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 December 31, 1996

                         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              30,966,883 as of January 31, 1997


<PAGE>


<TABLE>
                                                INDEX TO FORM 10-Q



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

                Item 1.    Financial Statements

                           Condensed Consolidated Balance Sheets as of December 31, 1996                          3
                                 and June 30, 1996

                           Condensed Consolidated Statements of Operations for the three                          4
                                 months and six months ended December 31, 1996 and 1995

                           Condensed Consolidated Statements of Cash Flows for the                                5
                                 six months ended December 31, 1996 and 1995

                           Notes to Condensed Consolidated Financial Statements                                   6

                Item 2.    Management's Discussion and Analysis of Financial Condition                           11
                                 and Results of Operations


PART II         OTHER INFORMATION

                Item 1.    Legal Proceedings                                                                     16

                Item 4.    Submissions of Matters to a Vote of Security Holders                                  16

                Item 6.    Exhibits and Reports on Form 8-K                                                      16


SIGNATURES                                                                                                       18

</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>
                                                                       December 31,             June 30,
                                                                          1996                    1996
                                                                        ---------               ---------
<S>                                                                     <C>                     <C>      
                                     ASSETS
Current assets:
     Cash and cash equivalents                                          $  21,319               $  59,238
     Short-term investments                                                63,091                  32,354
     Trade accounts receivable, net                                        18,681                  13,213
     Inventories                                                            6,029                   3,352
     Deferred income tax                                                    2,016                   2,016
     Prepaid expenses and other current assets                              6,820                   2,338
                                                                        ---------               ---------
        Total current assets                                              117,956                 112,511
Deferred income tax                                                           172                     172
Property, plant and equipment, net                                         16,072                   8,974
Purchased technology and other intangible assets, net                         422                     500
                                                                        ---------               ---------
        Total assets                                                    $ 134,622               $ 122,157
                                                                        =========               =========


                                  LIABILITIES
Current liabilities:
     Accounts payable                                                   $   2,342               $   1,671
     Accrued expenses                                                       2,948                   2,479
     Income taxes payable                                                    --                     1,436
                                                                        ---------               ---------
        Total current liabilities                                           5,290                   5,586
                                                                        ---------               ---------

                              STOCKHOLDERS' EQUITY
Common stock                                                                   31                      31
Additional paid-in capital                                                 92,589                  91,776
Notes receivable for common stock                                            (301)                   (301)
Deferred compensation                                                         (59)                    (87)
Treasury stock                                                               (390)                   --
Cumulative translation adjustment                                             (61)                   --
Retained earnings                                                          37,523                  25,152
                                                                        ---------               ---------
        Total stockholders' equity                                        129,332                 116,571
                                                                        ---------               ---------
        Total liabilities and stockholders' equity                      $ 134,622               $ 122,157
                                                                        =========               =========





<FN>

                                                       See accompanying notes
</FN>
</TABLE>

                                                                  3
<PAGE>


<TABLE>

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

<CAPTION>

                                                       Three Months Ended                   Six Months Ended
                                                          December 31,                         December 31,
                                                 -----------------------------        --------------------------
                                                     1996              1995             1996              1995
                                                   -------           -------           -------           -------
<S>                                                <C>               <C>               <C>               <C>    
Net sales                                          $18,228           $11,142           $36,796           $21,714
Cost of sales                                        3,733             2,427             6,644             4,918
                                                   -------           -------           -------           -------
Gross profit                                        14,495             8,715            30,152            16,796
                                                   -------           -------           -------           -------

Operating expenses:
     Research and development                        2,259               657             4,114             1,205
     Selling, general and administrative             6,204               812             9,335             1,258
                                                   -------           -------           -------           -------
        Total operating expenses                     8,463             1,469            13,449             2,463
                                                   -------           -------           -------           -------

Operating income                                     6,032             7,246            16,703            14,333
Interest and other income                            1,054               138             2,329               260
                                                   -------           -------           -------           -------
Income before provision for income taxes             7,086             7,384            19,032            14,593
Provision for income taxes                           2,480             2,513             6,661             4,966
                                                   -------           -------           -------           -------
Net income                                         $ 4,606           $ 4,871           $12,371           $ 9,627
                                                   =======           =======           =======           =======

Net income per share                               $  0.15           $  0.18           $  0.39           $  0.35


Shares used in per share calculation                31,590            27,308            31,611            27,301




<FN>

                                                       See accompanying notes
</FN>
</TABLE>
                                                                 4
<PAGE>


<TABLE>

                            ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
                               CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                 (Unaudited)
                                               (In thousands)
<CAPTION>
                                                                                        Six Months Ended
                                                                                          December 31,
                                                                                  -----------------------------
                                                                                    1996                1995
                                                                                  --------            --------
<S>                                                                               <C>                 <C>     
Cash flows from operating activities:
     Net income                                                                   $ 12,371            $  9,627
     Adjustments to reconcile net income to net cash
        provided by (used in) operating activities:
            Depreciation and amortization                                              729                 338
            Provision for doubtful accounts                                            114                  76
            Provision for obsolete inventory                                            13                  66
            Amortization of deferred compensation                                       28                 157
            Income tax reduction relating to stock plans                               763               2,148
            Deferred income taxes                                                     --                   316
            Foreign currency translation                                               (61)               --
            Changes in assets and liabilities:
                Short-term investments                                             (30,737)               --
                Accounts receivable                                                 (5,582)             (3,965)
                Inventories                                                         (2,690)             (1,022)
                Prepaids and other current assets                                     (293)               (610)
                Accounts payable                                                       671                 621
                Accrued liabilities                                                    469                 (34)
                Customer deposits                                                     --                (1,405)
                Income taxes payable                                                (5,625)               (622)
                                                                                  --------            --------
                   Net cash provided by (used in) operating activities             (29,830)              5,691
                                                                                  --------            --------

Cash flows from investing activities:
     Proceeds from sale of investments                                                --                   100
     Acquisition of property, plant and equipment                                   (7,749)             (1,606)
                                                                                  --------            --------
                   Net cash used in investing activities                            (7,749)             (1,506)
                                                                                  --------            --------

Cash flows from financing activities:
     Proceeds from issuance of common stock                                             50                  35
     Acquisition of treasury stock                                                    (390)               --
                                                                                  --------            --------
                   Net cash provided by (used in) financing activities                (340)                 35
                                                                                  --------            --------

Net increase (decrease) in cash and cash equivalents                               (37,919)              4,220
Cash and cash equivalents, at beginning of period                                   59,238               2,533
                                                                                  --------            --------
Cash and cash equivalents, at end of period                                       $ 21,319            $  6,753
                                                                                  ========            ========


<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 and
           results  of  operations  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, 1996.

           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 and six months  ended  December  31,
           1996 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):

                                                 December 31,        June 30,
                                                    1996              1996
                                                ------------      -----------

                           Raw materials        $       839        $     456
                           Work in process            1,393            1,211
                           Finished goods             3,797            1,685
                                                ------------      -----------
                                                $     6,029        $   3,352
                                                ============      ===========

3.         Computation of Net Income Per Share

           Net income per share is computed using the weighted average number of
           common and  common  equivalent  shares,  when  dilutive,  outstanding
           during the period.  Common  equivalent  shares comprise stock options
           using the  treasury  stock  method.  Pursuant to the  Securities  and
           Exchange  Commission  Staff Accounting  Bulletins,  common and common
           equivalent  shares  issued by the Company at prices below the initial
           public  offering  price during the  twelve-month  period prior to the
           offering  have  been  included  in the  calculation  as if they  were
           outstanding  for all periods  presented  prior to the  offering  date
           (using the  treasury  stock  method and the initial  public  offering
           price).


                                       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
           may repurchase  shares of its common stock with an aggregate value of
           up to $10 million.  The  repurchases may be made from time to time on
           the  open  market  at  prevailing  market  prices  or  in  negotiated
           transactions off the market.  Although the Company does not currently
           intend to repurchase a significant  number of additional shares under
           the repurchase program,  the program will continue until discontinued
           by the Board of  Directors.  The Company has used,  and plans to use,
           existing  cash balances to finance any  repurchases.  The Company may
           use the repurchased shares to offset grants under its employee equity
           incentive  plan. As of December 31, 1996, the Company had repurchased
           30,000 shares of its common stock at an aggregate cost of $390,000.

5.         Contingencies

           ESS  Litigation.  In  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  purchased  assets  included the  technology  which
           resulted in the Company's only issued  patents.  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. 

                                       7
<PAGE>

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

           On February 10 and 12, 1997, the court overruled  defendants' special
           appearances and denied defendants' motions objecting to jurisdiction,
           motions  to dismiss  based on forum non  conveniens,  and  motions to
           abate or stay the Texas  proceedings.  The  Company  believes  it has
           meritorious defenses to the claims in the Texas action and intends to
           vigorously  defend itself.  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 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 

                                       8
<PAGE>

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

           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 early 1996, in connection  with the Company's  termination  of its
           distribution  relationship  with  Cardiologic GmbH effective April 8,
           1996, the Company received notice from such  distributor  alleging an
           exclusive  distribution  agreement  between the  parties  with a term
           expiring in December  1998.  The  distributor  threatened  to file an
           action for breach of the alleged agreement,  including making a claim
           for compensation  equal to one year's average  commission and seeking
           to enjoin distribution of the Company's products in Germany.

           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. in Belgium and The
           Netherlands,  respectively, effective September 30, 1996, the Company
           received notice that of a lawsuit filed by  Alfatec-Medicor in 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  $5.6 million  using  current  exchange
           rates),  of  which  BF30,000,000  (approximately  $885,000)  is being
           sought as a provisional  payment at a hearing scheduled for April 18,
           1997. The Company has requested from Alfatec-Medicor information that
           would  support  its  claims  for  indemnification,  but  has  not yet
           received such information.

           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   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,  1997,  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

                                       9
<PAGE>

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

           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. On January
           27, 1997, the Company filed an action in the debt  collection  office
           of Cham,  Switzerland  against  Medicor AG for $93,000  plus  accrued
           interest in  connection  with  unpaid  accounts  receivable  from the
           distributor relationship.

           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
           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  scheduling  hearing is  scheduled  for
           February 21, 1997.

           With respect to each of the aforementioned distributors,  the Company
           has  consulted  with local  counsel  in the  applicable  country  and
           believes   that   the   termination   of  each  of  the   distributor
           relationships was 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. 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
           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.

                                       10

<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,  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.

           Since its  inception  in 1991,  the Company  has been  engaged in the
           design, development, manufacturing and marketing of stent systems and
           balloon  angioplasty  catheters designed to be utilized in connection
           with the treatment of  atherosclerosis.  The Company began commercial
           sales of its balloon  angioplasty  catheters  in October 1993 and its
           coronary stents in October 1994. The Company's products are currently
           commercially  sold only  outside of the United  States,  primarily in
           Europe and Japan. In Japan, the Company  currently sells only balloon
           catheters.  The Company is seeking  regulatory  approval  for sale of
           certain of its stent  systems in Japan and Spain.  In November  1995,
           the  Company  received  United  States  Food and Drug  Administration
           ("FDA") clearance to conduct clinical trials with the Company's Micro
           Stent  and Micro  Stent II  systems  in the  United  States  under an
           Investigational Device Exemption ("IDE").  Subsequently,  the Company
           received FDA approval to include in these trials  patients  afflicted
           with  restenotic  lesions,  patients  with long  lesions  that can be
           treated  with the Micro  Stent II XL,  and  patients  with  abrupt or
           threatened vessel closure.  The Company has also received conditional
           approval to include in the trials its single-operator  stent delivery
           system. In addition, in December 1996, the Company received clearance
           from the FDA to  conduct  clinical  trials  with the  Company's  Peak
           balloon  angioplasty  catheter.  The  Company  does  not  expect  FDA
           approval of its stent products 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 for at least the next
           12 months. The Company expects to incur substantial clinical research
           and other costs in connection with obtaining regulatory approvals for
           its stents in the United States and other countries.

           The Company  has a limited  history of  operations  and only began to
           generate  positive  net income in fiscal  1995.  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 coronary balloon
           catheter  systems.  In order to support  increased levels of sales in
           the future and to augment  its long term  competitive  position,  the
           Company  anticipates  that  it will be  required  to make  continuing
           significant  additional  expenditures in manufacturing,

                                       11
<PAGE>

           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.  The Company has  established a direct
           sales  force  in each  of  those  countries.  The  establishment  and
           maintenance  of direct sales forces has required and will continue to
           require  significant  ongoing  expenditures,   additional  management
           resources and has resulted, and may continue to result, in additional
           costs to  eliminate  existing  distributor  relationships  (including
           litigation by former  distributors).  Sales in Belgium,  France,  The
           Netherlands  and   Switzerland   were   significantly   below  levels
           originally  anticipated  in the three months ended December 31, 1996,
           due in part to the Company's conversion to direct sales forces there,
           and there can be no  assurance  that any such direct sales force will
           be  successful in the future.  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
           AVE gfx Stent product. The Company  expects that this backlog will be
           reduced during the quarter ending March 31, 1997.

           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  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.  Failure to quickly or cost-effectively establish
           or maintain  and manage  effective  sales  forces in such  countries,
           particularly  in France and  Germany,  could have a material  adverse
           effect on the Company's business,  financial condition and results of
           operations.  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

                                       12
<PAGE>

           analysts.  The Company has experienced,  and may experience in one or
           more  future  quarters,   operating   results  which  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 and Six Months Ended  December 31, 1996
           and 1995

           Net sales.  For the three months ended  December 31, 1996,  net sales
           increased  to $18.2  million  from $11.1  million  in the  comparable
           period  in  fiscal  1996.  The  increase  in  net  sales  was  due to
           significant  increases  in  sales  of the  Company's  stent  systems,
           particularly  the AVE gfx  Stent  and the  Micro  Stent II  family of
           products.  The  AVE gfx  Stent  was  released  in  certain  countries
           internationally  in  September  1996,  and  the  Micro  Stent  II was
           released in certain countries internationally in October 1995.

           For the first six months of fiscal 1997, net sales increased to $36.8
           million  from $21.7  million in the first six months of fiscal  1996.
           The increase in net sales was due to  significant  increases in sales
           of the Company's  stent systems,  particularly  the AVE gfx Stent and
           the Micro Stent II family of products.

           The Company  anticipates  that stent  system  sales will  continue to
           constitute  the vast  majority  of total  net  sales.  In the  fourth
           quarter of fiscal 1996, the Company commenced direct sales operations
           in the United  Kingdom  and  Germany,  and in the  second  quarter of
           fiscal  1997  the   Company   began   selling   directly  in  France,
           Switzerland, Belgium and The Netherlands. All other sales made by the
           Company were through unaffiliated distributors.  The Company believes
           that 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
           quarter of fiscal 1997, which has caused the Company to reduce prices
           on its stent  systems.  Price  reductions in response to  competitive
           pressure  reduced net sales in the second quarter of fiscal 1997. The
           Company expects such price competition to continue. If the Company is
           forced to effect  further price  reductions,  such  reductions  would
           continue  to  reduce  net sales in future  periods  if not  offset by
           increased unit sales or other factors.

           Cost of Sales.  Cost of sales  increased to $3.7 million in the three
           months ended  December  31, 1996 from $2.4 million in the  comparable
           period in fiscal 1996,  and decreased as a percentage of net sales to
           20% in the fiscal 1997  period  from 22% in the fiscal  1996  period.
           Cost of sales  increased  to $6.6  million in the first six months of
           fiscal 1997 from $4.9 million in the first six months of fiscal 1996,
           and  decreased as a percentage of net sales to 18% in the 1997 period
           from 23% in the 1996 period.  The increase in absolute dollars during
           the  three-  and  six-month  periods  was  primarily  a result of the
           increased  volume of products sold and to a lesser extent,  the costs
           of  additional  manufacturing  capacity  and  personnel  necessary to
           support  increased sales volume.  The decrease as a percentage of net
           sales was primarily the result of leveraging  certain fixed  overhead
           expenses  across a  higher  base of sales  and an  increase  in stent
           system sales as a percentage of total sales. 

                                       13
<PAGE>

           Research and Development.  Research and development  expenses,  which
           include  clinical  study  and  regulatory  costs,  increased  to $2.3
           million in the three months ended  December 31, 1996 from $657,000 in
           the  comparable  period in fiscal 1996, and increased as a percentage
           of net sales to 12% in the fiscal  1997  period from 6% in the fiscal
           1996 period. Such research and development expenses increased to $4.1
           million in the first six months of fiscal  1997 from $1.2  million in
           the first six months of fiscal 1996, and increased as a percentage of
           net sales to 11% in the 1997 period from 6% in the 1996  period.  The
           increase during the three- and six-month periods was primarily due to
           the addition of research and development personnel,  increased levels
           of spending in connection with clinical  studies  relating to the AVE
           gfx Stent, the Micro Stent II and Micro Stent II XL systems and costs
           incurred in connection with the  development of additional  products,
           including the renal and iliac artery Bridge stents.

           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 $6.2 million
           in the three  months  ended  December  31, 1996 from  $812,000 in the
           comparable  period in fiscal 1996,  and  increased as a percentage of
           net  sales to 34% in the  1997  period  from 7% in the  1996  period.
           Selling,  general and  administrative  expenses increased in absolute
           dollars to $9.3  million in the first six months of fiscal  1997 from
           $1.3 million in the first six months of fiscal 1996, and increased as
           a  percentage  of net sales to 25% in the 1997  period from 6% in the
           1996 period.  The increase 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,  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,   and  the
           commencement  in October 1996 of direct sales  operations in Belgium,
           France, The Netherlands and Switzerland.  The Company also recognized
           a charge of approximately  $400,000 in the quarter ended December 31,
           1996 relating to expenses for a proposed  secondary offering that was
           postponed.

           The Company  expects  selling,  general and  administrative  costs to
           continue to increase in absolute  dollars in the future primarily due
           to  

                                       14

<PAGE>

           direct sales operations in certain European countries,  the increased
           level of sales,  product support and  manufacturing  operations,  and
           increases in finance,  legal and  administrative  costs in connection
           with public company obligations and ESS and other ongoing litigation.

           Interest and Other Income.  The Company had interest and other income
           of $1.1 million in the three months ended December 31, 1996, compared
           to $138,000 in the comparable  period in fiscal 1996. The Company had
           interest  and other income of $2.3 million in the first six months of
           fiscal  1997,  compared to $260,000 in the first six months of fiscal
           1996. The increase during such  periods was primarily due to interest
           income earned from the Company's  increased cash and cash equivalents
           and short-term investment balances.

           Provision for Income Taxes. The Company's  provision for income taxes
           was $2.5 million in the three  months ended  December 31, 1996 and in
           the  comparable  period in fiscal 1996.  The Company's  provision for
           income taxes was $6.7 million in the first six months of fiscal 1997,
           compared to $5.0 million in the first six months of fiscal 1996.  The
           increase in this  provision  during such  periods was a result of the
           Company's higher earnings during the fiscal 1997 period.

           Net Income.  The Company had net income of $4.6 million for the three
           months ended December 31, 1996 compared to net income of $4.9 million
           for  the  comparable  period  in  fiscal  1996.  Earnings  per  share
           decreased to $0.15 in the three  months ended  December 31, 1996 from
           $0.18 in the  comparable  period in fiscal 1996.

           The Company had net income of $12.4  million for the first six months
           of fiscal 1997  compared to net income of $9.6  million for the first
           six months of fiscal 1996.  Earnings per share  increased to $0.39 in
           the first  six  months  of  fiscal  1997 from  $0.35 in the first six
           months of fiscal 1996.  

           Liquidity and Capital Resources 

           Net cash used in operating  activities  was $29.8 million for the six
           months ended December 31, 1996, which included the Company's purchase
           of short-term  investments  totaling $30.7 million.  Excluding  these
           investments,   the  Company  had  net  cash   provided  by  operating
           activities of $907,000,  principally  arising as a result of positive
           net income for the period.  Cash,  cash  equivalents  and  short-term
           investments totaled $84.4 million at December 31, 1996 as compared to
           $91.6 million at June 30, 1996.  Working capital  increased to $112.7
           million at December  31,  1996 as compared to $106.9  million at June
           30, 1996.  Inventories increased to $6.0 million at December 31, 1996
           from $3.4 million at June 30, 1996, primarily due to the commencement
           of direct sales  operations in France,  Switzerland,  Belgium and The
           Netherlands  in the  second  quarter of fiscal  1997 and slower  than
           expected  sales in such  countries.  Of the $18.7 million in accounts
           receivable at December 31, 1996,  approximately  $2.4 million was 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 or expects to
           commence  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

                                       15

<PAGE>

           increase in absolute dollar amounts as sales increase. As of the date
           of this report, the Company had no outstanding debt.

           The Company expects to incur substantial  additional costs, including
           costs related to increased sales and marketing activities  (including
           the establishment of direct sales forces internationally),  increased
           research and  development,  expenditures  in connection  with seeking
           regulatory  approvals  and  conducting  additional  clinical  trials,
           capital  equipment and other costs  associated  with expansion of the
           Company's  manufacturing   capabilities.   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.
           However, there can be no assurance that events in the future will not
           require  the  Company  to seek  additional  capital  sooner 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 4.    Submission of Matters to a Vote of Security Holders

                             The Company's  annual meeting of  stockholders  was
                             held on December 4, 1996, to consider and vote upon
                             three  matters.  The first  matter  related  to the
                             election  of  five  director  nominees:  Bradly  A.
                             Jendersee, Robert D. Lashinski, John D. Miller, Dr.
                             J. Irawan Sugeng, and Dr. Simon Stertzer. The votes
                             cast  and  withheld  for  such   nominees  were  as
                             follows:

                             Name                    For               Withheld
                             ----                    ---               --------
                             Bradly A. Jendersee     23,708,777        453,408
                             Robert D. Lashinski     24,058,871        103,314
                             John D. Miller          24,058,871        103,314
                             Dr. J. Irawan Sugeng    24,050,216        111,969
                             Dr. Simon Stertzer      24,060,205        101,980

                             The second matter  related to the  ratification  of
                             the appointment of Ernst & Young LLP as independent
                             auditors of the Company for fiscal 1997. 23,971,511
                             votes  were  cast for  approval,  1,750  were  cast
                             against  and there were  188,924  abstentions.  The
                             third   matter   related  to  the  approval  of  an
                             amendment to the  Company's  1996 Equity  Incentive
                             Plan  to increase the shares issuable thereunder by
                             700,000.  21,828,774  votes were cast for approval,
                             1,922,065 were cast against, and there were 157,934
                             abstentions and 253,412 broker nonvotes.

                             Based  on  these  voting   results,   each  of  the
                             directors  nominated was elected and the second and
                             third matters were passed.

                  Item 6.    Exhibits and Reports on Form 8-K

                  (a)        Exhibits

                             10.26    International Distribution Agrement, dated
                                      as of  January  22,  1997,  between  Japan
                                      Lifeline  Co.,   Ltd.,  and  the  Company.
                                      (Confidential treatment has been requested
                                      for certain information  contained in this
                                      document.   Such   information   has  been
                                      omitted  and  filed  separately  with  the
                                      Securities    and   Exchange    Commission
                                      pursuant  to Rule 24b-2 of the  Securities
                                      Exchange Act of 1934, as amended.)

                             10.27    Form of Change in Control  Option  Vesting
                                      Acceleration Agreement between the Company
                                      and Lawrence J. Fassler and certain  other
                                      key employees.

                             10.28    Employment Agreement, dated as of February
                                      3, 1997,  between the Company and Scott J.
                                      Solano.

                             11.1     Statement  regarding  calculation  of  net
                                      income per share.

                             27       Financial Data Schedule

                                       17
<PAGE>

                  (b)        Reports on Form 8-K

                             No  reports  on Form  8-K  were  filed  during  the
quarter ended December 31, 1996.

                                       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: February 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

10.26             International  Distribution Agreement, dated as of January 22,
                  1997,    between   Japan    Lifeline   Co.,   Ltd.   and   the
                  Company.(Confidential treatment has been requested for certain
                  information  contained in this document.  Such information has
                  been  omitted and filed  separately  with the  Securities  and
                  Exchange  Commission  pursuant to Rule 24b-2 of the Securities
                  Exchange Act of 1934, as amended.)

10.27             Form  of  Change  in  Control  Option   Vesting   Acceleration
                  Agreement  between  the Company  and  Lawrence J.  Fassler and
                  certain other key employees. 

10.28             Employment  Agreement,  dated as of February 3, 1997,  between
                  the Company and Scott J. Solano.

11.1              Statement regarding calculation of net income per share.

27                Financial Data Schedule