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

                                    FORM 10-Q

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

                For the quarterly period ended September 30, 1997

                         Commission file number 0-27802

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

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

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

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

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

Yes  X       No
    ---          ---

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

Class                                       Outstanding
Common Stock, $0.001 par value              31,218,177 as of October 31, 1997

<PAGE>
<TABLE>

                                                INDEX TO FORM 10-Q

<CAPTION>
                                                                                                                Page
                                                                                                                ----
<S>             <C>                                                                                              <C>
PART I          FINANCIAL INFORMATION

                Item 1.    Financial Statements

                           Condensed Consolidated Balance Sheets as of September 30, 1997                         3
                                 and June 30, 1997

                           Condensed Consolidated Statements of Operations for the three                          4
                                 months ended September 30, 1997 and 1996

                           Condensed Consolidated Statements of Cash Flows for the                                5
                                 three months ended September 30, 1997 and 1996

                           Notes to Condensed Consolidated Financial Statements                                   6

                Item 2.    Management's Discussion and Analysis of Financial Condition                           12
                                 and Results of Operations


PART II         OTHER INFORMATION

                Item 1.    Legal Proceedings                                                                     17

                Item 2.    Change in Securities and Use of Proceeds                                              17

                Item 6.    Exhibits and Reports on Form 8-K                                                      18


SIGNATURES                                                                                                       19

</TABLE>

                                       2

<PAGE>


PART I       FINANCIAL INFORMATION

             Item 1.    Financial Statements

<TABLE>
              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                                 (In thousands)

<CAPTION>
                                                                  September 30,  June 30,
                                                                     1997         1997
                                                                   ---------    ---------
<S>                                                                <C>          <C>      
                                     ASSETS
Current assets:
     Cash and cash equivalents                                     $  27,666    $  25,036
     Short-term investments                                           57,596       62,192
     Trade accounts receivable, net                                   26,605       22,850
     Inventories                                                      10,754        7,302
     Deferred income tax                                               2,413        2,413
     Prepaid expenses and other current assets                         7,907        4,472
                                                                   ---------    ---------
        Total current assets                                         132,941      124,265

Deferred income tax                                                    1,598        1,598
Property, plant and equipment, net                                    31,070       21,759
Purchased technology and other intangible assets, net                    325          357
                                                                   ---------    ---------
        Total assets                                               $ 165,934    $ 147,979
                                                                   =========    =========


                                   LIABILITIES
Current liabilities:
     Short-term borrowings                                         $   2,449    $    --
     Accounts payable                                                  8,852        4,035
     Accrued expenses                                                  6,276        5,744
     Income taxes payable                                              2,912         --
                                                                   ---------    ---------
        Total current liabilities                                     20,489        9,779
                                                                   ---------    ---------

                              STOCKHOLDERS' EQUITY
Common stock                                                              31           31
Additional paid-in capital                                            94,669       93,021
Treasury stock                                                          (390)        (390)
Cumulative translation adjustment                                     (1,477)      (1,364)
Retained earnings                                                     52,612       46,902
                                                                   ---------    ---------
        Total stockholders' equity                                   145,445      138,200
                                                                   ---------    ---------
        Total liabilities and stockholders' equity                 $ 165,934    $ 147,979
                                                                   =========    =========
<FN>
                             See accompanying notes
</FN>
</TABLE>
                                       3
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                      (In thousands, except per share data)



                                                             Three months ended
                                                                September 30,
                                                           ---------------------

                                                            1997          1996
                                                           -------       -------

Net sales                                                  $26,263       $18,568
Cost of sales                                                5,489         2,911
                                                           -------       -------
Gross profit                                                20,774        15,657
                                                           -------       -------

Operating expenses:
   Research and development                                  5,478         1,855
   Selling, general and administrative                       7,517         3,132
                                                           -------       -------
       Total operating expenses                             12,995         4,987
                                                           -------       -------

Operating income                                             7,779        10,670
Interest and other income                                    1,006         1,275
                                                           -------       -------
Income before provision for income taxes                     8,785        11,945
Provision for income taxes                                   3,075         4,180
                                                           -------       -------
Net income                                                 $ 5,710       $ 7,765
                                                           =======       =======

Net income per share                                       $  0.18       $  0.25

Shares used in per share calculation                        32,237        31,632


                             See accompanying notes

                                       4
<PAGE>
<TABLE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                 (In thousands)
<CAPTION>
                                                                          Three Months Ended
                                                                             September 30,
                                                                         --------------------
                                                                           1997       1996
                                                                         --------    --------
<S>                                                                      <C>         <C>     
Cash flows from operating activities:
     Net income                                                          $  5,710    $  7,765
     Adjustments to reconcile net income to net cash
        provided by (used in) operating activities:
            Depreciation and amortization                                     662         339
            Provision for doubtful accounts                                   246          22
            Provision for obsolete inventory                                  104          (1)
            Amortization of deferred compensation                            --            12
            Income tax reduction relating to stock plans                    1,016        --
            Changes in assets and liabilities:
                Short-term investments                                      4,594     (48,479)
                Accounts receivable                                        (4,119)     (2,062)
                Inventories                                                (3,549)     (1,260)
                Prepaids and other current assets                          (3,719)     (1,291)
                Accounts payable                                            4,815         550
                Accrued liabilities                                           563        (534)
                Income taxes payable                                        3,195       3,633
                                                                         --------    --------
                   Net cash provided by (used in) operating activities      9,518     (41,306)
                                                                         --------    --------

Cash flows from investing activities:
     Acquisition of property, plant and equipment                          (9,943)     (3,017)
                                                                         --------    --------
                   Net cash used in investing activities                   (9,943)     (3,017)
                                                                         --------    --------

Cash flows from financing activities:
     Increase in short-term borrowings                                      2,449        --
     Proceeds from issuance of common stock                                   632        --
                                                                         --------    --------
                   Net cash provided by financing activities                3,081        --
                                                                         --------    --------

Effect of exchange rate changes on cash and cash equivalents                  (26)         (8)

Net increase (decrease) in cash and cash equivalents                        2,630     (44,331)
Cash and cash equivalents, at beginning of period                          25,036      59,238
                                                                         ========    ========
Cash and cash equivalents, at end of period                              $ 27,666    $ 14,907
                                                                         ========    ========
<FN>

                             See accompanying notes
</FN>
</TABLE>
                                       5
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

1.         Basis of Presentation

                    The condensed  consolidated  financial  statements  included
           herein  have  been  prepared  by  the  Company,   without  audit,  in
           accordance with generally accepted accounting  principles for interim
           financial  information  and pursuant to the rules and  regulations of
           the Securities and Exchange Commission. In the opinion of management,
           all  adjustments  (consisting of only normal  recurring  adjustments)
           considered  necessary  to  present  fairly  the  financial  position,
           results  of  operations  and cash  flows  have been  included.  These
           consolidated  financial statements should be read in conjunction with
           the  audited  consolidated  financial  statements  contained  in  the
           Company's Form 10-K for the fiscal year ended June 30, 1997.

                    Certain  information  and  footnote   disclosures   normally
           included  in  financial   statements   prepared  in  accordance  with
           generally  accepted  accounting  principles  have been  condensed  or
           omitted.  The  year-end  balance  sheet data was derived from audited
           financial  statements,  but does not include disclosures  required by
           generally accepted accounting principles.

                    Operating  results for the three months ended  September 30,
           1997 are not necessarily indicative of the results to be expected for
           any other interim period or for the full fiscal year.

2.         Inventories (in thousands):

                                                September 30,       June 30,
                                                    1997              1997
                                                ------------      -----------

                           Raw materials          $   1,441        $     925
                           Work in process            5,589            3,044
                           Finished goods             3,724            3,333
                                                ------------      -----------
                                                   $ 10,754       $    7,302
                                                ============      ===========

3.         Computation of Net Income Per Share

                  Net income per share is computed  using the  weighted  average
           number of common and common stock equivalent  shares,  when dilutive,
           outstanding  during the period.  Common  equivalent  shares  comprise
           stock options using the treasury stock method. 

                  In February 1997,  the Financial  Accounting  Standards  Board
           issued Statement No. 128,  "Earnings per Share (SFAS No. 128)," which
           is effective  for both interim and annual  financial  statements  for
           periods ended after  December 15, 1997.  The Company will be required
           to change the method currently used to compute earnings per share and
           to  restate  all  prior  periods.  Under  the  new  requirements  for
           calculating  primary  (or basic)  earnings  per share,  the  dilutive
           effect of stock  options will be excluded.  The impact is expected to
           result in an increase in primary  earnings  per share.  The impact of
           Statement 128 on the calculation of fully diluted  earnings per share
           is not expected to be material.

                                       6
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                   (Unaudited)

4.         Stock Repurchase Program

                  During  the  first  quarter  of  fiscal  1997,  the  Board  of
            Directors  authorized a stock  repurchase  program pursuant to which
            the  Company  could  repurchase  shares of its common  stock with an
            aggregate value of up to $10 million. The repurchases were made from
            time to time on the open market at  prevailing  market  prices or in
            negotiated transactions off the market. In November 1997 the program
            was  discontinued  by the Board of  Directors.  As of September  30,
            1997, the Company had repurchased  30,000 shares of its common stock
            at an aggregate cost of $390,000.

5.         Contingencies

                  ESS Litigation.  Effective as of October 1992, a subsidiary of
           the Company  purchased  substantially  all the assets of  Endothelial
           Support Systems,  Inc.  (subsequently  known as Endovascular  Support
           Systems,  Inc.) ("ESS") in  consideration of certain royalty payments
           payable by the Company  based on the net sales of  products  using or
           adapted  from  such  assets.   The  Company  was  informed  that  the
           shareholders  of ESS ratified the  transaction  on May 27, 1993.  The
           purchased  assets  included an  application  for a stent patent which
           resulted  in a patent  owned by the  Company.  Following  such  asset
           purchase,  the Company  between June 1993 and March 1995 purchased in
           several  transactions 100% of the shares of capital stock of ESS from
           its  shareholders in  consideration  of shares of common stock of the
           Company and, in certain instances,  other consideration,  and ESS was
           merged into the Company. In June 1996, the Company received notice of
           a lawsuit filed by Dr. Azam Anwar and Benito Hidalgo, each of whom is
           a former  shareholder of ESS (who together held  approximately 48% of
           ESS's outstanding  shares of common stock) and each of whom currently
           holds shares of common stock of the Company, in the District Court of
           Dallas  County,  Texas.  The suit names as  defendants  the  Company,
           Bradly A. Jendersee and John D. Miller, each a director,  officer and
           principal  stockholder  of the  Company,  Dr.  Simon H.  Stertzer,  a
           director and  principal  stockholder  of the Company,  and Dr. Gerald
           Dorros, a principal  stockholder of the Company. In January 1997, the
           plaintiffs  filed an  amended  petition  alleging  common  law fraud,
           negligent  misrepresentation,  securities fraud pursuant to the Texas
           Securities  Act,  fraud pursuant to the Texas Business and Commercial
           Code,  control person  liability,  aider and abetter liability of the
           individual  defendants,  civil conspiracy,  breach of fiduciary duty,
           and constructive  fraud in connection with the Company's  acquisition
           of ESS and the Company's  acquisition  of shares of ESS capital stock
           from  the  plaintiffs.   The  plaintiffs  seek  unspecified  damages,
           rescission  of the  Company's  acquisition  of the ESS assets and its
           subsequent  acquisition  of the  ESS  stock,  reconstitution  of ESS,
           punitive  damages,  interest and attorneys' fees and other relief. On
           February 10 and 12, 1997,  the court  overruled  defendants'  special
           appearances and denied motions objecting to jurisdiction,  motions to
           dismiss based on forum non  conveniens,  and motions to abate or stay
           the Texas proceedings.  The

                                       7
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                   (Unaudited)

           defendants,  including the Company,  have filed an answer denying the
           plaintiffs'  claims,  and  also  filed  a  counterclaim  against  the
           plaintiffs.  The counterclaim  alleges claims against Mr. Hidalgo for
           specific  performance,  breach of  contract,  breach  of the  implied
           covenant of good faith and fair dealing, and declaratory relief based
           on  comparative  indemnity,  contribution  and absence of fraud.  The
           counterclaim  alleges  claims against Dr. Anwar for  intentional  and
           negligent   interference  with  contract,   equitable   estoppel  and
           declaratory  relief  based  on  absence  of  fraud.  A trial  date of
           February 1, 1998 has been scheduled for the Texas action. The Company
           believes it has  meritorious  defenses  to the claims  alleged by the
           plaintiffs,   and  that  it  has   meritorious   claims  against  the
           plaintiffs,  in the Texas action.  However, no assurance can be given
           as to the  outcome of the  action.  The  inability  of the Company to
           prevail in the action,  including the loss or impairment of the right
           to produce products based on the Company's issued patents, could have
           a  material  adverse  effect  on the  Company's  business,  financial
           condition and results of operations.

                  The Company also  received  notice in August 1996 of a lawsuit
           filed by Messrs.  Anwar and Hidalgo in the  Superior  Court of Sonoma
           County,  California,  which names the same defendants as in the Texas
           action and  alleges  claims  for  securities  fraud and  unregistered
           securities under the California  securities laws, breach of fiduciary
           duty and fraud. The plaintiffs seek unspecified  damages,  rescission
           of the  Company's  acquisition  of the ESS assets and its  subsequent
           acquisition of the ESS stock, reconstitution of ESS and other relief.
           The defendants,  including the Company,  have filed an answer denying
           plaintiff's  claims,  and also filed a  cross-complaint  against  the
           plaintiffs.  The  cross-complaint  alleges claims against Mr. Hidalgo
           for specific performance,  breach of contract,  breach of the implied
           covenant of good faith and fair dealing, and declaratory relief based
           on  comparative  indemnity,  contribution  and absence of fraud.  The
           cross-complaint  alleges claims against Dr. Anwar for intentional and
           negligent   interference  with  contract,   equitable   estoppel  and
           declaratory  relief  based on absence of fraud.  Mr.  Hidalgo and Dr.
           Anwar have filed an answer generally  denying the claims contained in
           the cross-complaint.

                  On July 11,  1996,  the  Company,  along  with the  individual
           defendants  named in the Texas and Sonoma County  actions,  filed two
           actions  against  Mr.  Hidalgo  in the  Superior  Court of San  Mateo
           County,  California.  The first  action  alleges  claims for specific
           performance,  breach of contract,  breach of the implied  covenant of
           good  faith  and  fair  dealing,  and  declaratory  relief  based  on
           indemnity.  These  claims  arise  out of a stock  exchange  agreement
           entered  into  between Mr.  Hidalgo and the  Company,  and out of Mr.
           Hidalgo's  actions as a director of ESS.  The second  action  alleges
           claims for specific  performance,  breach of contract,  and breach of
           the implied  covenant of good faith and fair  dealing.  These  claims
           arise out of a separation and release  agreement entered into between
           Mr. Hidalgo and the Company.

                  On  December 6, 1996,  the  Superior  Court of Sonoma  County,
           California,  pursuant to the stipulation of the parties,  transferred
           the Sonoma County  action to the Superior  Court of San Mateo County.
           On  December  11,  1996,  the  Superior  Court of San  Mateo  County,
           pursuant to the  stipulation of the parties,  consolidated  all three
           pending  

                                       8
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                   (Unaudited)

           California actions into a single action (the "Consolidated  Action"),
           and ordered that the pleadings from the Sonoma County action shall be
           the operative  pleadings in the Consolidated  Action. A motion by the
           Company and the individual  defendants for summary  judgment  against
           Mr.  Hidalgo in the  Consolidated  Action was denied by the  Superior
           Court of San Mateo  County on May 5, 1997 with respect to each of the
           plaintiffs'  claims. A trial date of March 2, 1998 has been scheduled
           for  the  Consolidated  Action.  The  Company  believes  that  it has
           meritorious  defenses to the claims  alleged by the  plaintiffs,  and
           that  it  has  meritorious  claims  against  the  plaintiffs,  in the
           Consolidated  Action.  However,  no assurance  can be given as to the
           outcome of the Consolidated  Action.  The inability of the Company to
           prevail in the Consolidated Action,  including the loss or impairment
           of the  right  to  produce  products  based on the  Company's  issued
           patents,  could  have a  material  adverse  effect  on the  Company's
           business, financial condition and results of operations.

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

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

                  In November 1996, in connection with the Company's termination
           of  its   distribution   relationship   with   Alfatec-Medicor   N.V.
           ("Alfatec-Medicor")  and Medicor Nederland B.V. ("Medicor Nederland")
           in Belgium and The Netherlands, respectively, effective September 30,
           1996,   the   Company   received   notice  of  a  lawsuit   filed  by
           Alfatec-Medicor  in the  Second  Chamber of the  Commercial  Court of
           Brussels,  Belgium,  alleging insufficient notice of termination of a
           distribution   agreement   between  the  parties,   promotion  costs,
           personnel   restructuring   claims   and   additional   compensation.
           Alfatec-Medicor  seeks  compensation of BF189,389,135  (approximately
           $5.3 million using current  exchange  rates),  of which  BF30,000,000
           (approximately  $843,000)  is sought as a  provisional  payment.  The
           Company has entered  counterclaims  for  $257,000 in unpaid  accounts
           receivable and has requested from  Alfatec-Medicor  information  that
           would  support  its  claims  for  indemnification,  but  has  not yet
           received such information. Following a hearing on April 18, 1997, the
           court postponed further consideration of the matter until the parties
           have  conducted an appropriate  exchange of information  and prepared
           written  pleadings.  On February 20, 1997,  the Company  commenced an
           action against Medicor Nederland before the Amsterdam  District Court
           for payment of $269,000 in unpaid  accounts  receivable.  On July 23,
           1997,  Medicor  Nederland  filed a statement of defense and entered a
           counterclaim  for  DG2,284,379   (approximately  $1.2  million  using
           current  exchange  rates) on the  grounds of  insufficient  notice of
           termination  of a  distribution  agreement  between  the  parties and
           unjust enrichment. On October 29, 1997, the Company filed a reply and
           answer to the counterclaim.

                  On  August  19,  1996,  in   connection   with  the  Company's
           termination of its  distribution  relationship  in  Switzerland  with
           Medicor AG, effective  September 30, 1996, such distributor  filed an
           action  against the Company in the United States  District  Court for
           the Northern District of California alleging breach of written,  oral
           and  implied-in-fact

                                       9
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                   (Unaudited)

           contracts,  inducement to breach an  employment  contract with one of
           such   distributor's   employees,   intentional   interference   with
           contractual  relations,  intentional and negligent  interference with
           prospective  economic  advantage,  misappropriation of trade secrets,
           and intentional and negligent misrepresentation. On October 11, 1996,
           the court  denied  the  distributor's  request  for  preliminary  and
           temporary  injunctive  relief. On January 30, 1997, the court entered
           an  order  dismissing  the  entire  action  on forum  non  conveniens
           grounds.  As part of the  dismissal,  AVE has agreed to submit to the
           jurisdiction  of the  appropriate  forum in  Switzerland,  waive  any
           defense of statute of limitations to any substantially similar claims
           made there, make available  witnesses and documents there and satisfy
           any judgment  entered against it there.  The distributor has appealed
           the court's dismissal of the action. On January 27, 1997, the Company
           filed an action in the debt  collection  office of Cham,  Switzerland
           against  the  distributor  for  $93,000  plus  accrued   interest  in
           connection  with  unpaid  accounts  receivable  from the  distributor
           relationship. The distributor obtained a preliminary stay on the debt
           collection  proceedings  and a hearing with respect to the  Company's
           motion  to lift such  stay was held on March  11,  1997.  On July 14,
           1997, the District  Court of Zug denied the Company's  motion to lift
           such stay in a summary  proceeding.  The Company  intends in November
           1997 to file a claim in ordinary court  proceedings with the District
           Court of Zug to have the stay lifted.

                  In   connection   with  the  Company's   termination   of  its
           distribution    relationship    in   France   with   Medi    Service,
           S.A.R.L./Fournitures Hospitalieres S.A. effective September 30, 1996,
           the Company  received notice from such  distributor that it had filed
           an action  before the  Tribunal  de Grande  Instance  of  Mulhouse in
           France  seeking  compensation  for  breach  of an  alleged  exclusive
           distribution  agreement  for  an  indeterminate  period  between  the
           parties.  The action included a claim for  compensation  equal to the
           total value of such  distributor's  business,  which the  distributor
           valued at  FF400,000,000  (approximately  $69 million  using  current
           exchange  rates).  The  Company  counterclaimed  for unpaid  accounts
           receivable of approximately  $1.8 million and for damages for abusive
           legal  proceedings.  On September 23, 1996, the Tribunal rejected the
           distributor's  claims for damages for unlawful termination as well as
           the  Company's  counterclaim  for  abusive  legal  proceedings.   The
           Tribunal  reserved  judgement  with respect to the  repurchase of the
           distributor's  inventory  of AVE  products  and the payment of unpaid
           accounts receivable sought by the Company. The parties have submitted
           briefs on these issues and a procedural hearing was held on March 10,
           1997,  at which time the  distributor  filed an additional  brief.  A
           procedural hearing was held on May 9, 1997, at which time the Company
           added a counterclaim for unfair competition.  The Tribunal has closed
           the  procedural  phase of the action and has scheduled oral arguments
           for December 1, 1997. On February 10, 1997, the distributor  filed an
           appeal of the  Tribunal's  decision  of  September  23, 1996 with the
           Court of Appeals of Colmar,  and the parties have exchanged briefs in
           the appellate proceeding.

                  The   Company  is  also  in  ongoing   discussions   with  its
           distributor in South Korea  regarding the status of such  distributor
           relationship and of approximately $491,000 in accounts receivable due
           the Company from such distributor.

                                       10
<PAGE>

              ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                   (Unaudited)

                  With respect to each of the aforementioned  distributors,  the
           Company has consulted  with local counsel in the  applicable  country
           and believes that the termination (or potential  termination) of each
           of the distributor relationships was (or will be) lawful. The Company
           understands  that  under  the laws of  certain  countries,  including
           Belgium and The  Netherlands,  under certain  circumstances,  certain
           indemnities may be claimed by distributors for insufficient notice of
           termination  and/or  goodwill  compensation.  The Company  intends to
           vigorously  defend itself against pending claims and any other claims
           that may be brought  by such  distributors  and to pursue  claims for
           unpaid accounts  receivable  against such distributors.  However,  no
           assurance can be given as to the outcome of any pending or threatened
           litigation, and any successful claim for damages or injunctive relief
           by one or more of such distributors, or the failure by the Company to
           succeed on its claims  against its former French  distributor,  could
           have a material adverse effect on the Company's  business,  financial
           condition and results of operations.

                  Former Cordis  Employee  Litigation.  On October 6, 1997,  the
           Company  received  notice that Cordis  Corporation,  a subsidiary  of
           Johnson & Johnson  ("Cordis"),  had filed a claim in federal district
           court in Buffalo,  New York  against the Company and Charles J. Soles
           in  connection  with the  Company's  hiring of Mr.  Soles and several
           other  former  Cordis  employees.  The  complaint  alleges  breach of
           contract  by  Mr.  Soles  and  tortious   interference  with  Cordis'
           contractual  rights by the  Company.  Cordis  seeks  preliminary  and
           permanent  injunctive  relief,  compensatory  and  punitive  damages,
           attorneys'  fees and other  relief.  The  Company  has  answered  the
           complaint  and moved for summary  judgment  on the  grounds  that the
           agreement at issue is inapplicable  and  unenforceable as a matter of
           law.  The  District  Court  held a  hearing  on  Cordis'  motion  for
           preliminary  injunction in late October 1997,  and further briefs and
           oral  arguments are scheduled to be completed in December  1997.  The
           Company has agreed to limit its contact  with Mr.  Soles  pending the
           District Court's determination on preliminary injunctive relief.

                  U.S.  Patent  Litigation.  On October  21,  1997,  the Company
           received  notice  that it had been  joined  in a  lawsuit  by  Cordis
           against Advanced  Cardiovascular  Systems, Inc., Guidant Corporation,
           Boston  Scientific  Corporation  and SCIMED  Life  Systems,  Inc.  in
           federal  district  court in  Delaware.  Cordis  alleges,  among other
           things, that the Company, upon receipt of regulatory approvals,  will
           begin selling in the United  States stents which  infringe on certain
           patents of Cordis.  The complaint  seeks  declaratory  and injunctive
           relief,  unspecified  damages,  attorneys  fees and other relief.  On
           November  6, 1997,  the  Company  filed a motion to  dismiss  Cordis'
           complaint.  The Company believes that it has meritorious  defenses to
           the claims alleged by Cordis in the action. However, no assurance can
           be  given as to the  outcome  of the  action.  The  inability  of the
           Company to prevail in the action, including the loss or impairment of
           the right to  produce  products  in the United  States,  could have a
           material  adverse  effect  on  the  Company's   business,   financial
           condition and results of operations.

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

                                       11
<PAGE>

Item 2.    Management's Discussion and Analysis of Financial Condition and
           Results of Operations

            Overview

                  The  statements  contained  in this  Form  10-Q  that  are not
            historical  are  forward-looking  statements  within the  meaning of
            Section  27A of the  Securities  Act of 1933 and  Section 21E of the
            Securities Exchange Act of 1934,  including statements regarding the
            Company's expectations,  beliefs, intentions or strategies regarding
            the future.  Forward-looking statements made herein include, without
            limitation,  statements  regarding  the  extent  and  timing  of new
            product    introductions,    competition,    regulatory   approvals,
            manufacturing  scale-up,  expenditures  and margin  levels,  and the
            establishment  of direct  sales  forces in targeted  countries.  All
            forward-looking statements in this document are based on information
            available  to the  Company as of the date  hereof,  and the  Company
            assumes no obligation to update any such forward-looking  statement.
            It is  important to note that the  Company's  actual  results  could
            differ  materially  from those in such  forward-looking  statements.
            Additional risk factors include those discussed in the reports filed
            by the Company from time to time on Forms 10-K, 10-Q and 8-K.

                  The   Company   is  engaged   in  the   design,   development,
            manufacturing  and  marketing  of  stent  systems  and  percutaneous
            transluminal  coronary angioplasty ("PTCA") catheters designed to be
            utilized   in   connection   with   less   invasive   treatment   of
            cardiovascular  disease.  The Company began  commercial sales of its
            PTCA  catheters  in October  1993,  its  coronary  stent  systems in
            October 1994, and its peripheral stent systems in December 1996. The
            Company's  products are currently  commercially sold only outside of
            the United States, primarily in Europe and Japan. In April 1996, the
            Company  began its first  direct  sales  operation  in  Europe,  and
            currently it has direct operations in each of France,  Germany,  the
            Netherlands  (servicing the Benelux countries),  Switzerland and the
            United  Kingdom.  In June 1997, the Company's  Japanese  distributor
            received  regulatory approval for the sale in Japan of the Company's
            coronary  stent  systems;  however,  as of  the  date  hereof,  such
            distributor had not yet received the related reimbursement approval.
            The Company does not expect reimbursement approval in Japan prior to
            December  1997,  and  there  can be no  assurance  when  or if  such
            approval will be obtained.

                  In August 1997,  the Company  submitted a pre-market  approval
            ("PMA")   application   to  the   United   States   Food   and  Drug
            Administration (the "FDA") in connection with its ongoing efforts to
            gain  approval  to  begin  commercial  sales of its  coronary  stent
            systems   in  the  United   States.   Clinical   studies   under  an
            investigational  device  exemption  are ongoing  with certain of the
            Company's products.  The Company does not expect FDA approval of its
            coronary  stent systems for sale in the United States prior to 1998,
            and  there  can be no  assurance  when or if such  approval  will be
            obtained.  As a result, the Company expects  international  sales to
            account for  substantially  all of its revenues until at least 1998.
            The  Company  has  incurred,  and  expects  to  continue  to  incur,
            substantial  clinical  research and other costs in  connection  with
            obtaining  regulatory  approvals for its stent systems in the United
            States and other countries.

                  The Company has a limited history of operations.  The increase
           in the Company's sales to date has been due to greater demand for the
           Company's  stent  systems and, to a lesser  degree,  its PTCA balloon
           catheter  systems.  The Company  believes that it is 

                                       12
<PAGE>
           currently   one  of  the   leading   providers   of   stent   systems
           internationally. In order to support increased levels of sales in the
           future and to augment its long term competitive position, the Company
           anticipates  that it will be required to make continuing  significant
           additional  expenditures in  manufacturing,  research and development
           (including clinical study and regulatory costs),  sales and marketing
           and  administration,  both in absolute dollars and as a percentage of
           net sales.  The Company has also  experienced  higher  administrative
           expenses  resulting  from  its  obligations  as  a  public  reporting
           company.

                  Until April 1996,  substantially  all of the  Company's  sales
            were to  international  distributors  who resell  products to health
            care  providers.   The  Company  terminated  its  relationship  with
            distributors  in  Germany  and the  United  Kingdom in April and May
            1996,  respectively,  and in France,  Switzerland,  Belgium  and The
            Netherlands  effective September 30, 1996. Moreover, in October 1997
            the Company  established  a direct sales force in Canada and largely
            completed the  development of a sales force in the United States for
            the direct sales of its  coronary  stent  systems  there if and when
            such sales are  approved by the FDA. The Company  believes  that the
            establishment  and  maintenance  of direct  sales  forces in Canada,
            France,  Germany, the Netherlands (servicing the Benelux countries),
            Switzerland,  the United  Kingdom and the United States has required
            and will  continue  to  require  significant  ongoing  expenditures,
            additional  management resources and has resulted,  and may continue
            to result,  in additional  costs to eliminate  existing  distributor
            relationships  (including  costs relating to litigation  with former
            distributors).  See Note 5 to the unaudited  Condensed  Consolidated
            Financial Statements in Item 1.

                  Generally,  the Company manufactures and ships product shortly
            after the receipt of orders,  and anticipates  that it will do so in
            the future.  The Company developed a significant  short-term backlog
            during January 1997 in connection with the scale-up of manufacturing
            of its GFX(TM) stent product. Such backlog was significantly reduced
            during the same fiscal  quarter in which it arose.  Upon  receipt of
            the necessary  regulatory  approvals,  the Company intends to market
            over-the-wire  models of its stent  systems  in the  United  States,
            unlike  the  rapid  exchange  models   generally   manufactured  for
            international  markets.  There can be no assurance  that the Company
            will be  successful  in scaling  up  production  of new or  modified
            products or that it will not experience  manufacturing  difficulties
            or develop backlogs in the future,  particularly with respect to the
            potentially  significant demands of the U.S. market. The Company has
            begun  to  produce  inventory  for  the  short-term  supply  of  the
            potential U.S.  market,  and it has begun  construction of a 130,000
            square foot building adjacent to its corporate headquarters in Santa
            Rosa, California,  at an estimated cost of $20 million,  which, when
            completed,  will be  largely  devoted to  manufacturing  activities.
            However,  there  can be no  assurance  that  such new  manufacturing
            facility  will  be  completed  in  time  to  allow  the  Company  to
            adequately  supply the potentially  significant  demands of the U.S.
            market on a long-term  basis,  nor that such new facility  will pass
            regulatory  inspection  for  compliance  with  applicable  U. S. and
            international regulations.

                  The Company  anticipates  that its results of  operations  may
            fluctuate  for  the  foreseeable  future  due  to  several  factors,
            including  variations  in  operating  expenses,  the  costs  and the
            outcome of litigation,  competition  (including pricing  pressures),
            costs and the timing of establishing  direct sales  operations,  the
            timing of research  and  development  expenses  (including  clinical
            trial related expenditures), the timing of new product introductions
            or transitions to new products,  sales by  distributors,  the mix of
            sales 

                                       13
<PAGE>

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

            Results of  Operations - Three Months Ended  September  30, 1997 and
            1996

                  Net sales.  For the three months ended September 30, 1997, net
            sales   increased  to  $26.3  million  from  $18.6  million  in  the
            comparable  period in fiscal 1997. The increase in net sales was due
            to  significant  increases in sales of the Company's  stent systems,
            particularly  the GFX family of  products.  The GFX was  released in
            certain  countries  internationally  in September  1996, and the GFX
            2.5(TM)  and the GFX  XL(TM)  were  released  in  certain  countries
            internationally in June 1997.

                  The Company  anticipates that stent system sales will continue
            to constitute  the vast  majority of total net sales.  In the second
            quarter of fiscal 1997 the Company began selling directly in France,
            Switzerland, and the Netherlands (to service the Benelux countries).
            In the three months  ended  September  30, 1997,  these direct sales
            operations,  together with those  established  previously in Germany
            and the  United  Kingdom,  produced  a  significant  portion  of the
            Company's total net sales.  All other  commercial  sales made by the
            Company  were  to  unaffiliated  distributors,  with  a  significant
            portion of total net sales for the three months ended  September 30,
            1997  attributable  to  stocking  orders by the  Company's  Japanese
            distributor.

                  The increasing  number of devices in the  international  stent
            market  and the  desire  of  companies  to obtain  market  share has
            resulted in increased price competition,  particularly in the second
            and third  quarters of fiscal  1997.  Such  competition  has, in the
            past,  caused the Company to reduce prices on its stent systems.  If
            the  Company  is forced to effect  further  price  reductions,  such
            reductions would reduce net sales in future periods if not offset by
            increased unit sales or other factors.

                  Cost of Sales.  Cost of sales increased to $5.5 million in the
            three  months  ended  September  30,  1997 from $2.9  million in the
            comparable  period in fiscal 1997,  and increased as a percentage of
            net sales to 21% in the fiscal  1998  period  from 16% in the fiscal
            1997 period. The increase in absolute dollars during the three-month
            period was  primarily a result of the  increased  volume of products
            sold and to a lesser extent,  the costs of additional  manufacturing
            capacity and personnel  necessary to support increased 

                                       14
<PAGE>

            sales  volume.  The increase as a percentage of net sales during the
            three-month  period was  primarily  the result of lower unit pricing
            compared to the prior period.

                  The Company  expects  cost of sales to continue to increase in
            absolute  dollars as the  Company  increases  the volume of products
            sold and adds additional manufacturing capacity and personnel.

                  Research and Development.  Research and development  expenses,
            which include clinical study and regulatory costs, increased to $5.5
            million  in the three  months  ended  September  30,  1997 from $1.9
            million in the comparable  period in fiscal 1997, and increased as a
            percentage of net sales to 21% in the fiscal 1998 period from 10% in
            the fiscal 1997 period.  The  increase in absolute  dollars and as a
            percentage of net sales during the three-month  period was primarily
            due to the addition of research and development personnel, increased
            levels of spending in connection with clinical  studies  relating to
            the GFX,  the Micro Stent II and Micro Stent II XL systems and costs
            incurred in connection with the development of additional products.

                  The  Company  expects  research  and  development  expenses to
            continue to increase  in absolute  dollars as the Company  increases
            clinical trial activities and pursues development of next generation
            products.

                  Selling,  General  and  Administrative.  Selling,  general and
            administrative  expenses  increased  in  absolute  dollars  to  $7.5
            million  in the three  months  ended  September  30,  1997 from $3.1
            million in the comparable  period in fiscal 1997, and increased as a
            percentage  of net sales to 29% in the 1998  period  from 17% in the
            1997 period.  The increase during the three-month period in absolute
            dollars and as a percentage of sales primarily reflected  additional
            costs of  marketing  and other  personnel  necessary  to support the
            Company's higher level of operations,  including the commencement of
            direct sales  operations in France,  The Netherlands  (servicing the
            Benelux countries),  and Switzerland in the second quarter of fiscal
            1997.  Additionally,  the increase  reflects  increased  legal costs
            relating  primarily  to  litigation  with  former   shareholders  of
            Endothelial   Support   Systems,   Inc.,   subsequently   known   as
            Endovascular Support Systems,  Inc. ("ESS"), and certain distributor
            terminations,  which together  resulted in related legal expenses of
            $1.3 million during the quarter.

                  The Company expects selling,  general and administrative costs
            to continue to increase in absolute  dollars in the future primarily
            due to increased levels of sales,  product support and manufacturing
            operations  (particularly  with respect to increased levels of sales
            operations in the United States already developed in anticipation of
            FDA approval,  although there can be no assurance of such approval),
            as well as  increases  in finance,  legal and  administrative  costs
            relating to public company obligations, and ongoing litigation.

                  Interest and Other Income.  The Company had interest and other
            income of $1.0 million in the three months ended September 30, 1997,
            compared to $1.3  million in the  comparable  period in fiscal 1997.
            The decrease  during the  three-month  period was  primarily  due to
            certain real property rental income earned,  and greater  short-term
            investment balances, in the prior period.

                  Provision for Income Taxes. The Company's provision for income
            taxes was $3.1 million in the three months ended September 30, 1997,
            compared to $4.2  million in the  comparable  period in fiscal 1997.
            The decrease in this provision  during the three-

                                       15
<PAGE>

            month period was a result of the Company's lower earnings during the
            fiscal 1998 period.

                  Net Income.  The Company  had net income of $5.7  million,  or
            21.7% of net sales,  in the three  months ended  September  30, 1997
            compared to net income of $7.8 million,  or 41.9% of net sales,  for
            the comparable period in fiscal 1997.

            Liquidity and Capital Resources

                  Net cash provided by operating activities was $9.5 million for
            the three months ended  September 30, 1997.  Excluding the effect of
            transactions  in  short-term  investments,  the Company had net cash
            provided by operating activities of $4.9 million for the three-month
            period,  principally  arising as a result of positive net income for
            the  period.  Cash,  cash  equivalents  and  short-term  investments
            totaled  $85.3  million at  September  30, 1997 as compared to $87.2
            million  at June 30,  1997.  Working  capital  decreased  to  $112.5
            million at September 30, 1997 as compared to $114.5  million at June
            30, 1997.  Inventories  increased to $10.8  million at September 30,
            1997 from $7.3 million at June 30, 1996,  primarily due to increased
            product   inventories  in  preparation   for  the   commencement  of
            commercial  sales  in  Japan  and the  United  States.  Included  in
            accounts  receivable  at September  30, 1997 is  approximately  $2.4
            million  due from  former  distributors  of the  Company  that  have
            threatened  or  commenced   litigation   in   connection   with  the
            termination of distribution relationships. The Company has commenced
            litigation  against  such  terminated  distributors  to collect such
            amounts.  See  Note  5  to  the  Condensed   Consolidated  Financial
            Statements in Item 1. The Company  expects  accounts  receivable and
            inventories  to  increase  in  absolute   dollar  amounts  as  sales
            increase.

                  In  August  1997,  the  Company  entered  into a  bank  credit
            agreement  for a  revolving  credit  facility of $20  million.  Such
            revolving  credit  facility  is secured by certain of the  Company's
            short-term  investments  and is due and payable on August 31,  1998.
            The  bank  credit   agreement   contains  no  material   restrictive
            covenants.  As of  September  30,  1997,  the Company had drawn down
            approximately  $2.4 million of such revolving credit  facility.  The
            interest  rate  on such  facility  is  LIBOR  plus  one-half  of one
            percent.

                  The Company  expects to incur  substantial  additional  costs,
            including  costs  relating  to  capital  equipment  and other  costs
            associated   with   expansion   of   the   Company's   manufacturing
            capabilities,  increased sales and marketing  activities  (including
            the  establishment  of direct  sales  forces  internationally),  and
            increased  research and development  expenditures in connection with
            seeking  regulatory  approvals and  conducting  additional  clinical
            trials.   Among  other   things,   the  Company   expects  to  spend
            approximately $20 million on a new manufacturing  facility currently
            under  construction  in Santa  Rosa,  California.  The  Company  may
            require  additional  equity or debt financing to address its working
            capital needs or to provide funding for capital  expenditures in the
            future. Furthermore, any additional equity financing may be dilutive
            to  stockholders,  and debt  financing,  if  available,  may involve
            restrictive  covenants.  However,  there  can be no  assurance  that
            events in the future will not require the Company to seek additional
            capital  or,  if so  required,  that it will be  available  on terms
            acceptable to the Company.

                                       16
<PAGE>

PART II           OTHER INFORMATION


                  Item 1.    Legal Proceedings

                                    Reference is made to Note 5 to the Condensed
                             Consolidated  Financial  Statements  in  this  Form
                             10-Q.


                  Item 2.    Change in Securities and Use of Proceeds

                                    The   effective   date   of  the   Company's
                             registration  statement filed on Form S-1 under the
                             Securities Act of 1933 (No. 333-00824) was April 2,
                             1996 (the "Registration  Statement").  The class of
                             securities   registered   was  Common  Stock.   The
                             offering   commenced  on  April  2,  1996  and  all
                             securities were sold in the offering.  The managing
                             underwriters for the offering were Cowen & Company,
                             Bear, Stearns & Co. Inc. and J.P. Morgan & Co.

                                    Pursuant to the Registration Statement,  the
                             Company sold  4,250,000  shares of Common Stock for
                             its own account, for an aggregate offering price of
                             $89,250,000,  and 1,500,000  shares of Common Stock
                             for the  account of certain  selling  stockholders,
                             for an aggregate offering price of $31,500,000.

                                    The    Company    incurred    expenses    of
                             approximately  $7,897,500  in  connection  with the
                             offering,    of   which   $6,247,500    represented
                             underwriting    discounts   and   commissions   and
                             $1,650,000  represented  estimated  other expenses.
                             All such expenses were direct or indirect  payments
                             to others. The net offering proceeds to the Company
                             after total expenses was approximately $81,352,000.

                                    The   Company    has   used    approximately
                             $12,800,000 of the net proceeds of the offering, of
                             which $6,200,000  represents  payments  relating to
                             the construction of plant,  building and facilities
                             and $6,600,000  represents payments relating to the
                             purchase of real  estate.  All such  payments  were
                             direct or indirect  payments  to others.  All other
                             net proceeds of the offering  have been invested in
                             various  short-term  investments.  The  use  of the
                             proceeds  of the  offering  does  not  represent  a
                             material change in the use of proceeds described in
                             the   prospectus   that   formed   a  part  of  the
                             Registration Statement.

                                       17
<PAGE>

Item 6.           Exhibits and Reports on Form 8-K

                  (a)         Exhibits


                             11.1      Statement regarding calculation of net 
                                       income per share.

                             27        Financial Data Schedule.

                  (b)         Reports on Form 8-K

                             No reports on Form 8-K were filed  during the three
                             months ended September 30, 1997.

                             On October 23, 1997,  the Company  filed a Form 8-K
                             with  respect to its being  named as an  additional
                             defendant, along with Boston Scientific Corporation
                             and  SciMed  Life  Systems,   Inc.,  in  a  lawsuit
                             originally  filed  by  Cordis  Corporation  against
                             Guidant  Corporation  and  Advanced  Cardiovascular
                             Systems,   Inc.  in  federal   district   court  in
                             Delaware.   The  lawsuit  alleges  infringement  or
                             potential  infringement of one or more U.S. patents
                             held by Cordis.

                             Report Date: October 21, 1997
                             Filing Date: October 23, 1997
                             Item 5 - Other Events
                             Item 7 - Exhibits


                                       18
<PAGE>

SIGNATURES

         Pursuant to the  requirements  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.



                             ARTERIAL VASCULAR ENGINEERING, INC.



Date: November 11, 1997      /s/ John D. Miller
                             -------------------------------------------
                             John D. Miller
                             Vice President of Finance, Chief Financial Officer
                             (Principal Financial and Accounting Officer)



                                       19
<PAGE>

                                INDEX TO EXHIBITS


Exhibit
-------

11.1              Statement regarding computation of net income per share.

27                Financial Data Schedule