<PAGE>
 
================================================================================

                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                   FORM 10-K
                                        
                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
                                        
(Mark One)
[X]             ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                 For the fiscal year ended December 31, 1998.
                                       OR
[_]        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
           For the transition period from __________ to __________.
                        Commission File Number 0-12128

                                MATRITECH, INC.
            (Exact Name of Registrant as Specified in Its Charter)

         Delaware                                        04-2985132
(State or Other Jurisdiction of             (IRS Employer Identification Number)
Incorporation or Organization)
 
         330 Nevada Street                                            02460
        Newton, Massachusetts                                      (ZIP Code)
(Address of Principal Executive Offices)


      Registrant's telephone number, including area code: (617) 928-0820
          Securities registered pursuant to Section 12(b) of the Act:

   Title of Each Class                 Name of Each Exchange on Which Registered
   -------------------                 -----------------------------------------
         None                  

                                        
          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.01 Par Value
                               (Title of Class)

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

    Aggregate market value, as of March 15, 1999, of Common Stock held by
non-affiliates of the registrant: $29,981,633 based on the last reported sale
price on the Nasdaq Stock Market.

    Number of shares of Common Stock outstanding on March 15, 1999: 18,629,252.

                      DOCUMENTS INCORPORATED BY REFERENCE

    The registrant intends to file a Definitive Proxy Statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December 31,
1998. Portions of such Proxy Statement are incorporated by reference in Part III
of this report.

================================================================================
<PAGE>
 
                                    PART I

ITEM 1.  BUSINESS.

Overview

         Matritech, Inc. (the "Company" or "Matritech") develops, manufactures
and markets innovative cancer diagnostic products based on its proprietary
nuclear matrix protein ("NMP") technology.  The nuclear matrix, a three
dimensional protein framework within the nucleus of cells, plays a fundamental
role in determining cell type by physically organizing the contents of the
nucleus, including DNA.  The Company has demonstrated that there are differences
in the types and amounts of NMPs found in cancerous and normal tissue and
believes the detection of such differences in NMPs provides important diagnostic
information about cellular abnormalities, including cancer.  Using its
proprietary NMP technology and expertise, the Company has developed non-invasive
or minimally invasive cancer diagnostic tests for bladder and colon cancer and
is developing additional tests for cervical, breast and prostate cancer.  The
Company's objective is to develop tests that will be more accurate and allow for
reduced treatment costs and a higher standard of patient care than currently
available tests.

         NMP22 Test Kit for Bladder Cancer. The Company's first product based on
its NMP technology, the NMP22 (*) Test Kit for bladder cancer, was approved for
sale in the United States by the U.S. Food and Drug Administration ("FDA") in
1996 as a prognostic indicator for the recurrence of bladder cancer. In May
1998, the NMP22 Test Kit for bladder cancer was approved for sale in Japan by
the Japanese Ministry of Health and Welfare ("Koseisho") for use in screening
previously-undiagnosed bladder cancer patients. The NMP22 Test Kit for bladder
cancer has been commercially available in Europe since 1995 and is currently
being marketed in Asia and in many other countries outside the United States.
The Company has retained worldwide manufacturing rights for the NMP22 Test Kit
for bladder cancer as well as certain marketing rights in the United States. The
Company has entered into an exclusive distribution agreement for the NMP22 Test
Kit for bladder cancer in Japan and has additional distribution arrangements in
selected European and other countries worldwide. In March 1998, the Company and
Curtin Matheson Scientific, a division of Fisher Healthcare Company, L.L.C.
("CMS") entered into a co-exclusive distribution agreement for the NMP22 Test
Kit for bladder cancer in the United States.

         Test Kit for Colon Cancer.  The Company has also developed a blood-
based test utilizing its NMP technology for the management of colon cancer
patients.  Blood specimens for use in generating clinical data for a premarket
approval submission to the FDA have been collected and the Company believes that
these specimens are sufficient to permit the tests necessary to substantiate a
claim for the use of its colon cancer test kit for the differential diagnosis of
individuals exhibiting symptoms such as rectal bleeding.  The Company intends to
use these specimens in conjunction with its current manual format test, the
NuMA(TM) Test Kit, or in validating the performance of a second generation NMP-
based colon cancer test employing other colon cancer NMPs.  In either case, the
Company intends to conduct the specimen testing and the FDA submission in
collaboration with an automated instrument partner. Consequently, the timing of
an FDA submission for the Company's colon cancer test will depend upon
concluding a satisfactory agreement with an automated instrument partner, if
any, and upon completion of work necessary to design the test's automated
format, as the Company and such partner may agree. The Company has retained
worldwide manufacturing and marketing rights for its colon cancer assay.

_______________________
(*)  NMP22/R/ is a registered trademark and NuMA/TM/, NMP-179/TM/ and 
     Matritech/TM/ are trademarks of Matritech, Inc. All other trademarks, 
     service marks or trade names used in this report are the property of their
     respective owners.
<PAGE>
 
                                      -2-


          Cervical, Breast and Prostate Cancer Tests.  The Company has also
identified NMPs specific to cervical, breast and prostate cancer and is
currently developing diagnostic tests based on its proprietary NMP technology
for these cancers.   Matritech's scientists have reported the results of pre-
clinical trials of its NMP-179(TM) Test for the identification of women with
cancer or pre-cancerous conditions of the cervix.  These studies, which were
conducted in collaboration with several leading women's health centers in New
England, confirm the efficacy of the NMP-179 antibody in identifying women at
elevated risk for cervical cancer.  The Company is in the process of optimizing
the format and procedures relating to the test in preparation for conducting FDA
clinical trials to obtain approval to market the test in the United States.
Matritech scientists have identified cancer specific proteins for both breast
and prostate cancers and are in the process of developing blood and tissue based
tests for use in the identification and management of individuals with these
cancer types.

          Matritech was incorporated in Delaware in October 1987.  The Company's
facilities are located at 330 Nevada Street, Newton, Massachusetts 02460 and its
telephone number is (617) 928-0820.

Cancer Diagnostics Market

          The cancer diagnostics market is comprised of several overlapping
categories, each corresponding to a stage in the identification and management
of the disease.  The categories are screening, diagnosing, monitoring and
evaluating prognosis.  Screening tests and procedures, such as mammograms and
Pap smears, are performed regularly on individuals who may have no evidence of
ill health because the tests are effective in revealing hidden, asymptomatic
disease.  Screening tests do not yield a final diagnosis.  An actual diagnosis
of cancer is usually made after microscopic examination of a tissue biopsy.
Following diagnosis, additional tests can be used to monitor the course of the
disease and the patient's response to treatment.  These monitoring tests may be
repeated at regular intervals, often every three months, and may be continued
for the life of an individual in order to detect the recurrence of cancer.  In
addition, diagnostic tests are also used to evaluate a patient's prognosis and
to select appropriate therapy.  Patients identified as having a high risk of
recurrence will be monitored more closely and may receive more aggressive
treatment.  In the United States, cancer diagnostic assays have generally been
approved by the FDA for monitoring patients with known disease and only
occasionally have been approved for screening purposes.

          Ideally, a cancer diagnostic assay for use in a clinical laboratory
should be both sensitive and specific.  Clinical sensitivity refers to the
percentage of cases in which the assay correctly identifies the presence of
disease.  Clinical specificity refers to the percentage of cases in which the
assay correctly identifies the absence of disease.  Clinical sensitivity and
specificity percentages reported from studies and trials of cancer diagnostic
products may not be directly comparable, as results may be affected by
laboratory-to-laboratory differences in specimen handling, the number of
subjects studied, variability in the stages of disease present in the subject
population and the demographic composition of the subject population, among
other factors.

          Effective in vitro diagnostic assays can reduce the need for more
invasive or expensive procedures for diagnosing and managing cancer, such as
surgery, biopsy, bone scans and in vivo imaging.  There are only a limited
number of FDA-approved in vitro cancer diagnostic tests currently available and
the relatively low clinical sensitivity and specificity of these tests have
limited their clinical utility.  The Company believes that these tests suffer
from inherent inaccuracies because they detect substances that are only
indirectly correlated with the cancer cells.  As a consequence of low clinical
sensitivity, these tests yield false negatives and many patients with cancer are
not diagnosed early enough to receive effective treatment, resulting in
additional costs and morbidity.  Conversely, low 
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                                      -3-


clinical specificity yields false positives resulting in unnecessary, expensive
and painful treatment of patients without malignant disease.

NMP Technology

          The Company believes that its NMP technology allows it to develop
cost-effective in vitro assays that are more accurate than others currently
available.  The nuclear matrix, a three-dimensional protein framework within the
nucleus of cells, helps organize active genes ("DNA") in the nucleus.  In this
way, the nuclear matrix plays a fundamental role in determining cell type and
cell function.  Although the specific mechanisms of action are not yet fully
understood, Matritech and independent scientists have demonstrated that there
are differences in the types and amounts of NMPs found in cancerous and normal
tissues and also among different types of normal cells.  Independent academic
investigators have also confirmed the Company's findings in papers published in
scientific journals which described NMPs specific to kidney, prostate, breast
and colon cancer tissues.  Certain of these NMPs were shown to be present in
100% of the cancer tissue specimens examined, but were absent in all of the
normal tissue specimens.  Subsequent to these papers, the Company has examined
numerous additional cancer tissue specimens with similar results.  Matritech
also has demonstrated that cell death, including cell death related to early
tumor development, results in the release of NMPs into bodily fluids.  As a
result, elevated levels of certain NMPs may be found in the bodily fluids of
cancer patients.  The Company is not aware of any other cancer marker, or class
of markers, which exhibit this level of clinical specificity and sensitivity.

          The Company uses its proprietary technology and expertise to identify,
isolate and extract NMPs from cancerous and normal tissues.  Following
extraction, the Company's scientists characterize and sequence cancer-specific
NMPs, which generally are absent, or present at low levels, in the urine, blood
and cells of healthy individuals.  The Company then develops proprietary
antibodies to these NMPs and incorporates the antibodies into industry-standard
diagnostic formats, such as blood-based immunoassays.

          The Company's core NMP technology is licensed from the Massachusetts
Institute of Technology ("MIT").  Under the current terms of the Company's
license from MIT, the Company's worldwide license is exclusive until  the
expiration of all patent rights in 2006.  The Company has made additional
advances in NMP technology, has filed its own patent applications for related
protection and to date has been granted nine additional United States patents.

Matritech's Products and Products Under Development

          NMP22 Test Kit for Bladder Cancer

          In 1996, Matritech's NMP22 Test Kit for bladder cancer was approved
for sale in the United States by the FDA as a prognostic indicator for the
recurrence of bladder cancer.  The test was approved based upon an extensive
clinical trial of the NMP22 Test Kit for bladder cancer involving more than
1,000 subjects at 13 sites, including bladder cancer patients, patients with
other cancers, patients with non-cancerous urinary conditions (such as urinary
tract infections) and healthy subjects.  In May 1998, the NMP22 Test Kit for
bladder cancer was also approved for sale in Japan by Koseisho for use in
screening previously undiagnosed individuals.  The Company is currently
marketing this product in the U.S. through its own sales force and distributors
and in other major markets worldwide through distributors. Sales of the NMP22
Test Kit for bladder cancer began in certain countries in Europe in 1995.
<PAGE>
 
                                      -4-

          The Company believes that the use of the NMP22 Test Kit for bladder
cancer will enable urologists to manage bladder cancer patients with less
invasive and less frequent procedures, thereby potentially reducing treatment
costs while maintaining a high standard of patient care.  If a bladder cancer
patient's NMP22 value is low (less than or equal to 10 units per milliliter) 10
or more days after surgery, there is a high probability that there will be no
evidence of disease upon  follow-up cystoscopic examination.  Consequently, the
urologist may decide to postpone this exam in order to reduce the cost, anxiety
and risk to the patient.  Similarly, an NMP22 value greater than 10 units per
milliliter indicates a higher risk that the follow-up cystoscopic examination
will indicate a recurrence of disease, enabling the urologist to make more
aggressive treatment decisions.

          In 1994, the Company entered into a distribution agreement with Konica
Corporation ("Konica").  The Konica agreement grants exclusive distribution
rights in Japan for the NMP22 Test Kit for bladder cancer in exchange for
$325,000 in licensing fees.  Under the terms of its agreement with Konica,
Matritech will sell NMP22 Test Kits to Konica for resale in Japan at prices
based on Japanese reimbursement rates.   Konica has limited manufacturing rights
if the Company fails to deliver required quantities of test kits.

          In March 1998, the Company entered into a distribution agreement with
CMS.  Pursuant to this agreement, the Company retained its right to distribute
the NMP22 Test Kit for bladder cancer in the United States through its own sales
force, but granted CMS an otherwise exclusive right to distribute the NMP22 Test
Kit for bladder cancer to hospitals and commercial laboratories within the
United States.  The Company has retained worldwide manufacturing rights for the
NMP22  Test Kit for bladder cancer.  The Company has entered into distribution
arrangements in selected European and other countries worldwide.

          Test Kit for Colon Cancer

          The Company has also developed a blood-based test utilizing its NMP
technology for the management of colon cancer patients.  Blood specimens for use
in generating clinical data for a premarket approval submission to the FDA have
been collected and the Company believes that these specimens are sufficient to
permit the tests necessary to substantiate a claim for the use of its colon
cancer test kit for the differential diagnosis of individuals exhibiting
symptoms such as rectal bleeding.  The Company intends to use these specimens in
conjunction with its current manual format test, the NuMA Test Kit, or in
validating the performance of a second generation NMP-based colon cancer test
employing other colon cancer NMPs.  In either case, the Company intends to
conduct the specimen testing and FDA submission in collaboration with an
automated instrument partner. Consequently, the timing of an FDA submission for 
the Company's colon cancer test will depend upon concluding a satisfactory 
agreement with an automated instrument partner, if any, and upon completion of 
work necessary to design the test's automated format, as the Company and such 
partner may agree.

          The Company has retained worldwide manufacturing and marketing rights
for its colon cancer test.  The Company is seeking distributors and an automated
instrument partner for this test.

          Cervical Cancer Product

          Matritech's scientists have reported the results of pre-clinical
trials of its NMP-179 Test for the identification of women with cancer or pre-
cancerous conditions of the cervix. These studies, which were conducted in
collaboration with several leading women's health centers in New England,
confirm the efficacy of the NMP-179 antibody in identifying women at elevated
risk for cervical cancer. The Company is in the process of optimizing the format
and procedures relating to the test in preparation for conducting FDA clinical
trials to obtain approval to market the test in the United States. Matritech has
maintained its worldwide manufacturing and marketing rights to its cervical
cancer product.

<PAGE>
 
                                      -5-

          Breast Cancer Product

          During 1998, Matritech scientists, using a mass spectrometer
instrument, demonstrated the ability to detect certain breast cancer markers in
the blood of cancer patients at higher levels than in normal individuals. These
scientists are now evaluating these proteins to attempt to select an assay
combination suitable for pre-clinical evaluation in 1999. Following this, the
Company intends to conduct clinical trials to generate data required to apply
for FDA approval of such assays. Matritech believes that the distinctive NMPs
found in breast cancer cells and the Company's ability to detect these NMPs in
blood may enable it to develop a breast cancer blood-based assay more accurate
than products presently available. The Company has retained worldwide
manufacturing and marketing rights for its breast cancer product under 
development.

          Prostate Cancer Product

          In collaboration with clinicians at Johns Hopkins University Medical
School ("Hopkins"), Matritech scientists have identified a nuclear matrix
protein, NMP-23, present in elevated amounts in the cells of prostate cancer
patients and absent, or present in low amounts, in normal individuals and those
with benign disease.  The Company has developed an antibody, PRO4:216, to this
protein which has been tested by the Hopkins scientists using prostate biopsies.
Hopkins scientists have reported that the antibody is clinically useful in
differentiating prostate cancer cells from their normal and benign counterparts.
Matritech scientists are pursuing another NMP which they believe may be released
into the blood and are presently evaluating other antibodies to this protein
using conventional assay development techniques as a first step in developing a
clinical fluid-based assay for use in the management of prostate cancer
patients. The Company has retained worldwide manufacturing and marketing rights 
for its prostate cancer product under development.

Marketing and Sales

          The Company has retained rights to sell all of its products in the
United States.  Matritech is selling its NMP22 Test Kit for bladder cancer in
the United States to clinical laboratories using its own direct sales force, and
in March 1998 entered into a distribution agreement with CMS granting CMS the
right, co-exclusive with Matritech, to distribute the NMP22 Test Kit for bladder
cancer to hospitals and commercial laboratories within the U.S. The Company
currently has three full-time sales representatives and such sales force may be
expanded as sales of the Company's products warrant. Outside the United States,
the Company sells the NMP22 Test Kit through distributors.

          During the fiscal year ended December 31, 1998 the Company received
approximately 29% and 31% of its revenue from product sales from Wallac ADL and
CMS, respectively.

          During the fiscal years ended December 31, 1996, 1997 and 1998, 24%,
42% and  52%, respectively, of the Company's total product sales were from the
United States and 76%, 58% and 48%, respectively, were from foreign countries.
Product sale revenue generated outside the U.S. during the fiscal years ended
December 31, 1996, 1997 and 1998 was primarily from Europe.  See Note 9 of Notes
to Financial Statements -- "Segment and Geographic Information."

Third-Party Reimbursement

          The Company's ability to successfully commercialize its products will
depend in part on the extent to which reimbursement for the cost of such
products will be available from government

<PAGE>
 
                                      -6-


health administration authorities, private health insurers and other third-party
payors. The Company believes that FDA approval of a diagnostic product
facilitates third-party reimbursement, but there can be no assurance that
reimbursement will be available for such products or, if available, that it will
be adequate.

          In the case of private insurance, the reimbursement of any medical
device, whether approved, or for investigational use only or for research use,
is at the sole discretion of the patient's individual carrier.  The decision to
reimburse can be made on a case-by-case basis (as is done for research
therapies) or on a system-wide basis (such as screening mammography).
Historically, the decision to reimburse for a new medical procedure is made by
the carrier's medical director or review committee.  This group will base their
reimbursement decision on published clinical data and information by the
treating physicians.  Even if a procedure has been approved for reimbursement,
there are no assurances that the insurance carrier will continue to reimburse
the procedure.

          Health care reform is an area of continuing national attention and a
priority of many governmental officials.  Certain reform proposals, if adopted,
could impose limitations on the prices the Company will be able to charge in the
United States for its products or the amount of reimbursement available for the
Company's products from governmental agencies or third-party payors.

Manufacturing and Facilities

          The Company currently assembles its test kits in a portion of its
22,500 square-foot facility in Newton, Massachusetts and relies on
subcontractors for certain components and processes.  The Company's lease is for
a term of five years and expires on December 31, 2000.  The annual base rent for
each year of the term is $230,625.  The Company believes that its current
facilities are adequate to satisfy the Company's needs for the foreseeable
future.  Thereafter, if the Company is required to expand its manufacturing
capabilities, it may be required to establish additional facilities elsewhere.
There can be no assurance that the Company will be able to extend its lease or
lease other space on reasonable terms.  The Company has retained all
manufacturing rights for its products and products under development, except for
certain rights that could be granted to the Company's NMP22 Test Kit
distribution partner in Japan if the Company fails to perform under its
agreement with such distributor.

          The Company currently relies on sole suppliers for certain key
components for its NMP22 Test Kit for bladder cancer.  In the event that the
components from such suppliers should become unavailable for any reason, the
Company would seek alternative sources of supply, which may entail making
regulatory submissions and obtaining regulatory approvals from the FDA or such
alternative suppliers.  Although the Company attempts to maintain an adequate
level of inventory to provide for these and other contingencies, should its
manufacturing process be disrupted as a result of a shortage of key components
or a revalidation of new components, there can be no assurance that the Company
would be able to meet its commitments to customers.  The Company is also subject
to the FDA's Good Manufacturing Practice ("GMP") requirements.  See "--
Government Regulation."

Competition

          Matritech is not aware of any other company using NMP technology to
develop diagnostic or therapeutic products.  However, competition in the
development and marketing of cancer diagnostics and therapeutics, using a
variety of technologies, is intense.
<PAGE>
 
                                      -7-

          There are many pharmaceutical companies, biotechnology companies,
public and private universities and research organizations actively engaged in
the research and development of clinical cancer diagnostic products.  Many of
these organizations have financial, manufacturing, marketing and human resources
greater than those of the Company.  Matritech expects that its diagnostic
products will compete largely on the basis of clinical utility, accuracy
(sensitivity and specificity), ease of use and other performance
characteristics, price, patent position, as well as on the capabilities of the
Company and its marketing partners.

          The Company expects that certain of its assays will compete with
existing FDA-approved assays, including BTA, which is used for monitoring
bladder cancer, CEA, which is used primarily for monitoring colorectal and
breast cancers, PSA and PSA related markers, which are used primarily for
monitoring and screening prostate cancer, and TRUQUANT BR RIA, which is used for
monitoring breast cancer.  Matritech is also aware of a number of companies
exploring the application of oncogene technology to cancer diagnostics.

          A number of companies are attempting to develop automated instruments
for Pap smear analysis that would compete with the cervical cancer product
currently being developed by the Company.  These companies are computerizing
image analysis techniques to automate much of the work currently done by
cytotechnologists.  To date,  several  of these instruments have been approved
by the FDA for rescreening Pap smear slides previously identified by a
cytotechnologist as normal as well as the primary screening of cervical
specimens.

          The Company's products will also compete with more invasive or
expensive procedures such as surgery, bone scans, magnetic resonance imaging
("MRI") and other in vivo imaging techniques.  Matritech believes that its
products, if successfully commercialized, will contribute to improved patient
management and lower overall costs, by providing accurate information and, in
some cases, by providing an alternative to these invasive or costly procedures.

          Should the Company decide to develop and seek to market therapeutic
products, competition will be based, among other things, on product efficacy,
safety, reliability, price and patent position as well as the state of the
industry and capabilities of the Company, future marketing partners and
competitors.

          In addition, there can be no assurance that competing diagnostic and
therapeutic products based on other technologies will not be introduced by other
companies and adversely affect the competitive position of the Company.

Patents, Licenses and Trade Secrets

          Matritech's diagnostic technology is protected by three United States
patents owned by MIT and expiring in 2006, with corresponding foreign patents
granted and/or patent applications pending in Canada and selected countries in
Europe and the Far East.  One of the three United States patents was granted
following a reissue proceeding before the United States Patent and Trademark
Office.  The NMP technology owned by MIT is licensed to Matritech worldwide in
exchange for royalties payable until the expiration of underlying patent rights.
MIT has licensed its patent rights to Matritech on an exclusive basis through
2006.

          The protection offered by these patents extends to the detection and
measurement of NMPs, or associated nucleic acids, using antibody or gene probe
formats, as well as to certain assay methods exploiting NMPs.  With regard to
related NMP advances, Matritech has filed additional United States
<PAGE>
 
                                      -8-

patent applications and, in certain circumstances, foreign counterparts in one
or more countries including Australia, Canada and selected countries in Europe
and the Far East. The Company currently has nine United States patents and six
applications on file in the United States on these disclosures. Certain United
States patents provide additional protection for Matritech's NMP22 Test Kit for
bladder cancer until 2015. The Company intends to file additional patent
applications in the future. The Company believes that any patents that may issue
from its applications will provide competitive protection for its products after
expiration of its license from MIT. The Company also intends to rely on its
unpatented proprietary information to maintain and develop its commercial
position.

Government Regulation

          Diagnostic Products

          The medical devices to be marketed and manufactured by the Company are
subject to extensive regulation by the FDA, and, in some instances, by foreign
governments.  Pursuant to the Federal Food, Drug and Cosmetic Act of 1976, as
amended, and the regulations promulgated thereunder (the "FDC Act"), the FDA
regulates the clinical testing, manufacture, labeling, distribution, and
promotion of medical devices.  Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of marketing approvals, and criminal prosecution.  The FDA also has
the authority to request repair, replacement or refund of the cost of any device
manufactured or distributed by the Company.

          In the United States, medical devices and diagnostics are classified
into one of three classes (class I, II, or III) on the basis of the controls
deemed necessary by the FDA to reasonably assure their safety and effectiveness.
Under FDA regulations, class I devices are subject to general controls (for
example, labeling, premarket notification and adherence to GMPs) and class II
devices are subject to general and special controls (for example, performance
standards, postmarket surveillance, patient registries, and FDA guidelines).
Generally, class III devices are those which must receive premarket approval
("PMA") by the FDA to ensure their safety and effectiveness (for example, life-
sustaining, life- supporting and implantable devices, or new devices which have
not been found substantially equivalent to legally marketed devices).

          Before a new device can be introduced into the market, the
manufacturer must generally obtain marketing clearance through the filing of
either a 510(k) notification or a PMA.  A 510(k) clearance will be granted if
the submitted information establishes that the proposed device is "substantially
equivalent" to a legally marketed class I or II medical device, or to a class
III medical device for which the FDA has not called for a PMA.  The FDA may
determine that a proposed device is not substantially equivalent to a legally
marketed device, or that additional information or data are needed before a
substantial equivalence determination can be made.  A request for additional
data may require that clinical studies of the safety and efficacy of the device
be performed.

          Commercial distribution of a device for which a 510(k) notification is
required can begin only after the FDA issues an order finding the device to be
"substantially equivalent" to a predicate device.  It generally takes from four
to twelve months from submission to obtain a 510(k) clearance, but may take
longer.  The FDA may determine that a proposed device is not substantially
equivalent to a legally marketed device, or that additional information is
needed before a substantial equivalence determination can be made.
<PAGE>
 
                                      -9-

          A PMA application must be filed if a proposed device is not
substantially equivalent to a legally marketed class I or class II device, or if
it is a class III device for which the FDA has called for PMAs.  A PMA
application must be supported by valid scientific evidence which typically
includes clinical trial data to demonstrate safety and the effectiveness of the
device.  The PMA application must also contain the results of all relevant bench
tests, laboratory and animal studies, a complete description of the device and
its components, and a detailed description of the methods, facilities and
controls used to manufacture the device, as well as proposed labeling.

          Upon receipt of a PMA application, the FDA makes a threshold
determination as to whether the application is sufficiently complete to permit a
substantive review.  If the FDA determines that the PMA application is
sufficiently complete to permit a substantive review, the FDA will accept the
application for filing.  Once the submission is accepted for filing, the FDA
begins an in-depth review of the PMA.  An FDA review of a PMA application
generally takes one to two years from the date the PMA application is accepted
for filing, but may take significantly longer.  The review time is often
significantly extended as a result of the FDA requiring more information or
clarification of information already provided in the submission.  During the
review period, an advisory committee, typically a panel of clinicians and/or
other appropriate experts in the relevant fields, will likely be convened to
review and evaluate the application and provide recommendations to the FDA as to
whether the device should be approved.  The FDA is not bound by the
recommendations of the advisory committee but generally follows them.  Toward
the end of the PMA review process, the FDA generally will conduct an inspection
of the manufacturer's facilities to ensure that the facilities are in compliance
with applicable GMP requirements.

          If the FDA's evaluations of both the PMA application and the
manufacturing facilities are favorable, the FDA will either issue an approval
letter or an approvable letter, which usually contains a number of conditions
which must be met in order to secure final approval for sale of the device.
When and if those conditions have been fulfilled to the satisfaction of the FDA,
the agency will issue a PMA approval letter, authorizing commercial marketing of
the device for certain indications.  If the FDA's evaluations of the PMA
application or manufacturing facilities are not favorable, the FDA will deny
approval of the PMA application or issue a "not approvable letter." The FDA may
also determine that additional clinical trials are necessary, in which case a
PMA may be substantially delayed while additional clinical trials are conducted
and submitted in an amendment to the PMA.  The PMA process can be expensive,
uncertain and lengthy and a number of devices for which FDA approval has been
sought by other companies have never been approved for marketing.

          Once a device has successfully completed the PMA process,
modifications to the device, its labeling, or manufacturing process may require
approval by the FDA of PMA supplements or new PMAs.  Supplements to a PMA often
require the submission of the same type of information required for an initial
PMA, except that the supplement is generally limited to that information needed
to support the proposed change from the product covered by the original PMA.

          Although clinical investigations of most devices are subject to the
investigational device exemption ("IDE") requirements, clinical investigations
of in vitro diagnostic ("IVDs") tests are exempt from the IDE requirements,
including FDA approval of investigations, provided the testing is non- invasive,
does not require an invasive sampling procedure that presents significant risk,
does not introduce energy into a subject, and the tests are not used as a
diagnostic procedure without confirmation of the diagnosis by another medically
established diagnostic product or procedure.  IVD manufacturers must also
establish distribution controls to assure that IVDs distributed for the purposes
of conducting clinical investigations are used only for that purpose.  Pursuant
to current FDA policy, manufacturers of
<PAGE>
 
                                      -10-


IVDs labeled for investigational use only ("IUO") or research use only ("RUO")
are encouraged by the FDA to establish a certification program under which
investigational IVDs are distributed to or utilized only by individuals,
laboratories, or health care facilities that have provided the manufacturer with
a written certification of compliance indicating that (1) the device will be
used for investigational or research purposes only, and (2) results will not be
used for diagnostic purposes without confirmation of the diagnosis under another
medically established diagnostic device or procedure. In addition, the
certification program requirements for IUO products should include assurances
that all investigations or studies will be conducted with approval from an
institutional review board ("IRB"), using an IRB-approved study protocol and
patient informed consent and that the device will be labeled in accordance with
the applicable labeling regulations. Sponsors of clinical trials are permitted
to sell those devices distributed in the course of the study provided such
compensation does not exceed recovery of the costs of manufacture, research,
development and handling.

          In 1996, the FDA approved Matritech's NMP22 Test Kit for bladder
cancer for sale in the United States as a prognostic indicator for bladder
cancer (i.e., as a predictor of bladder cancer recurrence following therapy,
such as surgical excision of cancerous tissue).  A number of independent urology
investigators have evaluated Matritech's NMP22 Test Kit for bladder cancer to
determine its value in resolving the symptom of hematuria (blood in the urine)
to identify those hematuria patients who actually have bladder cancer.  Based
upon these published results, as well as the successful submission and approval
of the NMP22 Test Kit for bladder cancer for this claim in Japan, the Company
intends to complete an FDA clinical trial for this claim.  The Company is in the
final stages of collecting and documenting urine specimens from hematuria
patients with the objective of submitting the NMP22 Test Kit for bladder cancer
for FDA approval in the second quarter of 1999.

          In connection with Matritech's colon cancer program, blood specimens
for use in generating clinical data for a PMA submission to the FDA have been
collected and the Company believes that these specimens are sufficient to permit
the tests necessary to substantiate a claim for the use of Matritech's colon
cancer test for the differential diagnosis of individuals exhibiting symptoms
such as rectal bleeding. The Company intends to use these specimens in
conjunction with its current manual format test, the NuMA Test Kit, or in
validating the performance of a second generation NMP-based colon cancer test
employing other colon cancer NMPs. In either case, the Company intends to
conduct the specimen testing and FDA submission in collaboration with an
automated instrument partner. Consequently, the timing of an FDA submission for 
the Company's colon cancer test will depend upon concluding a satisfactory 
agreement with an automated instrument partner, if any, and upon completion of 
work necessary to design the test's automated format, as the Company and such 
partner may agree.

          Any products manufactured or distributed by the Company pursuant to
FDA clearances or approvals are subject to pervasive and continuing regulation
by the FDA, including recordkeeping requirements and reporting of adverse
experiences with the use of the device.  Device manufacturers are required to
register their establishments and list their devices with the FDA, and are
subject to periodic inspections by the FDA and certain state agencies.  The FDC
Act requires devices to be manufactured in accordance with GMP regulations which
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
and, in certain instances, by the Federal Trade Commission.  In the United
States, the NMP22 Test Kit for bladder cancer may only be promoted by the
Company to aid in the management of bladder cancer patients.  The FDA actively
enforces regulations prohibiting the promotion of devices for unapproved uses
and the promotion of devices for which premarket clearance or approval has not
been obtained.  Consequently, in the United States the Company cannot promote
the NMP22 Test Kit for cancer screening or for any other unapproved use.
Failure to comply with these requirements can result in regulatory enforcement
action by the FDA that would adversely affect the Company's ability to conduct
testing necessary to obtain
<PAGE>
 
                                      -11-

market clearance for these products and, consequently, could have a material
adverse effect on the Company's business, financial condition and results of
operations.

          The Company and its products are also subject to a variety of state
laws and regulations in those states or localities where its products are or
will be marketed.  Any applicable state or local regulations may hinder the
Company's ability to market its products in those states or localities.
Manufacturers are also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, manufacturing practices,
environmental protection, fire hazard control, and disposal of hazardous or
potentially hazardous substances.  There can be no assurance that the Company
will not be required to incur significant costs to comply with such laws and
regulations now or in the future or that such laws or regulations will not have
a material adverse effect upon the Company's ability to do business.

          Foreign Sales

          Export of unapproved products subject to the PMA requirements must be
approved in advance by the FDA for export unless they are approved for use by
the regulatory authorities in any member community of the European Community and
certain other countries, in which case they may be exported to any country
without FDA approval.  To obtain FDA export approval, when it is required,
certain requirements must be met and information must be provided to the FDA,
including, with some exceptions, documentation demonstrating that the product is
approved for import into a country to which it is to be exported and safety data
from animal or human studies.  There can be no assurance that FDA will grant
export approval when such approval is necessary, or that the countries to which
the devices are to be exported will approve the devices for import.  Failure on
the part of the Company to obtain export approvals, when required, could
significantly delay and impair the Company's ability to continue exports of its
devices and could have a material adverse effect on the Company's business,
financial condition or results of operations.

          The introduction of the Company's developmental-stage test products in
foreign markets will also subject the Company to foreign regulatory clearances
which may impose additional substantial costs and burdens.  International sales
of medical devices are subject to the regulatory requirements of each country.
The regulatory review process varies from country to country.  Many countries
also impose product standards, packaging requirements, labeling requirements and
import restrictions on devices.  In addition, each country has its own tariff
regulations, duties and tax requirements.  In Germany, where the Company began
selling its NMP22 Test Kit for bladder cancer in 1995, no regulatory approval
comparable to the United States PMA is required prior to public sale of
diagnostic products.  In May 1998, the Koseisho approved the NMP22 Test Kit for
bladder cancer for sale in Japan for use in screening previously undiagnosed
patients.

          The approval by the FDA and foreign government authorities is
unpredictable and uncertain and no assurance can be given that the necessary
approvals or clearances will be granted on a timely basis or at all.  Delays in
receipt of, or a failure to receive, such approvals or clearances, or the loss
of any previously received approvals or clearances, could have a material
adverse effect on the business, financial condition and results of operations of
the Company.

          Changes in existing requirements or adoption of new requirements or
policies could adversely affect the ability of the Company to comply with
regulatory requirements.  Failure to comply with regulatory requirements could
have a material adverse effect on 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 laws or regulations will 
<PAGE>
 
                                      -12-

not have a material adverse effect upon the Company's business, financial
condition or results of operations.

          CLIA

          Pursuant to the Clinical Laboratory Improvement Amendments ("CLIA"),
the FDA will assign a complexity category to each new in vitro diagnostic test.
This category will determine the rigor of quality control that must be followed
by purchasers and users of the device and, thus, can affect purchasing decisions
of laboratories and hospitals.  In addition, as part of the premarket review
process, manufacturers must establish that the device's quality control
instructions are commensurate with CLIA quality control requirements for that
device.  The review period for in vitro diagnostic tests may be extended due to
these new CLIA requirements.

          Other

          In order for the Company to conduct preliminary studies or clinical
trials at a hospital or other health care facility, the Company's research
collaborators must first obtain approval from the IRB of the hospital or health
care facility.  In each case, a written protocol must be submitted to the IRB
describing the study or trial, which is reviewed by the IRB with a view to
protecting the safety and privacy of the institution's patients.

          In addition to the regulatory framework for clinical trials and
product approvals, the Company is subject to regulation under federal, state and
local law, including requirements regarding occupational safety, laboratory
practices, environmental protection and hazardous substance control, and may be
subject to other present and possible future local, state, federal and foreign
regulation.

Employees

          As of March 15, 1999, the Company had 40 full-time employees, 21 of
whom were engaged in research and development.  The Company's future success
depends in part on its ability to recruit and retain talented and trained
scientific, technical, marketing and business personnel.  The Company has been
successful to date in hiring and retaining such personnel, but there can be no
assurance that such success will continue.  None of the Company's employees is
represented by a labor union, and the Company considers its relations with its
employees to be excellent.

Research and Development

          Matritech's future success will depend in large part on its ability to
develop and bring to market new products based on its proprietary NMP
technology.  Accordingly, Matritech devotes substantial resources to research
and  development.  The Company has assembled a scientific staff with a variety
of  complementary skills in several advanced research disciplines, including
molecular biology, immunology and protein chemistry.  In addition, Matritech
maintains consulting and advisory relationships with a number of prominent
researchers.

          In 1997, Matritech was awarded a Phase I Small Business Innovation
Research ("SBIR") Grant from the National Cancer Institute to further develop
NMP tests for use in the detection and management of colon cancer patients.
Matritech had recorded $6,000 and $73,000 in funding related to this SBIR grant
for the years ended December 31, 1997 and  1998, respectively.
<PAGE>
 
                                      -13-

          During 1996, 1997 and 1998 Matritech spent approximately $3.9 million,
$3.9 million and $4.0 million, respectively, on research and development.
Substantially all of these expenditures were related to the development of
diagnostic products.


ITEM 2.   PROPERTIES.

          The Company's  facilities are located in Newton, Massachusetts, where
the Company leases corporate headquarters, research and development and
manufacturing facilities which occupy approximately 22,500 square feet.  The
Company's lease is for a term of five (5) years and expires on or about December
31, 2000.  The annual base rent for each year of the term is $230,625.  The
Company believes that its current facilities are adequate to satisfy the
Company's needs for the foreseeable future, and has not made a determination
whether it will seek to extend its lease when it expires in 2000 or seek to
lease space elsewhere.  There can be no assurance that the Company will be able
to extend its lease or lease other space on reasonable terms.


ITEM 3.   LEGAL PROCEEDINGS.

          The Company is not currently a party to any material pending legal
          proceeding.


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

          No matters were submitted to a vote of security holders during the
          fourth quarter of 1998.
<PAGE>
 
                                      -14-

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

         Since August 6, 1997, the Company's Common Stock has been traded on
The Nasdaq National Market tier of The Nasdaq Stock Market ("Nasdaq National
Market") under the symbol: "NMPS." Prior to that date the Company's Common Stock
was traded on The Nasdaq SmallCap Market tier of The Nasdaq Stock Market
("Nasdaq SmallCap Market") under the symbol: "NMPS" and on the Boston Stock
Exchange under the symbol: "MPS."  The following table sets forth the range of
quarterly high and low sales price information for the Common Stock as reported,
for the period prior to August 6, 1997, by the Nasdaq SmallCap Market, and for
all subsequent periods, by the Nasdaq National Market.

<TABLE>
<CAPTION>
 Fiscal 1997                   High                 Low
------------                   ----                 ---   
<S>                         <C>                 <C>             
First Quarter                $ 10-1/4             $  4-5/8
Second Quarter                  8-3/8              3-11/16
Third Quarter                       7                4-7/8
Fourth Quarter                  7-3/4               3-9/16

<CAPTION>                                          
Fiscal 1998                              
-----------
<S>                         <C>                 <C>   
First Quarter                $      6             $  3-3/8
Second Quarter                  5-1/8              1-25/32
Third Quarter                 2-15/16                29/32
Fourth Quarter                      3                  5/8
</TABLE>

          As of March 15, 1999, there were approximately 322 shareholders of
record.  The Company believes that shares of the Company's Common Stock held in
bank, money management, institution and brokerage house "nominee" names may
account for an estimated 7,000 additional beneficial holders.

          The Company has never paid cash dividends on its Common Stock.  The
Company currently intends to retain any earnings to finance future growth and
therefore does not anticipate paying any cash dividends in the foreseeable
future.
<PAGE>
 
                                      -15-

ITEM 6.   SELECTED FINANCIAL DATA.

     The selected financial data presented below for each year in the five-year
period ended December 31, 1998 have been derived from the Company's financial
statements, which have been audited by Arthur Andersen LLP, independent public
accountants.  This data should be read in conjunction with the financial
statements, related notes, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and other financial information included
elsewhere in this Form 10-K.

<TABLE>
<CAPTION>
                                            1994               1995               1996               1997               1998
                                 ----------------------------------------------------------------------------------------------
<S>                                <C>                <C>                <C>                <C>                <C>
Statements of Operations Data:
Revenues:
 Collaborative research and             $ 1,314,334        $ 1,023,438        $ 1,881,833        $   747,532        $   967,759
  development, license fees and
  product sales
 Interest and other income                   91,591            216,865            528,583            566,686            457,678
                                        -----------        -----------        -----------        -----------        -----------
Total revenues                            1,405,925          1,240,303          2,410,416          1,314,218          1,425,437
 
Expenses:
 Research & development                   3,470,122          3,014,125          3,909,793          3,943,390          4,010,368
 Selling, general &                       1,591,525          2,308,773          3,665,298          4,845,915          4,950,593
  administrative                        -----------        -----------        -----------        -----------        -----------
Total expenses                            5,061,647          5,322,898          7,575,091          8,789,305          8,960,961
                                        -----------        -----------        -----------        -----------        -----------
Net loss                                $(3,655,722)       $(4,082,595)       $(5,164,675)       $(7,475,087)       $(7,535,524)
                                        ===========        ===========        ===========        ===========        ===========
Basic and diluted net loss per          $      (.46)       $      (.38)       $      (.32)       $      (.43)       $      (.40)
 common share(1)                        ===========        ===========        ===========        ===========        ===========
Weighted average number of                7,951,721         10,733,769         15,900,467         17,512,242         18,608,784
 common shares outstanding(1)           ===========        ===========        ===========        ===========        ===========
</TABLE>
<TABLE>
<CAPTION>
                                            1994                1995                 1996                1997               1998
                                 --------------------------------------------------------------------------------------------------
Balance Sheet Data:
<S>                                <C>                <C>                  <C>                 <C>                 <C>
Cash, cash equivalents and             $  3,974,237         $ 11,009,310        $  6,770,336        $ 11,067,414       $  4,146,821
 short-term investments
Working capital                           3,419,323           10,838,756           7,165,462          10,989,534          3,787,709
Total assets                              4,582,194           11,959,203           8,669,861          12,691,773          5,511,825
Accumulated deficit                     (16,893,135)         (20,975,730)        (26,140,405)        (33,615,492)       (41,151,016)

Total stockholders' equity             $  3,878,067         $ 11,351,178        $  7,783,984        $ 11,688,674       $  4,399,981
</TABLE>

                                                                               
______________________
(1)  Basic and diluted loss per share are the same for all periods presented.
     See Note 1 of Notes to Financial Statements.
<PAGE>
 
                                      -16-

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

Overview

     The Company was incorporated in 1987 to develop, manufacture and market
innovative cancer diagnostic products based on its proprietary NMP technology.
Matritech has been unprofitable since inception and expects to incur significant
operating losses for at least the next several years.  For the period from
inception to December 31, 1998, the Company incurred a cumulative net loss of
approximately $41.2 million.

Results of Operations

Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
-----------------------------------------------------------------------

     Product sales and collaborative research and development revenue increased
to $968,000 for the year ended December 31, 1998 from $748,000 for the year
ended December 31, 1997.  Revenue from product sales increased to $895,000 for
the year ended December 31, 1998 from $602,000 for the year ended December 31,
1997 due primarily to increased sales of the NMP22 Test Kit for bladder cancer
in the United States and Europe.  Product revenue may fluctuate from quarter to
quarter and from year to year based on the timing of distributors' orders for
the NMP22 Test Kits for bladder cancer.  Revenue from collaborative research and
development included $73,000 and $6,000 in SBIR funding for Matritech's NuMA
Tumor Marker project for the years ended December 31, 1998 and December 31,
1997, respectively.  In addition, Matritech recorded $140,000 in revenue from
collaborative research and development for the year ended December 31, 1997,
consisting of a milestone payment associated with a development agreement with
Bayer Corporation.

     Interest and other income was $458,000 for the year ended December 31, 1998
and $567,000 for the year ended December 31, 1997.  The decrease was due to
lower average cash balances available for investment in 1998 as compared to
1997.

     Research and development expenses increased slightly to $4,010,000 for the
year ended December 31, 1998 from $3,943,000 for 1997.  The increase was
primarily due to increased staffing of clinical affairs personnel to manage the
Company's colon cancer FDA submission and the NMP22 screening trial and related
site management costs.

     Selling, general and administrative expenses increased to $4,951,000 for
the year ended December 31, 1998 from $4,846,000 for the year ended December 31,
1997.  The increase was due to the augmentation of the sales force for the NMP22
Test Kit for bladder cancer and increased public relations and media relations
consulting fees.  In April 1997, the Company issued a warrant to a public
relations consultant.  The Company expensed the value of the warrant, $500,000,
ratably over the one year term of its agreement with such consultant.  The
Company expensed $150,000 and $350,000 of the value of this warrant during the
years ended December 31, 1998 and December 31, 1997, respectively.

     The Company incurred a net loss of $7,536,000 for the year ended December
31, 1998 as compared with a net loss of $7,475,000 for the year ended December
31, 1997.  The increased loss was primarily due to increased sales and marketing
expenses for the NMP22 Test Kit for bladder cancer, consulting fees, and to a
lesser extent, increased clinical affairs costs associated with the colon cancer
project.
<PAGE>
 
                                      -17-

Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
-----------------------------------------------------------------------

     Product sales, collaborative research and development revenue and license
fees decreased to $748,000 for the year ended December 31, 1997 from $1,882,000
for the year ended December 31, 1996.  Revenue from product sales decreased to
$602,000 for the year ended December 31, 1997 from $1,678,000 for the year ended
December 31, 1996.  This decrease primarily reflects initial stocking orders of
the NMP22 Test Kit for bladder cancer that were made by new distributors in 1996
which were not repeated in 1997.  Product revenue may fluctuate from quarter to
quarter and from year to year based on the timing of distributors' orders for
the NMP22 Test Kits for bladder cancer.  Matritech's revenue from collaborative
research and development for the year ended December 31, 1997 and 1996 was
$140,000 and $120,000, respectively, consisting of milestone revenue from a
funded development agreement with Bayer Corporation.  Matritech also received
$6,000 in SBIR funding during the year ended December 31, 1997 for its NuMA
Tumor Marker project and $84,000 in SBIR funding for its cancer therapy
development project during the year ended December 31, 1996.

     Interest and other income was $567,000 for the year ended December 31, 1997
and $528,000 for the year ended December 31, 1996.  The increase was due to
higher average cash balances available for investment and higher interest rates
in 1997 as compared to 1996.

     Research and development expenses increased slightly to $3,943,000 for the
year ended December 31, 1997 from $3,910,000 for 1996.  The increase was
primarily due to costs associated with product development personnel,
consultants, reagents and supplies for the Company's colon and cervical cancer
projects.

     Selling, general and administrative expenses increased to $4,846,000 for
the year ended December 31, 1997 from $3,665,000 for the year ended December 31,
1996.  The increase was due to the augmentation of the sales force for the NMP22
Test Kit for bladder cancer, increased public relations and media relations
consulting fees and fees associated with the inclusion of the Company on the
Nasdaq National Market system.  The increase in selling expenses for the NMP22
Test Kit for bladder cancer was primarily attributable to increased staffing in
sales, including recruitment, travel, administrative supplies and promotional
materials for the Company's sales representatives for the NMP22 Test Kit in the
United States, as well as, increased expenditures on clinical marketing programs
and consultants with clinical expertise. In April 1997, the Company issued a
warrant to a public relations consultant. The Company expensed the value of the
warrant, $500,000, ratably over the one year term of its agreement with such
consultant. The Company expensed $350,000 of the value of this warrant in the
year ended December 31, 1997. During 1996, the Company expensed approximately
$209,000 of costs associated with a proposed public offering which the Company
elected not to complete.

     The Company incurred a net loss of $7,475,000 for the year ended December
31, 1997 as compared with a net loss of $5,165,000 for the year ended December
31, 1996.  The increased loss resulted primarily from decreased revenues and
increased sales and marketing expenses for the NMP22 Test Kit for bladder
cancer.

Liquidity and Capital Resources

     Since its inception, the Company has financed its operations primarily
through private and public offerings of its securities and through funded
development and marketing agreements. At December 31, 1998, 1997 and 1996 the
Company had cash and cash equivalents of $4,147,000, $11,067,000 and
<PAGE>
 
                                      -18-

$6,770,000, respectively, and working capital of $3,788,000, $10,990,000 and
$7,165,000, respectively. The Company's primary cash infusion in 1997 was from
the private sale of common stock which totaled $10,904,000, and in 1996 the
Company received its primary cash infusion from the exercise of common stock
options and warrants which totaled $1,514,000.

     The Company's operating activities used cash of approximately $6,901,000,
$6,486,000 and $5,505,000 for the years ended December 31, 1998, 1997 and 1996,
respectively, primarily to fund the Company's operating loss.

     The Company's investing activities used cash of approximately $56,000,
$516,000 and $240,000 in the years ended December 31, 1998, 1997 and 1996,
respectively, primarily for purchases of computer systems, office and laboratory
equipment, leasehold improvements and certain intangible assets.  The Company
currently estimates that capital expenditures during the year ending December
31, 1999 will not be significant.

     Financing activities provided cash of approximately $36,000, $11,299,000
and $1,506,000 in the years ended December 31, 1998, 1997 and 1996,
respectively, primarily from the sale of equity securities, the exercise of
stock options and warrants and proceeds from a capital equipment loan in 1997,
net of payments of capital lease obligations.

     In 1997, the Company entered into an equipment line of credit with Phoenix
Leasing, Incorporated under which it could borrow up to $1,200,000 for equipment
purchases.  The equipment line of credit has since expired and was converted
into a term note on October 20, 1997 totaling $286,000.  The term note is
payable over 48 months and is secured by the underlying equipment.  The term
note bears interest at 11.75% and has an outstanding balance of $209,000 at
December 31, 1998.

     The Company expects to incur continued research and development expenses
and other costs, including costs related to clinical studies to commercialize
additional products based upon its NMP technology.  The Company will require
substantial additional funds to fund operations, complete new product
development, conduct clinical trials and manufacture and market its products.

     The Company's future capital requirements will depend on many factors,
including, but not limited to: continued scientific progress in its research and
development programs; the magnitude of its research and development programs;
progress with clinical trials for its diagnostic products; the magnitude of
product sales; the time involved in obtaining regulatory approvals; the costs
involved in filing, prosecuting and enforcing patent claims; competing
technological and market developments; and the ability of the Company to
establish additional development and marketing arrangements to provide funding
for research and development and to conduct clinical trials, obtain regulatory
approvals, and manufacture and market certain of the Company's products.

     The Company has implemented certain cost-reduction measures to conserve
capital resources. Such measures include changing the Company's public relations
firm and deferring the hiring of non-essential personnel. The Company believes
that such measures will not materially detract from its marketing and sales
effort for its FDA-approved product for bladder cancer nor materially affect its
existing programs relating to colon, cervical, breast, or prostate cancer
product development.

          During March 1999, the Company entered into an agreement with certain
investors providing for the sale of 3,094,811 shares of the Company's Common
Stock, in a private placement, for an aggregate net selling price of
approximately $4,000,000 (the "Private Placement").  The transactions
contemplated 
<PAGE>
 
                                      -19-


by this agreement are expected to close during April 1999, subject to customary
closing conditions. The Company expects to receive net proceeds of approximately
$3,940,000 after deducting the estimated expenses of the transaction.

          The Company is also actively seeking additional long-term funding from
public and private sources including strategic collaborations and partnerships.
There can be no assurance, however, that capital will be available on terms
acceptable to the Company, if at all.  If the Company uses equity to finance its
capital needs, such a financing could result in significant dilution to existing
stockholders.

          As of December 31, 1998, the Company had $4,147,000 in cash and cash
equivalents and $3,788,000 of working capital.  The Company believes that its
existing  cash resources, expected cash flow from operating activities and the
proceeds from the Private Placement will satisfy its capital needs through 1999.
If the Private Placement should fail to close for any reason, the Company would
immediately seek to replace such financing.  There can be no assurance that such
replacement financing could be obtained on terms acceptable to the Company, if
at all.  If such replacement financing is not obtained, the Company believes
that its existing cash resources and expected cash flow from operating
activities may not be sufficient to fund its operations at current levels beyond
mid-1999.  In such an event, the Company would be required to significantly
reduce the scope of operations after the second quarter of 1999.  The Company
has  contingency plans for cost reductions which could enable it to continue
limited operations through the end of 1999 under such circumstances.

          The Company has reviewed all of its information systems to assess what
steps, if any, are required to achieve full Year 2000 compliance.  The Company
relies upon microprocessor-based personal computers and commercially available
applications software.  These technologies have been put into service recently,
and the Company's review indicates that certain of the Company's systems are
currently Year 2000 compliant.  The Company has begun to address the small
number of systems that are not yet Year 2000 compliant, and anticipates
achieving full compliance early in the fourth quarter of 1999.  The Company is
currently in the process of reviewing its critical non-information technology
systems and anticipates completing such review by the end of the second quarter
of 1999.  The Company does not anticipate that it will incur material expenses
to make its computer software and operating systems Year 2000 compliant and has
accrued $25,000 in its financial statements at December 31, 1998 related to such
expenses.  The Company is currently discussing Year 2000 readiness with its
material supply and service vendors.  To date, those suppliers and service
vendors that have been contacted have indicated that their hardware or software
is or will be Year 2000 compliant in time frames that meet the Company's
requirements.  The Company intends to continue to assess its exposure to Year
2000 noncompliance on the part of any of its material vendors and there can be
no assurance that their systems will be Year 2000 compliant.  In the event that
certain material suppliers or service vendors indicate that they will not
successfully address their Year 2000 problems in a timely fashion and that such
failure may have a material adverse effect on the Company, management may elect
to suspend such business relationships until such time that such vendors become
fully compliant.  The Company is currently formulating contingency plans to
address problems that may arise in the event either the Company or its material
suppliers and vendors fail to address their Year 2000 problems in a timely
fashion.  The Company presently believes that the Year 2000 issue will not pose
significant operational problems for the Company.  However, if all Year 2000
issues are not properly identified, or assessment, remediation and testing are
not effected timely with respect to Year 2000 problems that are identified,
there can be no assurance that the Year 2000 issue will not materially adversely
impact the Company's results or operations or materially adversely affect the
Company's relationships with customers, suppliers or others.  Additionally,
there can be no assurance that the Year 2000 issues of third parties will not
have a material adverse impact on the Company's systems or results of
operations.
<PAGE>
 
                                      -20-

          The foregoing discussion includes forward-looking statements that are
subject to risks and uncertainties and actual results may differ materially from
those currently anticipated depending on a variety of factors including those
discussed below.  See "Factors that may Affect Future Results."  The survival of
the Company in the long term, however, is dependent on its ability to generate
revenue from sales of its products.  There can be no assurance that, in the long
term, the Company will be able to generate sufficient revenue to achieve and
maintain profitability.

Factors That May Affect Future Results

          The Company's future financial and operational results are subject to
a number of material risks and uncertainties that may affect such results or
conditions, including:

          Access to Capital. Even with expected proceeds from the pending
Private Placement, the Company needs to obtain additional long-term financing
and will consider various financing alternatives, including equity or debt
financings and corporate partnering arrangements.  There can be no assurance,
however, that this financing will be available on terms acceptable to the
Company, if at all.  If additional financing is not available, the Company may
be required to further curtail expenses or take other steps that adversely
affect the Company's future performance.

          Risk of Delisting from the Nasdaq National Market.  The Company's
Common Stock is currently listed on the Nasdaq National Market ("NNM").  For
continued listing of the Company's Common Stock on the NNM, it must, among other
things, maintain at least $4 million in net tangible assets and a minimum bid
price of $1.00.  If the Company's net tangible assets fall below $4 million, or
the Company's Common Stock trades at a price of less than $1.00 for 30
consecutive business days or more, it may result in the delisting of the
Company's securities from NNM, and trading, if any, of the Company's securities
would thereafter be conducted on a non-Nasdaq over-the-counter market.  If the
Company's securities are delisted, an investor could find it more difficult to
dispose of, or to obtain accurate quotations as to the market value of, the
Company's securities.  In addition, if the Company's securities were delisted,
they may be subject to a rule that imposes additional sales practice
requirements on broker-dealers who sell such securities to persons other than
established customers and accredited investors.  For transactions covered by
this rule, the broker-dealer must make a special suitability determination for
the purchaser and must have received the purchaser's written consent to the
transaction prior to sale.  Consequently, delisting, if it occurred, may affect
the ability of broker-dealers to sell the Company's securities and the ability
of the stockholders to sell their securities.

          History of Operating Losses and Anticipated Future Losses. The Company
has incurred operating losses since its inception and does not expect to be
profitable within the next several years. While the Company expects to improve
operating results in future periods, there can be no assurance that the Company
will achieve or maintain profitability or that its revenue will grow in the
future.

          Fluctuation in Operating Results. The Company's future operating
results may vary significantly from quarter to quarter or from year to year
depending on a number of factors including: the timing and size of orders from
the Company's customers and distributors; regulatory approvals and the
introduction of new products by the Company; and the market acceptance of the
Company's products. The Company's current planned expense levels are based in
part upon expectations as to future revenue. Consequently, profits may vary
significantly from quarter to quarter or year to year based on the timing of
revenue. Revenue or profits in any period will not necessarily be indicative of
results in subsequent periods.
<PAGE>
 
                                      -21-

     Uncertainties Associated with Future Performance. The Company's
success in the market for diagnostic products will depend, in part, on the
Company's ability to: successfully develop, test, produce and market its
products; obtain necessary governmental approvals in a timely manner; attract
and maintain key employees; and successfully respond to technological changes in
its marketplace. The Company's success in markets outside the United States is
dependent on the performance of independent distributors over which the Company
has limited control.

     Near-Term Dependence Upon NMP22. The Company anticipates that in the
near-term it will be substantially dependent on the success of the NMP22 Test
Kit for bladder cancer, which was approved for sale in the U.S. by the FDA in
1996 and approved for sale in Japan in 1998, and expects to generate
substantially all of its near-term product sales from the sale of NMP22 Test
Kits for bladder cancer. The Company would experience a material adverse effect
on its business, financial condition and results of operations if the NMP22 Test
Kit for bladder cancer does not achieve wide market acceptance. The remainder of
the Company's products have not been approved by the FDA or are in development
and there can be no assurance that it will be successful with such regulatory
approvals and product development.

     Reliance on Sole Suppliers. The Company currently relies on sole suppliers 
for certain key components for its NMP22 Test Kit. In the event that the
components from such suppliers should become unavailable for any reason, the
Company would seek alternative sources of supply, which may entail making
regulatory submissions and obtaining regulatory approvals from the FDA or such
alternative suppliers. Although the Company attempts to maintain an adequate
level of inventory to provide for these and other contingencies, should its
manufacturing process be disrupted as a result of a shortage of key components
or a revalidation of new components, there can be no assurance that the Company
would be able to meet its commitments to customers.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

     Investment Portfolio.  The Company does not use derivative financial
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer, and type of instrument.  See Note 1 of
Notes to Financial Statements -- "Operations and Significant Accounting
Policies."


ITEM 8.   CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     The information required by this item is contained in the financial
statements set forth in Item 14(a) under the caption "Financial Statements" as a
part of this report.


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

     There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's two most recent
fiscal years.
<PAGE>
 
                                      -22-

                                   PART III
                                        
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Directors

     The information concerning directors of the Company required under this
item is incorporated herein by reference to the Company's definitive proxy
statement pursuant to Regulation 14A, to be filed with the Commission not later
than 120 days after the close of the Company's fiscal year ended December 31,
1998 under the headings "Occupations of Directors and Executive Officers" and
"Section 16(a) Beneficial Ownership Reporting Compliance."

Executive Officers

     The information concerning executive officers of the Company required under
this item is incorporated herein by reference to the Company's definitive proxy
statement pursuant to Regulation 14A, to be filed with the Commission not later
than 120 days after the close of the Company's fiscal year ended December 31,
1998 under the headings "Occupations of Directors and Executive Officers" and
"Section 16(a) Beneficial Ownership Reporting Compliance."


ITEM 11.  EXECUTIVE COMPENSATION.

     The information required under this item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, to be filed with the Commission not later than 120 days after the close of
the Company's fiscal year ended December 31, 1998, under the heading
"Compensation and Other Information Concerning Directors and Officers."


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

     The information required under this item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, to be filed with the Commission not later than 120 days after the close of
the Company's fiscal year ended December 31, 1998, under the heading "Securities
Ownership of Management and Principal Stockholders."


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information, if any, required under this item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, to be filed with the Commission within 120 days after the close of the
Company's fiscal year ended December 31, 1998, under the heading "Certain
Relationships and Related Transactions."
<PAGE>
 
                                      -23-

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

(a) 1.    Financial Statements.
          Report of Independent Public Accountants.
          Balance Sheets as of December 31, 1997 and 1998.
          Statements of Operations for the Years ended December 31, 1996, 
          1997 and 1998.

          Statements of Stockholders' Equity (Deficit) for the years ended
          December 31, 1996, 1997 and 1998.

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

          Notes to Financial Statements.

    2.    No schedules are submitted because they are not applicable, not
          required or because the information is included in the Financial
          Statements or Notes to Financial Statements.

    3.    List of Exhibits.

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

          3.1                  Amended and Restated Certificate of Incorporation
                               of the Registrant (filed as Exhibits 3, 4.1 to
                               the Company's Registration Statement No. 33-46158
                               on Form S-1 and incorporated herein by
                               reference).

          3.2                  Amended and Restated By-Laws of the Registrant
                               (filed as Exhibits 3.2, 4.1 to the Company's
                               Registration Statement No. 33-46158 on Form S-1
                               and incorporated herein by reference).

          3.3                  Certificate of Amendment dated June 16, 1994, of
                               Amended and Restated Certificate of Incorporation
                               of the Registrant (filed as Exhibit 3.2 of the
                               Company's Quarterly Report on Form 10-Q for the
                               fiscal quarter ended June 30, 1995 and
                               incorporated herein by reference).

          3.4                  Certificate of Amendment dated June 5, 1995, of
                               Amended and Restated Certificate of Incorporation
                               of the Registrant (filed as Exhibit 3.3 of the
                               Company's Quarterly Report on Form 10-Q for the
                               fiscal quarter ended June 30, 1995 and
                               incorporated herein by reference).

          4.1                  Description of Capital Stock contained in the
                               Registrant's Amended and Restated Certificate of
                               Incorporation, filed as Exhibits 3.1, 3.3 and
                               3.4.
<PAGE>
 
                                      -24-

          10.1*                License Agreement between Matritech and the
                               Massachusetts Institute of Technology dated
                               December 14, 1987, as amended March 15, 1988,
                               December 20, 1989 and March 4, 1992 (filed as
                               Exhibit 10.1 to the Company's Registration
                               Statement No. 33-46158 on Form S-1 and
                               incorporated herein by reference).

          10.2+                1988 Stock Plan (filed as Exhibit 10.8 to the
                               Company's Registration Statement No. 33-46158 on
                               Form S-1 and incorporated herein by reference).

          10.3+                1992 Stock Plan as amended as of June 13, 1997
                               (filed as Exhibit 10.4 to the Company's Annual
                               Report on Form 10-K for the fiscal year ended
                               December 31, 1997 and incorporated herein by
                               reference).

          10.4+                Amended and Restated 1992 Non-Employee Director
                               Stock Plan as amended as of June 7, 1996 (filed
                               as Exhibit 10.2 to the Company's Quarterly Report
                               on Form 10-Q for the fiscal quarter ended June
                               30, 1996 and incorporated herein by reference).

          10.5+                1992 Employee Stock Purchase Plan (filed as
                               Exhibit 10.11 to the Company's Registration
                               Statement No. 33-46158 on Form S-1 and
                               incorporated herein by reference).

          10.6                 Second Amended and Restated Registration Rights
                               Agreement dated May 4, 1990, as amended February
                               26, 1992 (filed as Exhibit 10.13 to the Company's
                               Registration Statement No. 33-46158 on Form S-1
                               and incorporated herein by reference).

          10.7                 Form of Indemnity Agreement with directors (filed
                               as Exhibit 10.14 to the Company's Registration
                               Statement No. 33-46158 on Form S-1 and
                               incorporated herein by reference).

          10.8                 Fourth Amendment dated March 18, 1993 to License
                               Agreement between the Company and the
                               Massachusetts Institute of Technology dated
                               December 14, 1987, as amended (filed as Exhibit
                               10.9 to the Company's Annual Report on Form 10-K
                               for the fiscal year ended December 31, 1997 and
                               incorporated herein by reference).

          10.9*                License Agreement between the Company and The
                               Johns Hopkins University dated as of August 4,
                               1993 (filed as Exhibit 10.2 to the Company's
                               Quarterly Report on Form 10-Q for the quarter
                               ended September 30, 1993 and on paper as File No.
                               1-12128 and incorporated herein by reference).

          10.10                Fifth Amendment dated April 14, 1994 to License
                               Agreement between the Company and the
                               Massachusetts Institute of Technology dated
                               December 14, 1987 (filed as Exhibit 10.1 to the
                               Company's Form 10-Q for the quarter ended March
                               31, 1994 and incorporated herein by reference).
<PAGE>
 
                                      -25-

          10.11*               Exclusive Distribution Agreement between the
                               Company and Konica Corporation dated as of
                               November 9, 1994. (Filed as Exhibit 10.26 to the
                               Company's Annual Report on Form 10-K for the
                               fiscal year ended December 31, 1994 and
                               incorporated herein by reference).

          10.12*               License Agreement between the Company and Yale
                               University dated as of March 21, 1995 (filed as
                               Exhibit 10.2 to the Company's Quarterly Report on
                               Form 10-Q for the quarter ended March 31, 1995
                               and incorporated herein by reference).

          10.13                Lease Agreement between the Company and One
                               Nevada Realty Trust dated October 6, 1995 (filed
                               as Exhibit 10.2 to the Company's Quarterly Report
                               on Form 10-Q for the fiscal quarter ended
                               September 30, 1995 and incorporated herein by
                               reference).

          10.14                Sixth Amendment dated March 1, 1996 to License
                               Agreement between Matritech and the Massachusetts
                               Institute of Technology dated December 31, 1987,
                               as amended (filed as Exhibit 10.26 to the
                               Company's Annual Report on Form 10-K for the
                               fiscal year ended December 31, 1995 and
                               incorporated herein by reference).

           10.15               Senior Loan and Security Agreement No. 0096
                               between the Company and Phoenix Leasing,
                               Incorporated dated August 29, 1997 including form
                               of Senior Secured Promissory Note between the
                               Company and Phoenix Leasing, Incorporated (filed
                               as Exhibit 10.20 to the Company's Annual Report
                               on Form 10-K for the fiscal year ended December
                               31, 1997 and incorporated herein by reference).

          10.16*               Distributorship Agreement by and between the
                               Company and Curtin Matheson Scientific, a
                               division of Fisher Scientific Company, L.L.C.
                               dated as of March 19, 1998 (filed as Exhibit
                               10.21 to the Company's Annual Report on Form 10-K
                               for the fiscal year ended December 31, 1997 and
                               incorporated herein by reference).

          10.17**              Form of Subscription Agreement dated March 10,
                               1999 by and between the Company and certain
                               investors.

          23**                 Consent of Arthur Andersen LLP.

          27**                 Financial Data Schedule.

________________________ 
*    Confidential Treatment Granted for portions thereof
**   Filed herewith
+    Indicates management contract or compensatory plan or arrangement required
     to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this
     report.
(b)  Reports on Form 8-K.
     Not Applicable
(c)  Exhibits.
     The Company hereby files as exhibits to this Form 10-K those exhibits
     listed in Item 14(a)(3),   above.
(d)  Financial Statement Schedules.
     The Company hereby files as financial statement schedules to this Form 10-K
     those financial statement schedules listed in Item 14(a)(2), above.
<PAGE>
 
                                MATRITECH, INC.


                         Index to Financial Statements



                                                                 PAGE
<TABLE>
<CAPTION>
 
 
Report of Independent Public Accountants                          F-2
<S>                                                               <C>
                                                                     
Balance Sheets as of December 31, 1997 and 1998                   F-3
                                                                     
Statements of Operations for the Years Ended                         
December 31, 1996, 1997 and 1998                                  F-4
                                                                     
Statements of Stockholders' Equity for the                           
Years Ended December 31, 1996, 1997 and 1998                      F-5
                                                                     
Statements of Cash Flows for the Years Ended                         
December 31, 1996, 1997 and 1998                                  F-6
                                                                     
Notes to Financial Statements                                     F-7 
 
</TABLE>

                                      F-1
<PAGE>
 
                    Report of Independent Public Accountants



To Matritech, Inc.:

We have audited the accompanying balance sheets of Matritech, Inc. (a Delaware
corporation) as of December 31, 1997 and 1998, and the related statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Matritech, Inc. as of December
31, 1997 and 1998, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.



                                                             Arthur Andersen LLP



Boston, Massachusetts
February 8, 1999

                                      F-2
<PAGE>
 
                                MATRITECH, INC.

                                BALANCE SHEETS

                                    ASSETS
<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                        1997         1998
<S>                                                 <C>           <C>
 
CURRENT ASSETS:
 Cash and cash equivalents                           $11,067,414   $4,146,821
 Accounts receivable                                     101,941      162,261
 Inventories                                             487,360      336,398
 Interest receivable and prepaid expenses                127,156      113,582
                                                     -----------   ----------
  Total current assets                                11,783,871    4,759,062
                                                     -----------   ----------
PROPERTY AND EQUIPMENT, at cost:
 Laboratory equipment                                  1,370,929    1,418,042
 Office equipment                                        203,214      212,698
 Laboratory furniture                                     62,739       62,739
 Leasehold improvements                                   56,981       56,981
                                                     -----------   ----------
                                                       1,693,863    1,750,460
 
 Less--Accumulated depreciation and amortization         872,706    1,065,060
                                                     -----------   ----------
                                                         821,157      685,400
                                                     -----------   ----------
 
OTHER ASSETS, net                                         86,745       67,363
                                                     -----------   ----------
                                                     $12,691,773   $5,511,825
                                                     ===========   ==========
</TABLE>

                      LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
 
CURRENT LIABILITIES:
<S>                                              <C>            <C>
   Current maturities of note payable            $     60,733   $     68,271
   Accounts payable                                   378,700        329,660
   Accrued expenses                                   354,904        573,422
                                                 ------------   ------------
      Total current liabilities                       794,337        971,353
                                                 ------------   ------------
NOTE PAYABLE, less current maturities                 208,762        140,491
                                                 ------------   ------------
Commitments (Notes 3 and 6)
 
STOCKHOLDERS' EQUITY:
   Preferred stock, $1.00 par value
    Authorized--4,000,000 shares
    Issued and outstanding--none                            -              -
   Common stock, $.01 par value
    Authorized--40,000,000 shares
    Issued and outstanding--18,566,737 shares
    in 1997 and 18,626,602 shares in 1998             185,667        186,266
   Additional paid-in capital                      45,118,499     45,364,731
   Accumulated deficit                            (33,615,492)   (41,151,016)
                                                 ------------   ------------
      Total stockholders' equity                   11,688,674      4,399,981
                                                 ------------   ------------
                                                 $ 12,691,773   $  5,511,825
                                                 ============   ============
</TABLE>

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

                                      F-3
<PAGE>
 
                                MATRITECH, INC.

                            Statements of Operations
<TABLE>
<CAPTION>
 
 
                                                    Years Ended December 31,
                                                1996          1997          1998
<S>                                         <C>           <C>           <C>
 
REVENUES:
 Collaborative research and development,    $ 1,881,833   $   747,532   $   967,759
  license fees and product sales
 Interest and other income                      528,583       566,686       457,678
                                            -----------   -----------   ----------- 
                                              2,410,416     1,314,218     1,425,437
                                            -----------   -----------   ----------- 
EXPENSES:
 Research and development                     3,909,793     3,943,390     4,010,368
 Selling, general and administrative          3,665,298     4,845,915     4,950,593
                                            -----------   -----------   -----------
                                              7,575,091     8,789,305     8,960,961
                                            -----------   -----------   ----------- 
   Net loss                                 $(5,164,675)  $(7,475,087)  $(7,535,524)
                                            ===========   ===========   ===========
 
BASIC/DILUTED NET LOSS PER COMMON SHARE           $(.32)        $(.43)        $(.40)
                                            ===========   ===========   ===========
 
BASIC/DILUTED WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING                    15,900,467    17,512,242    18,608,784
                                            ===========   ===========   ===========
</TABLE>





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

                                      F-4
<PAGE>
 
                                MATRITECH, INC.

                       STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
 
 
                                                        Common Stock          Additional                     Total
                                                   Number                      Paid-in     Accumulated   Stockholders' 
                                                  of shares      Par Value     Capital       Deficit        Equity     
<S>                                               <C>           <C>          <C>             <C>           <C>
Balance, December 31, 1995                        15,194,127     $151,941    $32,174,967  $(20,975,730)   $11,351,178 
 Exercise of common stock options                    104,294        1,043        181,359             -        182,402 
 Exercise of common stock                                                                                              
  purchase warrants                                  728,453        7,284      1,324,790             -      1,332,074 
 Issuance of common stock under                                                                                        
  employee stock purchase plan                          5,860           59         10,196             -         10,255 
 Compensation related to issuance of
  common stock options                                     -            -         72,750             -         72,750 
 Net loss                                                  -            -              -    (5,164,675)    (5,164,675)
                                                  ----------  -----------   ------------   -----------     ---------- 
Balance, December 31, 1996                        16,032,734      160,327     33,764,062   (26,140,405)     7,783,984
 Sale of common stock, net of commissions 
  and issuance costs of $92,430                    2,457,609       24,576     10,879,492             -     10,904,068
 Exercise of common stock options                     12,878          128         27,525             -         27,653
 Exercise of common stock purchase warrants           55,895          560         70,822             -         71,382
 Issuance of common stock under           
  employee stock purchase plan                         7,621           76         26,598             -         26,674
 Compensation related to issuance of 
  common stock warrants                                    -            -        350,000             -        350,000
 Net loss                                                  -            -              -    (7,475,087)    (7,475,087)
                                                  ----------  -----------   ------------   -----------     ---------- 
Balance, December 31, 1997                        18,566,737      185,667     45,118,499   (33,615,492)    11,688,674
 Exercise of common stock                 
  Options                                             43,513          435         51,400             -         51,835
 Exercise of common stock                 
  purchase warrants                                   10,000          100         17,900             -         18,000
 Issuance of common stock under           
  employee stock purchase plan                         6,352           64         26,932             -         26,996
 Compensation related to                  
  issuance of common stock                
  warrants                                                 -            -        150,000             -        150,000
 Net loss                                                  -            -              -    (7,535,524)    (7,535,524)
                                                  ----------  -----------   ------------   ------------    ----------
Balance, December 31, 1998                        18,626,602  $   186,266   $ 45,364,731   $(41,151,016)   $4,399,981
                                                  ==========  ===========   ============   ============    ==========
</TABLE>

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

                                      F-5
<PAGE>
 
                                MATRITECH, INC.

                            Statements of Cash Flows
<TABLE>
<CAPTION>
 
 
                                                              Years Ended December 31,
                                                          1996          1997          1998
<S>                                                   <C>           <C>           <C>
 
Cash Flows from Operating Activities:
  Net loss                                            $(5,164,675)  $(7,475,087)  $(7,535,524)
  Adjustments to reconcile net loss to net cash
  used in operating activities
   Depreciation and amortization                          133,952       226,924       210,648
   Operating expense related to issuance of common
   stock warrant                                                -       350,000       150,000
   Compensation related to issuance of common
   stock options                                           72,750             -             -
   Changes in assets and liabilities
     Accounts receivable                                 (701,405)      712,603       (60,320)
     Inventories                                         (150,673)     (144,302)      150,962
     Interest receivable and prepaid expenses               8,546        (3,755)       13,574
     Accounts payable                                      81,999       (43,859)      (49,040)
     Accrued expenses                                     249,140      (108,414)      218,518
     Deferred revenue                                     (34,900)            -             -
                                                      -----------   -----------   -----------
        Net cash used in operating activities          (5,505,266)   (6,485,890)   (6,901,182)
                                                      -----------   -----------   -----------
Cash Flows from Investing Activities:
  Purchase of property and equipment                     (285,386)     (456,484)      (56,597)
  (Increase) decrease in other assets                      45,334       (59,820)        1,089
                                                      -----------   -----------   -----------
        Net cash used in investing activities            (240,052)     (516,304)      (55,508)
                                                      -----------   -----------   -----------
 
Cash Flows from Financing Activities:
   Proceeds from note payable                                   -       288,376             -
   Payments on note payable                               (18,387)      (18,881)      (60,734)
   Proceeds from sale of common stock and warrants              -    10,904,068             -
   Proceeds from the exercise of common stock
    purchase warrants                                   1,332,074        71,382        18,000
   Proceeds from exercise of common stock options         182,402        27,653        51,835
   Proceeds from issuance of common stock under
    employee stock purchase plan                           10,255        26,674        26,996
                                                      -----------   -----------   -----------
Net cash provided by financing activities               1,506,344    11,299,272        36,097
                                                      -----------   -----------   -----------
Increase (Decrease) in Cash and Cash Equivalents       (4,238,974)    4,297,078    (6,920,593)
Cash and Cash Equivalents, beginning of year           11,009,310     6,770,336    11,067,414
                                                      -----------   -----------   -----------
Cash and Cash Equivalents, end of year                $ 6,770,336   $11,067,414   $ 4,146,821
                                                      ===========   ===========   =========== 
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for interest                $         -   $     5,420   $    28,479 
                                                      ===========   ===========   =========== 
</TABLE> 

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


                                      F-6
<PAGE>
 
                                MATRITECH, INC.

                         Notes to Financial Statements


(1)  Operations and Significant Accounting Policies

     Matritech, Inc. (the "Company") was incorporated on October 29, 1987 to
     develop, produce and distribute products for the diagnosis and potential
     treatment of cancer based on its proprietary nuclear matrix protein
     technology. This technology was licensed to the Company by the
     Massachusetts Institute of Technology ("MIT").

     The Company is devoting substantially all of its efforts toward product
     research and development, raising capital and marketing products. The
     Company is subject to risks common to companies in similar stages of
     development, including history of operating losses and anticipated future
     losses, fluctuation in operating results, uncertainties associated with
     future performance, dependence on key individuals, competition from
     substitute products and larger companies, the development of commercially
     usable products and the need to obtain adequate additional financing
     necessary to fund the development of its future products.

     In 1995, the Company began to sell its NMP22(R) Test Kits for bladder
     cancer in certain countries in Europe through distributors. In 1996, the
     Company received FDA approval to begin selling the NMP22 Test Kit as a
     prognostic indicator for use in the management of bladder cancer patients
     in the United States and in May, 1998 the Koseisho approved the NMP22 Test
     Kit for sale in Japan for screening of bladder cancer patients.

     The accompanying financial statements reflect the application of certain
     accounting policies as described in this note and elsewhere in the
     accompanying financial statements and notes.

     (a)  Revenue Recognition

          The Company recognizes revenue from product sales upon shipment;
          revenue from collaborative research and development arrangements as
          milestones are achieved; revenue from nonrefundable license agreements
          upon the signing of the agreement; and revenue from research grants as
          earned.

     (b)  Cash and Cash Equivalents

          The Company considers all highly liquid investments with original
          maturities of three months or less to be cash equivalents. The Company
          applies Statement of Financial Accounting Standards (SFAS) No. 115,
          Accounting for Certain Investments in Debt and Equity Securities.
          Under SFAS No. 115, securities that the Company has the positive
          intent and ability to hold to maturity are reported at amortized cost,
          which approximates fair market value, and are classified as held-to-
          maturity. These securities include cash and cash equivalents, which
          consist of auction market preferred stocks, money market accounts and
          repurchase agreements at December 31, 1997 and 1998.


                                      F-7
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)

     (c)  Inventories

          Inventories are stated at the lower of cost or market and consist of
          the following:
 
                                                   DECEMBER 31,  
                                                                 
                                                                 
                                                 1997      1998  
                                                                 
                Raw materials                 $305,241   $225,159
                Work-in-process                  6,634      3,195
                Finished goods                 175,485    108,044
                                              --------   -------- 
                                              $487,360   $336,398
                                              ========   ======== 

     (d)  Depreciation and Amortization

          The Company provides for depreciation and amortization using
          accelerated and straight-line methods by charges to operations in
          amounts that allocate the cost of property and equipment over their
          estimated useful lives as follows:

                     ASSET CLASSIFICATION          USEFUL LIFE

                     Laboratory equipment           10 years
                     Office equipment                5 years
                     Laboratory furniture            5 years
                     Leasehold improvements       Life of lease

          The Company amortizes certain intangible assets, including license
          fees, over their estimated useful lives of three to five years.

     (e)  Uses of Estimates in the Preparation of Financial Statements

          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.

     (f)  Concentration of Credit Risk

          SFAS No. 105, Disclosure of Information About Financial Instruments
          with Off-Balance-Sheet Risk and Financial Instruments with
          Concentrations of Credit Risk, requires disclosure of any significant
          off-balance-sheet and credit risk concentrations. Financial
          instruments that subject the Company to credit risk consist primarily
          of cash and cash equivalents and trade accounts receivable. The
          Company places its investments in highly rated financial institutions
          and investment-grade securities. The Company has not experienced any
          losses on its investments to date.

          The Company received revenue of greater than 10% of total
          collaborative research and development, license fees and product sales
          from the following number of customers during the following periods:

                                           Percentage of Product Revenues
          SIGNIFICANT                                 Customer
          CUSTOMERS ------------------------------------------------------------
                                         A       B      C      D      E      F
          Year ended December      4    16%      -      -     21%    11%    13%
          31, 1996
          Year ended December
          31, 1997                 2     -       -     19%     -      -     18%
          Year ended December      
          31, 1998                 2     -       31%    -      -      -     29%


                                      F-8
<PAGE>
 
          The Company had accounts receivable balances greater than 10% of total
          accounts receivable from the following customers as of  December 31,
          1997 and 1998:


                                   Percentage of Total Accounts Receivable
                                                  Customer
                               ------------------------------------------------
                               A        B        C        D       F    G     H

          As of December 31,
          1997                 -        -       53%       -       -    -     -
          1998                 -        -        -        -      60%  11%    12%

     (g)  Disclosure of Fair Value of Financial Instruments

          The Company's financial instruments consist mainly of cash and cash
          equivalents, accounts receivable, accounts payable and note payable.
          The carrying amounts of the Company's financial instruments
          approximate fair value.

     (h)  Research and Development

          Research and development expenses in the accompanying statements of
          operations are expensed as incurred and include both funded and
          unfunded research and development expenses.

     (i)  Net Loss per Common Share

          In March 1997, the Financial Accounting Standards Board issued SFAS
          No. 128, Earnings per Share, which established new standards for
          calculating and presenting earnings per share. Basic net loss per
          common share was computed by dividing net loss by the weighted average
          number of common shares outstanding during the year. Diluted loss per
          share is the same as basic loss per share as the effects of the
          potential common stock are antidilutive. This accounting change had no
          effect on the Company's historical net loss per common share.  The
          number of common stock equivalents excluded from the diluted net loss
          per share were 1,049,338, 1,497,176 and 1,649,391 for the years ended
          December 31, 1996, 1997 and 1998, respectively.

     (j)  Postretirement Benefits

          The Company has no obligations for postretirement benefits.

     (k)  Comprehensive Income

          Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting
          Comprehensive Income.  This statement requires that all items
          recognized under accounting standards as components of comprehensive
          earnings be reported in the annual financial statements.  It also
          requires that an entity classify items of other comprehensive earnings
          (e.g., foreign currency translation adjustments and unrealized gains
          and losses on certain marketable securities) by their nature in an
          annual financial statement.  The Company's total comprehensive loss
          was the same as the reported net loss for all periods presented.

(2)  Income Taxes

     The Company follows the provisions of SFAS No. 109, Accounting for Income
     Taxes. Under the provisions of SFAS No. 109, the Company recognizes a
     current tax liability or asset for current taxes payable or refundable and
     a deferred tax liability or asset for the estimated future tax effects of
     temporary differences between the carrying value of assets and liabilities
     for financial reporting and their tax basis and carryforwards to the extent
     they are realizable.


                                      F-9
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)

     The net operating loss carryforwards and tax credits expire as follows:
<TABLE> 
<CAPTION>
                                                   State
                              Federal Net     Net Operating                
                            Operating loss         Loss        Tax Credit  
Expiration Date              Carryforwards    Carryforwards   Carryforwards
---------------             --------------    -------------   -------------
<S>                       <C>                  <C>             <C>          
1999                              -             $ 4,344,000                
2000                              -               3,715,000                
2001                              -               3,986,000                
2002                              -               2,048,000                
2003-2018                    32,500,000           9,207,000      $1,719,000
                            -----------         -----------      ----------
                            $32,500,000         $23,300,000      $1,719,000
                            ===========         ===========      ========== 
</TABLE> 
 
The Company's net deferred tax asset consists of the following:

<TABLE> 
<CAPTION>  
                                                             DECEMBER 31,
                                                         1997            1998
<S>                                                  <C>             <C> 
Net operating loss carryforwards                     $10,874,000     $14,008,000
Capitalized research and development expenses          2,670,000       3,530,000
Tax credits                                            1,376,000       1,719,000
Temporary differences                                    (37,000)        (21,000)
                                                     -----------     ----------- 
 Net deferred tax asset                               14,883,000      19,236,000
Valuation allowance                                  (14,883,000)    (19,236,000)
                                                     -----------     ----------- 
                                                     $         -     $         -
                                                     ===========     ===========
</TABLE> 

     The valuation allowance has been provided due to the uncertainty
surrounding the realization of the deferred tax asset.

(3)  Lease Commitments

     The Company leases office and laboratory facilities and certain equipment
     under operating leases that expire through 2000. Annual commitments under
     these operating leases are as follows:


                   YEAR            AMOUNT
                   1999           $249,000
                   2000            242,000
                                  --------
                                  $491,000
                                  ========

     Rent expense for the years ended December 31, 1996, 1997 and 1998 was
     approximately $333,000, $275,000 and $275,000, respectively.

                                      F-10
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)

(4)  Note Payable

     In August 1997, the Company entered into an equipment line of credit under
     which it could borrow up to $1,200,000 for equipment purchases. This line
     of credit has since expired and in October 1997, the outstanding balance
     was converted into a 48 month term note.  The term note bears interest at
     11.75% and is secured by the underlying equipment. Payments under the term
     note payable are as follows:
<TABLE> 
<CAPTION> 

                      DECEMBER 31,       AMOUNT
<S>                   <C>              <C> 
                        1999             $68,271
                        2000              76,745
                        2001              63,746
                                        --------
                                        $208,762
                                        ========
</TABLE> 

(5)  Common Stock

     (a)  Sale of Common Stock

          In May 1997, the Company completed a private placement of 2,200,000
          shares of common stock at $5 per share resulting in proceeds of
          approximately $10,904,000, net of commissions and issuance costs. In
          connection with the private placement, the Company issued to the
          placement agent 257,609 shares of common stock and a warrant to
          purchase 245,761 shares of common stock at $5 per share. During 1997,
          5,530 of these warrants were exercised for 1,395 shares of common
          stock.

     (b)  Warrants

          In connection with a private placement in September 1994, the Company
          issued a warrant to purchase 234,637 units at an exercise price equal
          to $2.25 per unit to the placement agent ("Placement Agent Warrants").
          Each Placement Agent Warrant converts into one share of common stock
          and one Class B nonredeemable common stock purchase warrant. During
          1996, 214,637 of the Placement Agent Warrants and 204,637 of the
          underlying Class B non redeemable common stock purchase warrants were
          exercised for net proceeds of $756,886, pursuant to which the Company
          issued 400,693 shares of common stock. At December 31, 1997 and 1998,
          there are 20,000 Placement Agent Warrants and 10,000 Class B
          nonredeemable common stock purchase warrants outstanding.

          In April 1997, the Company issued a warrant to a public relations
          consultant for the purchase of up to 150,000 shares of the Company's
          common stock for a price of $6.50 per share expiring in April 2002.
          These warrants were valued at approximately $500,000 in accordance
          with SFAS No. 123 and were expensed ratably over the one-year term of
          the agreement. The Company expensed $150,000 and $350,000 as a
          component of selling, general and administrative expenses on the
          accompanying statement of operations for the years ended December 31,
          1998 and 1997, respectively.

                                      F-11
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)

     (c)  Stock Option and Purchase Plans

          The Company has granted incentive and nonqualified options under its
          1988 and 1992 option plans and the 1992 Directors' Plan. All option
          grants, prices and vesting periods are determined by the Board of
          Directors. Incentive stock options must be granted at a price not less
          than the fair market value on the date of grant.


         There are 375,461 common shares available for future grants under
         existing option plans at December 31, 1998. The following table
         summarizes stock option activity:
<TABLE>
<CAPTION>
 
                                                     NUMBER          OPTION PRICE PER
                                                   OF OPTIONS              SHARE
<S>                                                <C>               <C>           
 
         Options outstanding, December 31, 1995      438,124           .82-  5.00
           Granted                                   624,649          3.63-  13.13
           Exercised                                (104,294)          .82-   3.38
           Terminated                                (38,701)         1.81-  13.13
                                                   ---------         -------------
         Options outstanding, December 31, 1996      919,778           .82-  13.13
           Granted                                   195,671          4.00-   8.06
           Exercised                                 (12,878)         1.37-   4.00
           Terminated                                (55,626)         1.81-  12.00
                                                   ---------         -------------
         Options outstanding, December 31, 1997    1,046,945         $ .82- $13.13
           Granted                                   320,725          1.44-  4.375
           Exercised                                 (43,513)          .82-   4.00
           Terminated                               (114,997)          .82- 13.125
                                                   ---------         -------------
         Options outstanding, December 31, 1998    1,209,160         $1.37- $13.13
                                                   =========         ============= 
                                                                 
         Options exercisable, December 31, 1998      606,221         $1.37- $13.13
                                                   =========         ============= 
</TABLE>

<TABLE> 
<CAPTION>


                   OPTIONS OUTSTANDING                          OPTIONS EXERCISABLE
        ------------------------------------------------------ ---------------------
                                            WEIGHTED                                   
                                            AVERAGE                                    
                                           REMAINING   WEIGHTED                WEIGHTED 
                                          CONTRACTUAL  AVERAGE                 AVERAGE  
        RANGE OF EXERCISE      NUMBER      LIFE (IN    EXERCISE    NUMBER      EXERCISE  
               PRICE        OUTSTANDING     YEARS)      PRICE    EXERCISABLE     PRICE 
<S>                        <C>            <C>         <C>       <C>           <C> 
          $1.37 - $ 3.38       473,779       7.62      $ 1.95      203,254    $   1.93 
           3.62 -   7.87       623,781       7.89        6.86      292,167        6.84 
           8.06 -  13.13       111,600       7.89       10.63      110,800       10.82  
          --------------  ------------  ---------   ---------  -----------  ----------
              Total          1,209,160       7.78      $ 5.31      606,221    $   5.92

</TABLE> 

                                      F-12
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)


       The Company has reserved and may issue up to an aggregate of 225,000
       shares of common stock under the Employee Stock Purchase Plan pursuant to
       which stock is sold at 85% of fair market value, as defined. At December
       31, 1997 and 1998, the Company has accumulated payroll deductions of
       $26,996 and $3,975, respectively, for the issuance of 6,352 shares and
       2,650 shares of common stock, respectively, which are issued in the
       following year to employees pursuant to the plan. At December 31, 1998,
       189,925 shares are available for issuance under the plan.

         In October 1995, the Financial Accounting Standards Board ("FASB")
       issued SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No.
       123 requires the measurement of the fair value of stock options,
       including stock purchase plans, or warrants granted to employees to be
       included in the statement of operations or disclosed in the notes to
       financial statements. The Company has determined that it will continue to
       account for stock-based compensation for employees under Accounting
       Principles Board Opinion No. 25 and elect the disclosure-only alternative
       under SFAS No. 123. The Company has computed the pro forma disclosures
       required under SFAS No. 123 for options granted in 1996, 1997 and 1998
       and stock issued pursuant to the stock purchase plan using the Black-
       Scholes option pricing model prescribed by SFAS No. 123. The weighted
       average assumptions used for 1996 1997 and 1998 are as follows:
 
 
                                        1996         1997         1998
 
          Risk-free interest rate    5.54%-6.83%  5.83%-6.86%  4.65%-5.56%
          Expected dividend yield         -           -            -
          Expected life               7 years      7 years      7 years
          Expected volatility           80%          65%          65%


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

       The total fair value of the options granted during 1996, 1997 and 1998
       was computed as approximately $4,065,000, $819,000 and $504,000,
       respectively. Of these amounts, approximately $196,000, $1,130,000 and
       $1,143,000 would be charged to operations for the years ended December
       31, 1996, 1997 and 1998, respectively. The remaining amount,
       approximately $2,363,000, would be amortized over the remaining vesting
       period of the underlying options. The resulting pro forma compensation
       expense may not be representative of the amount to be expected in future
       years as pro forma compensation expense may vary based upon the number of
       options granted.

                                      F-13
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)


       The pro forma net loss and pro forma net loss per common share presented
       below have been computed assuming no tax benefit. The effect of a tax
       benefit has not been considered since a substantial portion of the stock
       options granted are incentive stock options and the Company does not
       anticipate a future deduction associated with the exercise of these stock
       options.

       The pro forma effect of SFAS No. 123 for the years ended December 31,
       1996, 1997 and 1998 is as follows:

<TABLE>
<CAPTION>
 
                                                   1996
<S>                                     <C>           <C>
                                         AS REPORTED    PRO FORMA
Net loss                                $(5,164,675)  $(5,360,717)
                                        ===========   ===========
Basic and diluted net loss per share    $      (.32)  $      (.34)
                                        ===========   ===========
 

                                                   1997
 
                                         AS REPORTED    PRO FORMA
Net loss                                $(7,475,087)  $(8,605,405)
                                        ===========   ===========
Basic and diluted net loss per share    $      (.43)  $      (.49)
                                        ===========   ===========
 

                                                   1998
 
                                         AS REPORTED    PRO FORMA
Net loss                                $(7,535,524)  $(8,678,197)
                                        ===========   ===========
Basic and diluted net loss per share    $      (.40)  $      (.47)
                                        ===========   ===========
</TABLE>

  (d)  Reserved Shares

       As of December 31, 1998, the following shares of common stock were
       reserved and available for future issuance:


             1988 and 1992 Stock Option Plans      1,369,621
             1992 Employee Stock Purchase Plan       189,925
             Exercise of warrants outstanding        440,231
             1992 Director Stock Option Plan         215,000
                                                   ---------
                                                   2,214,777
                                                   =========

                                      F-14
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)


(6)  License Agreement

     (a)  MIT License Agreement

          MIT has granted the Company a worldwide exclusive license to certain
          technology, which was extended when the Company obtained FDA approval
          of its first cancer diagnostic product in 1996, until the expiration
          of all patent rights in 2006. Pursuant to the license agreement, the
          Company pays royalties on the sales of products incorporating the
          licensed technology.  The Company paid $25,984, $19,096 and $17,776 in
          royalties in the years ended December 31, 1996, 1997, and 1998.

     (b)  Hybritech License Agreement

          In August 1994, the Company entered into a non-exclusive license
          agreement with Hybritech, Inc. for the manufacture and sale of certain
          patented technology for immunometric assays using monoclonal
          antibodies. The Company is required to pay a royalty equal to the
          greater of 8% of net sales of licensed products or $25,000 per year
          until the expiration of patent rights on a country-by-country basis
          beginning in 2000 through 2008. The Company paid $25,000, $53,863 and
          $25,000 in royalties during the years ending December 31, 1996, 1997
          and 1998, respectively. The Company presently is evaluating this
          license to determine whether future royalties, if any, are due on the
          future sale of any Matritech product.

(7)  Collaboration Agreements

     (a)  Joint Development and Distribution with Bayer

     In 1995, Matritech signed a joint development and distribution agreement
     with Bayer for the identification of cervical cancer-specific NMPs and the
     development of monoclonal antibodies which recognize malignant and pre-
     malignant or dysplastic cervical cancer cells.  In the years ended December
     31, 1996 and 1997, the Company recorded revenues of $120,000, $140,000,
     respectively. No revenues were recorded in the year ended December 31,
     1998.

     In December 1997, Matritech submitted pre-clinical evaluation data to Bayer
     which had been providing funding for this project.  After a period of
     discussion between the two companies Bayer elected not to proceed with the
     project.  Bayer's option to develop and launch an automated cervical cancer
     instrument for use with NMP-179 has terminated and Bayer is no longer
     obligated to provide further funding towards the commercialization of the
     system.  Matritech has regained all marketing and product rights which had
     been granted to Bayer Corporation in the cervical cancer development and
     supply agreement between the two companies.

     (b)  Yamanouchi Pharmaceutical, Co., Ltd.

     On November 10, 1998 the Company amended its development and supply
     agreement with Yamanouchi Pharmaceutical, Co., Ltd. resulting in the
     termination of development, supply and marketing rights.  In addition,
     Matritech reacquired all rights under the agreement in exchange for a two-
     percent royalty on future product sales covered by this agreement, sold in
     Japan, not to exceed $2,000,000.

                                      F-15
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)

(8)    Accrued Expenses

       Accrued expenses consist of the following:
 
 
                                         DECEMBER 31,
                                  
                                        1997     1998
                                  
     Payroll and related costs       $120,371  $245,777
     Professional fees                 52,027   222,107
     Royalties                              -    55,598
     Clinical trials costs            134,798    37,484
     Other                              4,108    12,456
     Printing and design costs         43,600         -
                                     --------  --------
                                     $354,904  $573,422
                                     ========  ========


(9)  Segment and Geographic Information

     The Company has adopted SFAS No. 131, Disclosures about Segments of an
     Enterprise and Related Information in the fiscal year ended December 31,
     1998. SFAS 131 establishes standards for reporting information regarding
     operating segments in annual financial statements and requires selected
     information for those segments to be presented in interim financial reports
     issued to stockholders. SFAS 131 also establishes standards for related
     disclosures about products and services and geographic areas. Operating
     segments are identified as components of an enterprise about which separate
     discrete financial information is available for evaluation by the chief
     operating decision maker or decision making group, in making decisions how
     to allocate resources and assess performance. The Company's chief decision
     maker, as defined under SFAS 131, is a combination of the Chief Executive
     Officer, President and the Chief Financial Officer. To date, the Company
     has viewed its operations and manages its business as principally one
     segment, the sale of cancer diagnostic products. Associated services are
     not significant. As a result, the financial information disclosed herein,
     represents all of the material financial information related to the
     principal operating segment.

     Geographic information product sales by destination as a percentage of
     total product sales are as follows:
 
                            YEARS ENDED DECEMBER 31,
 
                            1996     1997     1998          
          United States     24.0%    41.9%    52.1%
          Europe            41.5     37.0     36.0 
          Japan             31.5      1.4      6.2 
          All other          3.0     19.7      5.7 
                            ----     ----     ----  
                             100%     100%     100%        

     Product sales were $1,678,000, $602,000 and $895,000 in the years ended
     December 31, 1996, 1997, and 1998, respectively.  All of the Company's
     products were shipped from its facilities located in the United States.

                                      F-16
<PAGE>
 
                                MATRITECH, INC.

                         NOTES TO FINANCIAL STATEMENTS

                                  (Continued)

(10)  Subsequent event

     In March 1999, certain private investors agreed to invest approximately
     $4.0 million in the Company through a private placement of 3,094,811 shares
     of its Common Stock. The financing is expected to close in early April
     1999, subject to customary closing conditions. Matritech expects to receive
     net proceeds of approximately $3,940,000 after deducting the estimated
     expenses of the transaction. Matritech agreed to file a registration
     statement with the Securities and Exchange Commission covering the resale
     of the shares issued in connection with this private placement. The purpose
     of this transaction is to provide working capital, when combined with the
     reserves in Matritech's treasury at the beginning of the year, to
     adequately support the Company into the year 2000.

                                      F-17
<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, in the City of Newton,
Commonwealth of Massachusetts, on the 30th day of March, 1999.

                                          MATRITECH, INC.


                                          By: /s/ Stephen D. Chubb
                                             ----------------------------- 
                                             Stephen D. Chubb
                                             Director, Chairman 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 and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Signature                                  Title                                       Date
<S>                                        <C>                                         <C>
/s/ Stephen D. Chubb                       Director, Chairman, Chief Executive         March 30, 1999
-----------------------------------------  Officer and Treasurer (Principal
Stephen D. Chubb                           Executive Officer)
 
/s/ David L. Corbet                        Director, President and Chief Operating     March 30, 1999
-----------------------------------------  Officer
David L. Corbet

/s/ Robert W. Morgan                       Vice President and Chief Financial          March 30, 1999
-----------------------------------------  Officer (Principal Accounting and
Robert W. Morgan                           Financial Officer)
 
/s/ J. Robert Buchanan                     Director                                    March 30, 1999
-----------------------------------------
J. Robert Buchanan

/s/ Thomas R. Morse                        Director                                    March 30, 1999
-----------------------------------------
Thomas R. Morse

/s/ David Rubinfien                        Director                                    March 30, 1999
-----------------------------------------
David Rubinfien

/s/ T. Stephen Thompson                    Director                                    March 30, 1999
-----------------------------------------
T. Stephen Thompson

/s/ C. William Zadel                       Director                                    March 30, 1999
-----------------------------------------
C. William Zadel
</TABLE>
<PAGE>
 
                                 EXHIBIT INDEX
                                 -------------
                                        

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

       3.1               Amended and Restated Certificate of Incorporation of
                         the Registrant (filed as Exhibits 3, 4.1 to the
                         Company's Registration Statement No. 33-46158 on
                         Form S-1 and incorporated herein by reference).

       3.2               Amended and Restated By-Laws of the Registrant (filed
                         as Exhibits 3.2, 4.1 to the Company's Registration
                         Statement No. 33-46158 on Form S-1 and incorporated
                         herein by reference).

       3.3               Certificate of Amendment dated June 16, 1994, of
                         Amended and Restated Certificate of Incorporation of
                         the Registrant (filed as Exhibit 3.2 of the Company's
                         Quarterly Report on Form 10-Q for the fiscal quarter
                         ended June 30, 1995 and incorporated herein by
                         reference).

       3.4               Certificate of Amendment dated June 5, 1995, of Amended
                         and Restated Certificate of Incorporation of the
                         Registrant (filed as Exhibit 3.3 of the Company's
                         Quarterly Report on Form 10-Q for the fiscal quarter
                         ended June 30, 1995 and incorporated herein by
                         reference).

       4.1               Description of Capital Stock contained in the
                         Registrant's Amended and Restated Certificate of
                         Incorporation, filed as Exhibits 3.1, 3.3 and 3.4.

       10.1*             License Agreement between Matritech and the
                         Massachusetts Institute of Technology dated December
                         14, 1987, as amended March 15, 1988, December 20, 1989
                         and March 4, 1992 (filed as Exhibit 10.1 to the
                         Company's Registration Statement No. 33-46158 on
                         Form S-1 and incorporated herein by reference).

       10.2+             1988 Stock Plan (filed as Exhibit 10.8 to the Company's
                         Registration Statement No. 33-46158 on Form S-1 and
                         incorporated herein by reference).

       10.3+             1992 Stock Plan as amended as of June 13, 1997 (filed
                         as Exhibit 10.4 to the Company's Annual Report on Form
                         10-K for the fiscal year ended December 31, 1997 and
                         incorporated herein by reference).

       10.4+             Amended and Restated 1992 Non-Employee Director Stock
                         Plan as amended as of June 7, 1996 (filed as Exhibit
                         10.2 to the Company's Quarterly Report on Form 10-Q for
                         the fiscal quarter ended June 30, 1996 and incorporated
                         herein by reference).
<PAGE>
 
       10.5+             1992 Employee Stock Purchase Plan (filed as Exhibit
                         10.11 to the Company's Registration Statement No. 33-
                         46158 on Form S-1 and incorporated herein by
                         reference).

       10.6              Second Amended and Restated Registration Rights
                         Agreement dated May 4, 1990, as amended February 26,
                         1992 (filed as Exhibit 10.13 to the Company's
                         Registration Statement No. 33-46158 on Form S-1 and
                         incorporated herein by reference).

       10.7              Form of Indemnity Agreement with directors (filed as
                         Exhibit 10.14 to the Company's Registration Statement
                         No. 33-46158 on Form S-1 and incorporated herein by
                         reference).

       10.8              Fourth Amendment dated March 18, 1993 to License
                         Agreement between the Company and the Massachusetts
                         Institute of Technology dated December 14, 1987, as
                         amended (filed as Exhibit 10.9 to the Company's Annual
                         Report on Form 10-K for the fiscal year ended December
                         31, 1997 and incorporated herein by reference).

       10.9*             License Agreement between the Company and The Johns
                         Hopkins University dated as of August 4, 1993 (filed as
                         Exhibit 10.2 to the Company's Quarterly Report on Form
                         10-Q for the quarter ended September 30, 1993 and on
                         paper as File No. 1-12128 and incorporated herein by
                         reference).

       10.10             Fifth Amendment dated April 14, 1994 to License
                         Agreement between the Company and the Massachusetts
                         Institute of Technology dated December 14, 1987 (filed
                         as Exhibit 10.1 to the Company's Form 10-Q for the
                         quarter ended March 31, 1994 and incorporated herein by
                         reference).

       10.11*            Exclusive Distribution Agreement between the Company
                         and Konica Corporation dated as of November 9, 1994.
                         (Filed as Exhibit 10.26 to the Company's Annual Report
                         on Form 10-K for the fiscal year ended December 31,
                         1994 and incorporated herein by reference).

       10.12*            License Agreement between the Company and Yale
                         University dated as of March 21, 1995 (filed as Exhibit
                         10.2 to the Company's Quarterly Report on Form 10-Q for
                         the quarter ended March 31, 1995 and incorporated
                         herein by reference).

       10.13             Lease Agreement between the Company and One Nevada
                         Realty Trust dated October 6, 1995 (filed as Exhibit
                         10.2 to the Company's Quarterly Report on Form 10-Q for
                         the fiscal quarter ended September 30, 1995 and
                         incorporated herein by reference).
<PAGE>
 
       10.14             Sixth Amendment dated March 1, 1996 to License
                         Agreement between Matritech and the Massachusetts
                         Institute of Technology dated December 31, 1987, as
                         amended (filed as Exhibit 10.26 to the Company's Annual
                         Report on Form 10-K for the fiscal year ended December
                         31, 1995 and incorporated herein by reference).

       10.15             Senior Loan and Security Agreement No. 0096 between the
                         Company and Phoenix Leasing, Incorporated dated August
                         29, 1997 including form of Senior Secured Promissory
                         Note between the Company and Phoenix Leasing,
                         Incorporated (filed as Exhibit 10.20 to the Company's
                         Annual Report on Form 10-K for the fiscal year ended
                         December 31, 1997 and incorporated herein by
                         reference).

       10.16*            Distributorship Agreement by and between the Company
                         and Curtin Matheson Scientific, a division of Fisher
                         Scientific Company, L.L.C. dated as of March 19, 1998
                         (filed as Exhibit 10.21 to the Company's Annual Report
                         on Form 10-K for the fiscal year ended December 31,
                         1997 and incorporated herein by reference).

       10.17**           Form of Subscription Agreement dated March 10, 1999 by
                         and between the Company and certain investors.

       23**              Consent of Arthur Andersen LLP.

       27**              Financial Data Schedule.
 
___________________
*  Confidential Treatment Granted for portions thereof
** Filed herewith
+  Indicates management contract or compensatory plan or arrangement required
   to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this
   report.