stock award granted under the Incentive Plan
     or any stock option granted pursuant to the Company's previous stock option
     program shall for any reason expire or otherwise terminate,  in whole or in
     part,  without  having been exercised in full, the stock not acquired shall
     revert to and again  become  issuable  under the  Incentive  Plan.  Options
     granted to employees and consultants  after January 1996 are made under the
     terms of the Incentive  Plan.  The Incentive  Plan is  administered  by the
     Board of Directors or a committee  appointed by the Board, which determines
     recipients and types of awards to be granted, including the exercise price,
     number of shares subject to the award and the exercisability  thereof.  The
     terms of stock options  granted under the Incentive  Plan generally may not
     exceed  10  years.  Restricted  stock  purchase  awards  granted  under the
     Incentive Plan may be granted  pursuant to a repurchase  option in favor of
     the Company in accordance with a service vesting schedule determined by the
     Board.  Stock  bonuses may be awarded in  consideration  for past  services
     without a  purchase  payment.  Stock  appreciation  rights  authorized  for
     issuance under the Incentive Plan may be tandem stock appreciation  rights,
     concurrent  stock  appreciation  rights or independent  stock  appreciation
     rights.  To date,  no  restricted  stock  awards,  stock  bonuses  or stock
     appreciation  rights  have been  granted  under  the  Incentive  Plan.  The
     Incentive Plan will terminate in January 2006,  unless terminated sooner by
     the Board of Directors.

     In January 1996, the Board adopted the 1996  Non-Employee  Directors' Stock
     Option Plan (the  "Directors'  Plan") to provide for the automatic grant of
     options to purchase shares of common stock to non-employee directors of the
     Company. The Directors' Plan is administered by the Board, unless the Board
     delegates  administration  to a committee of disinterested  directors.  The
     maximum  number of shares of common  stock that may be issued  pursuant  to
     options granted under the Directors' Plan is 200,000. Pursuant to the terms
     of the  Directors'  Plan,  each person serving as a director of the Company
     and who is not an employee of the Company (a "Non-Employee  Director"),  on
     the effective date of the initial public  offering of the Company's  common
     stock,  or the date such person first becomes a Non-Employee  Director will
     then automatically be granted an option to purchase 12,000 shares of common
     stock.  Each person  elected to be a  Non-Employee  Director and who is not
     elected  for  the  first  time,  on the  date  of  the  annual  meeting  of
     stockholders  each year  following  the first  registration  of any  equity
     securities  under Section 12 of the Securities  Exchange Act of 1934,  will
     automatically

                                       51
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

8.   Stockholders' Equity (continued)

     be granted an option to  purchase  4,000  shares of common  stock.  Options
     under the Directors' Plan will vest in 4 annual installments  commencing on
     the date one year  after the grant  date.  The  exercise  price of  options
     granted  under the  Directors'  Plan must equal or exceed  the fair  market
     value of the common stock granted on the date of grant.  No option  granted
     under the  Directors'  Plan may be exercised  after the  expiration  of ten
     years from the date it was granted.
<TABLE>
     A summary of the  activity  under the stock  option plans is as follows (in
     thousands, except per share data):
 
<CAPTION>

                                                   Reserved                            Optioned Shares 
                                                      but       --------------------------------------------------------
                                                   Unoptioned    Number of            Price             Weighted Average
                                                     Shares       Shares            Per Share            Exercise Price
                                                  ----------    ----------    ----------------------    ----------------
<S>                                                  <C>           <C>          <C>                        <C>  
        Balances, June 30, 1995                       4,338        11,644      $ 0.0009-$ 0.4545            $ 0.0152
          Shares reserved - 1996 plans                1,800             -              -                           -
          1991 option plan termination               (4,016)            -              -                           -
          Options exercised                               -        (9,642)     $ 0.0009-$ 0.0331            $ 0.0037
          Options granted                              (982)          982      $ 4.7728-$17.5625            $ 8.5740
          Options canceled                               80           (80)     $ 0.0009-$17.5625            $ 4.5808
                                                  ----------    ----------
        Balances, June 30, 1996                       1,220         2,904      $ 0.0009-$17.5625            $ 2.8265
          Shares reserved - 1996 plan                 1,400             -              -                           -
          Options exercised                               -          (370)     $ 0.0009-$10.5000            $ 0.5375
          Options granted                            (1,796)        1,796      $ 6.5000-$12.4375            $ 7.5935
          Options canceled                              148          (148)     $ 6.5000-$11.3750            $ 8.2575
                                                  ----------    ----------
        Balances, June 30, 1997                         972         4,182      $ 0.0009-$17.5625            $ 4.8220
          Shares reserved - 1996 plan                 2,000             -              -                           -
          Options exercised                               -        (1,808)     $ 0.0009-$29.2500            $ 1.9609
          Options granted                            (1,859)        1,859      $12.0000-$41.5000            $27.3692
          Options canceled                              229          (229)     $ 0.4545-$29.2500            $ 7.3151
          1991 options canceled & terminated            (66)            -           $ 0.4545                $ 0.4545
                                                  ----------    ----------
        Balances, June 30, 1998                       1,276         4,004      $ 0.0009-$41.5000            $16.5026
                                                  ----------    ----------
</TABLE>

<TABLE>
     The following  table  summarizes  information  concerning  outstanding  and
     exercisable  options as of June 30,  1998 (in  thousands,  except per share
     data):
<CAPTION>
                                                Options Outstanding                   Options Exercisable
                                        -------------------------------------        ----------------------
                                                    Weighted      Weighted                       Weighted
                                         Number      Average       Average            Number     Average
                   Range of                of       Remaining     Exercise              of       Exercise
                Exercise Prices          Shares    Contractual      Price             Shares      Price
            ---------------------       ---------  ------------  ------------        ---------  -----------
<S>                                        <C>         <C>         <C>                    <C>    <C>
            $ 0.0009 -$ 4.7728               378       4.9         $   2.705              224    $   2.132
            $ 6.0000 -$ 6.5000               887       8.6         $   6.480              149    $   6.460
            $ 6.6250 -$12.4375               896       8.3         $   9.816              233    $   9.965
            $15.7500 -$27.1250               998       9.2         $  22.351               31    $  22.660
            $27.6875 -$41.5000               845       9.6         $  33.375               12    $  29.267

            ---------------------       ---------  ------------  ------------        ---------  -----------
            $ 0.0009 -$41.5000             4,004       8.5         $  16.503              649    $   7.428
            =====================       =========  ============  ============        =========  ===========
</TABLE>

     At June 30, 1996, 1997 and 1998, options to purchase  1,489,000,  1,631,000
     and 649,000  shares of common stock were  exercisable  at weighted  average
     exercise prices of $0.02, $1.41 and $7.43, respectively.

     The Company has elected to continue to follow  Accounting  Principles Board
     Opinion No. 25, "Accounting for Stock Issued to Employees (APB No. 25)" and
     related  interpretations  in  accounting  for its  employee  stock  options
     because the alternative fair value accounting prescribed under Statement of
     Financial Accounting Standards



                                       52
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

8.   Stockholders' Equity (continued)

     No. 123, "Accounting for Stock-Based  Compensation (SFAS No. 123)" requires
     the use of  option  valuation  models  that were not  developed  for use in
     valuing employee stock options.  Under APB No. 25, no compensation  expense
     is recognized  because the exercise  price of the Company's  employee stock
     options  equals the  market  price of the  underlying  stock on the date of
     grant.

     Pro forma  information  regarding  net  income and net income per share has
     been  determined  as if the Company had  accounted  for its employee  stock
     options  granted  subsequent  to June 30, 1995 under the fair value  method
     prescribed  by SFAS No. 123. The fair value for these options was estimated
     at the date of grant using a  Black-Scholes  option  pricing model with the
     following  weighted average  assumptions for the years ended June 30, 1996,
     1997  and  1998:  expected  dividend  yield  of 0%,  expected  stock  price
     volatility  of 55% risk free  interest  rates  ranging from 3.50 percent to
     7.75 percent, and the expected life of options of 4 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 from 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.

     The weighted  average fair value of options granted in the years ended June
     30, 1996, 1997 and 1998 was $1.78, $2.74 and $9.99 per share respectively.

     The pro forma effect on net income for the years ended June 30, 1996,  1997
     and 1998 is not  representative  of the pro forma  effect on net  income in
     future  periods  because  it does not take  into  consideration  pro  forma
     compensation  expense  related  to  grants  made  prior  to  1996  and  the
     compensation expense that will be recognized in future years as the options
     become exercisable.

     Pro forma  information  regarding  net  income and net income per share has
     been  determined  as if the Company had  accounted  for its Employee  Stock
     Purchase  Plan under the fair value method  prescribed by SFAS No. 123. The
     fair value for the ESPP was estimated using a Black-Scholes  option pricing
     model with the  following  assumptions  for the year  ended June 30,  1998:
     expected  dividend yield of 0%, expected stock price  volatility of 55%, an
     expected term of 1.4 years,  and risk free interest rates ranging from 5.49
     percent to 6.00 percent.  The  weighted-average  fair value of the purchase
     rights granted in the year ended June 30, 1998 was $9.59.

     For the purpose of pro forma  disclosures,  the estimated fair value of the
     options is amortized to expense  over the options'  vesting  period and the
     estimated  fair value of employee  stock  purchase  shares is  amortized to
     expense over the twenty-four  months in each offering period. The Company's
     pro forma information follows (in thousands, except per share data):
<TABLE>
<CAPTION>
                                                                           Year Ended June 30,
                                                                   -------------------------------------
                                                                      1998         1997         1996
                                                                   -----------  -----------  -----------
<S>                                                                <C>           <C>          <C>
          Net income - as reported                                 $   115,120   $  21,750    $  20,440
          Net income - pro forma                                   $   108,523   $  20,698    $  20,424
          Net income per share - basic - as reported               $      1.86   $    0.37    $    0.44
          Net income per share - diluted - as reported             $      1.76   $    0.34    $    0.36
          Net income per share - basic - pro forma                 $      1.75   $    0.35    $    0.44
          Net income per share - diluted - pro forma               $      1.66   $    0.33    $    0.36

</TABLE>




                                       53
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

9.   Income Taxes
<TABLE>
     The  components of income before  provision for income taxes are as follows
(in thousands):
<CAPTION>
                                                           Year Ended June 30,
                                               ----------------------------------------------
                                                   1998            1997             1996
                                               -------------    ------------     ------------
<S>                                                <C>              <C>              <C>   
            United States                          $184,640         $31,522          $31,352
            Foreign                                   1,606           1,939             (146)
                                               -------------    ------------     ------------
            Income before provision for            $186,246         $33,461          $31,206
            income taxes
                                               =============    ============     ============
</TABLE>
<TABLE>
     The provision for income taxes is as follows (in thousands):

<CAPTION>
                                                              Year Ended June 30,
                                               ----------------------------------------------
                                                   1998            1997             1996
                                               -------------    ------------     ------------
<S>                                                 <C>             <C>              <C>
            Federal                                 $69,148         $11,611          $10,756
            State                                    12,892           1,000            1,006
            Foreign                                     658             923              104
                                               -------------    ------------     ------------
                                                     82,698          13,534           11,866
            Deferred taxes                          (11,572)         (1,823)          (1,100)
                                               -------------    ------------     ------------
                                                    $71,126         $11,711          $10,766
                                               =============    ============     ============
</TABLE>

<TABLE>
     The Company's effective tax rate differs from the U.S. federal statutory rate as follows:
<CAPTION>
                                                               Year Ended June 30,
                                               ----------------------------------------------
                                                    1998            1997             1996
                                               -------------    ------------     ------------
<S>                                                 <C>              <C>              <C>    
            Federal tax at statutory rate           35.0%            35.0%            35.0%
            State tax, net of federal benefit        4.2              1.7              2.2
            FSC benefit                             (1.0)            (3.6)            (4.6)
            Other                                    -                1.9              1.9
                                               -------------    ------------     ------------
                                                    38.2%            35.0%            34.5%
                                               =============    ============     ============
</TABLE>



                                       54
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

9.   Income Taxes (continued)

     Significant  components  of the  Company's  deferred tax assets,  which are
     related  primarily  to federal  temporary  differences,  are as follows (in
     thousands):


                                                              June 30,
                                                      --------------------------
                                                         1998          1997
                                                      ------------  ------------

          Foreign deferred profits and losses           $     113       $   594
          Depreciation and amortization                       896         1,598
          State taxes, net of federal benefit               4,579           300
          Reserves and accruals                             8,215           718
          Deferred compensation                               262           218
          Inventories                                       1,463           517
          Other                                                55            66
                                                      ------------  ------------
                                                        $  15,583       $ 4,011
                                                      ============  ============


10.  Employee Agreements

     In March  1995  and  February  1996,  the  Company  entered  into  employee
     agreements  with certain key officers and  directors  over terms of four to
     five years.  Employees  currently  under contract have an aggregate  annual
     compensation  of  $980,000  and have  been  granted  4,805,000  options  to
     purchase  common stock of the Company at exercise prices of between $0.0009
     and $6.625 per share of which 4,470,000  options had been exercised at June
     30,  1998.  The Company may  terminate  any  agreement  for cause,  and the
     compensation  and  benefits  under  the  employee  agreements  shall  cease
     effective upon date of termination. If an agreement is terminated by reason
     of disability,  the employee's compensation and benefits shall continue for
     the first twelve weeks of the incapacity.

     In February  1996,  the Company  entered  into  certain  amendments  to the
     employee agreements of Bradly A. Jendersee and Robert D. Lashinski,  former
     executive  officers  and  directors  of  the  Company.   Pursuant  to  such
     amendments,   each  of  Messrs.  Jendersee  and  Lashinski  agreed  to  the
     elimination of provisions entitling them to certain royalties from the sale
     or license by the  Company of  products  covered by patents  for which such
     persons were named as inventors.  In connection with such  amendments,  the
     Company  agreed to pay Messrs.  Jendersee  and  Lashinski  an  aggregate of
     approximately  $3.9  million  in cash  and  issue to them an  aggregate  of
     110,000  shares of Common  stock.  Such  payments to Messrs.  Jendersee and
     Lashinski  resulted in the  recognition  by the Company,  in the year ended
     June 30, 1996, a one-time compensation expense of $5.2 million.

11.  Employee Benefit Plan

     The Company maintains a 401(k) retirement plan (the "Plan").  Employees may
     defer a portion of their salary up to the maximum  allowed under IRS rules.
     The Company has the discretion to make  contributions  to the Plan. For the
     years ended June 30, 1996, 1997, and 1998 the Company contributed  $66,000,
     $88,000 and $0 to the Plan, respectively.


                                       55
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

12.  Geographic Area Information and Concentration of Credit and Other Risks

   
     The Company operates in the medical products  industry sector and currently
     markets and sells a significant proportion of its products  internationally
     in Europe  and Asia.  Approximately  6% of total  consolidated  assets  are
     located  outside of the United States.  Over 19% of the Company's  revenues
     for the year ended June 30, 1998 and over 45% of the fiscal  1997  revenues
     were   derived   from   export   sales  to   non-affiliated   international
     distributors.  For the year ended June 30,  1998,  the Company had sales to
     one customer  representing  11% of net sales.  The Company performs ongoing
     credit  evaluations of its customers and provides an allowance for expected
     losses. Sales to both distributors and directly to hospitals and clinics as
     a percentage of total net sales by geographical region are as follows:
    

                                              Year Ended June 30,
                                   ------------------------------------------
                                      1998            1997           1996
                                   -----------     -----------    -----------
            USA                           65%               -              -
            Europe                        19%             75%            76%
            Asia                          12%              9%            16%
            Rest of World                  4%             16%             8%
                                         100%            100%           100%
                                   ===========     ===========    ===========


13.   Subsequent Events

     On April 10,  1998,  the Company  entered  into a  definitive  agreement to
     acquire World  Medical  Manufacturing  Corporation.  Under the terms of the
     agreement, World Medical's outstanding stock will be exchanged for, and its
     outstanding  stock options  converted into,  stock and stock options of the
     Company  valued  at  approximately  $62  million,  in a  transaction  to be
     accounted  for as a purchase.  The  exchange  ratio will be  determined  in
     accordance  with a formula  based on the  average  price of Company  common
     stock during a period prior to the closing of the  acquisition,  subject to
     certain  adjustments.  The Company expects to incur a significant  one-time
     charge related to the acquisition, largely in connection with the write-off
     of in-process  research and development.  The acquisition is expected to be
     completed in autumn 1998 and is subject to the approval of  shareholders of
     World Medical and certain other conditions.

     On July 9, 1998,  the Company  entered  into a  definitive  agreement  with
     respect  to the  Bard  Coronary  Cath  Lab  business.  The  transaction  is
     structured as an acquisition of the assets and certain  liabilities of Bard
     related to, and the  acquisition of stock of certain  subsidiaries  of Bard
     (the "Bard Subsidiaries")  engaged in the coronary catheter lab business of
     Bard (the "Business"),  and is to be accounted for as a purchase.  Pursuant
     to the  agreement,  the  Company  will not  acquire  any  cash or  accounts
     receivable of the Business in  consideration  of the $550 million  purchase
     price,  but  will  purchase  the  trade  accounts  receivable  of the  Bard
     Subsidiaries  for  an  amount  equal  to  95% of the  book  value  of  such
     receivables as of the closing of the transaction  after deducting  reserves
     for  doubtful  accounts.  The product  offerings  of the  Business  include
     coronary  PTCA  balloon  catheters   (including  perfusion  rapid  exchange
     catheters),  guidewires, guide catheters, coronary diagnostic catheters and
     guidewires;  introducers and vessel closure devices;  coronary stents;  and
     various other coronary components and accessories. In 1997, Bard's coronary
     catheter lab business reported revenues of approximately $215 million.  The
     Company  expects  to incur a  significant  one-time  charge  related to the
     acquisition,  largely  in  connection  with  the  write-off  of  in-process
     research and  development.  The  acquisition is expected to be completed in
     the  autumn of 1998.  When  closed,  these  acquisitions  are  expected  to
     substantially  increase the  Company's  personnel,  facilities  and product
     offerings  and to  enable  the  Company  to  participate  in new  areas  of
     interventional  cardiology  through a wider product portfolio and access to
     new markets and  customers.  However,  there can be no assurance that these
     acquisitions will be successfully consummated or, if consummated,  that the
     Company  will  successfully  participate  in new product  areas  subject to
     obtaining   antitrust  clearance  in  Ireland  and  certain  other  closing
     conditions.

     The Company expects to enter into a bank credit  agreement for $600 million
     in senior  secured  credit  facilities  in order,  among other  things,  to
     finance  substantially all of the Bard Cath Lab Acquisition.  The financing
     is expected to be subject to conditions  customary for transactions of this
     nature.




                                       56
<PAGE>
             ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

   
14.   Quarterly Financial Data (unaudited, in thousands except per share data)
    

                                 First        Second      Third        Fourth
                                Quarter      Quarter     Quarter      Quarter
                               ----------   ----------  -----------  ----------
       Net sales
         1998                  $26,263      $38,303     $141,203    $181,877
         1997                   18,568       18,228       20,402      22,222
       Gross profit
         1998                   20,774       30,647      113,657     149,878
         1997                   15,657       14,495       15,806      17,245
       Net income
         1998                    5,710        7,754       42,242      59,415
         1997                    7,765        4,606        4,633       4,746
       Net income per share
         1998 - Basic             0.10         0.12         0.67        0.95
         1998 - Diluted           0.09         0.12         0.64        0.90
         1997 - Basic             0.13         0.08         0.07        0.08
         1997 - Diluted           0.12         0.07         0.07        0.07


                                       57
<PAGE>


                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
                         ON FINANCIAL STATEMENT SCHEDULE

         We have  audited  the  consolidated  financial  statements  of Arterial
Vascular  Engineering,  Inc. and  Subsidiaries as of June 30, 1998 and 1997, and
for each of the three years in the period ended June 30,  1998,  and have issued
our report thereon dated July 17, 1998 (included elsewhere in this Annual Report
on Form 10-K). Our audits also included the financial  statement schedule listed
in  Item  14(a)  of this  Annual  report  on Form  10-K.  This  schedule  is the
responsibility of the Company's management.  Our responsibility is to express an
opinion based on our audits.

         In our opinion,  the financial  statement  schedule  referred to above,
when considered in relation to the basic financial  statements taken as a whole,
presents fairly in all material respects the information set forth therein.


                                                               ERNST & YOUNG LLP


Palo Alto, California
July 17, 1998



                                       58
<PAGE>

   
                                                                     SCHEDULE II
<TABLE>
              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                                 (in thousands)
<CAPTION>
                                                   Balance at       Charged to     Balance at
                                                   Beginning of     Costs and        End of 
                Description                        the Period        Expenses      the Period
                -----------                        ----------       ----------     ----------
<S>                                                 <C>              <C>             <C>   
Balances for the year ended June 30, 1996:
    Allowance for doubtful accounts receivable     $  104           $  186         $   290
    Allowance for obsolete inventory                   60              261             321
Balances for the year ended June 30, 1997:                                         
    Allowance for doubtful accounts receivable        290              790           1,080
    Allowance for obsolete inventory                  321              314             635
Balances for the year ended June 30, 1998:                                         
    Allowance for doubtful accounts receivable      1,080            8,607           9,687
    Allowance for obsolete inventory                  635            2,621           3,256

</TABLE>
    
                                       59
<PAGE>