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                      ECLIPSE SURGICAL TECHNOLOGIES, INC.
                           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 DECEMBER 31, 1997
                      Commission file number    0-28288

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

                     ECLIPSE SURGICAL TECHNOLOGIES, INC.
           (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

         CALIFORNIA                                        77-0223740
  ------------------------                            ----------------------
  (STATE OF INCORPORATION)                              (I.R.S. EMPLOYER
                                                      IDENTIFICATION NUMBER)

                                559 WEDDELL DRIVE
                           SUNNYVALE, CALIFORNIA 94089
                      (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                 (408) 747-0120
               ----------------------------------------------------
               (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

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

   TITLE OF EACH CLASS                  NAME OF EXCHANGE ON WHICH REGISTERED
   -------------------                  ------------------------------------
COMMON STOCK, NO PAR VALUE                    NASDAQ NATIONAL MARKET 

     Indicate by check mark whether the registrant (1) has filed all reports 
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 
1934 during the preceding 12 months (or for such shorter period that the 
registrant was required to file such reports), and (2) has been subject to 
such filing requirements for the past 90 days.

                            Yes   X    No
                                -----     -----

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

     Indicate the number of shares outstanding of each of the issuer's 
classes of common stock outstanding as of the last practicable date.

                             16,875,506 shares
                          As of February 27, 1998 


                     DOCUMENTS INCORPORATED BY REFERENCE


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                                                                                             PART OF FORM 10-K 
                                                                                           ANNUAL REPORT IN WHICH
                                  DOCUMENT                                                DOCUMENT IS INCORPORATED
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<S>                                                                                               <C>
Definitive Proxy Statement for the Registrant's Annual Meeting of Stockholders for the 
fiscal year ended December 31, 1997, to be filed pursuant to Regulation 14A.............          Part III
</TABLE>

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                                  INDEX TO FORM 10-K

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                                                                                                     PAGE
                                                                                                     ----
                                         PART I   
<S>                                                                                                    <C>
Item 1.   Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    1

Item 2.   Description of Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   14

Item 3.   Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   14

Item 4.   Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . .   14

                                         PART II

Item 5.   Market for Registrant's Shares and Related Shareholder Matters . . . . . . . . . . . . . .   15

Item 6.   Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . .   16

Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations. . .   17

Item 8.   Consolidated Financial Statements and Supplementary Schedules. . . . . . . . . . . . . . .   29

Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . .   29


                                        PART III

Item 10.  Directors and Officers of Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . .   29

Item 11.  Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   29

Item 12.  Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . .   29

Item 13.  Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . .   29


                                        PART IV

Item 14.  Exhibits, Financial Statement Schedule and Reports on Form 8-K . . . . . . . . . . . . . .   30

Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   46
</TABLE>
<PAGE>

                                       PART I

ITEM 1.   BUSINESS.

     THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT 
INVOLVE RISKS AND UNCERTAINTIES.  THE STATEMENTS CONTAINED HEREIN THAT ARE 
NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF 
SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT, 
INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, 
BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING 
STATEMENTS INCLUDED IN THIS DOCUMENT OR INCORPORATED BY REFERENCE HEREIN ARE 
BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE 
COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS.  
THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED 
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING 
THOSE ACT FORTH IN  ITEM 7 AND ELSEWHERE.

GENERAL

     The Company, incorporated in California in 1989,  designs, develops, 
manufactures and distributes laser-based surgical products and disposable 
fiber-optic accessories for the treatment of advanced cardiovascular disease 
through transmyocardial revascularization ("TMR") and percutaneous 
transluminal myocardial revascularization ("PTMR"). TMR and PTMR are new 
laser heart treatments in which millimeter channels are made in the heart 
muscle.   The pathways are intended to enable improved blood supply to the 
myocardium.  It is believed these procedures encourage new vessel formation, 
or angiogenesis, and result in reduced angina pain.  TMR is performed by a 
cardiac surgeon through a small incision in the chest.  PTMR is performed by 
a cardiologist in a catheter based procedure under local anesthesia.  Both 
procedures can be performed as stand alone treatments or adjunctively with 
coronary artery bypass graft ("CABG") or balloon angioplasty, respectively.  
The Company has ongoing clinical trials in each of these areas.  In the U.S., 
the Company currently offers its laser systems for sale in limited numbers 
for investigational use only pursuant to Investigational Device Exemptions 
("IDEs") from the U.S. Food and Drug Administration (the "FDA"). The 
Company's initial clinical trial is completed and an application to the FDA 
for preliminary marketing approval ("PMA") was submitted July 2, 1997.

BACKGROUND

     Cardiovascular disease is the leading cause of death and disability in 
the U.S., according to the American Heart Association (the "AHA"). Coronary 
artery disease is the principal form of cardiovascular disease and is 
characterized by a progressive narrowing of the coronary arteries, which 
supply blood to the heart. This narrowing process is usually due to 
atherosclerosis, the buildup of fatty deposits, or plaque, on the inner 
lining of the arteries. Coronary artery disease reduces the available supply 
of oxygenated blood to the heart muscle, potentially resulting in severe 
chest pain known as angina, as well as damage to the heart. Typically, the 
condition worsens over time and often leads to heart attack or death. 

     Based on standards promulgated by the Canadian Heart Association, angina 
is typically classified into four classes, ranging from Class I, in which 
anginal pain results only from strenuous exertion, to the most severe class, 
Class IV, in which the patient is unable to conduct any physical activity 
without angina and angina may be present even at rest. The AHA estimates that 
more than six million Americans experience anginal symptoms. 

     The primary therapeutic options for treatment of coronary artery disease 
are drug therapy, balloon angioplasty also known as percutaneous transluminal 
coronary angioplasty or ("PTCA"), other interventional techniques which 
augment or replace PTCA such as stent placement and atherectomy, and CABG. 
The objective of each of these approaches is to increase blood flow through 
the coronary arteries to the heart. 

     Drug therapy may be effective for mild cases of coronary artery disease 
and angina either through medical effects on the arteries that improve blood 
flow without reducing the plaque or by decreasing the rate of formation of 
additional plaque (E.G., by reducing blood levels of cholesterol). Because of 
the progressive nature of the disease, however, many patients with angina 
ultimately undergo either PTCA or open heart bypass surgery. 


                                       1
<PAGE>
     PTCA is a less-invasive alternative to CABG introduced in the early 1980s 
in which a balloon-tipped catheter is inserted into an artery, typically near 
the groin, and guided to the areas of blockage in the coronary arteries. The 
balloon is then inflated and deflated at each blockage site, thereby rupturing 
the blockage and stretching the vessel. Although the procedure is usually 
successful in widening the blocked channel, the artery often re-narrows within 
six months of the procedure, a process called "restenosis," often 
necessitating a repeat procedure. A variety of techniques for use in 
conjunction with PTCA have been developed in an attempt to reduce the 
frequency of restenosis, including stent placement and atherectomy. Stents are 
small metal frames delivered to the area of blockage using a balloon catheter 
and deployed or expanded within the coronary artery. The stent is a permanent 
implant intended to keep the channel open. Atherectomy is a means of using 
mechanical, laser or other techniques at the tip of a catheter to cut or grind 
away plaque. 

     CABG is an open chest procedure developed in the 1960s in which conduit 
vessels are taken from elsewhere in the body and grafted to the blocked 
coronary arteries so that blood can bypass the blockage. CABG typically 
requires use of a heart-lung bypass machine to render the heart inactive (to 
allow the surgeon to operate on a still, relatively bloodless heart) and 
involves prolonged hospitalization and patient recovery periods. Accordingly, 
it is generally reserved for patients with severe cases of coronary artery 
disease or those who have previously failed to receive adequate relief of 
their symptoms from PTCA or related techniques. Unfortunately, most bypass 
grafts fail within one to fifteen years following the procedure. Repeating the 
surgery ("re-do bypass surgery") is possible, but is made more difficult 
because of scar tissue and adhesions that typically form as a result of the 
first operation.  Moreover, for many patients CABG is inadvisable for various 
reasons, such as the severity of the patient's overall condition, the extent 
of coronary artery disease or the small size of the blocked arteries. 

     When these treatment options are exhausted, the patient is left with no 
viable surgical alternative other than, in limited cases, heart 
transplantation. Without a viable surgical alternative, the patient is 
generally managed with drug therapy, often with significant lifestyle 
limitations. TMR and PTMR, currently under clinical investigation by the 
Company and certain other companies, offer potential relief to a large class 
of patients with severe cardiovascular disease. 

THE TMR AND PTMR PROCEDURE 

     TMR, or transmyocardial revascularization, is a surgical procedure 
performed on the beating or non-beating  heart, in which a laser device is 
used to create pathways through the myocardium directly into the heart 
chamber. The pathways are intended to enable improved perfusion, or supply, of 
blood to the myocardium and reduce angina in the patient. TMR potentially can 
be performed using any of several different surgical approaches, including 
open chest surgery, minimally invasive surgery through a four inch incision 
between the ribs, or videoscopically through small openings or ports in the 
chest.  TMR potentially offers end-stage cardiac patients who are not 
candidates for PTCA or CABG a means to alleviate their symptoms and improve 
their quality of life. TMR may also be effective when used in conjunction with 
CABG to treat areas of the heart not treated after bypass surgery.  The 
Company has received IDEs from the FDA to conduct clinical trials which 
include TMR using an open chest approach, TMR in conjunction with CABG, TMR in 
a minimally invasive procedure, TMR with minimally invasive directed coronary 
artery bypass ("MIDCAB"), and TMR via small ports in the chest.  
   
     PTMR, or percutaneous transluminal myocardial revascularization, is an 
interventional procedure performed by a cardiologist.  PTMR is based upon the 
same principles as TMR, but the procedure is much less invasive. The patient 
is under local anesthesia, and is treated through a catheter inserted in the 
femoral artery at the top of the leg.  A laser transmitting catheter is 
threaded up into the heart chamber, where channels are created in the inner 
portion of the myocardium (i.e. heart muscle).  PTMR potentially offers angina 
sufferers another treatment option before being referred to a surgeon for a 
more invasive course of treatment.  PTMR may also be effective when used in 
conjunction with PTCA to treat areas of the heart not revascularized by a 
balloon or stent. The Company has received IDEs to conduct clinical trials 
studying PTMR, as well as PTMR in conjunction with PTCA.  

     The physiologic principles underlying TMR and PTMR as potential 
treatments for cardiovascular disease were first identified in the 1930s. It 
was observed then that, although the human myocardium depends on external 
coronary 

                                       2
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arteries for its blood supply, it displays elements of certain direct blood 
pathways found in reptilian hearts. In reptiles, blood is supplied directly to 
the myocardium through these pathways from the chambers of the heart. These 
observations led to a belief that impaired vascularization in the human 
myocardium could be treated by creating direct pathways through the myocardium 
into the heart chamber. Successes in other treatment techniques such as PTCA 
and CABG, however, as well as limitations in the technologies available to 
perform TMR and PTMR, limited the focus on TMR and PTMR until recently. 
Following numerous advancements in the use of laser technology in medical 
applications, human trials of laser-based TMR commenced in the 1980s and of 
PTMR in the 1990s. TMR and PTMR are  now being offered as  investigational 
procedures as part of clinical studies to determine the  safety and 
effectiveness of such procedures. 

BUSINESS STRATEGY

     The Company's objective is to become the leading supplier in the TMR and 
PTMR markets. The Company's strategies to achieve this goal are as follows: 

     DEMONSTRATE CLINICAL UTILITY OF TMR AND PTMR.  The Company is seeking to 
demonstrate the clinical safety and effectiveness of TMR and PTMR and achieve 
FDA approval of the Company's products through clinical trials. The Company's 
initial clinical trial commenced in November 1995 and is designed to assess 
the safety and effectiveness of the Company's TMR procedure as compared with 
drug therapy. The Company has commenced additional trials, including "TMR as 
an Adjunct to Bypass Surgery,"  "TMR as an Adjunct to Minimally Invasive 
Directed Coronary Artery Bypass," "TMR via Ports," "PTMR Compared to Drug 
Therapy," and "PTMR as an Adjunct to PTCA."  

     DEVELOP COMPREHENSIVE PRODUCT LINES FOR TMR AND PTMR.  The Company is 
seeking to develop multiple surgical platforms and provide a comprehensive 
suite of high quality products for TMR. The Company believes that its compact, 
flexible, fiber-optic based system will enable it to offer effective TMR 
solutions across the three principal TMR surgical approaches for TMR, open 
chest surgery, minimally invasive surgery and percutaneous TMR. The Company is 
also developing a broad range of disposable fiber-optic based surgical tools 
designed to operate with the Company's laser base unit and intended to provide 
physicians with a broad range of options for their individual tactile 
preferences and solutions for the different geometry of each patient's heart 
cavity. 

     LEVERAGE PROPRIETARY TECHNOLOGY.  The Company believes that its 
significant expertise in laser and catheter-based systems for cardiovascular 
disease and the proprietary technologies it has developed are important 
factors in its efforts to demonstrate the safety and effectiveness of its TMR 
procedures. The Company is  seeking to develop additional proprietary 
technologies for TMR and related procedures. The Company has 30 patents or 
allowed patent applications and 32 patent applications pending relating to 
various aspects of TMR, PTMR and other cardiovascular therapies. 

     EXPAND MARKET FOR THE COMPANY'S PRODUCTS.  The Company is seeking to 
expand market awareness of the Company's products among opinion leaders in the 
cardiovascular field, subject to appropriate regulatory guidelines. In 
connection with the current clinical trials, the Company has focused its 
initial efforts in the U.S. on the 200 hospitals that perform the greatest 
number of cardiovascular procedures. The Company also sells its products 
through its direct international sales organization and a network of 
distributors and agents. In addition, the Company has assembled a board of 
scientific advisors consisting of a number of influential cardiac surgeons and 
cardiologists. The Company has also developed a comprehensive training program 
to assist physicians in acquiring the expertise necessary to utilize the 
Company's TMR or PTMR products and procedures. The Company is seeking to expand
the approved indications for TMR or PTMR through additional clinical studies.

     RISK FACTORS

     The Company's success will depend upon successful completion of clinical 
trials, some of which are currently at an early stage; the receipt of FDA and 
other governmental approvals, which may take considerable time, and may not be 
granted at all; acceptance of TMR or PTMR, which are new surgical procedures, 
among the medical community; the ability to protect its intellectual property 
rights; the risks of claims of infringement of third party intellectual 
Company's property rights; the ability of the Company to manage change and 
growth in its business, particularly in light of the Company's limited history 
of TMR operations and history of operating losses; the status of medical 
reimbursement and 

                                       3
<PAGE>

other regulatory matters; the ability of the Company to succeed in light of 
significant competition; and other risks.  See "Certain Factors Bearing on 
Future Results" under Item 7.

PRODUCTS AND TECHNOLOGY

ECLIPSE TMR 2000 SYSTEM

     The Eclipse TMR 2000 system consists of the Eclipse TMR 2000 laser base 
unit and a line of fiber-optic, laser based surgical tools. Each surgical 
tool utilizes optical fiber to deliver laser energy from the source laser 
base unit to the distal tip of the surgical handpiece or PTMR catheter. The 
compact base unit occupies a small amount of operating room floor space, 
operates on a standard 208 or 220-volt power supply, features a 
self-contained cooling system which eliminates the need for electrical or 
plumbing modifications to the hospital operating room or catheterization 
laboratory where it is typically used on patients, and is light enough to 
move within the operating room or among operating rooms in order to use 
operating room space efficiently. Moreover, the flexible, lightweight and 
slender optical fiber used to deliver the laser energy to the patient enables 
ready access to the patient and to various sites within the heart. 

     The Eclipse TMR 2000 system and related surgical procedures are designed 
to be used without the requirement of the external systems utilized with 
certain competitive TMR systems. For example, the Eclipse TMR 2000 does not 
require electrocardiogram synchronization, which monitors the electrical 
output of the heart and times the use of the laser to minimize electrical 
disruption of the heart, or transesophageal echocardiography, which tests 
each application of the laser to the myocardium during the TMR procedure to 
determine if the pathway has penetrated through the myocardium into the heart 
chamber.

     ECLIPSE HOLMIUM LASER.  The Eclipse TMR 2000 laser base unit generates 
laser light of a 2-micron wavelength by photoelectric excitation of a solid 
state holmium crystal. The holmium laser, because it uses a solid state 
crystal as its source, is compact, reliable and requires low maintenance. The 
Company has been using holmium lasers since its inception. 

      DISPOSABLE SURGICAL TOOLS.  The Company offers to physicians a broad 
range of surgical tool options for their individual tactile preferences and 
solutions for the different geometry of each patient's heart cavity. These 
products are designed to give the surgeon control of the procedure, access to 
difficult to reach areas of the heart and clear visualization of the surgical 
field. Each such tool is designed for disposal after use in a single surgical 
procedure. The products include the following devices: 

           CRYSTALPOINT.  The CrystalPoint fiber-optic handpiece system 
      utilizes a single, one millimeter diameter optical fiber to deliver the 
      energy from the Eclipse TMR 2000 laser base unit to the targeted 
      surgical sites within the body. The single strand design provides 
      maximum tactile feedback to the surgeon, as he or she monitors the 
      penetration of the laser into the myocardium. The fiber-optic design 
      provides flexibility and maneuverability for the surgeon, particularly 
      as compared to the articulated mechanical arms required in connection 
      with CO2 laser-based devices. 

          CRYSTALFLEX AND SOLO-GRIP.  The CrystalFlex handpiece system is 
      comprised of multiple, fine fiber-optic strands in a one millimeter 
      diameter bundle. The CrystalFlex fiber delivers the same amount of 
      laser energy as the CrystalPoint, but the fiber bundle makes the 
      CrystalFlex more flexible than the CrystalPoint with its single solid 
      core. The CrystalFlex is used in conjunction with the Solo-Grip 
      handpiece to provide access to hard to reach sites within the heart 
      cavity while enabling single hand control.

          PTMR CATHETER AND SLIMFLEX.  The PTMR catheter is an over-the-wire, 
      steerable, disposable catheter system that features torque control, 
      deflection capability, infusion port, radioopaque markers for enhanced 
      visualization and depth control.  After insertion into an artery of the 
      leg, the PTMR catheter is advanced over the aortic arch, across the 
      aortic valve and into the heart chamber.  Visualization is achieved 
      using standard fluoroscopic or x-ray techniques common to all hospitals 
      doing cardiac catheterization.


                                       4
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     The CrystalPoint, CrystalFlex and SlimFlex fiber-optic handpieces each 
have an easy to install connector which screws into the laser base unit, and 
each device is pre-calibrated in the factory so it requires no special 
preparation.

REGULATORY STATUS 

     The Company has completed the final phase of a clinical study designed 
to assess the safety and effectiveness of TMR performed in an open chest 
procedure for the treatment of patients with Class IV angina as compared with 
drug therapy.  The Company originally received FDA clearance to commence this 
clinical study in September 1995, and undertook Phase I of the study shortly 
thereafter in November 1995. Phase I was intended to provide indications of 
safety prior to undertaking expanded clinical trials, and was completed in 
January 1996. In February 1996, the FDA reviewed the Phase I results and 
authorized commencement of Phase II.

     Phase II of the study involves a minimum of 126 patients and was 
completed in November 1996.  The Company began analyzing six month follow-up 
data from this trial in April 1997, prior to submission of a PMA application 
in July 1997. The Company was subsequently notified by the FDA that twelve 
month follow-up data would be required. Twelve month data became available in 
October 1997 and is being analyzed and prepared for submission as an 
amendment to the original PMA application. The Company intends to submit this 
additional data in the first quarter of 1998.

     In February 1996, the Company obtained FDA clearance to undertake Phase 
I of another clinical study of TMR intended to assess the safety and 
effectiveness of  "TMR Used in Conjunction with CABG" as compared with CABG 
alone. In September 1996, the FDA provided the Company with clearance to 
begin Phase II of this study which is currently in process.  During 1996 the 
Company was granted FDA clearance to begin Phase I of two additional clinical 
trials.  Both of these trials are currently in process.

     In January 1997, the Company received an IDE to begin its first 
minimally invasive clinical trial ,"TMR as an Adjunct to Minimally Invasive 
Direct Coronary Artery Bypass Surgery".

     In June 1997, the Company received an IDE from the FDA to begin its 
first PTMR clinical trial, comparing patients treated with PTMR to patients 
receiving only drug therapy.  In November 1997, the FDA gave the Company 
authorization to begin Phase II of this trial.

     In December 1997, the Company received its most recent IDE from the FDA, 
authorizing commencement of Phase I of another PTMR clinical trial.  This 
trial is studying PTMR in conjunction with PTCA or various other 
interventional procedures, compared to people receiving only PTCA.

     There can be no assurance that the results of the Company's studies will 
be sufficient to obtain the PMA required to commercialize its TMR products. 
Additionally, there can be no assurance that the Company will not be required 
to conduct additional trials which may result in substantial costs and 
delays. 

SALES AND MARKETING

     The Company is currently restricted to selling its TMR and PTMR products 
for investigational use only. Due to a  recent change in the Health Care 
Financing Administration ("HCFA") policy regarding Medicare reimbursement for 
TMR procedures, the Company expects revenues from sales of investigational 
devices to decrease and expenses in support of clinical trials to increase 
significantly over the short term and possibly thereafter. To the extent 
permitted under FDA rules, the Company is seeking to promote market awareness 
of the Company's products among opinion leaders in the cardiovascular field 
and to recruit physicians and hospitals to participate in the Company's 
clinical trials.  To address this market area, the Company maintains a 
domestic direct sales force consisting of nine sales people in the five sales 
regions and utilizes a regional distributor of cardiovascular surgical 
products to manage sales in the sixth designated U.S. sales region. In the 
event the FDA approves a PMA application for the Company's TMR products, the 
Company intends to expand its direct sales and support personnel. 


                                       5
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     The Company currently offers a laser base unit, at a current end user 
list price of $295,000 per unit, and disposable surgical tools (at least one 
of which must be used with each procedure) at an end user unit list price of 
$1,895 for a TMR handpiece or $2,295 for a PTMR catheter.  In order to assist 
hospitals in making a substantial investment in the Company's laser system, 
the Company intends to continue selling the systems to the hospital outright 
or placing the system with the hospital, for a placement fee (currently 
$25,000) plus an additional fee for each procedure performed.   The Company 
has also made contingency placements of its laser systems which are not taken 
as revenue until a sale ensues only after FDA approval is received or HCFA 
reimbursement becomes available.  

     The Company intends to continue to broaden its line of disposable 
products as part of its strategy to develop multiple platforms for TMR. The 
open chest, minimally invasive TMR procedures and percutaneous TMR procedures 
are made possible by the use of the Company's flexible, lightweight and 
slender fiber-optic based surgical tools. Open chest TMR procedures and 
minimally invasive TMR surgical procedures are performed by cardiac surgeons. 
In contrast, percutaneous TMR is performed by interventional cardiologists 
using catheter-based products. 

     Internationally, the Company sells its products through a direct sales 
and support organization of seven people and a network of distributors and 
agents.

     From September 1995 through December 31, 1997, the Company shipped 114 
systems worldwide.  

     The Company has developed, in conjunction with several major hospitals 
using the Company's TMR or PTMR products, a training program to assist 
physicians in acquiring the expertise necessary to utilize the Company's 
products and procedures. This program includes a comprehensive one-day course 
including observation of live procedures, didactic training and hands-on 
performance of TMR or PTMR in vivo. 

     The Company exhibits its products at major cardiovascular meetings and 
recruits new investigators to buy the Company's products for investigational 
use in their hospitals.  Investigators of the Company's products have made 
presentations at meetings around the world, describing their results.  
Abstracts have been published and articles will be submitted to peer-reviewed 
publications and industry journals to present the results of the ongoing 
clinical trials. 

SCIENTIFIC ADVISORY BOARD

     The Company's Scientific Advisory Board meets with the Company on an 
individual and group basis  to discuss the Company's TMR products and 
procedures, relevant developments in cardiology and the treatment of heart 
disease, and strategic directions. In addition, the Company has worked with 
the medical staffs of several major universities in developing the protocols 
for the Company's TMR procedures and in clinical data monitoring and 
statistical analysis. 

     The Scientific Advisory Board consists of a number of prominent members 
of the medical and scientific communities, including the following persons: 

<TABLE>
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Name                     Occupation/Title
----                     ----------------
<S>                      <C>
Eric Powers, M.D.        Professor of Medicine and Director
                         Cardiac Cath Laboratory
                         University of Virginia
  
Vaughn Starnes, M.D.     Professor of Surgery and Chief
                         Cardiothoracic Surgery
                         University of Southern California School of Medicine

 Eric Topol, M.D.        Chairman
                         Department of Cardiology
                         Cleveland Clinic Foundation
</TABLE>


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     In addition, the Company meets several times each year, during 
professional conferences and exhibitions, with the group of physicians who 
serve as investigators in connection with the Company's clinical trials, in 
order to discuss clinical procedures and results. 

RESEARCH AND DEVELOPMENT

     The Company's ongoing research and product development efforts are 
focused on the development of new and enhanced lasers, fiber-optic handpieces 
and TMR applications. In addition, the Company continues to develop new laser 
handpieces in order to enhance the utility and quality of the Company's line 
of disposable surgical tools and to expand the indications for use and 
variety of procedures that can be performed with the Company's surgical 
tools. Specifically, the Company is seeking to achieve continual improvements 
in its TMR procedure, including greater surgical access and visualization of 
the surgical field; greater precision in the placement of pathways; reduced 
epicardial bleeding and bruising of heart muscle; greater margins of safety 
with respect to underlying heart structures; and reduced likelihood of 
induction of arrhythmia. 

     In furtherance of the Company's strategy to develop the three principal 
surgical platforms for performance of TMR, current research efforts include 
enhancements to open chest surgical TMR as well as complementary techniques 
for minimally invasive surgical TMR and percutaneous TMR. In all these cases, 
the Company anticipates new disposable products will be required to satisfy 
market requirements.

     The Company's research and development spending, including expenditures 
related to clinical trials, was $12,007,000, $6,586,000 and $1,010,000, 
respectively, in 1997, 1996 and 1995. The Company expects that research and 
development expenses will continue to increase in connection with the 
Company's clinical trials and ongoing development efforts. Additionally, due 
to a May 1997 change in the HCFA policy regarding Medicare reimbursement for 
TMR procedures in clinical trials, the Company expects expenses in support of 
clinical trials to increase significantly at least over the short term and 
possibly thereafter.  See "Third Party Reimbursement".

     All medical products of the types produced by the Company require a PMA 
prior to commercial marketing in the U.S.  There can be no assurance that the 
Company will obtain a PMA from the FDA for the Company's TMR or PTMR 
products. 

MANUFACTURING AND QUALITY ASSURANCE

     The Company manufactures and assembles its products from purchased 
components and subassemblies, primarily at the Company's facility in 
Sunnyvale, California. 

     Each laser is mobile and shock resistant, complies with Underwriters 
Laboratory ("UL") standards and is equipped with safety interlocks and user 
friendly controls and meters. Company production personnel assemble and test 
each laser system in a process designed to test the integrity of the laser 
system and to provide for accurate calibration of system components. Upon 
completion of these tests, the laser is packaged for shipment. Company 
personnel uncrate and install the laser at the hospital, and verify that the 
system meets acceptance criteria, including all laser power output 
specifications. 

     Laser handpieces are fabricated from tubing, connectors and optical 
fibers, each of which is purchased from outside vendors. The individual 
optical fibers are cut to the appropriate length, bundled and placed in the 
extruded tubing and metal connectors, and the tip of the device is molded and 
polished. Prior to packaging, each handpiece is tested on a laser system to 
verify acceptable power output. 

     The Company's assembly and manufacturing activities to date have 
consisted primarily of producing limited quantities of its laser units and 
fiber-optic accessories for sale to clinical investigators. The Company's 
future profitability will depend, in part, on its ability to achieve 
manufacturing efficiencies as production volumes increase. 


                                       7
<PAGE>

     The core components of the Company's laser units and fiber-optic 
handpieces are generally acquired from multiple sources. The Company 
currently purchases certain laser and fiber-optic components and 
subassemblies from single sources. Although the Company has identified 
alternative vendors, the qualification of additional or replacement vendors 
for certain components or services is a lengthy process. Any significant 
supply interruption would have a material adverse effect on the Company's 
ability to manufacture its products and, therefore, would materially and 
adversely affect the Company's business, financial condition and results of 
operations. The Company intends to continue to qualify multiple sources for 
components that are presently single sourced and also to build an inventory 
of these items for use in the event of supply interruptions. 

     In May 1997, the Company received ISO  9001 Certification for its 
quality assurance process.  The Company is committed to continuous quality 
improvement in its manufacturing and assembly operations. Each subassembly 
and product is thoroughly tested at multiple stages of production to ensure 
proper operation and compliance with applicable regulatory standards. 
Manufacturing quality is documented and monitored continually under ISO 
guidelines.

     The Company is required to register as a manufacturer of medical devices 
with the FDA and state agencies such as the California Department of Health 
Services. As a condition to receipt of a PMA, the Company's facilities, 
procedures and practices will be subject to pre-approval GMP inspections and 
thereafter to ongoing, periodic inspections by the FDA and such other 
regulatory agencies. 

     The Company is also subject to certain federal, state and local 
regulations regarding environmental protection and hazardous substance 
controls, among others. Although the Company believes it currently complies 
in all material respects with such regulations, failure to comply could 
subject the Company to fines or other enforcement actions. 

     The Company provides to its customers in the U.S. and to its foreign 
distributors a free one-year parts and service warranty for each laser unit. 
The Company offers extended warranty coverage for one-year periods to 
customers in the U.S. The Company also performs service on a fee basis on 
laser units that are no longer covered by warranty. Annual service contracts 
are generally priced at 10% of the purchase price of the laser unit. 
Handpieces are sold without warranty. 

COMPETITION

     The Company expects that the market for TMR and PTMR, which is currently 
in the early stages of development, will be intensely competitive. 
Competitors include PLC Systems, Inc. ("PLC"), CardioGenesis Corporation 
("CardioGenesis"), Johnson and Johnson ("J&J"), and U.S. Surgical 
Corporation ("U.S. Surgical") which are currently selling TMR or PTMR 
products for investigational use in the U.S. and abroad. Other competitors 
may also enter the market, including large companies in the laser and cardiac 
surgery markets. Many of these companies have or may have significantly 
greater financial, research and development, marketing and other resources 
than the Company. 

     PLC is a publicly traded corporation which uses a CO2 laser and an 
articulated mechanical arm in its TMR products. PLC obtained an IDE to 
undertake clinical trials in January 1990. PLC has conducted extensive trials 
but has not yet received a PMA. PLC presented its results to an FDA advisory 
panel in July 1997 and was instructed to gather more data. PLC has received 
the CE Marking which allows sales of its products commercially in all 
European Union countries. PLC has been issued patents for its apparatus and 
methods for TMR. 

     CardioGenesis is a publicly held company which uses a holmium laser and 
fiber optics in its TMR and PTMR products. CardioGenesis has been issued 
patents for its methods of TMR and PTMR, is actively promoting its products 
in Europe through a distribution agreement with Boston Scientific Corporation 
and has begun clinical trials in the U.S. under an IDE. 

     J&J is a publicly traded company which uses a holmium laser and 
fiber-optics in its PTMR products.  J&J has acquired a ventricular mapping 
company to further its PTMR product line and has begun U.S. trials under an 
IDE.


                                       8
<PAGE>
     U.S. Surgical is a publicly traded company which uses an excimer laser 
and fiberoptics in its TMR products.  U.S. Surgical is actively promoting its 
products in Europe and has begun clinical trials in the U.S. under an IDE.  
U.S. Surgical has acquired one laser company and rights to products from 
another laser supplier.

     The Company believes that the factors which will be critical to market 
success include the timing of receipt of requisite regulatory approvals, 
effectiveness and ease of use of the TMR products and procedures on both a 
stand alone basis and in conjunction with other procedures such as CABG and 
PTCA, breadth of product line, system reliability, brand name recognition and 
effectiveness of distribution channels and cost of capital equipment and 
disposable devices. 

     TMR also competes with other methods for the treatment of cardiovascular 
disease, including drug therapy, PTCA and CABG. Although the Company is 
seeking to demonstrate the safety and effectiveness of the Company's TMR and 
PTMR procedures in patients for whom other cardiovascular treatments are not 
likely to provide relief, and when used in conjunction with other treatments, 
there can be no assurance that the Company's TMR or PTMR products will be 
accepted. Moreover, technological advances in other therapies for 
cardiovascular disease such as pharmaceuticals or future innovations in 
cardiac surgery techniques could make such other therapies more effective or 
lower in cost than the Company's TMR procedure and could render the Company's 
technology obsolete. There can be no assurance that physicians will use the 
Company's TMR procedure to replace or supplement established treatments, or 
that the Company's TMR procedure will be competitive with current or future 
technologies. Such competition could materially and adversely affect the 
Company's business, financial condition and results of operations. 

     Any product developed by the Company that gains regulatory approval will 
face competition for market acceptance and market share. An important factor 
in such competition may be the timing of market introduction of competitive 
products. Accordingly, the relative pace at which the Company can develop 
products, complete clinical testing and regulatory approval processes, gain 
reimbursement acceptance and supply commercial quantities of the product to 
the market are expected to be important competitive factors. In the event a 
competitor is able to obtain a PMA for its products prior to the Company, the 
Company's ability to compete successfully could be materially and adversely 
affected. There can be no assurance that the Company will be able to compete 
successfully against current and future competitors. Failure to do so would 
materially and adversely affect the Company's business, financial condition 
and results of operations.

GOVERNMENT REGULATION

     Laser-based surgical products and disposable fiber-optic accessories for 
the treatment of advanced cardiovascular disease through TMR are considered 
medical devices, and as such are subject to regulation in the U.S. by the FDA. 
The Company has FDA clearance for the sale of the Eclipse laser system for 
thoracic surgery. However, the Company has voluntarily submitted the device to 
the more rigorous PMA process with the objective of gaining approval for more 
specific labeling for the treatment of advanced cardiovascular disease. 

     To obtain a PMA for a medical device, the Company must file a PMA 
application that includes clinical data and the results of pre-clinical and 
other testing sufficient to show that there is a reasonable assurance of 
safety and effectiveness of the product for its intended use. To begin a 
clinical study, an IDE must be obtained and the study must be conducted in 
accordance with FDA regulations. An IDE application must contain preclinical 
test data demonstrating the safety of the product for human investigational 
use, information on manufacturing processes and procedures, and proposed 
clinical protocols. If the IDE application is cleared by the FDA, human 
clinical trials may begin. The results obtained from these trials, if 
satisfactory, are accumulated and submitted to the FDA in support of a PMA 
application. Premarket approval from the FDA is required before commercial 
distribution of devices similar to those under development by the Company is 
permitted in the U.S. In addition to the results of clinical trials, the PMA 
application must include other information relevant to the safety and 
effectiveness of the device, a description of the facilities and controls used 
in the manufacturing of the device, and proposed labeling. By law, the FDA has 
180 days to review a PMA application. While the FDA has responded to PMA 
applications within the allotted time frame, reviews more often occur over a 
significantly longer period and may include requests for additional 
information or extensive additional trials. There can be no assurance that the 
Company will not be required to conduct additional trials which may result in 
substantial 

                                       9
<PAGE>
costs and delays, nor can there be any assurance that a PMA will be obtained 
in a timely manner, if at all. In addition, changes in existing regulations or 
the adoption of new regulations or policies could prevent or delay regulatory 
approval of the Company's products. Furthermore, even if a PMA is granted, 
subsequent modifications of the approved device for the manufacturing process 
may require a supplemental PMA or the submission of a new PMA which could 
require substantial additional clinicial efficacy data and FDA review. After 
the FDA accepts a PMA application for filing, and after FDA review of the 
application, a public meeting is frequently held before an FDA advisory panel 
in which the PMA is reviewed and discussed. The panel then issues a favorable 
or unfavorable recommendation to the FDA or recommends approval with 
conditions. Although the FDA is not bound by the panel's recommendations, it 
tends to give such recommendations significant weight. 

     Products manufactured or distributed by the Company pursuant to a PMA 
will be subject to pervasive and continuing regulation by the FDA, including, 
among other things, postmarket surveillance and adverse event reporting 
requirements. Failure to comply with applicable regulatory requirements can 
result in, among other things, warning letters, fines, suspensions or delays 
of approvals, seizures or recalls of products, operating restrictions or 
criminal prosecutions. The Federal Food, Drug and Cosmetic Act ("FD&C Act") 
requires the Company to manufacture its products in registered establishments 
and in accordance with GMP regulations and to list its devices with the FDA. 
Furthermore, as a condition to receipt of a PMA, the Company's facilities, 
procedures and practices will be subject to additional pre-approval GMP 
inspections and thereafter to ongoing, periodic GMP inspections by the FDA. 
These GMP regulations impose certain procedural and documentation requirements 
upon the Company with respect to manufacturing and quality assurance 
activities. Labeling and promotional activities are subject to scrutiny by the 
FDA. Current FDA enforcement policy prohibits the marketing of approved 
medical devices for unapproved uses. Changes in existing regulatory 
requirements or adoption of new requirements could materially and adversely 
affect the Company's business, financial condition and results of operations. 
There can be no assurance that the Company will not be required to incur 
significant costs to comply with laws and regulations in the future or that 
current or future laws and regulations will not materially and adversely 
affect the Company's business, financial condition and result of operations. 

     The Company is also regulated by the FDA under the Radiation Control for 
Health and Safety Act, which requires laser products to comply with 
performance standards, including design and operation requirements, and 
manufacturers to certify in product labeling and in reports to the FDA that 
their products comply with all such standards. The law also requires laser 
manufacturers to file new product and annual reports, maintain manufacturing, 
testing and sales records, and report product defects. Various warning labels 
must be affixed and certain protective devices installed, depending on the 
class of the product. In addition, the Company is subject to California 
regulations governing the manufacture of medical devices, including an annual 
licensing requirement. The Company's facilities are subject to ongoing, 
periodic inspections by the FDA and California regulatory authorities. 

     Sales, manufacturing and further development of the Company's TMR and 
PTMR systems also may be subject to additional federal regulations pertaining 
to export controls and environmental and worker protection, as well as to 
state and local health, safety and other regulations that by locality, which 
may require obtaining additional permits. The impact of such regulations on 
the Company's business, financial condition and results of operations cannot 
be predicted. 

     Sales of medical devices outside of the U.S. are subject to foreign 
regulatory requirements that vary widely by country.  In addition, the FDA 
must approve the export of devices to certain countries. To market in Europe, 
a manufacturer must obtain the certifications necessary to affix to its 
products the CE Marking. The CE Marking is an international symbol of 
adherence to quality assurance standards and compliance with applicable 
European medical device directives. In order to obtain a CE Marking, a 
manufacturer must be in compliance with appropriate ISO 9001 standards and 
obtain certification of its quality assurance systems by a recognized European 
Union notified body. However, certain individual countries within Europe 
require further approval by their national regulatory agencies. Failure to 
receive the right to affix the CE Marking or other requisite approvals will 
prohibit the Company from selling its TMR products in member countries of the 
European Union or elsewhere, and there can be no assurance that the Company 
will be successful in meeting the European certification requirements.  In 
December 1996, the Company obtained a CE Marking for its TMR laser system. 

                                       10
<PAGE>
INTELLECTUAL PROPERTY MATTERS

     The Company's success will depend, in part, on its ability to obtain 
patent protection for its products, preserve its trade secrets, and operate 
without infringing the proprietary rights of others. The Company's policy is 
to seek to protect its proprietary position by, among other methods, filing 
U.S. and foreign patent applications related to its technology, inventions and 
improvements that are important to the development of its business. The 
Company has 30 patents or allowed patent applications and 32 patent 
applications pending relating to various aspects of TMR, PTMR and other 
cardiovascular therapies. There can be no assurance that any of the Company's 
patents or patent applications will not be challenged, invalidated or 
circumvented in the future or that the rights granted thereunder will provide 
a competitive advantage. The Company intends to vigorously protect and defend 
its intellectual property. It is uncertain whether patent protection will 
continue to be available for surgical methods in the future. Costly and 
time-consuming litigation brought by the Company may be necessary to enforce 
patents issued to the Company, to protect trade secrets or know-how owned by 
the Company, or to determine the enforceability, scope and validity of the 
proprietary rights of others. 

     The Company also relies upon trade secrets, technical know-how and 
continuing technological innovation to develop and maintain its competitive 
position. The Company typically requires its employees, consultants and 
advisors to execute confidentiality and assignment of inventions agreements in 
connection with their employment, consulting, or advisory relationships with 
the Company. There can be no assurance, however, that these agreements will 
not be breached or that the Company will have adequate remedies for any 
breach. Furthermore, no assurance can be given that competitors will not 
independently develop substantially equivalent proprietary information and 
techniques or otherwise gain access to the Company's proprietary technology, 
or that the Company can meaningfully protect its rights in unpatented 
proprietary technology. 

     The medical device industry in general, and the industry segment that 
includes products for the treatment of cardiovascular disease in particular, 
have been characterized by substantial competition and litigation regarding 
patent and other intellectual property rights. In this regard, competitors of 
the Company have been issued a number of patents related to TMR and PTMR. In 
September 1995 the Company received from a competitor a notice of potential 
infringement of the competitor's patent regarding a method for TMR utilizing 
synchronization of laser pulses to the electrical signals from the heart. In 
January 1996, the Company received from a second competitor a notice of 
potential infringement of the competitor's patents regarding methods to 
perform TMR/PTMR using fiber optics. The Company had concluded in each case, 
following discussion with its patent counsel, that it did not utilize the 
process and/or apparatus which is the subject of the patent at issue, and had 
responded to the respective competitor to such effect and has received no 
further correspondence on either matter. There can be no assurance, however, 
that further claims or proceedings will not be initiated by either competitor, 
or that claims by other parties will not arise in the future. Any such claims 
in the future, with or without merit, could be time-consuming and expensive to 
respond to and could divert the attention of the Company's technical and 
management personnel. The Company may be involved in litigation to defend 
against claims of infringement by the Company, to enforce patents issued to 
the Company, or to protect trade secrets of the Company. If any relevant 
claims of third party patents are upheld as valid and enforceable in any 
litigation or administrative proceeding, the Company could be prevented from 
practicing the subject matter claimed in such patents, or would be required to 
obtain licenses from the patent owners of each such patent or to redesign its 
products or processes to avoid infringement. 

     Patent applications in the United States are maintained in secrecy until 
patents issue, and patent applications in foreign countries are maintained in 
secrecy for a period after filing. Publication of discoveries in the 
scientific or patent literature tends to lag behind actual discoveries and the 
filing of related patent applications. Accordingly, there can be no assurance 
that current and potential competitors and other third parties have not filed 
or in the future will not file applications for, or have not received or in 
the future will not receive, patents or obtain additional proprietary rights 
that will prevent, limit or interfere with the Company's ability to make, use 
or sell its products either in the United States or internationally. In the 
event the Company were to require licenses to patents issued to third parties, 
there can be no assurance that such licenses would be available or, if 
available, would be available on terms acceptable to the Company, nor can 
there be any assurance that the Company would be successful in any attempt to 
redesign its products or processes to avoid infringement or that any such 
redesign could be accomplished in a cost-effective manner. Accordingly, an 

                                       11
<PAGE>
adverse determination in a judicial or administrative proceeding or failure to 
obtain necessary licenses could prevent the Company from manufacturing and 
selling its products, which would materially and adversely affect the 
Company's business, financial condition and results of operations. 

     Unrelated to the products used in its TMR procedure, the Company has 
received notices from three holders of patents requesting that the Company 
become a licensee. Although the Company believes that either these patents are 
subject to challenge as being invalid or are not infringed by the Company's 
products, there can be no assurance that the Company would prevail in any such 
action. In one case, the Company has taken a non-exclusive license to a patent 
involving arthroscopy use. In a second case, the Company buys components only 
from licensees of the patent holder, which the Company believes obviates the 
need for a separate license. In addition, the Company has received notice of 
interference of one of its patents involving products that the Company is not 
actively pursuing. The Company has received a non-exclusive license to the 
technology. Should the Company determine that it is necessary for it to obtain 
a license to any patents or intellectual property, there can be no assurance 
that any such license would be available on acceptable terms or at all, or 
that the Company would be able to develop or otherwise obtain alternative 
technology. Failure of the Company to obtain necessary licenses could prevent 
the Company from manufacturing and selling its products, which would 
materially and adversely affect the Company's business, financial condition 
and results of operations. 

THIRD PARTY REIMBURSEMENT

     The Company expects that sales volumes and prices of the Company's 
products will depend significantly on the availability of reimbursement for 
surgical procedures using the Company's products from third party payors such 
as governmental programs, private insurance and private health plans. 
Reimbursement is a significant factor considered by hospitals in determining 
whether to acquire new equipment. Reimbursement rates from third party payors 
vary depending on the third party payor, the procedure performed and other 
factors. Moreover, third party payors, including government programs, private 
insurance and private health plans, have in recent years been instituting 
increasing  cost containment measures designed to limit payments made to 
healthcare providers by, among other measures, reducing reimbursement rates, 
limiting services covered, negotiating prospective or discounted contract 
pricing and carefully reviewing and increasingly challenging the prices 
charged for medical products and services. 

     Medicare reimburses hospitals on a prospectively determined fixed amount 
for the costs associated with an in-patient hospitalization based on the 
patient's discharge diagnosis, and reimburses physicians on a prospectively 
determined fixed amount based on the procedure performed, regardless of the 
actual costs incurred by the hospital or physician in furnishing the care and 
unrelated to the specific devices used in that procedure. Medicare and other 
third party payors are increasingly scrutinizing whether to cover new products 
and the level of reimbursement for covered products. In addition, Medicare 
traditionally has considered items or services involving devices that have not 
been approved or cleared for marketing by the FDA to be precluded from 
Medicare coverage. Under a HCFA policy effective November 1, 1995, Medicare 
coverage will not be precluded for items and related services involving 
devices that have been classified by the FDA as "non-experimental/ 
investigational" ("Category B") devices and that are furnished in accordance 
with FDA-approved protocols governing clinical trials.  Even with items or 
services involving Category B devices, however, Medicare coverage may be 
denied if other coverage requirements are not met, for example if the 
treatment is not medically needed for the specific patient.  In November 1995, 
the Company received Category B designation for its TMR procedure from the 
HCFA. Accordingly, the Company's procedures had received third party 
reimbursement in many cases under HCFA's policy. As of May 19, 1997, although 
Category B status is retained, under a recent HCFA ruling, there will not be 
coverage for any manufacturer's TMR procedures at this time. There can be no 
assurance that this coverage will be given in the future or that Medicare will 
adequately reimburse the costs of the Company's TMR or PTMR procedures when 
and if a PMA is granted.  While the Company is unable to determine the 
ultimate effect of this policy change on the business and operating results, 
the Company anticipates that research and development expenses will increase 
significantly due to increased expenses in support of clinical trials, and 
revenues from sale of investigational products are likely to decrease, at 
least over the short term and possibly thereafter.

     The Company has limited experience to date with the acceptability of its 
TMR procedures for reimbursement by private insurance and private health 
plans. There can be no assurance that private insurance and private health 
plans will approve reimbursement for TMR or PTMR. 

                                       12
<PAGE>

     In foreign markets, reimbursement is obtained from a variety of sources, 
including governmental authorities, private health insurance plans and labor 
unions. In most foreign countries, there are also private insurance systems 
that may offer payments for alternative therapies. Although not as prevalent 
as in the U.S., health maintenance organizations are emerging in certain 
European countries. The Company may need to seek international reimbursement 
approvals, and there can be no assurance that any such approvals will be 
obtained in a timely manner, if at all. Failure to receive foreign 
reimbursement approvals could have an adverse effect on market acceptance of 
the Company's products in the foreign markets in which such approvals are 
sought. 

     The Company believes that reimbursement in the future will be subject to 
increased restrictions such as those described above, both in the U.S. and in 
foreign markets. The Company believes that the 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 that third party reimbursement and coverage will be 
available or adequate in U.S. or foreign markets, that current levels of 
reimbursement 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. Fundamental reforms in 
the healthcare industry in the U.S. and Europe that could affect the 
availability of third party reimbursement continue to be proposed, and the 
Company cannot predict the timing or effect of any such proposal. If third 
party payor coverage or reimbursement is unavailable or inadequate, the 
Company's business, financial condition and results of operations could be 
materially and adversely affected. 

PRODUCT LIABILITY AND INSURANCE

     The Company maintains insurance against product liability claims in the 
amount of $3 million per occurrence and $3 million in the aggregate, and 
expects to seek to increase such coverage if and when a PMA is obtained. 
However, there can be no assurance that such coverage will continue to be 
available in the amount desired or on terms acceptable to the Company, or 
that such coverage will be adequate for liabilities actually incurred. Any 
uninsured or underinsured claim brought against the Company, or any claim or 
product recall that results in significant cost to or adverse publicity 
against the Company, could materially and adversely affect the Company's 
business, financial condition and results of operations. 

EMPLOYEES

     As of December 31, 1997 the Company had 113 employees, including 39 in 
research and development, 33 in manufacturing, 27 in sales and marketing and 
14 in administration. All employees have entered into confidentiality 
agreements with the Company but the Company does not otherwise have 
employment agreements with any of its employees. None of the Company's 
employees is covered by a collective bargaining agreement and the Company has 
experienced no work stoppages to date. 


                                       13
<PAGE>

ITEM 2.  DESCRIPTION OF PROPERTY.  

     The Company's facilities are comprised of 36,990 square feet under five 
separate leases.  The facility contains a Class 10,000 clean room for laser 
handpiece and catheter fabrication. The leases expire from December 1998 
through December 2002.  The Company's headquarters are located in Sunnyvale, 
California.  The Company believes its facilities are adequate to meet its 
foreseeable requirements through at least 1998. There can be no assurance 
that additional facilities will be available to the Company, if and when 
needed, thereafter. 

ITEM 3.  LEGAL PROCEEDINGS.

     There are no pending legal proceedings against the Company other than 
ordinary litigation incidental to the Company's business, the outcome of 
which, individually or in the aggregate, is not expected to have a material 
adverse effect on the Company's business or financial condition.

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

     None.  


                                       14
<PAGE>

                                     PART II



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

     The Company's Common Stock is traded on the Nasdaq National Market under 
the symbol, ESTI, commencing May 31, 1996. For the periods indicated, the 
following table presents the range of high and low sale prices for the Common 
Stock as reported by the Nasdaq National Market. 

<TABLE>
<CAPTION>

            1997                                            High      Low
            ----                                            ----      ---
            <S>                                           <C>       <C>
            First Quarter. . . . . . . . . . . . . . .    $  9.75   $  4.88
            Second Quarter . . . . . . . . . . . . . .    $  8.50   $  4.88
            Third Quarter. . . . . . . . . . . . . . .    $ 10.00   $  6.75
            Fourth Quarter . . . . . . . . . . . . . .    $  9.50   $  5.50

<CAPTION>
            1996                                            High      Low  
            ----                                            ----      ---
            <S>                                           <C>       <C>
            First Quarter. . . . . . . . . . . . . . .        N/A       N/A
            Second Quarter . . . . . . . . . . . . . .    $ 19.00   $ 12.25
            Third Quarter. . . . . . . . . . . . . . .    $ 14.00   $  7.50
            Fourth Quarter . . . . . . . . . . . . . .    $ 14.00   $  7.25
</TABLE>

     As of December 31, 1997, shares of the Company's Common Stock were held 
by 156 registered shareholders.  

     The Company has never paid a cash dividend on its capital stock and does 
not anticipate paying any cash dividends on the Common Stock in the 
foreseeable future, as it intends to retain its earnings, if any, to generate 
increased growth and for general corporate purposes.


                                       15
<PAGE>

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA.

     The following selected consolidated financial data with respect to the 
Company for the five years ended December 31, 1997, are derived from the 
consolidated financial statements of the Company which have been audited by 
Coopers & Lybrand L.L.P. for the five fiscal years ended December 31, 1997.  
The data should be read in conjunction with the financial statements, related 
notes and other financial information included herein.

                         SELECTED CONSOLIDATED FINANCIAL DATA
                      (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>

                                                               YEAR ENDED DECEMBER 31,
                                                  -------------------------------------------------
                                                     1997      1996      1995      1994      1993
                                                  ---------  --------  --------  --------  --------
<S>                                               <C>       <C>        <C>       <C>       <C>
STATEMENT OF OPERATIONS DATA:
Net revenues . . . . . . . . . . . . . . . . .    $  5,499  $  9,759   $ 2,707   $ 2,020   $ 2,105
Cost of revenues . . . . . . . . . . . . . . .       2,779     3,558     1,642     1,173     1,013
                                                  --------   -------   -------   -------    ------
     Gross profit  . . . . . . . . . . . . . .       2,720     6,201     1,065       847     1,092
                                                  --------   -------   -------   -------    ------
Operating Expenses:
  Research and development . . . . . . . . . .      12,007     6,586     1,010       971       906
  Sales and marketing. . . . . . . . . . . . .       7,345     3,327       879       392       794
  General and administrative . . . . . . . . .       4,036     2,000       681     1,031       325
                                                  --------   -------   -------   -------    ------
Total operating expenses . . . . . . . . . . .      23,388    11,913     2,570     2,394     2,025
                                                  --------   -------   -------   -------    ------
     Operating loss  . . . . . . . . . . . . .     (20,668)   (5,712)   (1,505)   (1,547)     (933)
Interest and other income (expense), net . . .       2,421     1,556      (921)     (435)       (3)
                                                  --------   -------   -------   -------    ------
     Net loss  . . . . . . . . . . . . . . . .    $(18,247)  $(4,156)  $(2,426)  $(1,982)   $ (936)
                                                  --------   -------   -------   -------    ------
                                                  --------   -------   -------   -------    ------
     Net loss per share - basic and diluted  .    $  (1.11)  $ (0.30)  $ (0.23)  $ (0.19)   $(0.10)
                                                  --------   -------   -------   -------    ------
                                                  --------   -------   -------   -------    ------
     Shares used in per share calculation  . .      16,404    14,078    10,470    10,231     9,381 
                                                  --------   -------   -------   -------    ------
                                                  --------   -------   -------   -------    ------

<CAPTION>

                                                     1997      1996      1995      1994      1993
                                                  ---------  --------  --------  --------  --------
<S>                                               <C>        <C>       <C>       <C>       <C>
BALANCE SHEET DATA:
Cash and cash equivalents. . . . . . . . . . .    $ 16,997   $ 24,106  $    123  $    132  $   131 
Marketable securities. . . . . . . . . . . . .      18,197     27,957         -         -        - 
Working capital (deficit). . . . . . . . . . .      36,434     47,861    (1,549)      657      834 
Total Assets . . . . . . . . . . . . . . . . .      43,474     58,706     2,459     2,922    1,953
Long term debt less current portion. . . . . .          10         20         -     1,009        - 
Accumulated deficit. . . . . . . . . . . . . .     (28,418)   (10,171)   (6,015)   (3,589)  (1,607)
Total shareholders' equity (deficit) . . . . .      38,228     55,666    (1,429)     (139)   1,011 
</TABLE>


                                       16
<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS.
     
     THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
RESULTS OF OPERATIONS AND OTHER PARTS OF THIS REPORT ON FORM 10-K CONTAIN 
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES.  THE 
COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN 
SUCH FORWARD-LOOKING STATEMENTS.  FACTORS THAT MAY CAUSE SUCH A DIFFERENCE 
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "FACTORS AFFECTING FUTURE 
RESULTS."

OVERVIEW

     The Company was founded in 1989 as an outgrowth of certain research and 
development efforts initially undertaken by the Company's founders in the 
early 1980s related to the use of laser technology to treat cardiovascular 
disease. From 1989 through September 1995, the Company engaged in research, 
development and sale of surgical laser products principally for procedures 
such as atherectomy and arthroscopy.  In 1995, the Company determined that 
there is a significant opportunity in the TMR market, and that the Company is 
well-positioned to enter this market because of the Company's expertise with 
laser-based surgical techniques and the treatment of cardiovascular disease. 
Accordingly, in late 1995, the Company changed its strategic direction.

     Prior to 1996, the Company had focused almost exclusively on research 
and development activities relating to surgical laser products, substantially 
contributing to annual operating losses since inception. Since 1996, the 
Company has focused on TMR and PTMR activities, particularly research and 
development activities and clinical trials.  At December 31, 1997, the 
Company had an accumulated deficit of $28,418,000.  There are currently seven 
clinical trials in progress in either TMR or PTMR.  The Company has submitted 
an application to the FDA for marketing clearance ("PMA" or Pre-Market 
Approval) of its TMR products in the United  States.  The Company has 
received the European Conforming Mark ("CE Mark") allowing the commercial 
sale of its TMR laser system to the European Community.

     The Company expects to continue to incur operating losses related to the 
expansion of sales and marketing resources,  research and development 
activities, including clinical studies, and the continued development of 
corporate infrastructure. The timing and amounts of the Company's 
expenditures will depend upon a number of factors, including the progress of 
the Company's clinical trials, the status and timing of regulatory approval, 
the timing of market acceptance, if any, of the Company's products, and the 
efforts required to develop the Company's sales and marketing organization.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

REVENUES

     Net revenues of $5,499,000 for the year ended December 31, 1997 
decreased $4,260,000 or 44% when compared to net revenues of $9,759,000 for 
the year ended December 31, 1996. The decrease  resulted primarily from a 
change in the mix of lasers sold versus placed.  This change was primarily 
due to a Health Care Financing Administration ("HCFA") policy effective May 
19, 1997 which restricts Medicare reimbursement for TMR equipment and 
procedures.  The Company's products had received third party reimbursement 
under the preceding HCFA policy. Reimbursement is a significant factor 
considered by hospitals in determining whether to acquire new equipment. 

     Future revenues could continue to be affected by restrictions on third 
party reimbursement and the timing and manner of sale of a limited number of 
units of  TMR and PTMR laser systems. The Company intends to continue selling 
the systems to the hospital outright (list price is $295,000) or placing the 
system with the hospital for a placement fee (currently $25,000) plus an 
additional fee for each procedure performed.   The Company has also made 
contingency placements which are not taken as revenue until a sale ensues 
only after FDA approval is received or HCFA reimbursement becomes available. 
As a result of the HCFA policy restricting Medicare reimbursement for TMR 
equipment and procedures, the Company anticipates that these sales will 
continue to  be more difficult to obtain in the future than prior to the 
effective date of the policy.


                                       17
<PAGE>

GROSS PROFIT

     Gross profit decreased  to $2,720,000 or 49% of net revenues for the 
year ended December 31, 1997 as compared to $6,201,000 or 64% of net revenues 
for the year ended December 31, 1996. The decrease resulted from a higher 
level of manufacturing overhead associated with facility and infrastructure 
expansion including increased headcount, as well as a lower average sales 
price per laser in 1997 due to the higher mix of lasers placed versus sold in 
1997 as compared to 1996.

RESEARCH AND DEVELOPMENT EXPENSES

     Research and development expenditures of $12,007,000 increased 
$5,421,000 or 82% for the year ended December 31, 1997 when compared to 
$6,586,000 for the year ended December 31, 1996.  The increase in these 
expenses reflects a higher level of costs related to the development of new 
products, and increases in the number of clinical trials and the cost of 
supporting clinical trials, and an increase  in headcount to 39 from 25 
research and development employees at December 31, 1997 as compared to  
December 31, 1996.

     The Company's products are currently in clinical trials and therefore 
subject to limitations by the FDA. The Company believes that continued 
investment in the development of new and improved products and procedures and 
continued investment in the Company's clinical trials is critical to its 
future success. As a result of the new HCFA policy restricting Medicare 
reimbursement for TMR and PTMR equipment and procedures, the Company 
reimbursed clinical sites for expenses incurred in conjunction with 
performing clinical trials.  The Company anticipates a significant increase 
in future expenditures relating to hospital support of the Company's clinical 
trials as the number of clinical trials increases.  Accordingly, the Company 
believes that research and development expenses may continue to increase over 
the short term and possibly thereafter. There can be no assurance that the 
Company's future revenues, if any, will be sufficient to offset the research 
and development expenses required in connection with ongoing efforts 
including current and future clinical trials.

SALES AND MARKETING

     Sales and Marketing expenditures of $7,345,000 increased $4,018,000 or 
121% for the year ended December 31, 1997 when compared to $3,327,000 for the 
year ended December 31, 1996.  The increase is due primarily to a headcount 
increase to 27 in 1997 from nine in 1996.  This resulted in significant 
increases in salary, commission and travel expense. The additional headcount 
has been utilized in the areas of international sales, service, training and 
clinical support to the increasing number of clinical sites. The Company 
expects that sales and marketing expenses will continue to increase as the 
Company continues to focus resources on the development of the TMR and PTMR 
market.

GENERAL AND ADMINISTRATIVE

     General and administrative expenses increased to $4,036,000 in 1997 from 
$2,000,000 in 1996. The increase in 1997 as compared to 1996 reflects an 
increase in patent and patent related expenses.  At December 31, 1997, the 
Company had 30 patents or allowed patent applications and 32 patent 
applications pending relating to various aspects of TMR , PTMR and other 
cardiovascular therapies as compared to five and 29 at December 31, 1996.  
The increase also reflects expenses related to being a publicly traded 
company, including investor relations fees, legal, accounting and stock 
administration expenses incurred throughout the year as compared to seven 
months in 1996.

INTEREST INCOME AND EXPENSE, NET

     Interest income of $2,446,000 increased $694,000 or 40% for the year 
ended December 31, 1997 when compared to $1,752,000 for the year ended 
December 31, 1996.  This increase is due primarily to the investment of funds 
received in connection with an initial public offering in May 1996 for twelve 
months in 1997 as compared to seven months in 1996.


                                       18
<PAGE>

     Interest expense of $25,000 decreased $171,000 or 87% for the year ended 
December 31, 1997 when compared to $196,000 for the year ended December 31, 
1996.  This decrease reflects the use of funds from the initial public 
offering to repay debt, resulting in a lower debt level in 1997 as compared 
to 1996.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

REVENUES

     Revenues increased to  $9,759,000 in 1996 from $2,707,000 in 1995. The 
increase in 1996 as compared to 1995  was primarily due to the introduction 
of the Company's TMR products at the end of 1995 resulting in increased sales 
in the last quarter of 1995 and throughout 1996.  The increase in revenues 
also resulted in an increase in net accounts receivable to $2,483,000 at 
December 31, 1996 from $532,000 at December 31, 1995.   Since 1995, the 
Company has focused on the TMR market. Sales of TMR related products 
accounted for 98% and 32% of revenues in 1996 and 1995 respectively. 

GROSS PROFIT

     Gross profit increased  to $6,201,000 in 1996 from $1,065,000 in 1995. 
Gross margin increased to 64% in 1996, from a gross margin of 39% in 1995.  
The increase in gross margin in 1996 from 1995 reflects increased sales of 
TMR products which generally have a higher margin than non-TMR surgical 
products. 

RESEARCH AND DEVELOPMENT EXPENSES

     Research and development expenses increased to $6,586,000  in 1996 from 
$1,010,000 in 1995. The increase in these expenses in 1996  reflects a higher 
level of research and development expenses relating to TMR including costs 
related to the introduction of five new TMR products, filing 29 patent 
applications, costs to introduce and support four clinical trials, and an 
increase in headcount to 25 research and development employees at December 
31, 1996 from six at December 31, 1995. 

SALES AND MARKETING

     Sales and marketing expenses increased to $3,327,000 in 1996 from 
$879,000 in 1995.  The increase in 1996 reflects expansion of the Company's 
sales and marketing staff to nine in 1996 from six in 1995,  increased travel 
and trade show expenses, costs to develop the international market, and 
increased commission expense related to increased sales, expenses associated 
with the commencement of clinical trials for the Company's TMR products  and 
associated recruitment of participating physicians and hospitals.

GENERAL AND ADMINISTRATIVE

     General and administrative expenses increased to $2,000,000 in 1996 from 
$681,000 in 1995. The increase in 1996 as compared to 1995 reflects increased 
headcount to 12 at December 31, 1996 from five in December 31, 1995, and 
expenses related to being a publicly traded company, including investor 
relations fees, legal, accounting and stock administration expenses.  

INTEREST INCOME AND EXPENSE, NET

     Interest income, net of interest expense, of $1,556,000 in 1996 reflects 
investment income from the proceeds of the Company's public offering.  
Interest expense, net of interest income,  was $921,000 in 1995. The 
outstanding  debt at December 31,1995 was repaid from July 1996 through 
February 1997 resulting in a decrease in interest expense. 


                                       19
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

     Since its inception, the Company has satisfied its capital requirements 
primarily through sales of its equity securities and, to a lesser extent, 
loans from shareholders. In addition, the Company's operations have been 
funded in part through sales of the Company's products. At December 31, 1997, 
the Company had aggregate cash and marketable securities of  $35,194,000 and 
at December 31, 1996, the Company had cash and marketable securities of 
$52,063,000.  The Company used $17,374,000 and $6,173,000 for operating 
activities in1997 and 1996, respectively. At December 31, 1997, the Company 
had an accumulated deficit of $28,418,000.

     The Company anticipates that its current cash and marketable securities, 
together with sales of products for investigational use, will be sufficient 
to meet the Company's capital requirements through at least calendar year 
1998. There can be no assurance, however, that the Company will not require 
additional sources of cash at an earlier date in the future, depending upon 
the progress of expansion of the Company's clinical trials, any need for 
additional clinical trials or other testing of the Company's products, and 
the timing of other required expenditures as indicated above. If the Company 
is required to obtain additional financing in the future, there can be no 
assurance that capital will be available on terms acceptable to the Company, 
if at all.

RECENTLY ISSUED ACCOUNTING STANDARDS

     Management does not believe there are any recently issued accounting 
standards not yet adopted by the Company, the future adoption of which will 
have a material impact on the Company's financial position or results of 
operations.


                                       20
<PAGE>

FACTORS AFFECTING FUTURE RESULTS

     CERTAIN OF THE STATEMENTS ABOVE ARE FORWARD-LOOKING STATEMENTS.  IN 
ADDITION, THE COMPANY MAY FROM TIME TO TIME MAKE ORAL FORWARD-LOOKING 
STATEMENTS.  THE FOLLOWING ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL 
RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN ANY SUCH FORWARD-LOOKING 
STATEMENTS.

EARLY STAGE OF CLINICAL TRIALS

     The Company must obtain marketing clearance ("PMA") from the U.S. Food 
and Drug Administration (the "FDA") before the Company will be able to offer 
its products for TMR or PTMR on a commercial basis in the U.S.  A necessary 
prerequisite for submitting a PMA application is completion of clinical 
testing to demonstrate the safety and effectiveness of the Company's TMR 
products. 

      On July 2, 1997, the Company submitted a PMA  application to the FDA 
for use of the Eclipse laser system to treat patients with Class IV angina 
(chest pain) caused by coronary artery disease using the TMR procedure. The 
FDA review process can be lengthy and its results are uncertain.  There can 
be no assurance as to whether or when the FDA will approve this application.  
On July 28, 1997 an FDA panel recommended non-approval of a PMA application 
submitted by PLC Systems, Inc., a major competitor of the Company. The 
Company believes that this decision may have a significant impact on the 
FDA's review and approval of the Company's application. Subsequently, the FDA 
requested twelve month follow up data on all TMR applications in addition to 
the six month data previously provided. Although the Company has accumulated 
this data and is currently preparing it for submission to the FDA, there can 
be no assurance that the Company will not experience similar or other issues 
with the FDA which could have a material adverse impact on its business and 
operating results.

     Completion of the Company's clinical studies on a timely basis will 
depend, among other things, on the Company's ability to successfully 
establish TMR and PTMR sites and continue to identify and enroll 
participating patients in a timely fashion. In addition, the clinical studies 
will require substantial financial and management resources. There can be no 
assurance that the Company will have the resources necessary to complete such 
clinical studies. Furthermore, there can be no assurance that the Company's 
clinical studies will be completed within the currently anticipated time 
frame or otherwise in a timely manner, nor that such clinical studies will 
demonstrate the safety and effectiveness of the Company's  products to the 
extent necessary to obtain FDA and other regulatory approvals and establish a 
commercial market for the Company's products. Moreover, results of the 
initial clinical testing are not necessarily predictive of results to be 
achieved in later clinical studies, if undertaken, or commercially, if a PMA 
is obtained. Failure to complete the Company's clinical studies in a timely 
manner or to demonstrate the safety and effectiveness of the Company's TMR or 
PTMR products could delay or prevent regulatory approval and would materially 
and adversely affect the Company's business, financial condition and 
operating results.

NO ASSURANCE OF FDA OR OTHER REQUIRED GOVERNMENTAL APPROVALS

     The Company's products are regulated in the U.S. as medical devices by 
the FDA under the Federal Food, Drug, and Cosmetic Act ("FD&C Act") and, as 
such, require FDA approval of a PMA application prior to commercial sale in 
the U.S. The FDA approves PMA applications for specific indications only and 
FDA regulation prohibits commercial marketing in the U.S. of devices for 
indications that have not been approved by the FDA. The process of obtaining 
required regulatory approvals from the FDA and other regulatory authorities 
is lengthy, expensive and inherently uncertain, generally takes several years 
or longer to complete, if approval is obtained at all, and requires the 
submission of extensive clinical data and supporting information to the FDA.
 
     On July 2, 1997, the Company submitted a PMA application to the FDA for 
use of the Eclipse laser system to treat patients with Class IV angina (chest 
pain) caused by coronary artery disease using the TMR procedure. There can be 
no assurance that the FDA will approve this application in the foreseeable 
future if at all.  On July 28, 1997 an FDA panel recommended non-approval of 
a PMA application submitted by PLC Systems, Inc.  This decision may have an 
impact on the FDA's review and approval of the Company's application.  
Failure to obtain FDA approval on a timely 


                                       21
<PAGE>

basis or for the indications sought by the Company would materially and 
adversely affect the Company's business, financial condition and operating 
results. 

      The Company will also be required to follow applicable Good 
Manufacturing Practices ("GMP") regulations of the FDA, which include 
testing, control and documentation requirements, as well as similar 
requirements in other countries, including International Standards 
Organization ("ISO") 9001 standards. Although the Company became 9001 
certified in May 1997, failure to meet or to continue to satisfy these 
requirements in the future would preclude the Company from marketing its 
products on a commercial basis, and therefore would materially and adversely 
affect the Company's business, financial condition  and operating results.

     Sales of medical devices outside of the U.S. are subject to foreign 
regulatory requirements that vary widely by country. In addition, the FDA 
must approve the export of devices that require a PMA but are not yet 
approved domestically.  Foreign and domestic regulatory approvals, if 
granted, may include significant limitations on the indicated uses for which 
the product may be marketed. In addition, to obtain such approvals, medical 
device manufacturers must comply with numerous other requirements of the FDA 
and certain foreign regulatory authorities. For example, the European 
Conforming Mark (the "CE Mark") is required to sell products in European 
Union countries. The Company received CE Marking for its TMR laser in 
December 1996.  However, product approvals can be withdrawn due to various 
factors, including failure to comply with regulatory standards or unforeseen 
problems following initial marketing.

RISKS ASSOCIATED WITH NEW SURGICAL PROCEDURES; NO ASSURANCE OF MARKET 
ACCEPTANCE

     The Company's ability to successfully commercialize its TMR and PTMR 
products will depend upon its ability to achieve acceptance of its  products 
and procedures among cardiologists, cardiac surgeons and other members of the 
medical community as well as prospective patients. The Company believes that 
it will not achieve such acceptance until such time, if any, as the Company's 
TMR or PTMR products can be demonstrated to be safe, efficacious and 
cost-effective. Even if the clinical safety and effectiveness of the 
Company's TMR products is established, cardiologists, cardiac surgeons and 
other members of the medical community may elect not to recommend TMR or PTMR 
for any number of other reasons. Broad use of the Company's products will 
require training of numerous physicians, and the time required to complete 
such training could adversely affect market acceptance. Moreover, even if TMR 
and PTMR become generally accepted by the medical community, physicians 
trained in competitive  products may elect not to consider the Company's 
products, or may elect instead to recommend a competitor's products. Failure 
of the Company's products to achieve significant market acceptance would 
materially and adversely affect the Company's business, financial condition 
and operating results.

DEPENDENCE ON SINGLE PRODUCT LINE

     The Company has elected to focus its resources on the continued 
development and refinement of its TMR and PTMR  products. If the Company is 
unable to obtain requisite regulatory approvals or to achieve commercial 
acceptance of  these products, the Company's business, financial condition 
and operating results would be materially and adversely affected, which could 
result in cessation of the Company's business. 

UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS 
OF FUTURE LITIGATION

     The Company's success will depend, in part, on its ability to obtain 
patent protection for its products, preserve its trade secrets, and operate 
without infringing the proprietary rights of others. The Company's policy is 
to seek to protect its proprietary position by, among other methods, filing 
U.S. and foreign patent applications related to its technology, inventions 
and improvements that are important to the development of its business. 
Although the Company has a number of patents and patent applications pending 
relating to various aspects of TMR, PTMR and other cardiovascular therapies, 
there can be no assurance that any of the Company's patents or patent 
applications will not be challenged, invalidated or circumvented in the 
future or that the rights granted thereunder will provide a competitive 


                                       22
<PAGE>
advantage. The Company intends to vigorously protect and defend its 
intellectual property. It is uncertain whether patent protection will continue 
to be available for surgical methods in the future. Costly and time-consuming 
litigation brought by the Company may be necessary to enforce patents issued 
to the Company, to protect trade secrets or know-how owned by the Company, or 
to determine the enforceability, scope and validity of the proprietary rights 
of others. 

     The Company also relies upon trade secrets, technical know-how and 
continuing technological innovation to develop and maintain its competitive 
position. The Company typically requires its employees, consultants and 
advisors to execute confidentiality and assignment of inventions agreements in 
connection with their employment, consulting or advisory relationships with 
the Company. There can be no assurance, however, that these agreements will 
not be breached or that the Company will have adequate remedies for any 
breach. Furthermore, no assurance can be given that competitors will not 
independently develop substantially equivalent proprietary information and 
techniques or otherwise gain access to the Company's proprietary technology, 
or that the Company can meaningfully protect its rights in unpatented 
proprietary technology. 

     The medical device industry in general, and the industry segment that 
includes products for the treatment of cardiovascular disease in particular, 
have been characterized by substantial competition and litigation regarding 
patent and other intellectual property rights. In this regard, competitors of 
the Company have been issued a number of patents related to TMR. In September 
1995, the Company received from a competitor a notice of potential 
infringement of the competitor's patent regarding a method for TMR utilizing 
synchronization of laser pulses to the electrical signals from  the heart. In 
January 1996, the Company received from a second competitor a notice of 
potential infringement of the competitor's patent regarding a method to 
perform TMR using fiber optics. The Company has concluded in each case, 
following discussion with its patent counsel, that it does not utilize the 
process and/or apparatus which is the subject of the patent at issue, and has 
responded to the respective competitor to such effect. The Company has 
received no further correspondence on either matter. There can be no 
assurance, however, that further claims or proceedings will not be initiated 
by either competitor, or that claims by other parties will not arise in the 
future. Any such claims in the future, with or without merit, could be 
time-consuming and expensive to respond to and could divert the attention of 
the Company's technical and management personnel. The Company may be involved 
in litigation to defend against claims of infringement by the Company, to 
enforce patents issued to the Company, or to protect trade secrets of the 
Company. If any relevant claims of third party patents are upheld as valid and 
enforceable in any litigation or administrative proceeding, the Company could 
be prevented from practicing the subject matter claimed in such patents, or 
would be required to obtain licenses from the patent owners of each such 
patent or to redesign its products or processes to avoid infringement. 

     Patent applications in the U.S. are maintained in secrecy until patents 
issue, and patent applications in foreign countries are maintained in secrecy 
for a period after filing. Publication of discoveries in the scientific or 
patent literature tends to lag behind actual discoveries and the filing of 
related patent applications. Accordingly, there can be no assurance that 
current and potential competitors and other third parties have not filed or in 
the future will not file applications for, or have not received or in the 
future will not receive, patents or obtain additional proprietary rights that 
will prevent, limit or interfere with the Company's ability to make, use or 
sell its products either in the U.S. or internationally. In the event the 
Company were to require licenses to patents issued to third parties, there can 
be no assurance that such licenses would be available or, if available, would 
be available on terms acceptable to the Company, or that the Company would be 
successful in any attempt to redesign its products or processes to avoid 
infringement. Accordingly, an adverse determination in a judicial or 
administrative proceeding or failure to obtain necessary licenses could 
prevent the Company from manufacturing and selling its products, which would 
materially and adversely affect the Company's business, financial condition 
and results of operations. 

EXPECTATION OF INTENSE MARKET COMPETITION

     The Company expects that the markets for TMR and PTMR, which are 
currently in the early stages of development, will be intensely competitive. 
Competitors are likely to include at least four laser companies: PLC Systems, 
Inc. ("PLC"), CardioGenesis Corporation ("CardioGenesis"), U.S. Surgical 
Corporation ("U.S. Surgical"), and Johnson & Johnson ("J & J") all four of 
which are currently selling TMR and/or PTMR products for investigational use 

                                       23
<PAGE>

in the U.S. and abroad. Other competitors may include additional companies 
that elect to enter the market, including large companies in the laser, 
cardiac devices and cardiac surgery markets. The Company believes that a 
number of significant companies including Boston Scientific Corp., Baxter 
International, Inc., and C.R. Bard, Inc. have distribution rights to current 
or future products in TMR or PTMR. Many of these companies have significantly 
greater financial, development, marketing and other resources than the 
Company. In the event a competitor is able to obtain a PMA for its products 
prior to the Company, the Company's ability to compete successfully could be 
materially and adversely affected. 

     TMR and PTMR also compete with other more conventional or established 
methods for the treatment of cardiovascular disease, including drug therapy, 
PTCA and CABG. Although the Company is seeking to demonstrate the safety and 
effectiveness of the Company's TMR and PTMR procedures in patients for whom 
other cardiovascular treatments are not likely to provide relief, and in the 
future intends to pursue the safety and effectiveness of TMR or PTMR when 
used in conjunction with other treatments, there can be no assurance that the 
Company's  products will be accepted in these markets, nor can there be any 
assurance that physicians will use the Company's  procedures to replace or 
supplement established treatments, or that the Company's  procedures will be 
competitive with current or future technologies. In such event, the Company's 
business, financial condition and operating results could be materially and 
adversely affected. 

     Any product developed by the Company that gains regulatory approval will 
face competition for market acceptance and market share. An important factor 
in such competition may be the timing of market introduction of competitive 
products. Accordingly, the relative pace at which the Company is able to 
develop products, complete clinical testing and regulatory approval 
processes, gain third party reimbursement acceptance and supply commercial 
quantities of the product to the market are expected to be important 
competitive factors. There can be no assurance that the Company will be able 
to compete successfully against current and future competitors. Failure to do 
so would materially and adversely affect the Company's business, financial 
condition and operating results.

HISTORY OF OPERATING LOSSES

     From inception to December 31, 1997, the Company incurred cumulative net 
losses of approximately $28.4 million. The Company's revenues and operating 
income will continue to be constrained until such time, if ever, as FDA and 
other regulatory approval is obtained for the Company's  products, and for an 
indefinite period of time after any such approval is obtained. Furthermore, 
the Company expects its expenses in all categories to increase as its 
clinical trial and other business activities expand. Hence, there can be no 
assurance that the Company will achieve or sustain profitability in the 
future. Failure to achieve significant commercial revenues or profitability 
would materially and adversely affect the Company's business, financial 
condition and results of operations.

RISKS OF TECHNOLOGICAL CHANGE

     Significant resources are continually being expended to develop new and 
improved treatment methodologies for coronary disease.  Accordingly, the 
market acceptance and commercial success of the Company's TMR and PTMR 
products and procedures will depend not only on the safety and effectiveness 
of the Company's TMR and PTMR products and procedures, but also the relative 
safety and effectiveness of alternative treatment measures.  Any such 
alternatives could potentially include new treatments or improvements to 
treatments which would materially and adversely affect the Company's 
business, financial condition and results of operations.

POTENTIAL DIFFICULTIES IN MANAGING BUSINESS UNDERGOING RAPID CHANGE

     The Company's future success will depend to a significant extent on the 
ability of its current and future management personnel to operate 
effectively, both independently and as a group. In this regard, a number of 
members of the Company's senior management team have only recently joined the 
Company. Moreover, certain members of such management team have limited 
experience as a senior executive of a public corporation. There can be no 
assurance that the management team will operate together effectively. To 
compete successfully against current and future competitors, 


                                       24
<PAGE>
complete clinical trials in progress, prepare additional products for clinical 
trials and develop future products, the Company believes that it must continue 
to expand its operations, particularly in the areas of research and 
development, sales and marketing, training, and manufacturing. If the Company 
were to experience significant growth in the future, such growth would likely 
result in new and increased responsibilities for management personnel and 
place significant strain upon the Company's management, operating and 
financial systems and resources. To accommodate such growth and compete 
effectively, the Company must continue to implement and improve information 
systems, procedures and controls, and to expand, train, motivate and manage 
its work force. There can be no assurance that the Company's personnel, 
systems, procedures and controls will be adequate to support the Company's 
future operations. Any failure to implement and improve the Company's 
operational, financial and management systems or to expand, train, motivate or 
manage employees could materially and adversely affect the Company's business, 
financial condition and results of operations.

POTENTIAL FLUCTUATIONS IN OPERATING RESULTS

     Results of operations are expected to fluctuate significantly from 
quarter to quarter depending upon numerous factors, including the timing and 
results of clinical trials; delays associated with the FDA and other 
regulatory approval processes; health care reform and reimbursement policies; 
demand for the Company's products; changes in pricing policies by the Company 
or its competitors; the number, timing and significance of product 
enhancements and new product announcements by the Company and its competitors; 
the ability of the Company to develop, introduce and market new and enhanced 
versions of the Company's products on a timely basis; customer order deferrals 
in anticipation of new or enhanced products offered by the Company or its 
competitors; product quality problems; personnel changes; changes in Company 
strategy; and the level of international sales. Quarter to quarter operating 
results could also be affected by the timing of the receipt of individual 
customer orders, order fulfillment and revenue recognition with respect to 
small numbers of individual laser base units, since each such product carries 
a high price per unit. 
 
UNCERTAINTY REGARDING THIRD PARTY REIMBURSEMENT

     The Company expects that its ability to successfully commercialize its 
products will depend significantly on the availability of reimbursement for 
surgical procedures using the Company's products from third party payors such 
as governmental programs, private insurance and private health plans. 
Reimbursement is a significant factor considered by hospitals in determining 
whether to acquire new equipment. Notwithstanding FDA approval, if granted, 
third party payors may deny reimbursement if the payor determines that a 
therapeutic medical device is unnecessary, inappropriate, not cost-effective 
or experimental or is used for a non-approved indication.

     Medicare reimburses hospitals on a prospectively determined fixed amount 
for the costs associated with an in-patient hospitalization based on the 
patient's discharge diagnosis, and reimburses physicians on a prospectively 
determined fixed amount based on the procedure performed, regardless of the 
actual costs incurred by the hospital or physician in furnishing the care and 
unrelated to the specific devices used in that procedure. Medicare and other 
third party payors are increasingly scrutinizing whether to cover new products 
and the level of reimbursement for covered products. In addition, Medicare 
traditionally has considered items or services involving devices that have not 
been approved or cleared for marketing by the FDA to be precluded from 
Medicare coverage. Under a HCFA policy effective November 1, 1995, Medicare 
coverage will not be precluded for items and related services involving 
devices that have been classified by the FDA as "non-experimental/ 
investigational" ("Category B") devices and that are furnished in accordance 
with FDA-approved protocols governing clinical trials.  Even with items or 
services involving Category B devices, however, Medicare coverage may be 
denied if other coverage requirements are not met, for example if the 
treatment is not medically needed for the specific patient.  In November 1995, 
the Company received Category B designation for its TMR procedure from the 
HCFA. Accordingly, the Company's procedures had received third party 
reimbursement in many cases under HCFA's policy. As of May 19, 1997, although 
Category B status is retained, under a recent HCFA ruling, there will not be 
coverage for any manufacturer's TMR procedures at this time. There can be no 
assurance that this coverage will be given in the future or that Medicare will 
adequately reimburse the costs of the Company's TMR and PTMR procedures when 
and if a PMA is granted.  While the Company is unable to determine the 
ultimate effect of this policy change on the business and operating results, 
the Company anticipates that research 

                                       25
<PAGE>

and development expenses will increase significantly due to increased 
expenses in support of clinical trials, and revenues from sale of 
investigational products are likely to decrease, at least over the short term 
and possibly thereafter.

     There can be no assurance as to whether third party payors will cover 
TMR or PTMR procedures or as to the levels of reimbursement. There also can 
be no assurance that levels of reimbursement, if any, 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. Fundamental reforms in the healthcare industry in the U.S. 
and Europe that could affect the availability of third party reimbursement 
continue to be proposed, and the Company cannot predict the timing or effect 
of any such proposal. If third party payor coverage or reimbursement is 
unavailable or inadequate, the Company's business, financial condition and 
results of operations could be materially and adversely affected.

LIMITED SALES, MARKETING AND DISTRIBUTION SYSTEMS

     The Company has made limited sales of its TMR products to date, for 
investigational use only. Accordingly, the Company has maintained a limited 
sales and marketing organization in the U.S. and abroad. The Company plans to 
market its TMR and PTMR products, if approved, through a direct sales force 
and through relationships with  distributors or agents. Establishment of a 
sales force capable of effectively commercializing the Company's TMR and PTMR 
products will require substantial efforts and require significant management 
and financial resources. There can be no assurance that the Company will be 
able to establish such a sales capability on a timely basis, if at all. 
Moreover, there can be no assurance that the Company's distributors will 
devote sufficient resources to development of the markets for the Company's 
products or that they will be successful in such commercialization efforts.

POTENTIAL NEED FOR ADDITIONAL CAPITAL

     Although the Company anticipates that its current cash balances, 
together with sales of products for investigational use, will be sufficient 
to meet the Company's capital requirements through at least 1998, there can 
be no assurance that the Company will not require additional sources of cash 
at an earlier date. This will depend upon the progress of expansion of the 
Company's clinical trials and any need for additional trials or other testing 
of the Company's products, and the timing of required expenditures. If the 
Company is required to obtain additional financing in the future, there can 
be no assurance that capital will be available on terms acceptable to the 
Company, if at all.

RISK OF PRODUCT LIABILITY

     The Company faces an inherent and significant business risk of exposure 
to product liability claims in the event that the use of its products results 
in personal injury or death, and there can be no assurance that material 
product liability claims will not be assessed against the Company in the 
future. The Company maintains insurance against product liability claims in 
the amount of $3 million per occurrence and $3 million in the aggregate.  
However, there can be no assurance that such coverage will continue to be 
available in the amount desired or on terms acceptable to the Company, or 
that such coverage will be adequate for liabilities actually incurred. Also, 
in the event that any of the Company's products prove to be defective, the 
Company may be required to recall or redesign such products. Any uninsured or 
underinsured claim brought against the Company or any claim or product recall 
that results in significant cost to or adverse publicity against the Company 
could materially and adversely affect the Company's business, financial 
condition and results of operations.

LIMITED MANUFACTURING EXPERIENCE; DEPENDENCE ON KEY SUPPLIERS

     The Company's success will depend in part on its ability to manufacture 
its products in a timely, cost-effective manner and in compliance with GMP, 
ISO 9001 and other regulatory requirements. The manufacture of the Company's 
products is a labor-intensive, complex operation involving a number of 
separate processes and components. The Company's manufacturing activities to 
date have consisted primarily of manufacturing limited quantities of systems 
for use in clinical trials. The Company does not have experience in 
manufacturing its products in the commercial quantities 


                                       26
<PAGE>
that might be required if the Company receives regulatory approval for its 
TMR and PTMR products. Furthermore, as a condition to receipt of PMA 
approval, the Company's facilities, procedures and practices will be subject 
to pre-approval and ongoing GMP inspections by FDA. 

     Manufacturers often encounter difficulties in scaling up manufacturing of 
new products, including problems involving product yields, quality control and 
assurance, component and service availability, adequacy of control policies 
and procedures, lack of qualified personnel, compliance with FDA regulations, 
and the need for further FDA approval of new manufacturing processes and 
facilities. There can be no assurance that manufacturing yields, costs or 
quality will not be adversely affected as the Company seeks to increase 
production, and any such adverse effect could materially and adversely affect 
the Company's business, financial condition and results of operations. 

     The Company currently purchases certain laser and fiber-optic components 
from single sources. Although the Company has identified alternative vendors, 
the qualification of additional or replacement vendors for certain components 
or services is a lengthy process. There can be no assurance that materials 
obtained from outside suppliers will continue to be available in adequate 
quantities or at the times required by the Company or that the Company will be 
able to locate alternative suppliers on a timely basis. Any significant supply 
interruption would have a material adverse effect on the Company's ability to 
manufacture its products and, therefore, would materially and adversely affect 
the Company's business, financial condition and results of operations. The 
Company expects to manufacture its products based on forecasted product 
orders, and intends to purchase subassemblies and components prior to receipt 
of purchase orders from customers. Lead times for materials and components 
ordered by the Company vary significantly, and depend on factors such as the 
business practices of the specific supplier, contract terms and general demand 
for a component at a given time. As a result, there is a risk of excess or 
inadequate inventory if orders do not match forecasts. 

DEPENDENCE ON KEY PERSONNEL

     The Company's future business and operating results depend in significant 
part aggregate or for each upon the continued contributions of its key 
technical and senior management personnel, including Douglas Murphy-Chutorian, 
M.D., the Company's Chief Executive Officer, and Richard L. Mueller, Jr., the 
Company's President and Chief Operating Officer. The Company maintains key 
person life insurance policies on both of these individuals in the amount of 
$2 million. The Company's future business and operating results also depend in 
significant part upon its ability to attract and retain qualified additional 
management, manufacturing, technical, marketing and sales and support 
personnel for its operations. Competition for such personnel is intense, and 
there can be no assurance that the Company will be successful in attracting or 
retaining such personnel. In this regard, the Chief Financial Officer and Vice 
President of Quality Assurance, have agreed to remain with the Company until 
suitable replacements have been hired.  Although the Company has initiated a 
search for these positions, there can be no assurance that suitable 
replacements can be identified and successfully recruited in a timely fashion. 
 The loss of any key employee, the failure of any key employee to perform in 
his or her current position, or the Company's inability to attract and retain 
skilled employees, as needed, could materially and adversely affect the 
Company's business, financial condition and results of operations. 

TRADING MARKET FOR COMMON STOCK; VOLATILITY OF STOCK PRICE

     The market price of the Common Stock has been, and is likely to continue 
to be, highly volatile and may be significantly affected by factors such as 
actual or anticipated fluctuations in the Company's operating results, 
announcements of technological innovations, new products or new contracts by 
the Company or its competitors, developments with respect to patents or 
proprietary rights, conditions and trends in the medical device and other 
technology industries, healthcare reform measures, adoption of new accounting 
standards affecting the medical device industry, changes in financial 
estimates by securities analysts, general market conditions and other factors. 
In addition, the stock market has from time to time experienced significant 
price and volume fluctuations that have particularly affected the market 
prices for the common stocks of early stage companies. These broad market 
fluctuations may materially and adversely affect the market price of the 
Common Stock. In the past, following periods of volatility in the market price 
of a particular company's securities, securities class action litigation has 
often been brought against that company. Such litigation, if brought against 
the Company, could result in substantial costs and a diversion of management's 
attention and resources. 

                                       27
<PAGE>

CONCENTRATION OF SHARE OWNERSHIP

     The present directors and executive officers of the Company and their 
affiliates beneficially own approximately 39% of the outstanding Common 
Stock. As a result, these shareholders will be able to exercise significant 
influence over matters requiring shareholder approval, including the election 
of directors and approval of significant corporate transactions. Such 
concentration of ownership may have the effect of delaying or preventing a 
change in control of the Company.


                                       28
<PAGE>

ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     See Item 14 below and the Index therein for a listing of the financial 
statements and supplementary data filed as part of this report.

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

         None.


                                      PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     The information required by this item is incorporated by reference to 
the information set forth under the caption "Board of Directors" contained in 
the Proxy Statement to be used by the Company in connection with its 1998 
Annual Meeting of Shareholders, to be filed with the Securities and Exchange 
Commission on or prior to March 20, 1998.

ITEM 11.  EXECUTIVE COMPENSATION.

     The information required by this item is incorporated by reference to 
the information set forth under the similarly titled caption contained in the 
Proxy Statement to be used by the Company in connection with its 1998 Annual 
Meeting of Shareholders.

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

     The information required by this item is incorporated by reference to 
the information set forth under the similarly titled caption contained in the 
Proxy Statement to be used by the Company in connection with its 1998 Annual 
Meeting of Shareholders.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information required by this item is incorporated by reference to 
the information set forth under the similarly titled caption contained in the 
Proxy Statement to be used by the Company in connection with its 1998 Annual 
Meeting of Shareholders.


                                       29
<PAGE>

                                     PART IV

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


(a) (1)  FINANCIAL STATEMENTS.  The financial statements required to be filed 
by Item 8 herewith are as follows: 

<TABLE>
<CAPTION>
                                                                                                               Page
                                                                                                               ----
     <S>                                                                                                        <C>
     Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        32

     Consolidated Balance Sheets as of December 31, 1997 and 1996. . . . . . . . . . . . . . . . . . . .        33

     Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995. . . . .        34

     Consolidated Statements of Shareholders' Equity (Deficit) for the years ended December 31, 1997,
       1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        35

     Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995. . . . .        36

     Notes to the Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . .        37


     (2) FINANCIAL STATEMENT SCHEDULES.   The following financial statement schedules are filed herewith.

     Schedule II - Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . . . . . . .        47
     Report of Independent Accountants on Financial Statement Schedule . . . . . . . . . . . . . . . . .        48

     (3) EXHIBITS.

     The exhibits listed under Item 14(c) are filed or incorporated by reference herein.
       
(b)  REPORTS ON FORM 8-K.
      
     None.

(c)  EXHIBITS.

     The exhibits below are filed or incorporated herein by reference.
</TABLE>

EXHIBIT
NUMBER    DESCRIPTION
--------  -----------
  3.1*    Certificate of Amendment and Restated Articles of Incorporation of 
          Registrant.

  3.2*    Amended and Restated Bylaws of Registrant.

  4.1*    Form of Warrant issued in July 1993.

  4.3*    Form of Warrant issued in February 1994.

  4.4*    Form of Warrant issued in May 1994.


                                       30
<PAGE>

 (c) EXHIBITS -- (CONTINUED)

 
  4.5*    Form of Warrant issued in October 1995.

  4.6*    Form of Warrant issued in March 1996.

 10.1*    Form of Director and Officer Indemnification Agreement.

 10.2*    Stock Option Plan.

 10.3*    Director Stock Option Plan.

 10.4*    1996 Employee Stock Purchase Plan.

 10.5*    Facilities Lease for 1049 Kiel Court, Sunnyvale, California.

 10.6*    401(k) Plan.

 23.1     Consent of Coopers & Lybrand L.L.P.

 27.1     Financial Data Schedule

---------------
* Incorporated herein by reference from the Company's Registration Statement 
  on Form S-1 (File No. 333-03770), as amended, filed on April 18, 1996.)


                                       31
<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders
Eclipse Surgical Technologies, Inc.:

     We have audited the accompanying consolidated balance sheets of Eclipse 
Surgical Technologies, Inc. and subsidiaries as of December 31, 1997 and 
1996, and the related consolidated statements of operations, shareholders' 
equity (deficit) and cash flows for each of the three years in the period 
ended December 31, 1997.  These financial statements are the responsibility 
of the Company's management. Our responsibility is to express an opinion on 
these financial statements based on our audits. 

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

     In our opinion, the financial statements referred to above present 
fairly, in all material respects, the consolidated financial position of 
Eclipse Surgical Technologies, Inc. and subsidiaries as of December 31, 1997 
and 1996, and the consolidated results of their operations and their cash 
flows for each of the three years in the period ended December 31, 1997, in 
conformity with generally accepted accounting principles.


                              COOPERS & LYBRAND L.L.P.



San Jose, California
January 30, 1998


                                       32
<PAGE>

                                          
                        ECLIPSE SURGICAL TECHNOLOGIES, INC.
                            CONSOLIDATED BALANCE SHEETS
                             DECEMBER 31, 1997 AND 1996
                                    (IN THOUSANDS)

                                        ASSETS
<TABLE>
<CAPTION>

                                                                              1997         1996
                                                                            ---------    ---------
<S>                                                                         <C>          <C>
Current assets:
  Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . .      $  16,997    $  24,106
  Marketable securities. . . . . . . . . . . . . . . . . . . . . . . .         18,197       21,397
  Accounts receivable, net of allowance for doubtful accounts of 
     $757 and $280 at December 31, 1997 and 1996, respectively . . . .          2,054        2,483
  Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . .          3,866        2,464
  Prepaids and other current assets. . . . . . . . . . . . . . . . . .            556          431
                                                                            ---------    ---------
     Total current assets. . . . . . . . . . . . . . . . . . . . . . .         41,670       50,881
Property and equipment, net. . . . . . . . . . . . . . . . . . . . . .          1,420          906
Marketable securities. . . . . . . . . . . . . . . . . . . . . . . . .              -        6,560
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            384          359
                                                                            ---------    ---------
     Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . .      $  43,474    $  58,706
                                                                            ---------    ---------
                                                                            ---------    ---------
                                        LIABILITIES
 
Current liabilities:
  Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . .      $   3,190    $   2,043
  Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . .            965          908
  Customer deposits. . . . . . . . . . . . . . . . . . . . . . . . . .             71           28
  Note payable . . . . . . . . . . . . . . . . . . . . . . . . . . . .          1,000            -
  Current portion of long-term debt. . . . . . . . . . . . . . . . . .             10           41
                                                                            ---------    ---------
     Total current liabilities . . . . . . . . . . . . . . . . . . . .          5,236        3,020
Long-term debt, less current portion . . . . . . . . . . . . . . . . .             10           20
                                                                            ---------    ---------
     Total liabilities . . . . . . . . . . . . . . . . . . . . . . . .          5,246        3,040
                                                                            ---------    ---------
Commitments and contingencies (Note 9)

                                    SHAREHOLDERS' EQUITY
 
Preferred stock, no par value:
  Authorized: 5,000 shares;
  Issued and outstanding: none
Common stock, no par value:
  Authorized: 50,000 shares;
  Issued and outstanding: 16,858 shares at December 31, 1997 and 
     16,172 shares at December 31, 1996. . . . . . . . . . . . . . . .         66,596       65,339
Unrealized gain on marketable securities . . . . . . . . . . . . . . .             50          498
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . .        (28,418)     (10,171)
                                                                            ---------    ---------
     Total shareholders' equity. . . . . . . . . . . . . . . . . . . .         38,228       55,666
                                                                            ---------    ---------
     Total liabilities and shareholders' equity. . . . . . . . . . . .      $  43,474    $  58,706
                                                                            ---------    ---------
                                                                            ---------    ---------
</TABLE>


  The accompanying notes are an integral part of these financial statements


                                       33
<PAGE>

                        ECLIPSE SURGICAL TECHNOLOGIES, INC.
                       CONSOLIDATED STATEMENTS OF OPERATIONS
                FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                      (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                1997         1996         1995
                                                              --------     --------     --------
<S>                                                           <C>          <C>          <C>     
Net revenues . . . . . . . . . . . . . . . . . . . . .        $  5,499     $  9,759     $  2,707
Cost of revenues . . . . . . . . . . . . . . . . . . .           2,779        3,558        1,642
                                                              --------     --------     --------
  Gross profit . . . . . . . . . . . . . . . . . . . .           2,720        6,201        1,065
                                                              --------     --------     --------
Operating expenses:
  Research and development . . . . . . . . . . . . . .          12,007        6,586        1,010
  Sales and marketing. . . . . . . . . . . . . . . . .           7,345        3,327          879
  General and administrative . . . . . . . . . . . . .           4,036        2,000          681
                                                              --------     --------     --------
     Total operating expenses. . . . . . . . . . . . .          23,388       11,913        2,570
                                                              --------     --------     --------
       Operating loss. . . . . . . . . . . . . . . . .         (20,668)      (5,712)      (1,505)
Interest expense . . . . . . . . . . . . . . . . . . .             (25)        (196)        (923)
Interest and other income. . . . . . . . . . . . . . .           2,446        1,752            2
                                                              --------     --------     --------
       Net loss. . . . . . . . . . . . . . . . . . . .        $(18,247)   $  (4,156)   $  (2,426)
                                                              --------     --------     --------
                                                              --------     --------     --------


Net loss per share:
  Basic earnings per share . . . . . . . . . . . . . .        $  (1.11)    $  (0.30)    $  (0.23)
                                                              --------     --------     --------
                                                              --------     --------     --------
  Diluted earnings per share . . . . . . . . . . . . .        $  (1.11)    $  (0.30)    $  (0.23)
                                                              --------     --------     --------
                                                              --------     --------     --------
  Weighted average shares outstanding. . . . . . . . .          16,404       14,078       10,470 
                                                              --------     --------     --------
                                                              --------     --------     --------
</TABLE>

  The accompanying notes are an integral part of these financial statements


                                       34
<PAGE>

                          ECLIPSE SURGICAL TECHNOLOGIES, INC.
               CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
                                  (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                       NOTES
                                                                     RECEIVABLE      UNREALIZED
                                               COMMON STOCK             FOR            GAIN ON  
                                           --------------------        COMMON         MARKETABLE      ACCUMULATED
                                           SHARES        AMOUNT         STOCK         SECURITIES        DEFICIT        TOTAL
                                           ------        ------      ----------      -----------      -----------     --------
<S>                                        <C>          <C>             <C>            <C>           <C>              <C>
Balances, January 1, 1995 . . . . . . .    10,469       $  3,450                                     $  (3,589)       $  (139) 
  Issuance of common stock. . . . . . .       741          1,235        $  (104)                             -          1,131 
  Issuance of warrants. . . . . . . . .         -              5                                             -              5 
  Net loss. . . . . . . . . . . . . . .         -              -              -                         (2,426)        (2,426)
                                           ------      ---------        -------                      ---------       --------
Balances, December 31, 1995 . . . . . .    11,210          4,690           (104)                        (6,015)        (1,429)
  Issuance of common stock in 
     connection with initial 
     public offering. . . . . . . . . .     4,000         57,956                                                       57,956
  Issuance of common stock. . . . . . .       962          2,691                                                        2,691
  Payment on notes receivable . . . . .                                     104                                           104
  Issuance of warrants. . . . . . . . .         -              2                                                            2
  Unrealized gain on
     marketable securities. . . . . . .                                                $   498                            498
  Net loss. . . . . . . . . . . . . . .         -              -              -                         (4,156)        (4,156)
                                           ------      ---------        -------        -------       ---------       --------
Balances, December 31, 1996 . . . . . .    16,172         65,339              -            498         (10,171)        55,666
  Issuance of common stock. . . . . . .       552            956                                                          956
  Issuance of common stock 
     pursuant to exercise of 
     warrants . . . . . . . . . . . . .       134            301                                                          301
  Realized gain on
     marketable securities. . . . . . .                                                   (448)                          (448)
  Net loss. . . . . . . . . . . . . . .         -              -              -                        (18,247)       (18,247)
                                           ------      ---------        -------        -------       ---------       --------
Balances, December 31, 1997 . . . . . .    16,858      $  66,596        $     -        $    50       $ (28,418)      $ 38,228
                                           ------      ---------        -------        -------       ---------       --------
                                           ------      ---------        -------        -------       ---------       --------
</TABLE>


      The accompanying notes are an integral part of these financial statements


                                      35
<PAGE>

                        ECLIPSE SURGICAL TECHNOLOGIES, INC.
                       CONSOLIDATED STATEMENTS OF CASH FLOWS
               FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                                  (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                           1997         1996       1995  
                                                                        --------     --------     --------
<S>                                                                     <C>          <C>          <C>     
Cash flows from operating activities:
  Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  $(18,247)    $ (4,156)    $ (2,426)
  Adjustments to reconcile net loss to net cash used in operating 
    activities:
     Depreciation and amortization . . . . . . . . . . . . . . . . . .       724          200           72
     Amortization of discount and financing costs. . . . . . . . . . .         -            -          607
     Provision for doubtful accounts . . . . . . . . . . . . . . . . .       477          378           40
     Changes in operating assets and liabilities:
       Increase in accounts receivable . . . . . . . . . . . . . . . .       (48)      (2,329)        (191)
       (Increase) decrease in inventories. . . . . . . . . . . . . . .    (1,402)        (794)         163
       (Increase) decrease in prepaids and other current  assets . . .      (125)        (417)         349
       Increase in accounts payable. . . . . . . . . . . . . . . . . .     1,147          826          266
       Increase (decrease) in customer deposits. . . . . . . . . . . .        43         (242)          46
       Increase (decrease) in accrued liabilities. . . . . . . . . . .        57          361           (4)
                                                                        --------     --------     --------
         Net cash used in operating activities . . . . . . . . . . . .   (17,374)      (6,173)      (1,078)
                                                                        --------     --------     --------

Cash flows from investing activities:
  Purchase of marketable securities. . . . . . . . . . . . . . . . . .         -      (27,459)           -
  Sale of marketable securities  . . . . . . . . . . . . . . . . . . .     9,312            -            -
  Acquisition of property and equipment. . . . . . . . . . . . . . . .    (1,238)        (974)         (62)
  Increase in other assets . . . . . . . . . . . . . . . . . . . . . .       (25)        (337)           -
                                                                        --------     --------     --------
         Net cash provided by (used) investing activities. . . . . . .     8,049      (28,770)         (62)
                                                                        --------     --------     --------

Cash flows from financing activities:
  Payments on short-term borrowings. . . . . . . . . . . . . . . . . .         -          (45)        (782)
  Net proceeds from issuance of common stock and warrants. . . . . . .     1,257       60,649        1,136
  Payments on notes receivable . . . . . . . . . . . . . . . . . . . .         -          104            -
  Proceeds from note payable . . . . . . . . . . . . . . . . . . . . .     1,000            -            -
  Proceeds from short-term borrowings. . . . . . . . . . . . . . . . .         -            -          827
  Payments on long-term debt . . . . . . . . . . . . . . . . . . . . .       (41)      (1,782)         (50)
                                                                        --------     --------     --------
         Net cash provided by financing activities . . . . . . . . . .     2,216       58,926        1,131
                                                                        --------     --------     --------
           Net increase (decrease) in cash and cash 
             equivalents . . . . . . . . . . . . . . . . . . . . . . .    (7,109)      23,983           (9)
Cash and cash equivalents at beginning of period . . . . . . . . . . .    24,106          123          132
                                                                        --------     --------     --------
Cash and cash equivalents at end of period . . . . . . . . . . . . . .  $ 16,997     $ 24,106     $    123
                                                                        --------     --------     --------
                                                                        --------     --------     --------
Supplemental schedule of cash flow information:
  Interest paid. . . . . . . . . . . . . . . . . . . . . . . . . . . .  $     25     $    281     $     71
  Taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  $      -     $      -     $      1

Supplemental schedule of noncash investing and 
  financing activities:
  Unrealized gain on marketable securities . . . . . . . . . . . . . .  $     50     $    498     $      -
                                                                        --------     --------     --------
                                                                        --------     --------     --------
  Issuance of common stock and warrants in exchange for
    note receivable. . . . . . . . . . . . . . . . . . . . . . . . . .  $      -     $      -     $    104
                                                                        --------     --------     --------
                                                                        --------     --------     --------
  Acquisition of equipment under capital lease . . . . . . . . . . . .  $      -     $     34     $      -
                                                                        --------     --------     --------
                                                                        --------     --------     --------
</TABLE>


  The accompanying notes are an integral part of these financial statements 


                                      36
<PAGE>

                        ECLIPSE SURGICAL TECHNOLOGIES, INC.
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.    NATURE OF OPERATIONS:

     Eclipse Surgical Technologies, Inc. (the "Company") was founded in 1989 to
develop, manufacture and market surgical lasers and accessories for the
treatment of disease. Currently, the Company's emphasis is on development and
manufacture of products used for transmyocardial revascularization (TMR) and
percutaneous transluminal myocardial revascularization (PTMR), which are
cardiovascular procedures.  The Company markets its products for sale primarily
in the U.S., Europe and Asia.  In the U.S., the Company offers its laser systems
for sale in limited numbers for investigational use only pursuant to
Investigational Device Exemptions from the U.S. Food and Drug Administration.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BASIS OF PRESENTATION:

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

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:

     All highly liquid instruments purchased with an original maturity of three
months or less are considered cash equivalents, and are held primarily at one
commercial bank and one investment bank.

MARKETABLE SECURITIES:

     Marketable securities are classified as available-for-sale and are 
carried at fair value.  Marketable securities classified as current assets 
have scheduled maturities of less than one year, while marketable securities 
classified as noncurrent assets have scheduled maturities of more than one 
year. Unrealized holding gains on such securities are reported as a separate 
component of shareholders' equity.  Realized gains and losses on sales of all 
such securities are reported in earnings and computed using the specific 
identification cost method.

INVENTORIES:

     Inventories are stated at the lower of cost (principally standard cost, 
which approximates actual cost on a first-in, first-out basis) or market 
value. 

                                     37

<PAGE>

                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED):

FAIR VALUE OF FINANCIAL INSTRUMENTS:

     Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, accounts receivable, accounts payable,
accrued liabilities and customer deposits approximate fair value due to their
short maturities. Based on borrowing rates currently available to the Company
for loans with similar terms, the carrying value of the long-term debt
obligations also approximates fair value. 

CERTAIN RISKS AND CONCENTRATIONS:

     The Company sells its products primarily to hospitals and other health care
providers in North America, Europe and Asia. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. Although
the Company maintains allowances for potential credit losses that it believes to
be adequate, a payment default on a significant sale could materially and
adversely affect its operating results and financial condition.  At December 31,
1997 and 1996, three customers accounted for 37% and four customers accounted
for 68% of accounts receivable, respectively.   

     The Company purchases certain laser and fiber-optic components and
subassemblies from single sources.  Although the Company has identified
alternative vendors, the qualification of additional or  replacement vendors for
certain components or services is a lengthy process.  Any significant supply
interruption could affect the Company's ability to manufacture its products and
would, therefore, adversely affect operating results. 

REVENUE RECOGNITION:

     The Company typically recognizes revenue on product sales upon receipt of
purchase order and subsequent shipment of product. Where purchase orders allow
customers an acceptance period, revenue is recognized upon acceptance. 

     Revenues from service contracts, rentals, and per procedure fees are
recognized upon performance or over the terms of the contract as appropriate.

RESEARCH AND DEVELOPMENT:

     Research and development expenses are charged to operations as incurred. 

PROPERTY AND EQUIPMENT:

     Property and equipment are stated at cost and depreciated on a
straight-line basis over their estimated useful lives of three to five years.
Assets acquired under capital leases are amortized over the shorter of their
estimated useful lives or the term of the related lease (generally three to five
years). Amortization of leasehold improvements is based on the straight-line
method over the shorter of the estimated useful life or the lease term. 

WARRANTIES:

     The Company's laser products are generally warranted for one year. The
Company provides for estimated future costs of repair, replacement, or customer
accommodations which are reflected in the accompanying financial statements. 

                                     38

<PAGE>

                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED):

INCOME TAXES:

     The Company accounts for income taxes using the liability method under
which deferred tax assets or liabilities are calculated at the balance sheet
date using current tax laws and 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. 

STOCK BASED COMPENSATION:

     The Company accounts for its stock based compensation in accordance with
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees."  The Company has elected to adopt the disclosure only 
provisions of Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock Based Compensation," which requires pro forma disclosures
in the financial statements as if the measurement  provisions of SFAS 123 had
been adopted.

NET LOSS PER SHARE: 

     The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share," ("SFAS 128") effective December 31,
1997.  SFAS 128 requires the presentation of basic and diluted earnings per
share (EPS).  Basic EPS is computed by dividing loss available to common
shareholders by the weighted average number of common shares outstanding for the
period.  Diluted EPS is computed giving effect to all dilutive potential common
shares that were outstanding during the period.  Dilutive potential common
shares consist of incremental shares issuable upon the conversion of convertible
preferred stock (using the "if converted" method) and exercise of stock options
and warrants.  All  prior period earnings per share amounts have been restated
to comply with SFAS 128.  

     In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31, 
                                            ----------------------------------
                                               1997         1996        1995
                                               ----         ----        ----
<S>                                            <C>         <C>         <C>
Numerator - Basic and Diluted EPS
    Loss available to common stockholders...   $(18,247)   $(4,156)    $(2,426)
                                               --------    -------     -------
                                               --------    -------     -------

Denominator - Basic and Diluted EPS
    Weighted average shares outstanding....      16,404     14,078      10,470
                                               --------    -------     -------
    Basic earnings per share...............    $  (1.11)   $ (0.30)    $ (0.23)
                                               --------    -------     -------
                                               --------    -------     -------
    Diluted earnings per share.............    $  (1.11)   $ (0.30)    $ (0.23)
                                               --------    -------     -------
                                               --------    -------     -------
</TABLE>

     Options to purchase 2,885,000, 2,785,000 and 2,540,000 shares of common
stock were outstanding at December 31, 1997, 1996 and 1995, respectively, but
were not included in the calculation of diluted EPS because their inclusion
would have been antidilutive.

                                     39

<PAGE>
                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED):

RECENT PRONOUNCEMENTS: 

     In June 1997, the Financial Accounting Standards Board ("FASB") issued 
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive 
Income."  This statement establishes standards for reporting and display of 
comprehensive income and its components (including revenues, expenses, gains 
and losses) in a full set of general purpose financial statements. This 
statement is effective for fiscal years beginning after December 15, 1997, 
with earlier application permitted.
 
     In June 1997, the FASB issued Statement of Financial Accounting Standards 
No. 131, "Disclosures About Segments of an Enterprise and Related Information" 
("SFAS 131"), which supersedes SFAS 14, "Financial Reporting for Segments of a 
Business Enterprise."  SFAS 131 changes current practice under SFAS 14 by 
establishing a new framework on which to base segment reporting and also 
requires interim reporting of segment information.  SFAS 131 is effective for 
fiscal years beginning after December 15, 1997 with earlier application 
encouraged.  The statement's interim reporting disclosures would not be 
required until the first quarter immediately subsequent to the fiscal year in 
which SFAS 131 is effective.

3.  MARKETABLE SECURITIES:

     At December 31, 1997, marketable securities consisted of fixed income 
U.S. government securities held by an investment bank.  These marketable 
securities had a cost basis of approximately $18,147,000 and a fair value of 
$18,197,000 and mature at various dates through 1998.
 
4.  INVENTORIES:
 
     Inventories consist of the following (IN THOUSANDS): 

<TABLE>
<CAPTION>
                                                               DECEMBER 31, 
                                                              ---------------
                                                               1997     1996
                                                               ----     ----
<S>                                                           <C>      <C>
 Raw materials . . . . . . . . . . . . . . . . . . . .        $1,446   $  511
 Work in process . . . . . . . . . . . . . . . . . . .             -       99
 Finished goods. . . . . . . . . . . . . . . . . . . .         2,420    1,854
                                                              ------   ------
                                                              $3,866   $2,464
                                                              ------   ------
                                                              ------   ------
</TABLE>

5. PROPERTY AND EQUIPMENT:

    Property and equipment consists of the following (IN THOUSANDS): 

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                            ----------------
                                                               1997     1996
                                                            --------  ------
<S>                                                         <C>       <C>
 Computers and equipment . . . . . . . . . . . . . . .      $  1,638  $  879
 Manufacturing and demonstration equipment . . . . . .           850     467
 Leasehold improvements. . . . . . . . . . . . . . . .           124      28
                                                            --------  ------
                                                               2,612   1,374
                                                            --------  ------
 Less accumulated depreciation and amortization. . . .        (1,192)   (468)
                                                            --------  ------
                                                            $  1,420  $  906
                                                            --------  ------
                                                            --------  ------
</TABLE>

                                     40

<PAGE>

                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


     The Company leases certain equipment under a capital lease which expires in
February 2000.  Accordingly, capitalized costs of $34,000, net of accumulated
amortization of $11,900 and $5,100 at December 31, 1997 and 1996, respectively,
are included in property and equipment.

6.   ACCRUED LIABILITIES:

     Accrued liabilities consists of the following (IN THOUSANDS): 
<TABLE>
<CAPTION>
                                                           DECEMBER 31, 
                                                         -------------------
                                                           1997        1996
                                                         ------      -------
<S>                                                      <C>         <C>
         Accrued salaries and related. . . . . . . . .   $  483      $  487
         Accrued commissions . . . . . . . . . . . . .      127         156
         Accrued warranty. . . . . . . . . . . . . . .       78         141
         Accrued interest. . . . . . . . . . . . . . .        -           6
         Other . . . . . . . . . . . . . . . . . . . .      277         118
                                                         ------      ------
                                                         $  965      $  908
                                                         ------      ------
                                                         ------      ------
</TABLE>



7.  SHORT-TERM BORROWINGS:

     In October 1997, MicroHeart, a wholly-owned subsidiary of the Company,
entered into a note payable with an investor for $1,000,000 at 8% interest per
annum.  Principal and interest are due October 31, 1998. Additionally, warrants
to purchase 400,000 shares of MicroHeart's common stock at $0.50 per share were
granted to the investor.  The warrants are immediately exercisable and expire on
October 31, 2000.

 8.  LONG-TERM DEBT:

     Long term debt consists of a capital lease which bears interest at 10.33%
and expires in February, 2000.

9.   COMMITMENTS AND CONTINGENCIES:

     The Company has entered into five operating leases for office facilities
with terms extending from December 1998 to December 2002. The minimum future
rental payments are (in thousands): 

<TABLE>
<CAPTION>
          YEAR ENDED DECEMBER 31,
          -----------------------
<S>                                                     <C>
          1998 . . . . . . . . . . . . . . . . . . . .  $542
          1999 . . . . . . . . . . . . . . . . . . . .   355
          2000 . . . . . . . . . . . . . . . . . . . .   322
          2001 . . . . . . . . . . . . . . . . . . . .   333
          2002 . . . . . . . . . . . . . . . . . . . .   227
</TABLE>

     Rent expense was approximately $475,000,  $172,000 and  $139,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.

     The Company is engaged in certain legal and administrative proceedings
incidental to its normal business activities. While it is not possible to
determine the ultimate outcome of these actions at this time, management
believes that any liabilities resulting from such proceedings, or claims which
are pending or known to be threatened, will not have a material adverse effect
on the Company's financial position or results of operations. 

                                     41

<PAGE>
                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10.   SHAREHOLDERS' EQUITY:

WARRANTS:

     At December 31, 1997, warrants were outstanding to purchase a total of 
770,838 shares of common stock at exercise prices ranging from $1.67 to $4.17. 
The warrants, which were issued in connection with various debt and equity 
financings, are exercisable and terminate upon the earlier of;  sixteen  
months to five years from the effective grant date, a merger or sale of all or 
substantially all of the Company's assets to a noncontrolling entity, or 
certain other conditions. At December 31, 1997, the Company had reserved 
770,838 shares of common stock for issuance upon exercise of these warrants.  
During the year ended December 31, 1997 and 1996 133,743 and 267,057 warrants 
were exercised generating proceeds of approximately $245,510 and $524,000, 
respectively.

STOCK OPTION PLAN:

     The Company maintains a Stock Option Plan, which includes the Employee 
Program under which incentive and nonstatutory options may be granted to 
employees and the Consultants Program, under which nonstatutory options may be 
granted to consultants of the Company. As of  December 31, 1997, the Company 
had reserved for issuance under this plan a total of 4,000,000 shares of 
common stock. Under the plan, options may be granted at not less than fair 
market value (110% of fair market value for options granted to 10% 
shareholders), as determined by the Board of Directors. Options generally vest 
over a period of three years and expire ten years from date of grant (five 
years for options granted to 10% shareholders). No shares of common stock 
issued under the plan are subject to repurchase. 

DIRECTORS' STOCK OPTION PLAN:

     The Company maintains a Directors'  Stock Option Plan which provides for 
the grant of nonstatutory options to directors who are not officers or 
employees of the Company. As of December 31, 1997, the Company had reserved 
for issuance under this plan 200,000 shares of common stock. Under this plan, 
options are granted at the trading price of the common stock at the date of 
grant. Options generally vest over twelve to thirty-six months and expire ten 
years from date of grant. No shares of common stock issued under the plan are 
subject to repurchase.

STOCK BASED COMPENSATION: 

     The Company has  adopted the disclosure only provision of SFAS No. 123, 
"Accounting for Stock Based Compensation".  The Company, however, continues to 
apply APB Opinion No. 25, "Accounting for Stock Issued to Employees", and 
related interpretations in accounting for its plans.  Accordingly, no 
compensation cost has been recognized for options granted under the Stock 
Option Plan and Directors'  Stock Option Plan.  Had compensation cost for 
these plans been determined based on the fair value of the options at the 
grant date for awards in 1997, 1996 and 1995 consistent with the provisions of 
SFAS No. 123, the Company's net loss and net loss per share would have 
increased to the pro forma amounts indicated below (in thousands, except per 
share amounts):

<TABLE>
<CAPTION>
                                                                               DECEMBER 31,
                                                                  -------------------------------------
                                                                     1997          1996          1995
                                                                  ---------      -------       --------
<S>                                                               <C>            <C>           <C>
Net loss as reported . . . . . . . . . . . . . . . . . . .        $(18,247)      $(4,156)      $(2,426)
                                                                  --------       -------       -------
                                                                  --------       -------       -------
Net loss - pro forma . . . . . . . . . . . . . . . . . . .        $(20,951)      $(5,794)      $(2,636)
                                                                  --------       -------       -------
                                                                  --------       -------       -------
Basic net loss per share as reported . . . . . . . . . . .        $  (1.11)      $ (0.30)      $ (0.23)
                                                                  --------       -------       -------
                                                                  --------       -------       -------
Basic net loss per share - pro forma . . . . . . . . . . .        $  (1.28)      $ (0.41)      $ (0.25)
                                                                  --------       -------       -------
                                                                  --------       -------       -------
Diluted net loss per share as reported . . . . . . . . . .        $  (1.11)      $ (0.30)      $ (0.23)
                                                                  --------       -------       -------
                                                                  --------       -------       -------
Diluted net loss per share - pro forma . . . . . . . . . .        $  (1.28)      $ (0.41)      $ (0.25)
                                                                  --------       -------       -------
                                                                  --------       -------       -------
</TABLE>
                                     42

<PAGE>

                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. SHAREHOLDERS' EQUITY -- (CONTINUED):

     As the provisions of SFAS No. 123 are only applied to stock options 
granted after January 1, 1995 in the above pro forma amounts, the impact of 
the pro forma stock compensation cost will likely continue to increase as the 
vesting period for the Company's options and the period over which the stock 
compensation is charged to expense is generally three years.

     The fair value of each option grant is estimated on the date of grant 
using a type of  Black-Scholes option pricing model with the following 
weighted-average assumptions used for grants in 1997, 1996 and 1995.

<TABLE>
<CAPTION>
                                                                      DECEMBER 31, 
                                                         ------------------------------------
                                                           1997           1996          1995
                                                         -------        -------       -------
<S>                                                      <C>            <C>           <C>
Exercise price . . . . . . . . . . . . . . . . . . . .   $  4.04        $  2.79       $  1.40
Expected life of option. . . . . . . . . . . . . . . .   8 years        9 years       7 years
Risk-free interest rate. . . . . . . . . . . . . . . .     5.85%          6.36%         5.73%
Expected volatility. . . . . . . . . . . . . . . . . .       36%            45%           60%
</TABLE>

     Option activity under both plans is as follows (IN THOUSANDS, EXCEPT PER 
SHARE AMOUNTS): 

<TABLE>
<CAPTION>
                                                                                              OUTSTANDING OPTIONS
                                                                 SHARES       ---------------------------------------
                                                                AVAILABLE     NUMBER           WEIGHTED
                                                                  FOR           OF              AVERAGE
                                                                 GRANT         SHARES       PRICE PER SHARE     TOTAL
                                                               ----------     --------      ---------------    ------
<S>                                                            <C>            <C>           <C>                <C>
Balance, January 1, 1995 . . . . . . . . . . . . . . . . . .     1,006          1,236             $1.09        $1,434
     Additional shares reserved. . . . . . . . . . . . . . .     1,200
     Options granted . . . . . . . . . . . . . . . . . . . .    (1,308)         1,308             $1.67         2,180
     Options canceled. . . . . . . . . . . . . . . . . . . .         4             (4)            $1.45            (6)
                                                                ------         ------             -----        -------
Balance, December 31, 1995 . . . . . . . . . . . . . . . . .       902          2,540             $1.38         3,608

     Additional shares reserved. . . . . . . . . . . . . . .       750
     Options granted . . . . . . . . . . . . . . . . . . . .      (515)           515             $8.96         4,618
     Options canceled. . . . . . . . . . . . . . . . . . . .        56            (56)            $3.74          (208)
     Options exercised . . . . . . . . . . . . . . . . . . .         -           (214)            $0.91          (196)
                                                                ------         ------             -----      --------
Balance, December 31, 1996 . . . . . . . . . . . . . . . . .     1,193          2,785             $2.77      $  7,822

     Options granted . . . . . . . . . . . . . . . . . . . .      (775)           775             $7.52         5,823
     Options canceled. . . . . . . . . . . . . . . . . . . .       174           (174)            $6.70        (1,162)
     Options exercised . . . . . . . . . . . . . . . . . . .         -           (501)            $1.21          (604)
                                                                ------         ------             -----       -------
Balance, December 31, 1997 . . . . . . . . . . . . . . . . .       592          2,885             $4.04       $11,879
                                                                ------         ------             -----       -------
                                                                ------         ------             -----       -------
</TABLE>

     At December 31, 1997, 1996 and 1995, options to purchase 1,720,531,
1,517,045 and 1,241,646 shares of common stock, respectively were exercisable at
weighted average fair values of  $2.74, $1.38, and $0.96, respectively.

                                     43

<PAGE>

                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


10.  SHAREHOLDERS' EQUITY -- (CONTINUED):

<TABLE>
<CAPTION>
                                                                OPTIONS CURRENTLY
                          OPTIONS OUTSTANDING                       EXERCISABLE
                      ------------------------------    -------------------------------------
                                           WEIGHTED
                                           AVERAGE      WEIGHTED                     WEIGHTED
                         NUMBER OF         REMAINING     AVERAGE                      AVERAGE
       EXERCISE           SHARES          CONTRACTUAL    EXERCISE     NUMBER          EXERCISE
        PRICES          OUTSTANDING     LIFE IN YEARS    PRICE     EXERCISABLE         PRICE
       -------        ------------     -------------   --------   ------------     ---------
<S>                   <C>              <C>             <C>        <C>              <C>
                     (IN THOUSANDS)                               (IN THOUSANDS)
  $   0.03 - $ 1.43        400              3.66        $  0.94         400           $  0.94
  $   1.44 - $ 1.44        175              5.68        $  1.44         175           $  1.44
  $   1.67 - $ 1.67      1,191              7.90        $  1.67         843           $  1.67
  $   4.17 - $ 6.63        299              9.18        $  5.74          23           $  4.17
  $   6.75 - $ 8.50        531              9.14        $  8.07         169           $  8.08
  $   8.63 - $11.00        238              7.70        $ 10.19          91           $ 10.76
  $  11.50 - $16.00         51              8.79        $ 11.89          20           $ 11.90
</TABLE>

EMPLOYEE STOCK PURCHASE PLAN:

     The Company maintains an Employee Stock Purchase Plan, under which 250,000
shares of common stock have been reserved for issuance.  Eligible employees are
permitted to purchase common stock at 85% of the fair market value through
payroll deductions of up to 15% of an employee's compensation, subject to
certain limitations.  At December 31, 1997, 59,140 shares had been issued under
this plan.

11.   EMPLOYEE RETIREMENT PLAN:

     The Company maintains a 401(k) plan for its employees.  The plan allows
eligible employees to defer up to 15% of their earnings, not to exceed the
statutory amount per year on a pretax basis through contributions to the plan. 
The plan provides for employer contributions at the discretion of the Board of
Directors, however, no such contributions were made in 1997 or 1996.

12.  INTEREST AND OTHER INCOME:

     Interest and other income consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                                          ------------
                                                                1997          1996         1995
                                                                ----          ----         ----
<S>                                                          <C>            <C>            <C>
Interest Income . . . . . . . . . . . . . . . . . . . . . .  $  1,998       $  1,752       $  2
Gain on Sale of Marketable Securities . . . . . . . . . . .       448              -          -
                                                             --------       --------       ----
                                                             $  2,446       $  1,752       $  2
                                                             --------       --------       ----
                                                             --------       --------       ----
</TABLE>

                                     44

<PAGE>

                       ECLIPSE SURGICAL TECHNOLOGIES, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13.  INCOME TAXES:

    The components of the net deferred tax asset are as follows (IN THOUSANDS):

<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                                       ------------------------
                                                                          1997            1996
                                                                       ---------       --------
<S>                                                                    <C>            <C>
      Net operating losses . . . . . . . . . . . . . . . . . . . . . . $  10,212       $  2,939
      Research and development and other credits . . . . . . . . . . .     1,308            649
      Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . .       959            301
      Accrued Liabilities. . . . . . . . . . . . . . . . . . . . . . .       293            139
      Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       829             37
                                                                       ---------       --------
           Net deferred asset. . . . . . . . . . . . . . . . . . . . .    13,601          4,065
      Less valuation allowance . . . . . . . . . . . . . . . . . . . .   (13,601)        (4,065)
                                                                       ---------       --------
                                                                       $       -       $      -
                                                                       ---------       --------
                                                                       ---------       --------
</TABLE>

     The Company has established a valuation allowance to the extent of its
deferred tax asset since it is not certain that a benefit can be realized in the
future due to the Company's recurring operating losses. 

     The change in the valuation allowance was $9,536,000, $1,998,000 and
$436,000 in 1997, 1996, and 1995, respectively. 

     The noncurrent portion of the deferred tax assets, which totaled
$12,521,000 and $3,290,000 at December 31, 1997 and 1996, respectively, is
included above. 

     At December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $28,800,000 and $7,330,000, respectively,
available to offset future regular and alternative minimum taxable income. In
addition, the Company had federal and state credit carryforwards of
approximately $949,000 and $545,000 available to offset future tax liabilities.
The Company's net operating loss carryforwards, as well as credit carryforwards,
expire in 1998 through 2012, if not utilized. 

     The Tax Reform Act of 1986 limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a company. The Company believes that the sale of common stock in
its initial  public offering resulted in an ownership change which could
restrict the utilization of the carryforwards.

14.  MAJOR CUSTOMERS:

     For the year ended December 31, 1997 two customers accounted for 35% of net
revenues.  For the year ended December 31, 1996 one customer accounted for 11%
of net revenues.  Two customers accounted for 10% each of net revenues for the
year ended December 31, 1995.

     Export sales accounted for approximately 32%, 13% and  20% of net sales for
the years ended December 31, 1997, 1996 and 1995, respectively. 


                                     45

<PAGE>

                                   SIGNATURES

     PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.


                              ECLIPSE SURGICAL TECHNOLOGIES, INC.
                                Registrant


Date: February 27, 1998       By:  /s/   Douglas Murphy-Chutorian, M.D.
                                   -------------------------------------------
                                   DOUGLAS MURPHY-CHUTORIAN, M.D. 
                                   CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE 
                                   OFFICER 


      PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, 
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE 
REGISTRANT IN THE CAPACITIES AND ON THE DATE INDICATED.


<TABLE>
<CAPTION>
               Signature                                    Title                                     Date
               ---------                                    ------                                    -----
<S>                                             <C>                                           <C>
/s/  Douglas Murphy-Chutorian, M.D.               Chairman and Chief Executive
------------------------------------------      Officer (Principal Executive Officer)         February 27, 1998
     Douglas Murphy-Chutorian, M.D.


/s/  Richard L. Mueller, Jr.                    President, Chief Operating Officer            February 27, 1998
------------------------------------------                 and Director
     Richard L. Mueller, Jr.


/s/  Barbara A. Dreblow                               Chief Financial Officer                 February 27, 1998
------------------------------------------              (Principal Accounting and 
     Barbara A. Dreblow                                   Financial Officer)


/s/  Iain M. Watson                                          Director                         February 27, 1998
------------------------------------------
     Iain M. Watson


/s/  Robert L. Mortensen                                     Director                         February 27, 1998
------------------------------------------
     Robert L. Mortensen


/s/  Alan L. Kaganov, Sc.D.                                  Director                         February 27, 1998
------------------------------------------
     Alan L.  Kaganov, Sc.D.
</TABLE>
                                     46

<PAGE>

                                                                   SCHEDULE II


                        ECLIPSE SURGICAL TECHNOLOGIES, INC.
                   VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                                   (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                         BALANCE AT                                    BALANCE
                                                          BEGINNING                                     AT END
                                                          OF PERIOD    ADDITIONS(1)  DEDUCTIONS(2)     OF PERIOD
                                                          ---------    ------------   ------------     ----------
<S>                                                       <C>           <C>           <C>               <C>
Year ended December 31, 1995
   Allowance for doubtful accounts . . . . . . . . . .     $  60         $   40          $  71         $   29

Year ended December 31, 1996 . . . . . . . . . . . . .     $  29         $  258          $   7         $  280
   Allowance for doubtful accounts

Year ended December 31, 1997
   Allowance for doubtful accounts . . . . . . . . . .     $ 280         $  477          $   -         $  757
</TABLE>
____________________________
(1)  Charged to costs and expenses.
(2)  Accounts written off against the reserve.


                                         47

<PAGE>

                         REPORT OF INDEPENDENT ACCOUNTANTS
                          ON FINANCIAL STATEMENT SCHEDULE

     In connection with our audits of the consolidated financial statements of
Eclipse Surgical Technologies, Inc. as of December 31, 1997 and 1996, and for
each of the three years in the period ended December 31, 1997, which financial
statements are included in this Form 10-K, we have also audited the financial
statement schedule listed in Item 14a herein.

     In our opinion, this financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.




                         COOPERS & LYBRAND L.L.P.


San Jose, California
January 30, 1998


                                      48