<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                         ----------------------------
                                   FORM 10-K

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

(Mark One)

[X]  Annual Report Pursuant To Sections 13 or 15(d) of the Securities Exchange
     Act Of 1934

For the fiscal year ended December 31, 1997

or

[ ]  Transition Report Pursuant To Sections 13 or 15(d) of the Securities
     Exchange Act Of 1934

For the transition period from ____________ to ____________.


Commission File No. 0-21001

                      NITINOL MEDICAL TECHNOLOGIES, INC.
            ------------------------------------------------------
            (Exact Name of Registrant as Specified in its Charter)

           Delaware                                      95-4090463
--------------------------------         ------------------------------------
(State or Other Jurisdiction of          (I.R.S. Employer Identification No.)
Incorporation or Organization)

27 Wormwood Street, Boston, Massachusetts                            02210
------------------------------------------------------------------------------
(Address of Principal Executive Offices)                           (Zip Code)

Registrant's telephone number, including area code:  (617) 737-0930

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

Securities registered pursuant to Section 12(g) of the Act:
                    Common Stock, $.001 par value per share
                               (Title of Class)

     Indicate by check mark whether the registrant:  (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.    Yes   [X]       No [_]
                             

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

     The aggregate market value of voting Common Stock held by nonaffiliates of
the registrant on March 6, 1998, was $58,552,278, based on the last reported
sale prices of the registrant's Common Stock on the Nasdaq National Market on
that date.  Registrant had 9,823,186 shares of Common Stock outstanding as of
March 6, 1998.

Documents Incorporated By Reference
-----------------------------------
                                              Part of Form 10-K
          Document                            into which incorporated
-------------------------------------         --------------------------
Portions of the Registrant's Proxy            Items 10, 11, 12 and 13 of
Statement with respect to the Annual          Part III
Meeting of Stockholders to be held on
June 3, 1998
<PAGE>
 
                                    PART I

ITEM I.  BUSINESS


OVERVIEW

Nitinol Medical Technologies, Inc. (together with its subsidiaries, "the
Company" or "NMT"), designs, develops, and markets innovative medical devices
that utilize advanced technologies and are delivered by minimally invasive
procedures.  These products offer alternative approaches to complex medical
treatments, thereby reducing patient trauma, shortening procedure,
hospitalization and recovery times, and lowering overall treatment costs.  The
Company's patented medical devices include self-expanding stents, vena cava
filters (the Simon Nitinol Filter or "SNF") and septal repair devices (the
CardioSEAL Septal Occluder).  The Company's strategy is to develop and
commercialize a broad range of advanced medical devices for minimally invasive
applications to address unmet medical needs. At this time, the Company's stents
have been commercially launched in Europe and in the United States for certain
indications, its vena cava filters are marketed in the United States and abroad,
and the CardioSEAL Septal Occluder is in clinical trials in the United States
and is sold commercially in Europe and other international markets.

The Company has established agreements with Boston Scientific and Bard Radiology
("Bard"), worldwide leaders in sales of minimally invasive medical devices, for
the distribution, sale and marketing of its stents and its Simon Nitinol Filter,
respectively. The Company intends to continue to market products with extensive
distribution requirements through collaborations with established market
leaders. For products with smaller and more easily accessible user groups (such
as the CardioSEAL Septal Occluder) NMT has developed and intends to continue to
develop direct marketing and distribution capabilities.


BACKGROUND

The Company was founded in July 1986 to develop and commercialize medical
devices using nitinol. In April 1990, the Company obtained clearance from the
Food and Drug Administration (the "FDA") to market its initial product, the
Simon Nitinol Filter, in the United States. The Company entered into an
exclusive distribution agreement with Bard for distribution of the SNF in the
United States and certain other countries in May 1992. The Company's primary
stent patent was issued in November 1994 and, during the same month, the Company
entered into an exclusive license agreement with Boston Scientific to further
develop, manufacture, market and distribute NMT's stents
<PAGE>
 
worldwide. In November 1995, the Company expanded its relationship with Bard by
granting Bard International the right to distribute the SNF in most markets
outside the United States. In February 1996, the Company acquired the rights to
its CardioSEAL Septal Occluder to expand its product base and complement its
core technologies. In furtherance of the Company's strategy to develop and
commercialize a broad range of advanced medical technologies for minimally
invasive applications, in May 1997, the Company acquired a 23% ownership
interest in Image Technologies Corporation ("ITC"), a privately held company
that is developing a line of advanced imaging products for minimally invasive
surgery.

CORE TECHNOLOGIES

NMT has developed an expertise in precisely engineering nitinol and other
advanced materials, such as MP35N, for a variety of innovative medical device
applications.  The Company has developed capabilities in advanced device
fabrication, materials characterization, manufacturing and process control and
sophisticated in vitro testing resulting in highly efficient and reliable
manufacturing processes.

Nitinol, a nickel-titanium alloy, has unique superelastic and thermal shape-
memory characteristics.  The superelastic characteristics enable a nitinol-based
device to undergo severe deformation without permanent damage to either its
shape or strength.  The thermal shape-memory characteristics of nitinol enable a
device which has been radically deformed to return to its intended shape in
response to a small change in temperature. The mechanical properties that can be
engineered into nitinol-based devices permit innovative product designs that
presently would be difficult or impossible to replicate with other materials.
The Company utilizes the thermal shape-memory characteristic of nitinol for
medical device applications.  The Company has demonstrated its ability to
utilize this characteristic to provide for ease of access and delivery of
sophisticated medical devices that transform into their intended shape once
placed into the body. Nitinol is biocompatible and non-ferromagnetic, thereby
allowing the use of magnetic resonance imaging on patients with nitinol-based
device implants.

MP35N is an advanced metal alloy which is biocompatible and resistant to
corrosion and fatigue.  The Company has combined the use of MP35N with knitted
polyester in developing the CardioSEAL Septal Occluder.  Knitted polyester, a
biocompatible fabric that encourages tissue in-growth, has been extensively used
in the vasculature for many years.

                                       2
<PAGE>
 
PRODUCTS

Stents

Stents are small tubes that hold open arteries, veins and other passageways in
the body, such as the bile duct, that have closed or become obstructed as a
result of disease, trauma or aging.  Stents are placed in the body using
catheter-based delivery systems in minimally invasive procedures.  Once
deployed, they exert radial force against the walls of passageways to enable
such passageways to remain open and functional.  A number of different stent
designs, materials and delivery systems, with varying characteristics are
currently available.  The three most prevalent stent designs are slotted tubes
(a metal tube from which most of the material is removed, resulting in a
lattice-like structure), coiled stents (continuous coiled wire) and wire mesh
stents (knitted metal wire).  Most stents are currently manufactured using
stainless steel or similar alloys and are deployed through the expansion of a
balloon on a catheter-based delivery system.  After deployment, a second balloon
may be used to further expand the stent.  Certain stents, including the
Company's, are self-expanding, thereby eliminating the need for a balloon on the
delivery catheter.  The factors influencing the performance of a stent include
ease of deployment, radial strength, flexibility, stability and the ability to
achieve precise placement.

Stents have emerged as one of the fastest growing segments of the medical device
market and are used increasingly as adjuncts or alternatives to a variety of
medical procedures because it is believed that they are beneficial to overall
patient outcome and may, over time, reduce total treatment costs.

NMT's Hex-cell Stents.  The Company has developed and patented a nitinol stent
which relies on a novel hexagonal cell (hex-cell) design.  NMT's stents can be
customized into a variety of sizes, shapes, flexibilities and radial force
characteristics for use in treating specific indications.  The Company utilizes
the thermal shape-memory characteristic of nitinol to provide for ease of access
and delivery of its stents which transform into their intended shape once placed
into the body.

Market Opportunity.  From its infancy in 1990, the stent market has grown to
estimated worldwide sales in excess of $1 billion in 1997, with continued growth
expected.  To date, most stents have been used for the treatment of
atherosclerotic plaque in the coronary arteries.  The Company believes that the
increase in stent usage for other procedures and indications has been limited,
in part, by the characteristics of stents currently available. NMT believes that
its stents may offer certain advantages over currently available stents and, in
connection with its collaboration with Boston Scientific, is actively pursuing
the development of its stents in each of the market segments described below.

                                       3
<PAGE>
 
Peripheral Vascular.  Existing stents for vascular disease include both balloon-
-------------------                                                            
expandable and self-expanding stents.  While stent use is well established in
the larger vessels such as the iliac arteries, currently available stents have
limitations in their use in the smaller, more exposed vessels of the leg due to
difficulty of placement, insufficient radial strength and flexibility and a
higher risk of clot formation.

The Company believes that its stents may offer advantages over currently
available stents in flexibility, radial strength and placement.  NMT's stents
have precisely engineered radial strength, cannot be permanently deformed after
deployment, and can be delivered using a small diameter catheter.  Boston
Scientific has commercially launched the Company's stents for peripheral
vascular use in Europe and is currently conducting multi-center clinical trials
for this indication in the United States.

Carotid Arteries.  While some stenting of the carotid arteries (located near the
----------------                                                                
surface of the neck) is being done experimentally, the Company believes that the
characteristics of current stents limit their utility in the carotid arteries.
Balloon expandable stents require occluding blood flow to the brain during
deployment.  In addition, balloon expandable stents can be permanently deformed
by compression or trauma to the stented vessel.

The Company believes its stents will not require occluding blood flow to the
brain during deployment and, unlike currently available balloon expandable
stents, cannot be permanently deformed after deployment, thereby preventing
accidental closure of the vessel.  In addition, the Company believes that its
stents can be engineered to exert precise radial force to prevent movement, are
designed to conform well to the vessel shape, have minimal length change during
deployment for highly accurate placement, and can be delivered by a small
diameter catheter.

Biliary.  Existing stents for tumor ingrowth of the bile duct primarily include
-------                                                                        
plastic and self-expanding wire mesh stents.  Plastic stents can become blocked
rather quickly because of their narrow diameter, and the wire mesh stents, due
to their mesh design, may not resist further tumor growth.

The Company believes that its stents may have advantages for this indication.
NMT's stents have a large expansion ratio for delivery of a large diameter stent
on a small diameter catheter and exert sustained radial force which may resist
recoil from continued tumor growth.  Boston Scientific has commercially launched
the Company's stents for biliary use in Europe and in the United States.

Coronary Arteries.  Existing stents for coronary disease include balloon-
-----------------                                                       
expandable or self-expanding wire mesh stents.

                                       4
<PAGE>
 
The Company believes that its stents may have advantages over other stents for
use in coronary arteries.  NMT's stents are self-expanding to avoid balloon
occlusion of the vessel during placement, may not require post-deployment
ballooning, and exhibit minimal length change during deployment for highly
accurate placement.

Relationship with Boston Scientific.  In November 1994, NMT licensed to Boston
Scientific, a worldwide leader in sales of minimally invasive medical devices,
exclusive worldwide rights to develop, manufacture, market and distribute the
Company's stent technology. Boston Scientific is the leader in the peripheral
angioplasty market, a leader in the vascular graft market and a leader in the
coronary angioplasty market.  Under the terms of this agreement, Boston
Scientific funds, and has control over, product development, manufacturing
scale-up, clinical trials, marketing and distribution worldwide and has the sole
right to use the patents and technical information owned by NMT related to
stents. NMT receives a sales royalty, milestone payments, minimum license fees,
manufacturing cost reduction incentives and reimbursement of development costs.
Boston Scientific has assumed responsibility for conducting the necessary
preclinical and clinical studies, obtaining the regulatory approvals it deems
necessary, and manufacturing and marketing NMT's stents worldwide.

Boston Scientific is not prohibited from selling competing stents and has
established a broad-based stent program.  In addition to its collaboration with
the Company, Boston Scientific has obtained exclusive worldwide rights to
Medinol, Ltd.'s (NIR) balloon expandable stent technology and has developed its
own Strecker knitted stent technology and Radius/TM/ self-expanding stent
technology.  Boston Scientific launched Medinol's NIR/TM/ coronary stent in
Europe in March 1996.  In May 1996, Boston Scientific acquired Mintec, Inc., a
privately held company, which develops stent graft technology and has announced
its intention to launch a device for the repair of AAAs in the near future.

The Company believes that its relationship with Boston Scientific, a market
leader which has made a significant commitment to developing stent technology,
will facilitate the development and commercialization of the Company's stents.
The Company and Boston Scientific are currently pursuing projects to develop the
Company's stents for a variety of applications.  The markets ultimately targeted
for commercial sales will be determined by Boston Scientific pursuant to the
license agreement.

Current Status.  European clinical trials for the NMT stent in peripheral
vessels have been completed by Boston Scientific.  Boston Scientific began
marketing a line of the Company's peripheral vascular stents in Europe in
January 1997 and in the United States in June 1997 for biliary use under the
name Symphony and has begun clinical trials for peripheral vascular applications
in the U.S.  In May 1997, the Symphony obtained a CE Mark, allowing for
marketing of the device throughout the European Union.  Boston Scientific has
also initiated European trials of the NMT stent for peripheral vascular stent
grafts.  Such trials are intended to demonstrate that a stent graft may provide
for a new minimally invasive alternative to bypass surgery using multiple NMT
stents joined with graft material and inserted in the vessel percutaneously.

                                       5
<PAGE>
 
Boston Scientific has completed a scale-up of its peripheral vascular stent
manufacturing capabilities in the United States to enable it to manufacture
NMT's stents in quantities to support initial commercialization in certain
markets.  The Company and Boston Scientific continue to work collaboratively
towards the development of NMT's stents for additional indications and to
achieve manufacturing efficiencies.

Competition.  Competition in the stent market is intense and is expected to
increase. Most of the stents sold today are balloon expandable and have been
designed primarily for coronary applications.  However, the companies listed
below, as well as other companies, may be developing additional stents.  Some of
the stents being developed may be more similar to the Company's stents than
those in the market today, although the Company does not know of any competitor
that is developing a stent substantially similar to its product.

Johnson & Johnson Interventional Systems Co., Medtronic, Inc., Cook Inc.,
Guidant Corporation/ACS, Boston Scientific/Medinol, and Arterial Vascular
Engineering, Inc., among others, currently sell stainless steel, balloon
expandable stents in the United States or internationally.

The following table lists the Company's major competitors who are currently
selling or, to the Company's knowledge, developing self-expanding stents in the
United States or internationally.

<TABLE>
<CAPTION>
    COMPANY                              MATERIAL         DESIGN    
    --------------------------------  ---------------  ------------ 
    <S>                               <C>              <C>          
    Pfizer, Inc./Schneider            Stainless steel   Wire mesh   
    Medtronic, Inc.                   Nitinol           Coil        
    Boston Scientific (Strecker)      Tantalum          Wire mesh   
    Boston Scientific (Radius/TM/)    Nitinol           Slotted tube
    Bard/Angiomed                     Nitinol           Slotted tube 
</TABLE>

Vena Cava Filters

Vena cava filters are used for the prevention of pulmonary embolism (a blood
clot lodged in the vessels supplying blood to the lungs).  These emboli (clots),
which often develop initially in the veins of the legs, can break loose and
travel up the vena cava, through the heart and into the blood vessels of the
lungs, causing acute respiratory and circulation problems.  Vena cava filters
are intended to trap these clots before they can reach the lungs.  Patients at
high risk for pulmonary embolism include post-operative orthopedic and
neurosurgery patients, cancer patients undergoing surgery and chemotherapy and
severe trauma victims.  There are 600,000 incidents of pulmonary embolism
diagnosed in the United States each year with 125,000 to 150,000 deaths per
year.  While usually treated initially with anticoagulant drugs, vena cava
filters may be used in cases where drug therapy has failed or is
contraindicated.  Factors influencing 

                                       6
<PAGE>
 
the performance of vena cava filters include coverage of the vena cava and the
pattern of the filtering method. Additionally, the variety of entry site options
and the size of the delivery system affect ease of deployment.

Simon Nitinol Filter.  The Company has developed a nitinol vena cava filter
which possesses highly efficient clot filtering characteristics.  The Company
has engineered both the superelastic and thermal shape-memory characteristics of
nitinol to provide for ease of delivery of a vena cava filter which can be
easily implanted in the patient by a minimally invasive procedure using the
Company's patented catheter-based delivery systems.  The Company's vena cava
filter transforms into its intended shape once deployed into the body.  The SNF
can be implanted from the veins in the leg or neck, and is the only currently
available vena cava filter which can also be implanted from the veins in the
arm.

Market Opportunity.  The worldwide sales for vena cava filters were estimated to
be $65-$70 million in 1996.  The United States represents 75% of current
worldwide sales. NMT's vena cava filters currently rank second in worldwide
sales.

Current Status.  The Company received FDA 510(k) clearance to market the SNF,
and commenced sales, in April 1990.  All 510(k) notifications with respect to
subsequent modifications to the SNF have also been accepted by the FDA.  In
November 1995, the Company introduced a simplified, straight line catheter-based
delivery system for its SNF.  In November 1996, the Company received 510(k)
clearance for the implementation of the SNF through the subclavian vein in the
shoulder.

New Product Development.  The Company is currently developing a removable vena
cava filter as discussed below.

Removable Vena Cava Filter.  Currently available vena cava filters are permanent
--------------------------                                                      
implants which can only be removed surgically.  Therefore, patients who are at
risk for pulmonary embolism for a defined period of time (post-operative
recovery, recovery from trauma, etc.) and receive a vena cava filter have the
implant in place for life.  There is often a psychological resistance to
implantation of a permanent device.  As a result, a vena cava filter is often
not used until a patient at risk has experienced his or her first pulmonary
embolism.  However, recent controlled studies conducted by others of the
prophylactic use of currently available permanent vena cava filters in severe
trauma patients have demonstrated a significant reduction in morbidity and
mortality in this category of high-risk patients for pulmonary embolism.  The
Company believes that the availability of a removable vena cava filter may
result in greater prophylactic use, and may be used in lieu of a permanently
implanted device in certain circumstances.

The Company is conducting early design and feasibility work on a removable vena
cava filter which can be placed into the body and later removed.  Vena cava
filters which remained implanted for six weeks were successfully removed from
sheep in studies 

                                       7
<PAGE>
 
conducted by the Company in April 1996. Following additional laboratory and
animal testing, the Company anticipates filing an IDE for a removable vena cava
filter during 1998 to enable the Company to conduct human clinical trials in the
United States.

Relationship with Bard.  The Company entered into an exclusive distribution
agreement in May 1992 with Bard Radiology for distribution of the SNF in the
United States and certain other countries.  Sales and market penetration for the
SNF have increased significantly as a result of this agreement.  Beginning
November 30, 1995, Bard International was granted the exclusive right to
distribute the SNF in most markets outside the United States.  In addition, in
December 1997 the Company secured approval for CE Marking, which, beginning in
July 1998, will be required for all medical devices marketed in the European
Union.

Each of the distribution agreements is for a five year term.  Bard Radiology may
renew, at its option, its agreement thereafter for periods of five years.  The
Company's agreement with Bard International renews automatically for successive
one year periods unless terminated by either party.  Both distributors are
obligated to make annual minimum purchases and have agreed not to sell competing
vena cava filters during the term of the respective distribution agreements.
Bard Radiology has also agreed not to compete for an additional two years after
its distribution agreement with the Company has terminated.  In addition, the
Company has granted Bard Radiology a right of first offer for any of NMT's new
devices (including the removeable vena cava filter) which may be marketed to
interventional radiologists and for which NMT desires to enter into an exclusive
distributorship within the United States.

Manufacturing.  The Company has contracted with Lake Region Manufacturing for
the production of the filter component of the SNF.  The Company's agreement with
Lake Region grants Lake Region the right to manufacture a certain percentage of
the Company's worldwide requirements of the current filter until June 30, 2001.
The Company is obligated to order a minimum quantity of the current filters and
pay Lake Region a fixed price per unit.  Lake Region has agreed not to
manufacture filters for a third party for a period of two years after the
termination of the agreement.  Final assembly of the vena cava filter system is
conducted by the Company.

Competition.  Boston Scientific, among others, currently competes with the
Company in sales of vena cava filters.  Boston Scientific introduced the
Greenfield Filter to the market in the mid-1970's and is still the predominant
leader with more than half of current unit sales of vena cava filters in the
United States.  Since the introduction of the Simon Nitinol Filter in 1990, NMT
has achieved the second highest level of sales in the United States due
primarily to its distribution agreement with Bard Radiology and the introduction
of a new simplified delivery system.  Other competitors in this market include
Cook, Inc. and B. Braun.

                                       8
<PAGE>
 
Septal Repair Devices

In February 1996, to expand its product base and complement its core
technologies, the Company acquired the exclusive rights to its CardioSEAL Septal
Occluder, which is designed for the repair of intracardiac shunts commonly known
as "holes in the heart." Intracardiac shunts are common medical problems,
occurring primarily in children, that result in abnormal blood flow through the
chambers of the heart.  The most common defects occur in either the atrial
("ASD") or ventricular ("VSD") septum which divide the left and right pumping
chambers of the heart.  Patients with these defects may suffer from poorly
oxygenated blood and require increased cardiac effort to adequately supply blood
to the body.  This may lead to congestive heart failure and pulmonary
hypertension, resulting in severe incapacity or even death.  The current
treatment is open-heart surgery.  Open-heart surgery involves opening a
patient's chest, cutting through the sternum, connecting the patient to a
heart/lung machine and opening the heart to surgically repair the hole.  Such a
procedure is costly and generally requires up to a week of hospitalization and
an extensive recovery period.  The CardioSEAL Septal Occluder is designed to be
a minimally invasive, less costly alternative to open heart surgery.

Another common septal defect is the Patent Foramen Ovale ("PFO"), a transient
hole which may open under straining efforts (coughing, defecating, etc.).  PFO
has been implicated as a possible cause of embolic strokes, in which small blood
clots escape through the PFO and travel to the brain.  Current treatment for
patients who have experienced embolic strokes is lifelong anticoagulation
therapy, which may result in significant side effects and/or patient
noncompliance with the treatment regimen. Recently, some institutions have begun
advocating open heart surgery to close PFOs to prevent additional strokes.  The
Company believes that its septal repair device using a minimally-invasive
delivery system may address the needs of the PFO market.

CardioSEAL Septal Occluder.  The CardioSEAL Septal Occluder is a catheter-
delivered cardiac implant designed to close septal defects.  The device consists
of eight wire spring arms covered with two pieces of knitted polyester fabric
which form two opposed disk-like occluders each having an umbrella shape.  The
framework is made of MP35N, a material chosen because of its superior
characteristics as an implant material (biocompatibility and corrosion and
fatigue resistance).  Knitted polyester was chosen because of its extensive use
in the cardiovascular system and its ability to promote normal tissue in-growth.
At the center of the occluders is an inter-connection point which allows the
product to be placed within the septal defect so that one umbrella is opened on
each side of the defect.  The product is designed to be manufactured in five
diameter sizes ranging from 17mm to 40mm.

The CardioSEAL Septal Occluder is delivered to the site of the defect through a
puncture of the femoral vein in the leg.  The device is loaded into a delivery
catheter and moved toward the defect site.  At the defect site, the CardioSEAL
Septal Occluder is deployed 

                                       9
<PAGE>
 
through the defect and the first umbrella is opened. The delivery system is then
retracted through the hole so that the first umbrella comes into contact with
the septal wall. The delivery system is then retracted further allowing the
second umbrella to open and seal the defect from both sides. Once the position
of the CardioSEAL Septal Occluder is confirmed, the physician detaches the
delivery system and removes it from the patient. To date, the CardioSEAL implant
procedures have taken approximately one hour to complete, with patients
returning home to normal activity just one to two days later.

An earlier version of the septal repair device, named the Clamshell, was
developed by Bard in collaboration with Children's Hospital of Boston.  Between
1989 and 1991 Bard sponsored clinical trials of the Clamshell in over 700
patients with a variety of cardiac conditions.  In 1991, Bard discovered
fractures of the stainless steel framework in certain of the devices implanted
during such clinical trials and, following such discovery, suspended its
clinical trials.  However, Bard subsequently submitted, and the FDA approved, a
revised IDE to permit the continued use of the Clamshell for patients with
limited therapeutic alternatives and at high risk for surgical repair of their
condition. The Company is not aware of any significant adverse clinical
consequences resulting from the observed fractures.  Extensive engineering
redesign and testing, including the use of MP35N for the framework, resulted in
significant improvements in both the fatigue and corrosion resistance of the
device.  In 1995, Bard donated the technology and associated assets to
Children's Hospital of Boston which subsequently licensed the technology to
InnerVentions.  The Company acquired the rights to develop and commercialize the
current septal repair device in February 1996.   In connection with the
acquisition, the Company acquired all of the existing development, manufacturing
and testing equipment, patent licenses, know-how and documentation necessary to
manufacture septal repair devices which had been originally developed by Bard.

Market Opportunity.  The Company believes the CardioSEAL Septal Occluder may be
suitable for approximately 55,000 patient implants annually for congenital heart
defects and approximately 145,000 adult patients annually with PFOs.  Such
estimates are based on industry reports of the total numbers of patients
diagnosed with such conditions and the Company's own analysis of the portions of
such populations for whom its device may be suitable.

Current Status.  The CardioSEAL is sold commercially in Europe and other
international markets.  In the U.S., Children's Hospital of Boston is currently
conducting clinical trials of the redesigned Clamshell device manufactured by
Bard prior to the acquisition by the Company under an IDE granted by the FDA in
the second quarter of 1996 to allow for use of the devices in patients with a
variety of cardiac conditions and at high risk for surgery.  The devices being
tested by Children's Hospital of Boston were not included in the assets acquired
by the Company.  NMT began supplying Children's Hospital of Boston with
CardioSEAL Septal Occluders in December 1996.  The CardioSEAL Septal 

                                       10
<PAGE>
 
Occluder is manufactured by the Company based on the same design specifications
as the redesigned Clamshell devices being tested by Children's Hospital of
Boston.

In the United States, the FDA classifies the septal repair device as a Class III
medical device, which requires receipt of pre-market approval prior to
marketing.  In August 1996, NMT received approval of its IDE from the FDA to
conduct a multi-center pivotal clinical trial of the CardioSEAL in the United
States for ASDs, and implants of the device have been underway since October
1996.  Participants include Children's Hospital in Boston, Yale New Haven
Children's Hospital, Miami Children's Hospital, Texas Children's Hospital in
Houston, Cleveland Clinic, Children's Hospital of Philadelphia, the Medical
Center at the University of California San Francisco, Primary Children's Medical
Center/University of Utah in Salt Lake City, Presbyterian Hospital in
Albuquerque, Denver Children's Hospital, Children's Heart Clinic in Minneapolis,
University of Oregon Health Sciences Center in Portland, Loyola University
Medical Center in Maywood, Illinois, University of California-San Diego, and
Good Samaritan Hospital in Loma Linda, California.  Additionally, one Canadian
center is currently implanting the CardioSEAL under a clinical investigational
protocol. The Company filed an IDE with the FDA in February 1998 to pursue
clinical studies for the PFO indication in the United States, and expects to
begin PFO trials in Canada in 1998.

New Product Development.  The Company is currently evaluating design
enhancements to the CardioSEAL Septal Occluder as well as alternative designs
for the device.

Marketing and Sales Strategy.  The Company has developed its own sales force,
and is marketing the CardioSEAL Septal Occluder directly in Europe and to
selected distributors worldwide.  There are approximately 150 to 200 pediatric
interventional cardiologists in the United States who could potentially implant
the device.  These specialists practice at an estimated 75 to 100 institutions
that provide advanced cardiac care to children.  It is estimated that a similar
number of centers would be targeted internationally.  Therefore, the Company
believes that the size and scope of the target audience is manageable with a
small, specialized sales and marketing team.  The Company's marketing strategy
requires a specific physician training program prior to selling products into
any center.

Manufacturing.  The Company currently leases an approximately 27,000 square foot
manufacturing, laboratory and administrative facility in Boston, Massachusetts
where it manufactures its CardioSEAL Septal Occluder.  The facility includes a
Class 10,000 clean room.  The Company has received ISO 9000 certification, which
is based on adherence to established standards in the areas of quality assurance
and manufacturing process control, and has also received permission to affix the
prescribed "CE" mark to its products.  The European Union has promulgated rules
which provide that, beginning in July 1998, medical products may not be marketed
and sold commercially in the countries of the European Economic Area unless they
receive a CE mark.

                                       11
<PAGE>
 
Competition.  The Company believes that four companies, AGA Medical, Microvena
Corporation, Dr. Osypka GmbH, and Pediatric Cardiology Custom Medical Devices
have developed competitive devices which are being sold in Europe and other
international markets, and that AGA and Microvena are also conducting clinical
trials in the United States.


Imaging Products

In May 1997, the Company acquired a 23 percent ownership interest in Image
Technologies Corporation. ITC, a privately held company, is developing a line of
advanced imaging products for minimally invasive surgery which require less
equipment, are easier to use, reduce procedure time and personnel requirements,
improve operating room efficiency and reduce overall treatment costs. In
addition, the Company extended to ITC a $2.0 million senior credit line, which
is convertible into preferred stock of ITC representing up to an additional 20
percent ownership interest in ITC. The Company was also granted an option, which
is exercisable at any time until May 30, 1999, to purchase the remaining 57
percent of ITC for $24.5 million. The option may be extended for an additional
six months under certain conditions.

Thomas M. Tully, President and Chief Executive Officer of the Company, is the
Chairman and Chief Executive Officer of ITC and Theodore I. Pincus, Executive
Vice President of the Company, is its Chief Financial Officer.  ITC is located
in leased space immediately adjacent to the Company's facilities.

The principal products under development by ITC are:

     (i)   TroView/TM/, a compact, computerized image viewing system allowing
     for easy, surgeon controlled enhancement of endoscopic images, including
     the recording and remote transmission of both still and full motion video.

     (ii)  TroCam/TM/, an advanced endoscopic camera system for use with the
     TroView. The TroCam, unlike currently available systems, places the camera
     and lighting directly into the surgical field, allowing the surgeon to
     personally control the field of view by pivoting the camera and zooming in
     or out on the surgical field using a simple fingertip remote control
     device. The camera system is protected during surgery by a sterile,
     optically clear, disposable molded plastic cover that eliminates the need
     to re-sterilize the camera after each use.

     (iii) EndoCam/TM/, an endocoupler/camera system that allows rigid or
     flexible endoscopes from other manufacturers to be used in conjunction with
     the TroView.  The coupler is a sterile, single use device eliminating the
     need to re-sterilize the camera after each use.

                                       12
<PAGE>
 
     (iv) Operative TroCam/TM/, an endoscopic surgical system for use with the
     TroView that allows the camera system and surgical instruments to be
     inserted into the body through a single puncture site.

     (v)  GynaCam/TM/, a disposable device for use of the camera and TroView
     system for examination of the cervix.

The Company's investment will allow it to work with ITC to further develop ITC's
line of innovative products, and, if development is successful, to build a new
minimally invasive device franchise for the Company.

PATENTS AND PROPRIETARY TECHNOLOGY

The Company seeks to protect its technology through the use of patents and trade
secrets.  The Company is the owner or licensee of nine issued United States
patents, and corresponding foreign patents, relating to its stents, the SNF, the
septal repair device and nitinol radiopaque markers.  In addition, the Company
has pending applications for additional patents in the United States and abroad.
The Company's owned United States and foreign patents and patent applications
cover its stents, methods of manufacturing its stents, methods and devices for
inserting its stents, its SNF and devices for inserting its SNF.  The expiration
dates of the Company's patents relating to its stents range from 2012 to 2013.
The patent for its vena cava filters expires in 2001 and the patent for its
radiopaque markers expires in 2014.  In addition, the Company is the exclusive
licensee under certain patents relating to the CardioSEAL Septal Occluder and
methods for repairing cardiac and vascular defects.  The Company also holds
licenses to certain technology used in the SNF and in nitinol septal repair
devices.

The Company also relies on trade secrets and technical know-how in the
development and manufacture of its devices, which it seeks to protect, in part,
through confidentiality agreements with its employees, consultants and other
parties.  The Company has seven trademarks, two of which are registered in the
United States Patent and Trademark Office.

LICENSED TECHNOLOGY; ROYALTY OBLIGATIONS

In connection with its septal repair device, the Company has obtained an
exclusive worldwide license from Children's Medical Center Corporation under
United States patents entitled "Occluder and Method for Repair of Cardiac and
Vascular Defects" and "Occluder for Repair of Cardiac and Vascular Defects" and
the respective corresponding foreign patents, patent applications and associated
know-how.  The license agreement provides for royalty payments of five percent
based on net sales of the Company's CardioSEAL Septal Occluder until the end of
the term of the patents or termination of the agreement.  The patents expire in
September 2012 and June 2012, respectively. Pursuant to the license agreement,
the Company is required to achieve certain milestones 

                                       13
<PAGE>
 
in exploiting the patent rights. The Company has achieved all required
milestones to date. If the Company fails to achieve the milestones, Children's
Medical Center Corporation may terminate the license agreement. The Company also
has a royalty-free, worldwide sublicense under the United States patent entitled
"System for the Percutaneous Transluminal Front-End Loading Delivery and
Retrieval of a Prosthetic Occluder" and its corresponding foreign patents and
associated know-how. The sublicense is exclusive in the field of the repair of
atrial septal defects and nonexclusive in certain other fields. The Company has
also obtained an exclusive worldwide license from Lloyd A. Marks, M.D. under the
United States patent entitled "Aperture Occlusion Device." The license agreement
with Dr. Marks provides for royalty payments based on net sales of nitinol
septal repair devices which are covered by the patent until the end of term of
the patent in 2011. Certain minimum royalty payments must be paid regardless of
net sales.

In connection with the Simon Nitinol Filter, the Company entered into a
Technology Purchase Agreement dated April 14, 1987 with Morris Simon, M.D., the
Company's Scientific Director and co-founder and a current Director of the
Company.  Pursuant to the agreement, Dr. Simon assigned all the technology
relating to the SNF to the Company in exchange for certain royalty payments
based on net sales of technology invented by Dr. Simon relating to the SNF, to
continue perpetually unless the agreement is sooner terminated.  Dr. Simon
agreed not to compete with the Company in the vena cava filter market during the
term of the agreement.  In connection with the agreement, Beth Israel Hospital
Association granted the Company an exclusive worldwide license under U.S. patent
entitled "Blood Clot Filter."  In consideration for the license, Dr. Simon
assigned a percentage of his royalty payments from the Company to Beth Israel
Hospital Association.

Pursuant to their respective employment agreements, the Company has agreed to
pay royalties of one to five percent to Messrs. Kleshinski and Harry based on
sales or licenses of products where either Mr. Kleshinski or Dr. Harry, as the
case may be, was the sole or joint inventor.

AGREEMENTS WITH BOSTON SCIENTIFIC AND BARD

Boston Scientific

In November 1994, NMT entered into an agreement with Boston Scientific,
pertaining to its stent technology.  Under the terms of the agreement, NMT
granted to Boston Scientific exclusive worldwide rights to develop, manufacture,
market and distribute products incorporating NMT's stent technology.  Boston
Scientific has the right to market and advertise products based on the Company's
stent technology exclusively under its own name and the Company has no right to
any trademarks or tradenames developed by Boston Scientific.  Boston Scientific
has exclusive control over, and is responsible for, funding product development,
manufacturing scale-up, clinical trials, marketing and 

                                       14
<PAGE>
 
distribution worldwide. Boston Scientific is not prohibited from developing or
selling competing stents.

Boston Scientific is obligated to pay NMT a percentage of revenue from the sale
of products using NMT's stent technology.  If the fees payable are less than
certain minimum levels, Boston Scientific must pay the difference or NMT can
elect to make the license non-exclusive.  Boston Scientific is also obligated to
make payments upon the occurrence of certain developmental events and the
achievement of certain manufacturing cost reductions, and to reimburse certain
development costs.  The term of the agreement is for the longer of 20 years from
market launch or the date on which the last NMT patent relating to stents
expires.  Boston Scientific also has the perpetual non-exclusive and royalty-
free right to manufacture, use and sell all products as to which it has
previously paid licensing fees and on products for which all applicable patents
have expired or have been held invalid.  Such additional rights granted to
Boston Scientific survive termination of the agreement.

Bard

The Company has entered into strategic distribution agreements with Bard
Radiology (as amended, the "Bard Radiology Agreement") and Bard International
(the "Bard International Agreement") to distribute the SNF in the United States
and certain other countries.

The Bard Radiology Agreement, signed in May 1992 and amended in February 1993
and October 1995, grants Bard Radiology the exclusive right to distribute the
Simon Nitinol Filter, and any changes, improvements or modifications thereto, in
the United States and certain other countries for a five year term renewable by
Bard Radiology for additional five year terms thereafter.  The Company also
granted Bard Radiology a right of first offer to obtain exclusive distribution
rights in the United States for any new devices developed by the Company that
may be marketed to interventional radiologists and for which NMT desires to
enter into an exclusive distributorship within the United States. The Company
sells the SNF to Bard Radiology at determined prices and Bard Radiology is
required to purchase certain minimums to maintain its exclusivity.  Bard
Radiology has further agreed not to compete with the Company in the vena cava
filter market during the term of the agreement and for two years after
termination.  The Company has agreed not to make or sell any competing device as
long as Bard maintains its exclusivity under the agreement.

The Bard International Agreement, signed in November 1995, grants Bard
International the exclusive right to distribute the Simon Nitinol Filter, and
any changes, improvements or modifications thereto, worldwide (excluding the
United States and certain other countries) for a five year term which is
automatically renewed for successive one year periods unless terminated by
either party.  The Company sells the SNF to Bard International at determined
prices and Bard International is required to make certain 

                                       15
<PAGE>
 
minimum purchases which, if not met, could result in termination of the
agreement by the Company. Bard International has further agreed not to compete
with the Company in the vena cava filter market during the term of the Bard
International Agreement.

GOVERNMENT REGULATION

The manufacture and sale of medical devices intended for commercial distribution
are subject to extensive governmental regulations in the United States.  Medical
devices are regulated in the United States by the FDA under the Federal Food,
Drug and Cosmetic Act (the "FDC Act") and generally require pre-market clearance
or pre-market approval prior to commercial distribution.  In addition, certain
material changes or modifications to medical devices also are subject to FDA
review and clearance or approval.  Pursuant to the FDC Act, the FDA regulates
the research, testing, manufacture, safety, labeling, storage, record keeping,
advertising, distribution and production of medical devices in the United
States.  Noncompliance with applicable requirements can result in failure of the
government to grant pre-market clearance or approval for devices, withdrawal of
approvals, total or partial suspension of production, fines, injunctions, civil
penalties, recall or seizure of products, and criminal prosecution.  The FDA
also has the authority to request repair, replacement or refund of the cost of
any device manufactured or distributed by the Company.

Medical devices are classified into one of three classes, Class I, II or III, on
the basis of the controls deemed by the FDA to be necessary to reasonably ensure
their safety and effectiveness.  Generally, Class III devices are those that
must receive pre-market approval by the FDA to ensure their safety and
effectiveness (e.g., life-sustaining, life-supporting and implantable devices,
or new devices which have not been found to be substantially equivalent to
legally marketed devices), and require clinical testing to ensure safety and
effectiveness and FDA approval prior to marketing and distribution. The FDA also
has the authority to require clinical testing of Class I and Class II devices. A
PMA application must be filed if a proposed device is not substantially
equivalent to a legally marketed predicate device or if it is a Class III device
for which the FDA has called for such applications.

If human clinical trials of a device are required and if the device presents a
"significant risk," the manufacturer or distributor of the device is required to
file an IDE application with the FDA prior to commencing human clinical trials.
The IDE application must be supported by data, typically the results of animal
and, possibly, mechanical testing.  If the IDE application is approved by the
FDA, human clinical trials may begin at a specific number of investigational
sites with a maximum number of patients, as approved by the agency.  Sponsors of
clinical trials are permitted to sell those devices distributed in the course of
the study provided such costs do not exceed recovery of the costs of
manufacture, research, development and handling.  The clinical trials must be
conducted under the auspices of an independent institutional review board
("IRB") established pursuant to FDA regulations.  If one or more IRBs determine
that a clinical trial involves 

                                       16
<PAGE>
 
a "nonsignificant risk" device, the sponsor of the study is not required to
obtain FDA approval of an IDE application before beginning the study. However,
prior IRB approval of the study is required and the study must be conducted in
compliance with the applicable FDA regulations, including, but not limited to,
FDA regulations regarding the protection of human subjects.

Generally, before a new device can be introduced into the market in the United
States, the manufacturer or distributor must obtain FDA clearance of a pre-
market notification ("510(k) notification") submission or approval of a PMA
application.  If a medical device manufacturer or distributor can establish that
a device is "substantially equivalent" to a legally marketed Class I or Class II
device, or to a Class III device for which the FDA has not called for PMAs, the
manufacturer or distributor may seek clearance from the FDA to market the device
by filing a 510(k) notification.  The 510(k) notification may need to be
supported by appropriate data establishing the claim of substantial equivalence
to the satisfaction of the FDA.  The FDA's recently enacted Modernization Act
proposes alternative approaches to facilitate the process.

If a manufacturer or distributor of medical devices cannot establish that a
proposed device is substantially equivalent to a legally marketed device, the
manufacturer or distributor must seek pre-market approval of the proposed device
through submission of a PMA application.  A PMA application must be supported by
extensive data, including preclinical and clinical trial data, as well as
extensive literature to prove the safety and effectiveness of the device.  The
Modernization Act allows the filing of a PMA to be modular, permitting the FDA
to initiate review of the submission prior to completion of all sections.  Under
the FDC Act, the FDA has 180 days to review a filed PMA application.

Certain Class III devices that were on the market before May 28, 1976
("preamendments Class III devices"), and devices that are determined to be
substantially equivalent to them, can be brought to market through the 510(k)
process until the FDA, by regulation, calls for PMA applications for the
devices.  Generally, the FDA will not grant 510(k) clearance for such devices
unless the facilities at which they are manufactured successfully undergo an FDA
pre-approval GMP inspection.  In addition, the FDC Act requires the FDA either
to down-classify preamendments Class III devices to Class I or Class II, or to
publish a classification regulation retaining the devices in Class III.
Manufacturers of preamendments Class III devices that the FDA retains in Class
III must have PMA applications accepted by the FDA for filing within 90 days
after the publication of a final regulation in which the FDA calls for PMAs.  If
the FDA calls for a PMA for a preamendments Class III device, a PMA must be
submitted for the device even if the device has already received 510(k) pre-
market clearance; however, if the FDA down-classifies a preamendments Class III
device to Class I or Class II, a PMA application is not required.  The FDA's
reclassification determinations are to be based on safety and effectiveness
information that manufacturers of certain preamendments 

                                       17
<PAGE>
 
Class III devices are required to submit to the FDA as set forth in two FDA
orders published in August 1995.

The Company's first product, the SNF, underwent significant clinical
investigation under an IDE and received 510(k) clearance in 1990.  Subsequent
improvements and modifications to the SNF have also received 510(k) clearance
from the FDA.  The 510(k) clearances for the SNF were based on substantial
equivalence of the device to other cardiovascular intravascular filters, which
are preamendments Class III devices.  On July 22, 1996, the Company submitted
safety and effectiveness data to the FDA in accordance with one of the August
1995 FDA orders addressing the classification of preamendments Class III
devices.  The FDA will use this data, along with data furnished by manufacturers
of similar devices, in determining the final classification of the SNF.

Boston Scientific is responsible for applying for registrations and regulatory
approvals it deems necessary for NMT's stents.  It is believed that each of the
vascular indications for the stent (coronary arteries, carotid arteries,
peripheral vascular, AAA and peripheral vascular stent grafts) will require
separate PMA applications prior to commercialization in the United States.
Boston Scientific has completed clinical trials in Europe of NMT's stents for
peripheral vascular applications and has initiated clinical trials for
peripheral vascular stent graft applications.

The CardioSEAL will also be subject to the PMA process in the United States.
NMT submitted an application for an IDE to the FDA in May 1996 which was
subsequently approved and the Company began a multi-center, pivotal clinical
trial in the United States for ASDs in October 1996.  The Company submitted a
second IDE in February 1998 to study the CardioSEAL for PFO indications.

The Company is currently manufacturing the CardioSEAL.  The Company's
manufacturing facilities are required to be registered with the FDA and are
subject to the GMP regulations.  FDA approval will be required before the
Company may begin commercial distribution in the United States of medical
devices from its own manufacturing facilities.

The advertising of most FDA-regulated products is subject to both FDA and
Federal Trade Commission jurisdiction.  The Company also is subject to
regulation by the Occupational Safety and Health Administration and by other
governmental entities.

Sales of medical device products outside the United States are subject to
foreign regulatory requirements that vary widely from country to country.  The
time required to obtain approvals required by foreign countries may be longer or
shorter than that required for FDA approval, and requirements for licensing may
differ from FDA requirements.

                                       18
<PAGE>
 
The current regulatory environment in Europe for medical devices differs
significantly from that in the United States.  There is currently no universally
accepted definition of a medical device in Europe and there is no common
approach to medical device regulation among the various countries.  There are
several different regulatory regimes operating within the different European
countries.  Regulatory requirements for medical devices range from no
regulations in some countries to rigorous regulations approaching the
requirements of the FDA's regulations for Class III medical devices.  Several
countries require that device safety be demonstrated prior to approval for
commercialization.  The regulatory environment in certain European countries is
expected to undergo major changes as a result of the creation of medical device
directives by the European Union. In particular, the European Union has
promulgated rules which provide that, beginning in  July 1998, medical products
may not be marketed and sold commercially in the countries in the European
Economic Area unless they receive a CE mark.  The Company's Symphony stent, SNF
and CardioSEAL have received approval for CE Marking.

                                       19
<PAGE>
 
THIRD PARTY REIMBURSEMENT

Health care providers in the United States, such as hospitals and physicians,
that purchase medical devices such as stents, generally rely on third party
payers, principally Medicare, Medicaid and private health insurance plans, to
reimburse all or part of the costs and fees associated with the Company's
devices.  Major third party payers reimburse inpatient medical treatment,
including all operating costs and all furnished items or services, including
devices such as the Company's, at a prospectively fixed rate based on the
diagnosis-related group ("DRG") that covers such treatment as established by the
federal Health Care Financing Administration.  For interventional procedures,
the fixed rate of reimbursement is based on the procedure or procedures
performed and is unrelated to the specific devices used in that procedure.  The
amount of profit relating to the procedure may be reduced by the use of the
Company's devices.  If a procedure is not covered by a DRG, certain third party
payers may deny reimbursement. Alternatively, a DRG may be assigned that does
not reflect the costs associated with the use of the Company's devices,
resulting in underreimbursement.  If, for any reason, the Company's products
were not to be reimbursed by third party payers, the Company's ability to sell
its products may be materially adversely affected.  Mounting concerns about
rising health care costs may cause more restrictive coverage and reimbursement
policies to be implemented in the future.  Several states and the federal
government are investigating a variety of alternatives to reform the health care
delivery system and further reduce and control health care spending.  These
reform efforts include proposals to limit spending on health care items and
services, limit coverage for new technology and limit or control directly the
price health care providers and drug and device manufacturers may charge for
their services and products.  The Company believes that domestic health care
providers currently are reimbursed for the cost of purchasing the Company's SNF.
In the international market, reimbursement by private third party medical
insurance providers, including governmental insurers and providers, varies from
country to country.  In certain countries, the Company's ability to achieve
significant market penetration may depend upon the availability of third party
governmental reimbursement.  The Company's independent distributors, and the
health care providers to whom such distributors sell, obtain any necessary
reimbursement approvals.

PRODUCT LIABILITY AND INSURANCE

The Company's business involves the risk of product liability claims.  The
Company has not experienced any product liability claims to date.  The Company
maintains product liability insurance with coverage limits of $10 million per
occurrence and an annual aggregate maximum of $10 million.

EMPLOYEES

As of December 31, 1997, NMT employed 49 full-time employees and 1 part-time
employee.  Further staff will be added as required by the demands of the
manufacturing 

                                       20
<PAGE>
 
scale-up for the septal repair device and other development programs. No
employees are covered by collective bargaining agreements, and the Company
believes it maintains good relations with its employees.


ITEM 2.   PROPERTIES

The Company currently leases an approximately 27,000 square foot manufacturing,
laboratory and administrative facility in Boston, Massachusetts.

The Company's principal executive offices are located at 27 Wormwood Street,
Boston, Massachusetts 02210, and its telephone number is (617) 737-0930.


ITEM 3.   LEGAL PROCEEDINGS

The Company has no material pending legal proceedings.


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

No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year 1997.


EXECUTIVE OFFICERS OF THE COMPANY
---------------------------------

     The executive officers of the Company and their ages as of March 6, 1998
are as follows:

<TABLE>
<CAPTION>
NAME                    AGE              POSITION
----------------------  ---  ---------------------------------
<S>                     <C>  <C>
Thomas M. Tully          52  President, Chief Executive
                             Officer and Director

David A. Chazanovitz     47  President, Septal Repair Division

Theodore I. Pincus       55  Executive Vice President and
                             Chief Financial Officer
</TABLE>

                                       21
<PAGE>
 
THOMAS M. TULLY has served as President, Chief Executive Officer and Director of
NMT since January 1996.  From June 1995 to January 1996 Mr. Tully served as a
consultant to the Company.  From May 1994 to April 1995, Mr. Tully served as
President of the Institute of Molecular Biology, a biotechnology company focused
on tissue repair and regeneration and from August 1991 to March 1994, Mr. Tully
served as President of Organogenesis, Inc., a biotechnology company focused on
the commercialization of medical device applications of tissue engineering.
Prior to that Mr. Tully served for three years as the President of the Schneider
division of Pfizer, Inc., which concentrates on interventional radiology and
cardiology, spent nine years in various executive positions in consumer products
and medical devices at Johnson & Johnson, Inc. and was founding President of
Johnson & Johnson Interventional Systems, an interventional medicine company.

DAVID A. CHAZANOVITZ has served as President of NMT's Septal Repair Division
since January 1996.  Prior to joining the Company, Mr. Chazanovitz served as
President and Chief Executive Officer of InnerVentions from April 1995 until
January 1996.  Mr. Chazanovitz was employed by Bard from 1979 to 1995 in various
positions including President of the USCI Angiography Division, Bard
Electrophysiology Division and Bard Ventures Division where he was a founder.
During his last two and one-half years at Bard Mr. Chazanovitz had overall
responsibility for the septal defect repair program.

THEODORE I. PINCUS has served as Chief Financial Officer of the Company, as a
part-time employee since June 1995 and became an Executive Vice President and a
full-time employee in May 1996.  From September 1993 to April 1996 he served as
Chief Financial Officer of Immunotherapy, Inc., a privately-held
biopharmaceutical company, and from May 1990 to May 1996 he was President of the
Pincus Group, a management consulting firm.  From August 1992 to March 1995 he
also served as the Chief Financial Officer of Biofield Corp., then a privately-
held medical device company.  Mr. Pincus is a Certified Public Accountant and
from 1985 to 1989 he was a partner at Ernst & Young, an accounting firm.

                                       22
<PAGE>
 
                                    PART II


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

(a)  Market Prices and Recent Sales of Unregistered Securities

The Company's Common Stock has been traded on the Nasdaq National Market under
the symbol NMTI since September 27, 1996. Prior to September 27, 1996, the
Company's Common Stock was not publicly traded. There were approximately 80
shareholders of record of the Company's Common Stock on March 3, 1998. The
following table lists the high and low bid prices for the third quarter (for the
period from September 27, 1996 through September 30, 1996) and fourth quarter of
1996 and for each quarter of 1997.

<TABLE>
<CAPTION>
 
Period             High    Low
----------------  ------  ------
<S>               <C>     <C>
 
1996
----------------
 
Third quarter     12 1/4  11
Fourth quarter    12 1/2  10
 
1997
----------------
 
First quarter     12 1/2   7 3/4
Second quarter    15 1/8   8
Third quarter     17 1/4  12 1/2
Fourth quarter    16 1/2   7 7/8
</TABLE>

During the fiscal year ended December 31, 1997, the Company granted options to 
purchase 17,500 shares of Common Stock  at a weighted average exercise price of 
$9.74 to employees and one director and 19,000 shares of Common Stock at a 
weighted average exercise price of  $13.78 per share to employees pursuant to 
the Company's 1996 Stock Option Plan.  None of such options has been exercised. 
The Company believes that the transactions described in this paragraph are 
exempt from the registration requirements of the Securities Act of 1933, as 
amended, by reason of Section 4(2) thereof.  No underwriters were engaged in 
connection with these grants.
                                       23
<PAGE>
 
(b)  Uses of Proceeds from Registered Securities

There has been no change to the information previously provided by the Company
on its Quarterly Report on Form 10-Q for the period ended September 30, 1997, as
amended, relating to securities sold by the Company pursuant to its Registration
Statement on Form S-1 (Registration No. 333-06463), which was declared effective
on September 27, 1996.


Dividend Policy

The Company did not declare or pay any cash dividends on shares of its Common
Stock during the fiscal years ended December 31, 1996 and December 31, 1997 and
does not anticipate declaring or paying cash dividends in the foreseeable
future.  The Company expects that any earnings which it may realize will be
retained for use in its business.

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data of the
Company.  The selected consolidated financial data are derived from the
Company's Consolidated Financial Statements, which have been audited by Arthur
Andersen LLP, independent public accountants.  The selected consolidated
financial data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations", the
Consolidated Financial Statements and the Notes thereto and the other financial
information appearing elsewhere in this Annual Report on Form 10-K.

                                       24
<PAGE>
 
<TABLE>
<CAPTION>
                                                                 Year Ended December 31,
                                                  1993      1994      1995      1996      1997
                                                --------  --------  --------  --------  --------
<S>                                             <C>       <C>       <C>       <C>       <C>
In thousands, except per share data
STATEMENT OF OPERATIONS DATA:
Revenues:
  Product sales                                 $ 2,003   $ 1,837   $ 2,716   $ 4,557   $ 8,565
  License fees                                       --       773       625     2,375     1,500
  Product development                                --        38       492        92        61
                                                -------   -------   -------   -------   -------
                                                  2,003     2,647     3,833     7,024    10,126
Expenses:
  Cost of product sales                             655       812     1,264     2,387     3,765
  Research and development                          272       555       871     2,662     2,974
  General and administrative                        468       770       871     2,284     2,888
  Selling and marketing                             285       182       169       311     1,010
  In-process research and development(1)             --        --        --     1,111     2,449
  Restructuring charge (2)                                                                  194
                                                -------   -------   -------   -------   -------
                                                  1,680     2,319     3,175     8,755    13,280
                                                -------   -------   -------   -------   -------

Income(loss) from operations                        323       328       658    (1,731)   (3,154)
Interest income (expense), net                      (62)      (39)      (29)      568     1,546
Income(loss) before provision for income        -------   -------   -------   -------   -------
  taxes                                             261       289       628    (1,163)   (1,608)
Provision for income taxes(3)                        --        --        44        --       230
                                                -------   -------   -------   -------   -------
Net income(loss)                                $   261   $   289   $   584   $(1,163)  $(1,837)
                                                =======   =======   =======   =======   =======
Cash dividends declared per common share (4)    $    --   $   .13   $   .03   $    --   $    --
                                                =======   =======   =======   =======   =======
Basic income (loss) per share                   $   .07   $   .08   $   .16   $  (.21)  $  (.19)
                                                =======   =======   =======   =======   =======
Weighted average common shares outstanding        3,588     3,622     3,764     6,749     9,596
                                                =======   =======   =======   =======   =======
Diluted income (loss) per share                 $   .07   $   .08   $   .15   $  (.21)  $  (.19) 
                                                =======   =======   =======   =======   =======
Weighted average common and common              
 equivalent shares outstanding (5)                3,676     3,854     3,983     6,749     9,596
                                                =======   =======   =======   =======   =======
</TABLE> 
 
<TABLE>
<CAPTION>
                                                                 At December 31,
                                                  1993      1994      1995      1996      1997
                                                --------  --------  --------  --------  --------
<S>                                             <C>       <C>       <C>       <C>       <C>
In thousands                         
BALANCE SHEET DATA:
 
Cash and cash equivalents                       $   644   $   715   $   533   $ 4,082   $ 5,561
Short-term investments                               --        --        --    25,274    20,822
Working capital (deficit)                           512        68    (1,277)   30,301    29,262
Total assets                                      1,152     1,253     1,661    34,930    35,006
Long-term obligations                             1,957     1,690        --       416       612
Stockholders' equity (deficit)                   (1,190)   (1,331)     (844)   33,320    32,772
</TABLE>
                                        

                                       25
<PAGE>
 
----------------------

(1)  Relates to a write-off of in-process research and development incurred in
     connection with the Company's acquisition of the septal repair device
     technology in 1996 and ITC in 1997. See Notes to the Consolidated Financial
     Statements.

(2)  Relates to reorganization of the Company's vena cava filter operations in
     the second quarter of 1997. See Notes to the Consolidated Financial
     Statements.

(3)  In the periods prior to October 19, 1995 the Company elected to be taxed as
     an "S" corporation for income tax purposes. Accordingly, there was no
     provision for income taxes in these periods. See Notes to the Consolidated
     Financial Statements.

(4)  Computed based on the actual number of common shares outstanding at the
     time the dividend was declared. In the periods prior to October 19, 1995,
     the Company elected to be taxed as an "S" corporation for income tax
     purposes.

(5)  Computed on the basis described in Notes to the Consolidated Financial
     Statements.



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

The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the Consolidated Financial
Statements and Notes thereto included elsewhere in this Annual Report on Form
10-K.  This Annual Report on Form 10-K includes forward looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," and similar expressions are intended to identify forward-looking
statements.  All such forward-looking statements involve known and unknown
risks, uncertainties or other factors which may cause actual results,
performance or achievements of the Company to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements.   There are a number of important factors that could
cause the Company's actual results to differ materially from those indicated by
such forward-looking statements.  These factors include, without limitation,
those set forth below under the caption "Certain Factors That May Affect Future
Results."

OVERVIEW

Since its inception in 1986, the Company has focused its efforts on the design,
development and commercialization of medical technologies which are delivered by
minimally invasive procedures.  The products developed or under development
include self-expanding stents, vena cava filters and septal repair devices.

The Company's initial product, a vena cava filter system, was given FDA
clearance in 1990.  This product is distributed in the United States and certain
other countries by Bard and in other markets outside the United States by Bard
International. Both distributors are obligated to make annual minimum purchases.
The filter component of the current vena cava filter system is manufactured by
Lake Region Manufacturing Inc. ("Lake Region"). The Company currently purchases
components of its delivery systems of the vena cava filter system under purchase
orders with third party suppliers. Final assembly of the vena cava filter system
is done by the Company.

                                       26
<PAGE>
 
In November 1994, the Company entered into an agreement with Boston Scientific
pursuant to which Boston Scientific obtained exclusive worldwide rights to
develop, manufacture, market and distribute the Company's stent technology and
products which incorporate such technology. Under this license agreement, Boston
Scientific is responsible for performing clinical trials for stents under
development and for reimbursing the Company for stent development costs incurred
by the Company. These reimbursements are classified as product development
revenues in the Consolidated Statement of Operations. The Company also receives
license fees, including milestone payments, royalties based upon product sales
and certain manufacturing cost reduction incentives from Boston Scientific under
the license agreement, which are included in the Company's revenues in the
periods discussed below. Most of its costs associated with its stents are
included in research and development expenses.

In February 1996, the Company acquired, through the issuance of common stock,
the rights to develop and commercialize its septal repair device.  The Company
commenced sales of the CardioSEAL Septal Occluder at the end of September 1996
in connection with clinical trials of the device, and the device has been sold
commercially in Europe and other international markets since July 1997.  The
Company manufactures this device at its own facility.

In 1996, the Company significantly increased the scope of its operations,
including the addition of a new Chief Executive Officer, an Executive Vice
President and Chief Financial Officer and a President of the Septal Repair
Division, which was formed in February 1996.  In addition, in April 1996, the
Company entered into a lease for a new manufacturing, laboratory and
administrative space which increased the Company's annual facility lease
payments by approximately $400,000.  The Company took full occupancy of the
facility in September 1996.

The Company has agreed to make certain royalty payments to Children's Medical
Center Corporation based on net sales of the CardioSEAL Septal Occluder. The
Company has also agreed to pay certain royalties to Morris Simon, M.D., the
Company's Scientific Director and co-founder and a current Director of the
Company, and to Beth Israel Hospital, Boston, based on sales of products using
the technology invented by Dr. Simon relating to the SNF. In addition, pursuant
to the Company's employment agreements with Mr. Kleshinski and Dr. Harry,
respectively, the Company has agreed to pay certain royalties based on sales or
licenses of products where either Mr. Kleshinski or Dr. Harry, as the case may
be, was the sole or joint inventor.

RESULTS OF OPERATIONS

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

Revenues.  Revenues for the year ended December 31, 1997 increased to $10.1
million from $7.0 million for the year ended December 31, 1996 (a 44% increase).
Product sales increased to $8.6 million for the year ended December 31, 1997
from $4.6 million for the year ended December 31, 1996 (an 87% increase).  The
increase in product sales was primarily due to increased unit sales of vena cava
filters, a 3% increase in the price of 

                                       27
<PAGE>
 
vena cava filters, the commencement of sales of the CardioSEAL Septal Occluder
in connection with clinical trials at the end of September 1996, and the
commencement of commercial sales of the CardioSEAL Septal Occluder in June 1997
in certain European and other international markets. The Company recorded $1.5
million in license fees from Boston Scientific related to its stent technology
in the year ended December 31, 1997, consisting of $300,000 of milestone
payments and $1,200,000 of royalty payments. Product development revenues from
Boston Scientific (which consist of reimbursement of certain costs incurred by
the Company) decreased to $61,000 for the year ended December 31, 1997 from
$92,000 for the year ended December 31, 1996 (a 34% decrease), as a result of a
reduction of stent development costs incurred by the Company on behalf of Boston
Scientific in the year ended December 31, 1997 compared to the year ended
December 31, 1996.

Cost of Product Sales. Cost of product sales increased to $3.8 million for the
year ended December 31, 1997 from $2.4 million for the year ended December 31,
1996 (a 58% increase). The cost of product sales in 1997 includes sales of vena
cava filters and CardioSEAL Septal Occluders in connection with clinical trials
and foreign commercial sales. The cost of product sales for the year ended
December 31, 1996 was primarily related to sales of vena cava filers as sales
of the CardioSEAL Septal Occluder in connection with clinical trials commenced
at the end of September 1996. Cost of product sales, as a percent of product
sales, decreased to 44% for the year ended December 31, 1997 from 52% for the
year ended December 31, 1996. This decrease is primarily attributable to sales
of the CardioSEAL Septal Occluder, which has a lower cost of product sales as a
percent of sales than the vena cava filter, as well as a decrease in the cost
of the vena cava filter due to the reorganization of the Company's filter
operations in the second quarter of 1997. See Note 4 of the accompanying Notes
to Consolidated Financial Statements.

Research and Development.  Research and development expense increased to $3.0
million for the year ended December 31, 1997 from $2.7 million for the year
ended December 31, 1996 (an 11% increase).  The increase reflects an increase in
regulatory and clinical trial expenses for the CardioSEAL Septal Occluder
incurred in connection with clinical trials which commenced in September 1996,
as well as increase activity in the Company's development programs for vena cava
filters and other products under development. Increased expenses resulted
primarily from increases in personnel and related costs, engineering expenses
and facilities related costs.  The Company received reimbursement from Boston
Scientific for $61,000 and $92,000 of these expenses in the years ended December
31, 1997 and 1996, respectively, which amounts are included in revenues.

General and Administrative.  General and administrative expenses increased to
$2.9 million for the year ended December 31, 1997 from $2.3 million for the year
ended December 31, 1996 (a 26% increase).  The increase consisted primarily of
increases in personnel and related costs, legal and professional fees,
facilities costs, insurance costs, investors relations costs and computer
systems costs resulting from the Company's expanded scope of operations in 1997.

                                       28
<PAGE>
 
Selling and Marketing.  Selling and marketing expenses increased to $1.0 million
for the year ended December 31, 1997 from $311,000 for the year ended December
31, 1996 (a 222% increase).  The increase related primarily to marketing
activities related to the CardioSEAL Septal Occluder in connection with the
commencement of commercial sales of the CardioSEAL Septal Occluder in Europe and
other international markets in June 1997.

In-Process Research and Development.  For the year ended December 31, 1997, the
Company recorded a charge of $2.4 million for in-process research and
development related to the Company's investment in Image Technologies
Corporation on May 29, 1997.  See Note 3(b) of the accompanying Notes to
Consolidated Financial Statements.

Interest Income, Net.  Interest income, net was $1.5 million for the year ended
December 31, 1997 as compared to $569,000 for the year ended December 31, 1996
(a 164% increase).  This increase was primarily due to the closing of the
Company's initial public offering of 3,150,000 shares of common stock (including
150,000 shares sold upon exercise of the underwriters' over-allotment option) in
October 1996 resulting in net proceeds to the Company of $31.2 million.

Income Taxes.  The Company had a provision for income taxes of $229,500 for the
year ended December 31, 1997 which reflects the non-deductibility of the in-
process research and development and a portion of the restructuring charge
recorded during 1997, and the utilization of carry-forward net operating losses
from prior years.  There was no provision for income taxes for the year ended
December 31, 1996 as the Company incurred an operating loss.

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

Revenues.  Revenues for the year ended December 31, 1996 increased to $7.0
million from $3.8 million for the year ended December 31, 1995 (an 84%
increase).  Product sales increased to $4.6 million for the year ended December
31, 1996 from $2.7 million for the year ended December 31, 1995 (a 70%
increase).  The increase in product sales was primarily due to increased unit
sales of vena cava filters, which in turn, was primarily due to the introduction
of the straight-line delivery system in November 1995, and the commencement of
sales of the CardioSEAL Septal Occluder in connection with clinical trials at
the end of September 1996.  The Company recorded $2.4 million in license fees
from Boston Scientific related to its stent technology in the year ended
December 31, 1996, consisting of $1,625,000 milestone payments and $750,000
minimum royalty payments.  Product development revenues from Boston Scientific
(which consist of reimbursement of certain costs incurred by the Company)
decreased to $92,000 for the year ended December 31, 1996 from $492,000 for the
year ended December 31, 1995 (an 81% decrease), due to the completion of the
Company's transfer of its stent technology to Boston Scientific in November 1995
which has resulted in a reduction of stent development costs incurred by the
Company on behalf of Boston Scientific.

Cost of Product Sales.  Cost of product sales increased to $2.4 million for the
year ended December 31, 1996 from $1.3 million for the year ended December 31,
1995 (an 85% 

                                       29
<PAGE>
 
increase). The cost of product sales in 1995 was entirely related to vena cava
filters. The costs of product sales in 1996 includes vena cava filters and
CardioSEAL Septal Occluders and the increase reflects the increase in vena cava
filters sold in the year ended December 31, 1996 and the commencement of sales
of the CardioSEAL Septal Occluder in connection with clinical trials at the end
of September 1996. Cost of products sales, as a percent of product sales,
increased to 52% for the year ended December 31, 1996 from 48% for the year
ended December 31, 1995. This increase reflects the impact of the introduction
of the vena cava filter straight-line delivery system which has a higher unit
manufacturing cost as a percent of the selling price, and start-up manufacturing
costs related to the commencement of sales of the CardioSEAL Septal Occluder in
connection with clinical trials at the end of September 1996.

Research and Development.  Research and development expense increased to $2.7
million for the year ended December 31, 1996 from $871,000 for the year ended
December 31, 1995 (a 210% increase).  The increase reflects increased activity
in the Company's development programs for vena cava filters, the CardioSEAL
Septal Occluder and other products under development.  Increased expenses
resulted primarily from increases in personnel and related costs, engineering
expenses and facilities related costs.  The Company received reimbursement from
Boston Scientific for $92,000 and $492,000 of these expenses in the year ended
December 31, 1996 and 1995 respectively, which amounts are included in revenues.

General and Administrative.  General and administrative expenses increased to
$2.3 million for the year ended December 31, 1996 from $871,000 for the year
ended December 31, 1995 (a 164% increase).  The increase consisted primarily of
increases in personnel and related costs, legal and professional fees and
consulting expenses.  These increases resulted from the Company's expanded scope
of operations.

Selling and Marketing.  Selling and marketing expenses decreased to $311,000 for
the year ended December 31, 1996 from $169,000 for the year ended December 31,
1995 (an 84% increase).  The increase related primarily to the introduction of
the vena cava filter straight-line delivery system and to pre-marketing
activities related to the CardioSEAL Septal Occluder.  Selling and marketing
expenses for the year ended December 31, 1995 were entirely related to vena cava
filters.

In-Process Research and Development.  For the year ended December 31, 1996, the
Company recorded a charge of $1.1 million for in-process research and
development related to the CardioSEAL Septal Occluder which was acquired in
February 1996.  See Note 3(a) of Notes to Consolidated Financial Statements.

Interest Income (Expense), Net.  Interest expense, net was $569,000 for the year
ended December 31, 1996 as compared to interest expense, net amounting to
$29,000 for the year ended December 31, 1995.  This increased net interest
income was primarily due to the receipt in February 1996 of $7.5 million in net
proceeds from the sale of Convertible Preferred Stock and the closing of the
Company's initial public offering of 3,150,000 shares of common stock (including
150,000 shares sold upon exercise of the underwriters' over-allotment option) in
October 1996 resulting in net proceeds of $31.2 

                                       30
<PAGE>
 
million. Interest expense in 1996 consisted primarily of interest on
subordinated debt to stockholders, which was fully repaid in April 1996, and
interest on capital lease obligations. Interest expense in 1995 consisted
primarily of interest on subordinated debt to stockholders.

Income Taxes.  The Company had no income tax provision for the year ended
December 31, 1996 as it incurred an operating loss.  Prior to October in 1995,
the Company elected to be taxed as an "S" Corporation for federal and state
income tax purposes and, accordingly, the financial statements for the year
ended December 31, 1995 do not include a provision for income taxes for the
period from January 1, 1995 to October 19, 1995.  The provision for income taxes
relates to the period from October 19, 1995 to December 31, 1995 and consists of
certain state income taxes.  The Company has not recorded a pro forma tax
provision as there would have been sufficient net operating loss carryforwards
to offset income in 1995.  See Notes to Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

In the year ended December 31, 1997, the Company used cash of approximately $2.9
million, of which $2.4 million was used to acquire a 23% ownership interest in
Image Technologies Corporation (see Note 3(b) of the accompanying Notes to
Consolidated Financial Statements) and $500,000 was used for working capital
purposes primarily related to sales of the CardioSEAL Septal Occluder in
connection with clinical trials and commercial sales in Europe and other
international markets and for increased vena cava filter sales.  In the year
ended December 31, 1996, the Company's operations utilized cash of $1.7 million
which was used primarily to fund operating losses and for working capital.  Cash
flow from operations was used to fund increases in accounts receivable of $1.5
million and $459,000 in the years ended December 31, 1997 and 1996,
respectively. Such increases reflect the increases in product sales and the
timing of such product sales.

During the year ended December 31, 1997, the Company received proceeds of
$815,000 from the exercise of Common Stock options.  In October 1996, the
Company completed an initial public offering of 3,150,000 shares of Common Stock
for net proceeds of approximately 31,197,000, net of underwriting discounts and
expenses.  In February 1996, the Company received approximately $7.5 million in
net proceeds from the sale of 3,787,104 shares of Convertible Preferred Stock,
which funds were used in part to accelerate its facilities and infrastructure
expansion.  In the year ended December 31, 1996, the Company made a $100,000
distribution to its stockholders.  In 1996, the Company made its last payment on
a $1.5 million loan received in 1992 from Bard. Payments during 1996 and 1995
amounted to $781,000 and $477,000, respectively.  In addition, during the years
ended December 31, 1996 and 1995, the Company repaid subordinated debt to its
stockholders amounting to $309,000 and $2,500, respectively. The Company had no
such outstanding debt during the year ended December 31, 1997.

Purchases and capitalized leases of property and equipment for use in its
research and development, manufacturing and general and administrative
activities amounted to $672,000 and $2.2 million during the years ended December
31, 1997 and 1996, 

                                       31
<PAGE>
 
respectively. In May 1996, the Company entered into a lease for a new
manufacturing research and administrative facility which increased its annual
facility lease payments by approximately $400,000 beginning in the third quarter
of 1996. In connection therewith, the Company incurred costs for leasehold
improvements of approximately $1 million, net of the landlord's contribution. In
June 1996, the Company entered into a $1.5 million equipment lease line of
credit agreement without covenants. Upon expiration of this agreement in June
1997, the Company entered into a new agreement with similar terms that provides
the Company and its affiliate, ITC, the option to borrow up to $1 million
through March 31, 1998. As of December 31, 1997, the Company borrowed $572,000
and $376,000 under the $1.5 million and $1.0 million agreement, respectively,
including $221,000 borrowed under the $1.0 million agreement by ITC. The Company
has guaranteed the outstanding capital leases of ITC. See Note 8 of the
accompanying Notes to Consolidated Financial Statements.

The Company is party to various other substantial contractual arrangements
including salaries and fees for current employees and consultants which are
likely to increase as additional agreements are entered into and additional
personnel are retained.  The Company has also committed to purchase certain
minimum quantities of components from a supplier through June 2001.  See Note 8
of Notes to Consolidated Financial Statements.  All of these arrangements
require cash payments by the Company over varying periods of time.  Certain of
these arrangements are cancelable on short notice and certain require
termination or severance payments as part of any early termination.

The Company has reviewed its internal computer systems and their capability of 
recognizing the year 2000 and years thereafter.  The Company expects that any 
costs related to ensuring such systems to be year 2000 compliant will not be 
material to the financial condition or results of operations of the Company.


The Company believes that its existing resources and cash flow from current
operations will be sufficient to fund its current level of operations and
planned new product development, including increased working capital
requirements and capital expenditures, for the foreseeable future.  The Company
expects to expend substantial resources to complete development of the Company's
products, seek regulatory clearances or approvals, build its marketing, sales
and manufacturing organizations and conduct further research and development.

The Company may require additional funds for its research and product
development programs, preclinical and clinical testing, operating expenses,
regulatory processes, manufacturing and marketing programs and potential
licenses and acquisitions.  Any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
covenants.  The Company's capital requirements will depend on numerous factors,
including the sales of its products, the progress of its research and
development programs, the progress of preclinical and clinical testing, the time
and cost involved in obtaining regulatory approvals, the cost of filing,
prosecuting defending and enforcing any patent claims and other intellectual
property rights, competing technological and market developments, developments
and changes in the Company's existing research, licensing and other
relationships and terms of any collaborative, licensing and other arrangements
that the Company may establish.

                                       32
<PAGE>
 
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

The following important factors, among others, could cause actual results to
differ materially from those contained in forward-looking statements made in
this Annual Report on Form 10-K and presented elsewhere by management from time
to time.

Limited Commercialization; Uncertainties of Product Development and Market
Acceptance.  The Company currently markets three products, the Simon Nitinol
Filter, which is marketed worldwide, a line of the Company's peripheral vascular
stents under the name Symphony, which is marketed by Boston Scientific in Europe
and the United States, and the CardioSEAL Septal Occluder.  The Company's stents
and CardioSEAL Septal Occluder may require substantial further investment in
research, product development, preclinical and clinical testing and governmental
regulatory approvals prior to being marketed and sold in the United States.
There can be no assurance that the Company's current products, or any other
products developed by the Company will achieve or continue to have market
acceptance.  Certain of the medical indications that can be treated by the
Company's devices can also be treated by surgery, drugs or other medical
devices.  Many alternative treatments currently are widely accepted in the
medical community and have a long history of use.  There can be no assurance
that the Company's devices and procedures will be able to replace such
established treatments or that physicians or the medical community in general
will accept and utilize the Company's devices or any other medical products that
may be developed by the Company.

Dependence Upon Collaborators.  The Company has entered into distribution
agreements with Bard Radiology and Bard International granting them exclusive
distribution rights to the Company's SNF, and a license agreement with Boston
Scientific granting Boston Scientific exclusive worldwide rights to develop,
manufacture, market and distribute the Company's stent technology and products
which incorporate such technology.  Although Bard Radiology and Bard
International have agreed not to sell competing filters, Boston Scientific is
not prohibited from selling other stents and, in fact, manufactures and licenses
from others a variety of stents that may compete with the Company's stents.
Boston Scientific may choose to emphasize such other stents in its developmental
and marketing efforts.  There can be no assurance that these arrangements will
be renewed or that the Company's existing relationships with Bard Radiology,
Bard International or Boston Scientific will continue in their current form.
The Company's business could be materially adversely affected if its
arrangements with Bard Radiology, Bard International or Boston Scientific prove
unsuccessful or if such companies terminate their arrangements with the Company,
negotiate lower prices, sell additional competing products, whether manufactured
by themselves or others, or otherwise alter the nature of their relationships
with the Company.

Intense Competition; Rapid Technological Change.  The medical device industry is
characterized by rapidly evolving technology and intense competition.  Other
companies in the medical device industry are currently marketing products that
compete with the Company's devices and may be developing, or could in the future
develop, additional products that are competitive with the Company's.  Many of
the Company's competitors have substantially greater capital resources, greater
research and development, manufacturing and marketing resources and experience
and greater name recognition 

                                       33
<PAGE>
 
than the Company. In addition, new surgical procedures and medications could be
developed that replace or reduce the importance of current or future procedures
that use the Company's products.

Limited Manufacturing History; Dependence on Third Party Manufacturers.  The
Company currently uses third parties to manufacture components of the SNF system
and to distribute the SNF.  Final assembly of the vena cava filter system and
manufacturing of the CardioSEAL are done by the Company in its own facility.
Pursuant to an exclusive license agreement with Boston Scientific, Boston
Scientific manufactures and distributes the Company's stents.  The Company
intends to continue to use third parties to manufacture and distribute such
products and certain other products which the Company may seek to develop.  If
the Company should encounter delays or difficulties with third party
manufacturers in producing, packaging or distributing its proposed products,
market introduction and subsequent sales of such products would be adversely
affected and the Company may have to seek alternative sources of supply.  No
assurance can be made that the Company will be able to enter into alternative
supply arrangements at commercially acceptable rates, if at all.  If the Company
is unable to obtain or retain third party manufacturers on commercially
acceptable terms, it may not be able to commercialize medical products as
planned.

The Company's manufacturing facility is subject to Good Manufacturing Practice
("GMP") regulations, ISO 9000 and other regulatory requirements, is subject to
risks regarding delays or difficulties encountered in manufacturing any such
medical products and may require a substantial additional investment of capital.

Limited Marketing and Sales Experience.  Although the Company has limited
internal marketing and sales resources and personnel, and currently relies
primarily on third parties to market and sell its products, the Company plans to
market the CardioSEAL Septal Occluder directly, if and when it receives the
required regulatory approvals.  In order to market the CardioSEAL Septal
Occluder and any other products that it may develop, the Company will have to
develop a marketing and sales organization with technical expertise and
distribution capabilities.

Dependence on Patents and Proprietary Technology.  The Company's success will
depend, in part, on its ability to obtain patents, maintain trade secret
protection and operate without infringing on the proprietary rights of third
parties.  No assurance can be given that any pending patent applications or any
future patent application will result in issued patents, the scope of any patent
protection will exclude competitors or provide competitive advantages to the
Company, any of the Company's patents will be held valid if subsequently
challenged or others will not claim rights in or ownership of the patents and
other proprietary rights held by the Company.  Furthermore, there can be no
assurances that others have not or will not develop similar products, duplicate
any of the Company's products or design around any patents issued or that may be
issued in the future to the Company or its licensors.  In addition, whether or
not patents are issued to the Company or its licensors, others may hold or
receive patents which contain claims having a scope that covers products
developed by the Company.  The Company could incur substantial costs in
defending any patent infringement suits or in asserting 

                                       34
<PAGE>
 
any patent rights, including those granted by third parties. In addition, the
Company may be required to obtain licenses to patents or proprietary rights from
third parties. There can be no assurance that such licenses will be available on
acceptable terms if at all.

Government Regulation; Product Approvals Uncertain.  The manufacture and sale of
medical devices intended for commercial distribution are subject to extensive
governmental regulations in the United States.  Medical devices generally
require pre-market clearance or pre-market approval prior to commercial
distribution.  Certain material changes or modifications to medical devices are
also subject to regulatory review and clearance or approval.  The regulatory
approval process is expensive, uncertain and lengthy.  If granted, the approval
may include significant limitations on the indicated uses for which a product
may be marketed.  In addition, any products manufactured or distributed by the
Company are subject to continuing regulation by the FDA.  There can be no
assurance that the Company will be able to obtain necessary regulatory approvals
or clearances for its products on a timely basis or at all, and delays in
receipt of, or failure to receive, such approvals or clearances, the loss of
previously received approvals or clearances, limitations on intended use imposed
as a condition of such approvals or clearances, or failure to comply with
existing or future regulatory requirements could have a material adverse effect
on the Company's business, financial condition and results of operations.

Sales of medical device products outside the United States are subject to
foreign regulatory requirements that vary widely from country to country.
Failure to comply with foreign regulatory requirements also could have a
material adverse effect on the Company's business, financial condition and
results of operations.

Uncertain Availability of Third Party Reimbursement.  In the United States,
suppliers of health care products and services are greatly affected by Medicare,
Medicaid and other government insurance programs, as well as by private
insurance reimbursement programs.  Third party payers may affect the pricing or
relative attractiveness of the Company's products by regulating the maximum
amount of reimbursement provided for by such payers to the physicians and
clinics using the Company's devices, or any other products that the Company may
develop, or by taking the position that such reimbursement is not available at
all.  If, for any reason, the Company's products were not to be reimbursed by
third party payers, the Company's ability to sell its products may be materially
adversely affected.  Mounting concerns about rising health care costs may cause
more restrictive coverage and reimbursement policies to the implemented in the
future.  In the international market, reimbursement by private third party
medical insurance providers, and governmental insurers and providers varies from
country to country.  In certain countries, the Company's ability to achieve
significant market penetration may depend upon the availability of third party
governmental reimbursement.

Uncertainties of Successful Redesign of the Septal Repair Device.  Between 1989
and 1991 Bard sponsored trials of an earlier version of the septal repair
device, known as the Clamshell.  In 1991, Bard discovered fractures of the
stainless steel framework in certain 

                                       35
<PAGE>
 
of the devices implanted during such clinical trials and, following such
discovery, suspended its clinical trials worldwide except for patients at high
risk for surgery. It was determined that the fractures were caused by metal
fatigue resulting from higher than anticipated forces acting on the Clamshell.
Redesign efforts were initiated, resulting in the design of the current version
of the septal repair device. Although the CardioSEAL Septal Occluder has
undergone in vitro testing, there can be no assurance that such testing
accurately simulates the actual forces in the human body or that similar
fractures will not occur with the CardioSEAL Septal Occluder. If such fractures
occur with adverse clinical consequences, the Company's efforts to commercialize
the CardioSEAL Septal Occluder may be significantly delayed and the Company may
be required to invest significant resources in further designing and engineering
the device or to discontinue its development efforts.

Product Liability Risks; Insurance.  The testing, marketing and sale of
implantable devices and materials entail an inherent risk that product liability
claims will be asserted against the Company or its third party distributors in
the event that the use of the Company's devices is alleged to have adverse
effects on a patient.  A product liability claim or a product recall could have
a material adverse effect on the Company's business, financial condition and
results of operations.  Certain of the Company's devices are designed to be used
in life-threatening situations where there is a high risk of serious injury or
death. Although the Company currently maintains limited product liability
insurance coverage, there can be no assurance that in the future the Company
will be able to maintain such coverage on acceptable terms or that current
insurance or insurance subsequently obtained will provide adequate coverage
against any or all potential claims. Furthermore, there can be no assurance that
the Company will avoid significant product liability claims and the attendant
adverse publicity.  Any product liability claim or other claim with respect to
uninsured or underinsured liabilities could have a material adverse effect on
the Company's business, financial condition, and results of operations.

Uncertain Future Capital Requirements.  The Company may require additional funds
for its research and product development programs, preclinical and clinical
testing, operating expenses, regulatory processes and manufacturing and
marketing programs.  The Company's capital requirements will depend on numerous
factors, including the sales of its products, the progress of its research and
development programs, the progress of preclinical and clinical testing, the time
and cost involved in obtaining regulatory approvals, the cost of filing,
prosecuting, defending and enforcing any patent claims and other intellectual
property rights, competing technological and market developments, developments
and changes in the Company's existing research, licensing and other
relationships and the terms of any new collaborative, licensing and other
arrangements that the Company may establish.  There can be no assurance that
additional financing will be available when needed or, if available, will be
available on acceptable or affordable terms.  Insufficient funds may prevent the
Company from implementing its business strategy or may require the Company to
delay, scale back or eliminate certain of its research and product development
programs or to license to third parties rights to commercialize products or
technologies that the Company would otherwise seek to develop itself.  See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

                                       36
<PAGE>
 
Dependence on Qualified Personnel.  There is intense competition for qualified
personnel in the medical device field, and there can be no assurance that the
Company will be able to continue to attract and retain qualified personnel
necessary for the development of its business.  The loss of the services of
existing personnel as well as the failure to recruit additional qualified
scientific, technical and managerial personnel in a timely manner would be
detrimental to the Company's anticipated growth and expansion into areas and
activities requiring additional expertise such as marketing.  The failure to
attract and retain such personnel could adversely affect the Company's business.

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

Not Applicable.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

All financial statements required to be filed hereunder are filed as Appendix A
                                                                     ----------
hereto, are listed under Item 14(a) and are incorporated herein by this
reference.

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

None.

                                       37
<PAGE>
 
                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The response to this Item is contained in part under the caption "Executive
Officers of the Company" in Part I of this Annual Report on Form 10-K and in
part in the Company's Proxy Statement for the Annual Meeting of Stockholders to
be held on June 3, 1998 (the "1998 Proxy Statement") under the caption "Proposal
1 -- Election of Directors," which section is incorporated herein by this
reference.

Officers are elected on an annual basis and serve at the discretion of the
Board.

The information required by this Item regarding compliance with Section 16(a) of
the Securities Exchange Act of 1934, as amended, is contained in the 1998 Proxy
Statement under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" and is incorporated herein by this reference.


ITEM 11.  EXECUTIVE COMPENSATION

The response to this Item is contained in the 1998 Proxy Statement under the
caption "Proposal 1 -- Election of Directors," which section is incorporated
herein by this reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The response to this Item is contained in the 1998 Proxy Statement under the
caption "Stock Ownership of Certain Beneficial Owners and Management," which
section is incorporated herein by this reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The response to this Item is contained in the 1998 Proxy Statement under the
caption "Certain Transactions," which section is incorporated herein by this
reference.

                                       38
<PAGE>
 
                                    PART IV


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

     (a)  Financial Statements.  The following documents are filed as Appendix A
          --------------------                                        ----------
          hereto and are included as part of this Annual Report on Form 10-K:

     Financial Statements of Nitinol Medical Technologies, Inc.:
       Report of Independent Public Accountants
       Consolidated Balance Sheets as of December 31, 1997 and 1996
       Consolidated Statements of Operations for the years ended December 31,
       1997, 1996 and 1995
       Consolidated Statements of Stockholders' Equity (Deficit) for the years
       ended December 31, 1997, 1996 and 1995
       Consolidated Statements of Cash Flow for the years ended December 31,
       1997, 1996 and 1995
       Notes to Consolidated Financial Statements

     Financial Statements of Image Technologies Corporation:
       Report of Independent Public Accountants
       Balance Sheet
       Statements of Operations
       Statements of Stockholders' Equity
       Statements of Cash Flow
       Notes to Financial Statements

     (b) Financial Statement Schedules.  The Company is not filing any financial
         -----------------------------                                          
         statement schedules as part of this Annual Report on Form 10-K because
         they are not applicable or the required information is included in the
         financial statements or notes thereto.

     (c) Exhibits.  The exhibits filed as part of this Annual Report on Form 
         --------                                                             
         10-K are listed in the Exhibit Index immediately preceding such 
         exhibits, and are incorporated herein by this reference. The Company
         has identified with asterisks in the Exhibit Index each management
         contract and compensation plan filed as an exhibit to this Annual
         Report on Form 10-K in response to Item 14(i) of Form 10-K.

     (d) Reports on Form 8-K.  The Company did not file any Reports on Form 8-K
         -------------------                                                   
         during the fiscal quarter ended December 31, 1997. 

                                       39
<PAGE>
 
                                  SIGNATURES

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

                              NITINOL MEDICAL TECHNOLOGIES, INC.

                              By: /s/ Thomas M. Tully,
                                  -------------------------------------
                                  Thomas M. Tully,
                                  President and Chief Executive Officer

                              Dated:  March 16, 1998

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE                           TITLE                                      DATE
<S>                                 <C>                                        <C>
/s/ Thomas M. Tully                 President and Chief Executive              March 16, 1998
-------------------------------     Officer and Director (Principal                          
Thomas M. Tully                     Executive Officer)                                       
                                                                                             
/s/ Theodore I. Pincus              Executive Vice President, Secretary        March 16, 1998
-------------------------------     and Chief Financial Officer (Principal                   
Theodore I. Pincus                  Financial and Accounting Officer)                        
                                                                                             
/s/ C. Leonard Gordon               Director                                   March 16, 1998
-------------------------------                                                              
C. Leonard Gordon
                                                                            
/s/ Morris Simon, M.D.              Director                                   March 16, 1998
-------------------------------                                                              
Morris Simon, M.D.                                                                           

/s/ Michael C. Brooks               Director                                   March 16, 1998
-------------------------------                                                              
Michael C. Brooks                   
                                                         
/s/ Robert A. Van Tassel            Director                                   March 16, 1998
-------------------------------                                                              
Robert A. Van Tassel                
                                                         
/s/ R. John Fletcher                Director                                   March 16, 1998
-------------------------------                                                              
R. John Fletcher                    
                                                         
/s/ Jeffrey R. Jay, M.D.            Director                                   March 16, 1998 
-------------------------------     
Jeffrey R. Jay, M.D.
</TABLE>

                                       40
<PAGE>
 
                                                                      Appendix A
                                                                      ----------


              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                       INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                 NITINOL MEDICAL TECHNOLOGIES AND SUBSIDIARIES:
<TABLE>
<CAPTION>
<S>                                                                              <C>
 
Report of Independent Public Accountants                                         A-2
 
Consolidated Balance Sheets as of December 31, 1997 and 1996...................  A-3
 
Consolidated Statements of Operations for the Years Ended December 31, 1997,
     1996, and 1995............................................................  A-4
 
Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended
     December 31, 1997, 1996, and 1995.........................................  A-5
 
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997,
     1996, and 1995............................................................  A-6
 
Notes to Consolidated Financial Statements.....................................  A-7 - A-26
</TABLE>
                        IMAGE TECHNOLOGIES CORPORATION:
<TABLE>
<CAPTION>
<S>                                                                              <C>
 
Report of Independent Public Accountants                                         A-27
 
Balance Sheets as of December 31, 1997.........................................  A-28
 
Statements of Operations for the Year Ended December 31, 1997 and From
     Inception (November 17, 1995) to December 31, 1997 ......................   A-29
 
Statements of Stockholders' Equity (Deficit) for the Years Ended
     December 31, 1997, 1996, and 1995.........................................  A-30
 
Statements of Cash Flows for the Year Ended December 31, 1997, and From
     Inception (November 17, 1995) to December 31, 1997........................  A-31
 
Notes to Financial Statements..................................................  A-32 - A-40
 
</TABLE>

                                      A-1
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Nitinol Medical Technologies, Inc. and Subsidiaries:

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

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

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

Boston, Massachusetts
February 9, 1998






































 

                                      A-2
<PAGE>
 
                  MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
 
 
                                                                                             AT DECEMBER 31,

Assets                                                                                     1997                 1996
                                                                                  --------------------  --------------------
<S>                                                                                   <C>                   <C>
Current assets:
  Cash and cash equivalents                                                             $ 5,561,445           $ 4,082,486
  Marketable securities                                                                  20,822,405            25,273,555
  Accounts receivable, net of allowances for doubtful accounts
     of $125,000 and $17,000 in 1997 and 1996, respectively                               2,317,408               782,230
  Inventories                                                                             1,071,265               745,977
  Prepaid expenses and other current assets                                               1,110,271               610,017
                                                                                        -----------           -----------
     Total current assets                                                                30,882,794            31,494,265
                                                                                        -----------           -----------
 
Property and equipment, at cost:
  Leasehold improvements                                                                  1,135,583             1,191,498
  Laboratory and computer equipment                                                       1,091,380               925,166
  Equipment under capital lease                                                             948,155               548,063
  Office furniture and equipment                                                            143,640                93,031
                                                                                        -----------           -----------
                                                                                          3,318,758             2,757,758
  Less--Accumulated depreciation and amortization                                           845,512               504,909
                                                                                        -----------           -----------
                                                                                          2,473,246             2,252,849
                                                                                        -----------           -----------
 
Long-term investments in marketable securities                                            1,478,058             1,083,763
                                                                                        -----------           -----------
 
Other assets                                                                                171,415                98,627
                                                                                        -----------           -----------
                                                                                        $35,005,513           $34,929,504
                                                                                        ===========           ===========
      LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
  Accounts payable                                                                      $   166,248           $   420,424
  Accrued expenses                                                                          986,128               678,164
  Current portion of capital lease obligation                                               168,736                94,954
  Deferred revenue                                                                          300,000                    --
                                                                                        -----------           -----------
     Total current liabilities                                                            1,621,112             1,193,542
                                                                                        -----------           -----------
Capital lease obligation, net of current portion                                            612,458               415,591
                                                                                        -----------           -----------
Commitments and contingencies (Note 8)
 
Stockholders' equity:
  Preferred stock, $.001 par value--
    Authorized--3,000,000 shares
    Issued and outstanding--none                                                                 --                    --
  Common stock, $.001 par value--
    Authorized--30,000,000 shares
    Issued and outstanding--9,823,186 and 9,435,922
    shares at December 31, 1997 and 1996, respectively                                        9,824                 9,437
  Additional paid-in capital                                                             36,610,997            35,321,821
  Accumulated deficit                                                                    (3,848,878)           (2,010,887)
                                                                                        -----------           -----------
     Total stockholders' equity                                                          32,771,943            33,320,371
                                                                                        -----------           -----------
                                                                                        $35,005,513           $34,929,504
                                                                                        ===========           ===========
</TABLE>
                                                                                
  The accompanying Notes are an integral part of these Consolidated Financial
  Statements.

                                      A-3
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS



<TABLE>
<CAPTION>
                                                                       FOR THE YEARS ENDED DECEMBER 31,
                                                               1997                 1996                  1995
                                                               ----                 ----                  ---- 
Revenues:
<S>                                                      <C>                  <C>                    <C>
  Product sales                                           $ 8,564,810          $ 4,556,861             $2,716,022
  License fees                                              1,500,000            2,375,000                625,000
  Product development                                          60,898               91,662                491,857
                                                          -----------          -----------             ----------
                                                           10,125,708            7,023,523              3,832,879
                                                          -----------          -----------             ----------
Expenses:
  Cost of product sales                                     3,765,235            2,386,896              1,263,951
  Research and development                                  2,973,755            2,661,849                870,588
  General and administrative                                2,888,149            2,284,184                871,469
  Selling and marketing                                     1,010,123              310,988                169,308
  Acquired in-process research and development              2,449,071            1,111,134                     --
  Restructuring charge                                        193,636                   --                     --
                                                          -----------          -----------             ----------
                                                           13,279,969            8,755,051              3,175,316
                                                          -----------          -----------             ----------
     Income (loss) from operations                         (3,154,261)          (1,731,528)               657,563
                                                          -----------          -----------             ----------
Interest expense                                              (46,152)             (42,179)               (37,629)
Interest income                                             1,591,922              610,830                  8,328
                                                          -----------          -----------             ----------
                                                            1,545,770              568,651                (29,301)
                                                          -----------          -----------             ----------
     Income (loss) before provision for
       income taxes                                        (1,608,491)          (1,162,877)               628,262
Provision for income taxes                                    229,500                   --                 44,000
                                                          -----------          -----------             ----------
     Net income (loss)                                    $(1,837,991)         $(1,162,877)            $  584,262
                                                          ===========          ===========             ==========
Basic income (loss) per common share                            $(.19)               $(.21)                  $.16
                                                          ===========          ===========             ==========
Weighted average common shares outstanding                  9,595,969            6,748,810              3,763,587
                                                          ===========          ===========             ==========
Diluted income (loss) per common share                          $(.19)               $(.21)                  $.15
                                                          ===========          ===========             ==========
Diluted weighted average common shares
     outstanding                                            9,595,969            6,748,810              3,983,247
                                                          ===========          ===========             ==========
                                                          
</TABLE>
                                                                                
  The accompanying Notes are an integral part of these Consolidated Financial
  Statements.

                                      A-4
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
 
                                                                            
                                                 Convertible
                                               Preferred Stock              Common Stock     
                                      ------------------------------    -------------------- 
                                           Number        $  .001          Number      $.001  
                                         of Shares      Par Value       of Shares  Par Value 
                                      ---------------   ------------    ---------     ------ 
<S>                                      <C>           <C>            <C>          <C>  
                                                                                             
Balance, January 1, 1995                           --        $    --    3,758,322     $3,759 
  Exercise of common stock                                                                   
    options                                        --             --       15,790         16 
  Distributions to stockholders                                                              
    ($.03 per share)                               --             --           --         -- 
  Reclassification of S Corpora-                                                             
    tion losses to the extent of                                                             
    additional paid-in capital                     --             --           --         -- 
  Net income                                       --             --           --         -- 
                                          -----------   -----------  -----------  ----------
Balance, December 31, 1995                         --             --    3,774,112      3,775 
  Issuance of convertible                                                                    
    preferred stock, net of                                                                  
    issuance costs of                                                                        
    approximately $989,000                  3,787,104          3,787           --         -- 
  Common stock issued in                                                                     
    connection with the                                                                      
    purchase of technology                                                                   
    and other assets                               --             --      514,651        515 
  Exercise of common stock                                                                   
    options                                        --             --        3,947          4 
  Warrant grant in exchange                                                                  
    for license                                    --             --           --         -- 
  Accretion of convertible                                                                   
    preferred stock dividends                      --             --           --         -- 
  Proceeds from initial public                                                               
    offering, net of offering costs                                                                
    of approximately                               --             --    3,150,000      3,150 
    $ 1,028,000                                                                   
  Conversion of convertible                                                          
     preferred stock into common stock     (3,787,104)        (3,787)   1,993,212      1,993 
  Net loss                                         --             --           --         -- 
                                           -----------   -----------  ----------- ----------
Balance, December 31, 1996                         --             --    9,435,922      9,437 
  Exercise of common stock                                                                   
    options                                        --             --      322,485        322 
  Exercise of warrants                             --             --       64,779         65 
  Acceleration of vesting of                                                                 
   common stock options                            --             --           --         --          
  Tax benefit related to exercise                                                            
   of common stock options                         --             --           --         --   
  Net loss                                         --             --           --         -- 
                                          -----------    -----------  ----------- ----------
Balance, December  31, 1997                        --        $    --    9,823,186     $9,824 
                                          ===========   ============  =========== ==========
</TABLE>

<TABLE> 
<CAPTION> 
                                                                                  
                                      Additional                        Total   
                                       Paid-in      Accumulated     Stockholders' 
                                       Capital        Deficit      Equity/(Deficit)
                                     ------------   ------------   ---------------
<S>                                 <C>             <C>               <C>                   
                                                                                  
Balance, January 1, 1995              $   263,247    $(1,598,503)      $(1,331,497)
  Exercise of common stock options          2,984             --             3,000
  Distributions to stockholders                                                   
    ($.03 per share)                           --       (100,000)         (100,000)
  Reclassification of S Corpora-                                                  
    tion losses to the extent of                                                  
    additional paid-in capital           (266,231)       266,231                --
  Net income                                   --        584,262           584,262
                                      -----------    -----------       -----------
Balance, December 31, 1995                     --       (848,010)         (844,235)
  Issuance of convertible                                                         
    preferred stock, net of                                                       
    issuance costs of                                                             
    approximately $989,000              3,257,211             --         3,260,998
  Common stock issued in                                                                        
    connection with the                                                                         
    purchase of technology                                                                      
    and other assets                    1,104,442             --         1,104,957
  Exercise of common stock                                                        
    options                                 8,471             --             8,475
  Warrant grant in exchange                  
    for license                            11,200             --            11,200
  Accretion of convertible                                                        
    preferred stock dividends            (255,000)            --          (255,000)
  Proceeds from initial public                                                    
    offering, net of offering costs of                                                           
    approximately $ 1,028,000          31,193,703             --        31,196,853
  Conversion of convertible                                               
    preferred stock into common                                                  
    stock                                   1,794             --                --
  Net loss                                     --     (1,162,877)       (1,162,877)
                                      -----------    -----------       -----------
Balance, December 31, 1996             35,321,821     (2,010,887)       33,320,371
  Exercise of common stock                                                        
    options                               535,706             --           536,028
  Exercise of warrants                    275,894             --           275,959
  Compensation relating to 
   acceleration of vesting of                                                        
   common stock options                   111,576             --           111,576  
  Tax benefit related to exercise                                                   
   of common stock options                366,000             --           366,000 
Net loss                                       --     (1,837,991)       (1,837,991) 
                                      -----------    -----------       -----------  
Balance, December 31, 1997            $36,610,997    $(3,848,878)      $32,771,943  
                                      ===========    ===========       ===========  
</TABLE> 

 The accompanying Notes are an integral part of these Consolidated Financial
 Statements.


                                      A-5
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                                            
                    CONSOLIDATED STATEMENTS OF CASH FLOWS 


<TABLE> 
<CAPTION>                                                                                
                                                                                         
                                                                                         FOR THE YEARS ENDED DECEMBER 31,     
                                                                                         1997          1996          1995     
                                                                                     ------------  -------------  ----------  
Cash flows from operating activities:                                                                                         
<S>                                                                                  <C>           <C>            <C>         
  Net income (loss)                                                                  $(1,837,991)  $ (1,162,877)  $ 584,262   
  Adjustments to reconcile net income (loss) to net cash provided by (used                                                    
   in) operating activities--                                                                                                 
    Expense recorded on acceleration of stock options                                    111,576             --          --    
    Depreciation and amortization                                                        461,141        226,968      88,895    
    Write off of leasehold improvements                                                       --         75,000          --    
    Common stock issued for in-process research and development                               --        806,174          --    
    Warrant grant in exchange for license                                                     --         11,200          --    
    Changes in assets and liabilities--
            Accounts receivable                                                       (1,535,178)      (459,013)   (238,421)
            Inventories                                                                 (325,288)      (537,916)    (56,947)
            Prepaid expenses and other current assets                                   (500,254)      (209,048)   (152,512)
            Accounts payable                                                            (254,176)       (78,392)    379,347
            Accrued expenses                                                             673,966        462,181     (79,523)
            Deferred revenue                                                             300,000       (600,000)         --
                                                                                      ----------     ----------  ----------   
                Net cash provided by (used in) operating activities                   (2,906,204)    (1,465,723)    525,101
                                                                                      ----------     ----------  ----------
Cash flows from investing activities:
  Maturities (purchases) of marketable securities and long-term investments            4,056,855    (26,611,915)         --
  Purchases of property and equipment                                                   (272,380)    (1,317,250)   (201,121)
  Increase in other assets                                                               (81,855)       (39,495)    (29,513)
                                                                                     -----------   ------------   ---------
                Net cash provided by (used in) investing activities                    3,702,620    (27,968,660)   (230,634)
                                                                                     -----------   ------------   ---------
Cash flows from financing activities:
  Proceeds from initial public offering, net                                                  --     31,196,853          --
  Redemption of preferred stock including dividends                                           --     (4,505,000)         --
  Payments of subordinated debt                                                               --       (309,356)     (2,500)
  Payments of loan from distributor                                                           --       (780,830)   (477,120)
  Proceeds from issuance of convertible preferred stock, net                                  --      7,510,998          --
  Proceeds from issuance of common stock                                                 811,986          8,475       3,000
  Distributions to stockholders                                                               --       (100,000)         --
  Payments of capital lease obligations                                                 (129,443)       (37,518)         --
                                                                                     -----------   ------------   ---------
                Net cash provided by (used in) financing activities                      682,543     32,983,622    (476,620)
                                                                                     -----------   ------------   ---------
Net increase (decrease) in cash and cash equivalents                                   1,478,959      3,549,239    (182,153)
Cash and cash equivalents, beginning of period                                         4,082,486        533,247     715,400
                                                                                     -----------   ------------   ---------
Cash and cash equivalents, end of period                                             $ 5,561,445   $  4,082,486   $ 533,247
                                                                                     ===========   ============   =========
Supplemental disclosure of cash flow information:
  Cash paid during the period for--
    Interest                                                                         $    46,152   $     27,288   $  39,814
                                                                                     ===========   ============   =========
    Income Taxes                                                                     $    32,000   $    186,500   $   2,135
                                                                                     ===========   ============   =========
Supplemental disclosure of non-cash financing and investing transactions:
 Equipment acquired under capital lease obligations                                  $   400,091   $    548,063   $      --
                                                                                     ===========   ============   =========
 Abandonment of leasehold improvements                                               $   111,472   $         --   $      --
                                                                                     ===========   ============   =========
 Conversion of preferred stock into common stock                                     $        --   $      3,787   $      --
                                                                                     ===========   ============   =========
 Common stock issued for property and equipment                                      $        --   $    298,783   $      --
                                                                                     ===========   ============   =========
</TABLE>
                                                                                

The accompanying Notes are an integral part of these Consolidated Financial
Statements.

                                      A-6
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                        

  (1) OPERATIONS

      Nitinol Medical Technologies, Inc. (NMT or the Company) designs, develops
      and markets innovative medical devices that utilize advanced technologies
      and are delivered by minimally invasive procedures. The Company's products
      are designed to offer alternative approaches to existing complex
      treatments, thereby reducing patient trauma, shortening procedure,
      hospitalization and recovery times, and lowering overall treatment costs.
      The Company's patented medical devices include self-expanding stents, vena
      cava filters and septal repair devices (the CardioSEAL Septal Occluder).
      At this time, the Company's stents have been commercially launched in
      Europe and in the United States for certain indications, its vena cava
      filters are marketed in the United States and abroad, and the CardioSEAL
      Septal Occluder is in the clinical trials stage in U.S. and is sold
      commercially in Europe and other international markets. The Company is
      subject to a number of risks similar to those of other companies in this
      stage of development, including uncertainties regarding the development of
      commercially viable products, competition from alternative procedures and
      larger companies, dependence on key personnel and government regulation.


  (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      (a) Principles of Consolidation

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

      (b) Management Estimates

      The preparation of accrual-based financial statements in conformity with
      generally accepted accounting principles requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the
      date of the financial statements and the reported amounts of revenues and
      expenses during the reporting periods. Actual results could differ from
      those estimates.

                                      A-7
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

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

     (c) Cash and Cash Equivalents, Marketable Securities, and Long-Term
         Investments

     In accordance with Statement of Financial Accounting Standards (SFAS) No.
     115, Accounting for Certain Investments in Debt and Equity Securities, the
     Company has classified certain of its marketable securities and long-term
     investments as held-to-maturity and certain of its marketable securities as
     available-for-sale. Held-to-maturity securities represent those securities
     for which the Company has the intent and ability to hold to maturity and
     are reported at amortized cost. Available-for-sale securities represent
     those securities that do not meet the classification of held-to-maturity,
     are not actively traded and are reported at fair market value with
     unrealized gains and losses included in stockholders' equity. The Company
     considers all investments with maturities of 90 days or less from the date
     of purchase to be cash equivalents.

     Cash and cash equivalents, which are carried at cost and approximate
     market value, consist of the following:

<TABLE>
<CAPTION>
 
                                                  AT DECEMBER 31,
                                               1997            1996
                                               ----            ----
<S>                                         <C>            <C>
        Cash                                 $1,626,074     $  816,124
        Cash equivalents--
           Commercial paper                   2,964,195      2,994,829
           Money market                         971,176        271,533
                                             ----------     ----------
                                             $5,561,445     $4,082,486
                                             ==========     ==========
</TABLE>
                                                                                

                                      A-8
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

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

     (c)  Cash and Cash Equivalents, Marketable Securities, and Long-Term
          Investments--(continued)

     Marketable securities, with a weighted average maturity of approximately 6
     months and 4 1/2 months at December 31, 1997 and 1996, respectively,
     consist of the following:
 
     <TABLE>
     <CAPTION>
                                                       AT DECEMBER 31,
                                                    1997           1996
                                                    ----           ----
     <S>                                        <C>            <C>
       Held-to-maturity--                
          Eurodollar bonds                      $10,619,598     $11,084,453
          Commercial paper                        5,985,895      10,958,453
          Corporate debt securities               2,388,681         329,363
          Zero coupon bonds                       1,162,233              --
          Medium term notes                         665,998         501,596
                                                -----------     -----------
                                                 20,822,405      22,873,555
       Available-for-sale--              
          Taxable auction securities                     --       2,400,000
                                                -----------     -----------
                                                $20,822,405     $25,273,555
                                                ===========     ===========
     </TABLE>

        Long-term investments, with a weighted average maturity of approximately
        15 and 1/2 months and 15 months at December 31, 1997 and 1996,
        respectively, are carried at cost and approximate market value and
        consist of the following:
     
     <TABLE>
     <CAPTION>
 
                                                     AT DECEMBER 31,
                                                 1997              1996
                                                 ----              ----
     <S>                                    <C>                <C>
       Held-to-maturity--             
          Corporate debt securities          $  975,590         $       --
          Medium-term notes                     502,468                 --
          Eurodollar bonds                           --          1,083,763
                                             ----------         ----------
                                             $1,478,058         $1,083,763
                                             ==========         ==========
     </TABLE>
                                                                                

                                      A-9
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


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

     (c)  Cash and Cash Equivalents, Marketable Securities, and Long-Term
          Investments--(continued)

     In addition, the following amounts of interest receivable generated from
     the Company's cash and cash equivalents, marketable securities, and long-
     term investments are included in prepaid expenses and other current assets
     in the accompanying balance sheets:

     <TABLE>
     <CAPTION>
 
                                                        AT DECEMBER 31,
                                                     1997             1996
                                                     ----             ----
     <S>                                           <C>              <C>
       Short-term interest receivable              $476,559          $237,643
       Long-term interest receivable                  5,676            16,953
                                                   --------          --------
                                                   $482,235          $254,596
                                                   ========          ========
     </TABLE>
                                                                                
     (d)  Inventories

     Inventories are stated at the lower of cost (first-in, first-out) or market
     and consist of the following:

     <TABLE>
     <CAPTION>
      
                                                 AT DECEMBER 31,
                                                1997          1996
                                                ----          ----
     <S>                                     <C>            <C>
          Components                         $  625,381      $307,778
          Finished goods                        445,884       438,199
                                             ----------      --------
                                             $1,071,265      $745,977
                                             ==========      ========
     </TABLE>
                                                                                
     Finished goods consist of materials, labor and manufacturing overhead.
     
     (e)  Financial Instruments

     The estimated fair values of the Company's financial instruments, which
     include cash and cash equivalents, marketable securities, long-term
     investments, accounts receivable and capital lease obligations approximate
     their reported amounts.

                                      A-10
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

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

     (f) Concentration of Credit Risk

     SFAS No. 105, Disclosure of Information About Financial Instruments with
     Off-Balance-Sheet Risk and Financial Instruments with Concentrations of
     Credit Risk, requires disclosure of any significant off-balance-sheet and
     credit risk concentrations. Financial instruments that subject the Company
     to credit risk consist primarily of trade accounts receivable. The Company
     utilizes primarily one distributor for the sales of its filter products.
     This distributor had amounts due to the Company of approximately $923,000
     and $408,000 as of December 31, 1997 and 1996, respectively. This
     distributor accounted for 65%, 89% and 95% of product revenues for fiscal
     1997, 1996 and 1995, respectively for the year ended December 31, 1997,
     foreign sales accounted for 22% of total revenues.

     (g) Depreciation and Amortization

     The Company provides for depreciation and amortization by charges to
     operations using the straight-line method, which allocates the cost of
     property and equipment over the following estimated useful lives:

     <TABLE>
     <CAPTION>
                                                                 Estimated
                   Asset Classification                         Useful Life
                   --------------------                         -----------
     <S>                                                       <C>
              Leasehold improvements                            Life of Lease
              Laboratory and computer equipment                   3-7 Years
              Equipment under capital lease                     Life of Lease
              Office furniture and equipment                     5-10 Years
     </TABLE>

     (h) Revenue Recognition

     The Company records product sales upon shipment to the customer. Products
     sold to the Company's distributors are not subject to a right of return for
     unsold product. License fees and product development revenue are recognized
     as earned.

                                      A-11
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


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

     (i) Net Income (Loss) per Common and Common Equivalent Share

     In 1997, the Company adopted SFAS No. 128, Earnings per Share, effective
     December 15, 1997. SFAS No. 128 establishes standards for computing and
     presenting earnings per share and applies to entities with publicly held
     common stock or potential common stock. The Company has applied the
     provisions of SFAS No. 128 retroactively to all periods presented. In
     accordance with SAB No. 98, the Company has determined that there were no
     nominal issuances of common stock or potential common stock in the periods
     prior to the Company's initial public offering. The dilutive effect of
     potential common shares in 1995 was determined using the treasury stock
     method in accordance with SFAS No. 128. Diluted weighted average shares for
     1997 and 1996 excludes the potential common shares from stock options, as
     their effect would be antidilutive. Calculations of basic and diluted net
     income (loss) per share are as follows:

<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                             1997               1996              1995
                                                       -----------------  ----------------  -----------------
                                                
<S>                                                    <C>                <C>               <C>
       Net income (loss)                                    $(1,837,991)      $(1,162,877)         $  584,262
                                                     
       Accretion of convertible preferred            
            stock dividends                                         --            255,000                  --
                                                            -----------       -----------          ----------
       Net income (loss) available to common         
            stockholders                                    $(1,837,991)      $(1,417,877)         $  584,262      
                                                            ===========       ===========          ==========
                                                     
                                                     
       Weighted average common shares                  
            outstanding                                       9,595,969         6,748,810           3,763,587
       Potential common stock pursuant to stock        
            options                                                  --                --             219,660
                                                            -----------       -----------          ----------
       Diluted weighted average shares                        9,595,969         6,748,810           3,983,247
                                                            ===========       ===========          ==========
                                                     
       Basic earnings (loss)  per share                     $      (.19)      $      (.21)         $      .16
                                                            ===========       ===========          ==========
       Diluted earnings (loss) per share                    $      (.19)      $      (.21)         $      .15
                                                            ===========       ===========          ==========
</TABLE>
                                                                                

     (j) Postretirement Benefits

     The Company has no material obligations for postretirement benefits.

                                      A-12
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
                                        
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


(3) PURCHASE OF TECHNOLOGY AND OTHER ASSETS

    (a)  InnerVentions

    In February 1996, the Company issued 514,651 shares of its common stock and
    warrants to purchase 111,818 shares of common stock at $2.15 per share for
    the purchase of certain technology and related fixed assets. The Company
    valued the common stock issued in this transaction at $2.15 per share, which
    represented the fair value as determined by its Board of Directors and
    supported by an appraisal. The Company is required to pay certain future
    royalties, as defined in the agreement. The acquired technology relates to
    the CardioSEAL Septal Occluder for which the Company is conducting human
    clinical trials. At the time of the acquisition, it was determined that the
    commercial feasibility of the purchased technology was uncertain, and
    accordingly, the Company charged the amount of the purchase price allocated
    to the technology to operations as in-process research and development. The
    amount allocated to laboratory and computer equipment represents the
    estimated fair value at the date of acquisition of the acquired laboratory
    and computer equipment that have alternative future uses. The aggregate
    purchase price and acquisition costs incurred of $1,409,917 were allocated
    as follows:

<TABLE>

<S>                                                          <C>
          Laboratory and computer equipment                   $  298,783
          In-process research and development                  1,111,134
                                                              ----------
                                                              $1,409,917
                                                              ==========
</TABLE>

    (b)  Image Technologies Corporation

    On May 29, 1997 the Company entered into an agreement to invest $2.3 million
    in Image Technologies Corporation (ITC) in exchange for 345,722 shares of
    ITC's $.01 par value redeemable convertible preferred stock, representing a
    23% ownership interest in ITC. Under the terms of this agreement, the
    Company has also extended ITC a credit line of up to $2 million of senior
    debt, exchangeable for convertible preferred stock at the option of the
    Company and equivalent to up to an additional 20% ownership of ITC. ITC may
    draw against this line of credit based upon meeting its approved business
    plan. The Company, however, has the right to advance all of the line and
    exchange it for convertible preferred stock at its option. The Company also
    has a 24 month option to purchase the remaining 57% of ITC for $24.5
    million, of which up to $7.84 million may be payable in cash. The option may
    be extended for an additional six months under certain conditions. The
    Company guarantees the operating and capital leases of ITC (see Note 8(c)).

                                      A-13
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(3)  PURCHASE OF TECHNOLOGY AND OTHER ASSETS--(CONTINUED)

     (b)  Image Technologies Corporation--(continued)

     ITC uses certain facilities, management, administrative, and other services
     of NMT. Under this agreement ITC is to pay NMT $216,000 per annum for two
     years. During the year ended December 31, 1997, ITC's management service
     fees amounted to $126,000.

     ITC is a development stage company which is focusing its efforts on
     developing certain technologies and has generated no revenues to date. Due
     to the uncertainty regarding the realization of the investment, the Company
     charged the amount of the purchase price and related acquisition costs to
     operations as in-process research and development in the period of the
     investment in the accompanying statements of operations.

(4)  RESTRUCTURING CHARGE

     During 1997, the Company reorganized its vena cava filter operations and
     brought the assembly of its straight-line vena cava filters in-house. In
     connection with this restructuring, the Company reduced staff and incurred
     other non-recurring costs. The $194,000 restructuring charge in the
     accompanying statements of operations includes a non-cash charge of
     $112,000 for the accelerated vesting of certain stock options, cash
     severance and benefits of $62,000 and $20,000 for the transfer of assembly
     technology. Other start-up costs related to the in-house assembly of the
     straight-line vena cava filter, including the training of manufacturing
     personnel and associated materials and overhead, are included in cost of
     goods sold in the accompanying statements of operations.

                                      A-14
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

                                        
(5) INCOME TAXES

    The Company uses the liability method to account for income taxes in
    accordance with SFAS No. 109, Accounting for Income Taxes.

    Prior to October 19, 1995, the Company elected to be taxed as an S
    corporation for federal and state income tax purposes. Accordingly, the
    accompanying consolidated financial statements do not include a provision
    for the first 10 1/2 months of 1995. The provision for income taxes in the
    accompanying consolidated statement of operations for the period from
    October 19, 1995 to December 31, 1995 consists of the following:

<TABLE>
<CAPTION>

<S>                              <C>

                    Federal               $    --
                    State                  44,000                    
                                          -------                    
                                          $44,000                    
                                          =======                     
</TABLE>

    The accompanying 1995 consolidated statement of operations does not contain
    a pro forma income tax adjustment for periods prior to the termination of
    the S corporation election. If the election to be treated as an S
    corporation was not made, the Company would have been subject to federal and
    state corporate income taxes. However, the Company would have had sufficient
    net operating loss carryforwards to offset income in 1995. There is no
    provision for income taxes for the year ended December 31, 1996 as the
    Company incurred an operating loss during that year. The provision for
    income taxes in the accompanying consolidated statement of operations for
    the year ended December 31, 1997 consists of the following:

<TABLE>
<S>                                   <C>
                    Federal - current   $ 366,000
                    State - current        21,000
                                        ---------
                                          387,000
                                         
                    Federal - deferred  $(134,000)
                    State - deferred      (23,500)
                                        ---------
                                         (157,500)
                                        ---------
                                        $ 229,500
                                        =========
</TABLE>

    The Company has recorded the tax benefit of $366,000 associated with certain
    incentive stock option and non-qualified stock option exercises as a
    reduction in its current tax liability and as a component of additional paid
    in capital.

                                      A-15
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


(5) INCOME TAXES--(CONTINUED)

    As of December 31, 1997, the Company has net operating losses and credit
    carryforwards of approximately $81,000 and $515,000, respectively. The
    carryforwards expire through 2011 and are subject to possible adjustment
    by federal and state tax authorities.

    The approximate income tax effect of each temporary difference
    constituting the deferred tax asset, which is included in prepaid
    expenses and other current assets in the accompanying consolidated
    balance sheets, is as follows:


<TABLE>
<CAPTION>
                                                      DECEMBER 31,   DECEMBER 31,
                                                          1997           1996
                                                      ------------   ------------
     Deferred tax assets:
<S>                                                    <C>            <C>
        Tax credit carryforwards                        $ 515,000      $ 231,000
        Net operating loss carryforwards                   32,000        158,000
        Deferred revenue                                  120,000             --
        Reserves and nondeductible accruals                62,000         16,000
                                                        ---------      ---------
                                                          729,000        405,000
     Deferred tax liabilities:
        Depreciation                                      (24,000)       (21,000)
                                                        ---------      ---------
                                                          705,000        384,000
     Valuation allowance                                 (547,500)      (384,000)
                                                        ---------      ---------
     Net deferred tax asset                             $ 157,500      $      --
                                                        =========      =========
</TABLE>
                                                                                
    The Company has provided a valuation allowance for a portion of its gross
    deferred tax asset due to the uncertainty in its ability to fully utilize
    this asset. In 1997, the Company received a refund of $143,000 that was 
    recorded as refundable income taxes as of December 31, 1996.


(6) LOAN FROM DISTRIBUTOR

    The Company has an exclusive distribution agreement with an unrelated third
    party to provide for the sale and distribution of the Simon Nitinol Filter
    (SNF). In connection with this agreement, the Company received a loan of
    $1,500,000 from the distributor in 1992. The agreement called for the
    repayment of this loan by the Company through certain minimum purchases of
    the SNF by the distributor, as defined in the agreement. This loan was paid
    in full as of December 1996.

                                      A-16
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


(7) DEFERRED REVENUE

    On November 22, 1994, the Company licensed exclusive, worldwide rights,
    including the right to sublicense to others, to develop, produce and market
    its stent technology to an unrelated third party (the Licensee). In
    connection with the signing of the license agreement, the Company received
    $500,000 in consideration for the license granted and an additional
    $500,000 upon issuance of the United States patent for a specific stent.
    The Company was required to refund varying amounts of such payments based
    on the occurrence of certain events, as defined in the license agreement.
    The Company deferred recognition as revenue of amounts that were subject to
    refund until the expiration of the refund period. The final refund period
    expired in November 1996. Under this agreement the Company earned
    $1,200,000 and $750,000 in license revenues during the years ended December
    31, 1997 and 1996, respectively. All licensing revenues for 1995 were
    milestone revenues as discussed below. 

    During 1997, 1996 and 1995, the Company received $300,000, $1,625,000 and
    $625,000, respectively, in additional nonrefundable license fees upon the
    achievement of certain milestones, as defined in the license agreement.
    These amounts are included in license fees in the accompanying consolidated
    statements of operations. On December 31, 1997, the Company received a
    payment of $300,000 from the Licensee that pertains to a milestone achieved
    by the Company in 1998. This amount is included in deferred revenue in the
    accompanying balance sheet as of December 31, 1997 and will be recognized
    as revenue in 1998.
     
    Under a product development program with the Licensee, the Company received
    reimbursement of costs incurred related to the activities of product
    development, registration and transfer of technology to the Licensee. For
    the years ended December 31, 1997, 1996 and 1995, the Company received
    $61,000, $92,000, and $492,000, respectively, of reimbursements for
    development program costs. These reimbursed amounts are included in
    revenues in the accompanying consolidated statements of operations.

                                      A-17
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(8) COMMITMENTS, CONTINGENCIES AND CAPITAL LEASE ARRANGEMENTS

    (a) Manufacturing Agreement

    The Company contracts with an unrelated third party for the manufacture of
    certain components. Under the amended agreement dated February 15, 1996, the
    Company is required to purchase minimum unit quantities through June 2001.
    The aggregate minimum purchases under the agreement are approximately
    $2,600,000. In addition, in the event of an order cancellation or product
    conversion, the Company has agreed to purchase all in-process materials and
    all special materials purchased by the manufacturer for use in the
    production of these components, limited to purchase orders through 180 days
    after cancellation.

    (b) Operating Leases

    The Company has entered into operating leases for office and laboratory
    space. These leases expire through 2006. The leases require payment of all
    related operating expenses of the building, including real estate taxes and
    utilities in excess of base year amounts.

    Future minimum rental payments due under operating lease agreements as of
    December 31, 1997 are approximately as follows:

<TABLE>
<CAPTION>


               Year Ending                                    Amount 
               -----------                                    ------ 
         <S>                                               <C>       
                   1998                                    $  478,000
                   1999                                       472,000
                   2000                                       468,000
                   2001                                       503,000
                   2002                                       551,000
                   Thereafter                               1,973,000
                                                           ----------
                                                           $4,445,000
                                                           ========== 
</TABLE>

    Rent expense for the years ended December 31, 1997, 1996 and 1995 amounted
    to approximately $482,000, $303,000, and $103,000, respectively. In
    addition, the Company is a guarantor of the lease of office space for ITC
    (see Note 3(b)).

                                      A-18
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


(8) COMMITMENTS, CONTINGENCIES AND CAPITAL LEASE ARRANGEMENTS--(CONTINUED)

    (c) Capital Leases

    In June 1996, the Company entered into a $1.5 million lease finance facility
    agreement with a bank under which the Company leases equipment at an
    interest rate that is 200 basis points above the bank's cost of funds.
    Leases under this agreement are payable in equal monthly installments over a
    period of 36-60 months and expire through December 2002. Borrowings of
    $572,000 were made under this agreement, of which $433,000 was outstanding
    as of December 31, 1997.

    Upon expiration of this agreement in June 1997, the Company entered into a
    new agreement with the bank that provides the Company with similar terms and
    the option to borrow up to $1 million in the aggregate for the Company and
    ITC through March 31, 1998 (see Note 3(b)). Borrowings of $376,000 and
    $221,000 were made under this new agreement by the Company and ITC,
    respectively, of which $348,000 and $202,000 were outstanding as of December
    31, 1997. The Company has guaranteed the outstanding capital leases of ITC.

    Future minimum lease payments under the capital lease obligations of the
    Company as of December 31, 1997 are approximately as follows:

<TABLE>
<CAPTION>
 
         Year Ending                                          Amount
         -----------                                          ------
   <S>                                                      <C>     
             1998                                           $236,408
             1999                                            236,408
             2000                                            222,526
             2001                                            167,161
             2002                                             58,375
                                                            --------
                 Total minimum lease payments                920,878
             Less--Amount representing interest              139,684
                                                            --------
                                                             781,194
             Less--Current portion                           168,736
                                                            --------
                                                            $612,458
                                                            ======== 
</TABLE>
                                                                                

                                      A-19
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


(8) COMMITMENTS, CONTINGENCIES AND CAPITAL LEASE ARRANGEMENTS--(CONTINUED)

    (d) Royalties

    The Company has entered into various agreements that require payment of
    royalties based on specified percentages of future sales, as defined (see
    Notes 3 and 12). In addition, the Company has agreed to pay royalties to
    certain employees based on sales or licenses of products where they were the
    sole or joint inventor. Future minimum commitments under these agreements
    are approximately $15,000 per year. Royalty expense under royalty agreements
    was $278,000, $157,000 and $64,000 for the years December 31, 1997, 1996
    and 1995, respectively.

(9) COMMON STOCK

    (a) Authorized Common Stock

    On July 9, 1996, the Company increased the number of authorized shares of
    common stock from 10,000,000 to 30,000,000.

    (b) Stock Split

    On July 9, 1996, the Company effected a 1-for-1.9 reverse stock split of its
    common stock. Accordingly, all share and per share amounts of common stock
    have been retroactively restated for all periods presented to reflect the
    reverse stock split.

    (c) Initial Public Offering

    On October 2, 1996, the Company completed an initial public offering (the
    "Offering") of 3,000,000 shares of the Company's common stock at $11.00 per
    share for net proceeds of approximately $29,662,000, net of underwriting
    discounts and related expenses. Upon completion of the Offering, all
    outstanding shares of the Company's convertible preferred stock, par value
    $.001 per share, automatically converted into 1,993,212 and 3,787 shares of
    the Company's common stock and redeemable preferred stock, par value $.001
    per share, respectively. A portion of the proceeds from the Offering was
    used to redeem the redeemable preferred stock for $4,505,000, which included
    dividends of $255,000. Pursuant to an over-allotment option, on October 30,
    1996, the underwriters of the Offering purchased an additional 150,000
    shares of the Company's common stock at $11.00 per share, resulting in
    additional net proceeds to the Company of approximately $1,535,000.

                                      A-20
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(10) PREFERRED STOCK

     In February 1996, the Board of Directors authorized 3,800,000 shares of
     convertible preferred stock and 38,000 shares of redeemable preferred
     stock. The Company then sold 3,787,104 shares of preferred stock at $2.24
     per share, resulting in net proceeds to the Company of approximately
     $7,500,000. On July 9, 1996, the Company authorized 3,000,000 shares of
     undesignated preferred stock. As a result of the Offering discussed in Note
     9(c), the Company's convertible preferred stock was converted into common
     stock and redeemable preferred stock, and the redeemable preferred stock,
     including dividends, was redeemed for $4,505,000.


(11) STOCK OPTIONS AND WARRANTS

     (a) Nonqualified Stock Options

     The Company granted nonqualified options to various officers, directors,
     employees, and/or consultants to purchase shares of common stock. The
     options become exercisable in full or in part at issuance or within one to
     four years of the date of issuance. All unexercised grants expire on the
     earlier of approximately five to ten years from date of issuance or 90 days
     after termination of service as an officer, director, employee and/or
     consultant. Subsequent to December 31, 1997, the Company issued 25,000 such
     options at an exercise price of $10.50 per share.

     (b) Stock Option Plans

     1994 Stock Option Plan. In May 1994, the Board of Directors approved a
     stock option plan (the 1994 Plan), which authorizes the Company to issue
     options to purchase up to 315,789 shares of the Company's common stock. The
     Company may grant options to officers, key employees, directors and
     consultants of the Company at an exercise price not less than fair market
     value as determined by the Board of Directors. Through December 31, 1997
     the Company has granted 308,368 options under this plan and does not intend
     to grant any additional options under this plan.

                                      A-21
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(11) Stock Options and Warrants--(CONTINUED)

     (b)  Stock Option Plans--(continued)

     1996 Stock Option Plan. The Nitinol Medical Technologies, Inc. 1996 Stock
     Option Plan (the 1996 Plan) was approved by the Company's stockholders in
     July 1996. The 1996 Plan provides for the grant of options to acquire a
     maximum of 600,000 shares of common stock. As of December 31, 1997, 316,276
     shares are subject to outstanding options at an exercise price of $8.25-
     $14.63 per share. The Board of Directors has appointed a Stock Option
     Committee of the Board as the Plan Administrator. The 1996 Plan permits the
     granting of incentive stock options or nonstatutory stock options at the
     discretion of the Plan Administrator. Subject to the terms of the 1996
     Plan, the Plan Administrator determines the terms and conditions of options
     granted under the 1996 Plan. At December 31, 1997, 283,724 shares are
     available for future grants under the 1996 Plan. Subsequent to December 31,
     1997, the Company granted options to purchase 125,100 shares of common
     stock at $7.38-10.50 per share.

     The 1996 Directors Stock Plan. The Nitinol Medical Technologies, Inc. 1996
     stock option plan for non-employee directors (the 1996 Directors' Stock
     Plan) was approved by the Company's stockholders in July 1996. The 1996
     Directors' Stock Plan provides for the automatic grant of nonstatutory
     stock options to purchase shares of common stock to directors of the
     Company who are not employees of the Company and who do not otherwise
     receive compensation from the Company.

     Under the 1996 Directors' Stock Plan, 150,000 shares of common stock have
     been reserved for issuance of options. Each eligible director serving on
     the Board on the effective date of the 1996 Directors' Stock Plan
     automatically received an option to purchase 10,000 shares of common stock
     at a price equal to the initial public offering price, subject to vesting
     in equal monthly installments over a period of three years. In the future,
     each nonemployee director not otherwise compensated by the Company, who
     joins the Board will automatically receive an initial grant of options to
     purchase 10,000 shares of common stock at an exercise price equal to the
     fair market value per share at the date of grant, subject to vesting in
     equal monthly installments over a three year period.

                                      A-22
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(11) STOCK OPTIONS AND WARRANTS--(CONTINUED)

     (b)  Stock Option Plans--(continued)

     In each year other than the year in which a director receives an initial
     grant of options, such director will automatically receive options to
     purchase 2,500 shares of common stock that shall become fully-vested six
     months after the date of grant. As of December 31, 1997, 50,000 shares are
     subject to outstanding options at an exercise price of $9.88-$14.00 per
     share, of which 13,333 shares are exerciseable. Subsequent to December 31,
     1997, the Company granted options to purchase 10,000 shares of common stock
     at $7.38 per share.

     The following table summarizes all stock option activity under all of the
     Company's stock option plans, including grants outside of the 1996 and 1994
     Plans:

<TABLE>
<CAPTION>
                                                                         WEIGHTED
                                                                     AVERAGE EXERCISE
                                                       NUMBER OF        PRICE PER
                                                        Shares            Share
                                                      ---------          ---------
<S>                                            <C>                    <C>
         Balance, January 1, 1995                       392,104             $ 1.05
            Granted                                     539,459               2.15
            Exercised                                   (15,790)               .19
                                                      ---------          ---------     
         Balance, December 31, 1995                     915,773               1.70
            Granted                                   1,060,431               5.17
            Exercised                                    (3,947)              2.15
                                                      ---------          ---------
         Balance, December 31, 1996                   1,972,257               3.56
            Granted                                     141,500              12.04
            Canceled                                    (44,411)              9.72
            Exercised                                  (322,485)              1.68
                                                      ---------          ---------
         Balance, December 31, 1997                   1,746,861             $ 4.44
                                                      =========             ======
         Exercisable, December 31, 1997               1,037,188             $ 2.99
                                                      =========             ======
         Weighted average remaining
          contractual life of options
          oustanding                                 7.62 years

</TABLE>

                                      A-23
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(11) STOCK OPTIONS AND WARRANTS--(CONTINUED)

     (b)  Stock Option Plans--(continued)

     The following detail pertains to outstanding options of the Company at
     December 31, 1997:

<TABLE>
<CAPTION>

                                   WEIGHTED AVERAGE                     WEIGHTED AVERAGE
 NUMBER OF       EXERCISE PRICE     EXERCISE PRICE     NUMBER OF         EXERCISE PRICE 
  SHARES           RANGE PER           PER SHARE        SHARES             PER SHARE   
OUTSTANDING    SHARE OUTSTANDING     OUTSTANDING      EXERCISABLE          EXERCISABLE
-----------    -----------------   ---------------   ------------     -------------------
<S>             <C>                 <C>              <C>               <C>                 
  1,170,818        $   .76-3.19          $ 1.99          878,669            $ 1.91      
    493,293          6.95-10.88            8.77          178,144              8.21      
     82,750         11.50-14.63           13.23              375             11.50      
  ---------        ------------          ------        ---------            ------      
  1,746,861        $ .76-$14.63          $ 4.44        1,037,188            $ 2.99      
  =========        ============          ======        =========            ======       

</TABLE>
                                                                                
    The Company accounts for its stock-based compensation plans under APB
    Opinion No. 25, Accounting for Stock Issued to Employees. In October 1995,
    the Financial Accounting Standards Board issued SFAS No. 123, Accounting for
    Stock-Based Compensation, which is effective for fiscal years beginning
    after December 15, 1995. SFAS No. 123 establishes a fair-value based method
    of accounting for stock-based compensation plans. The Company has adopted
    the disclosure-only alternative under SFAS No. 123, which requires
    disclosure of the pro forma effects on earnings and earnings per share as if
    SFAS No. 123 had been adopted, as well as certain other information.

    The Company has computed the pro forma disclosures required under SFAS No.
    123 for all employee stock options granted in 1997, 1996 and 1995 using the
    Black-Scholes option pricing model prescribed by SFAS No. 123.

    The assumptions used and the weighted average information for the years
    ended December 31, 1997, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
                                                         DECEMBER 31,    December 31,      December 31,
                                                             1997            1996              1995
                                                         -------------  ---------------  ----------------
<S>                                                    <C>                 <C>              <C>
   Risk-free interest rates                                 5.71%-6.61%      5.14%-6.39%       5.39%-5.77%
   Expected dividend yield                                          --               --                --
   Expected lives                                            3-5 years        3-5 years           3 years    
   Expected volatility                                              67%              48%               48%
   Weighted average grant-date fair value of options                                                     
         granted during the period                         $      6.38      $      1.68       $       .82
   Weighted average exercise price                         $     12.15      $      4.15       $      2.15 

</TABLE>

                                      A-24
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(11) STOCK OPTIONS AND WARRANTS--(CONTINUED)

     (b)  Stock Option Plans--(continued)

     The effect of applying SFAS No. 123 would be as follows:

<TABLE>
<CAPTION>
                                                                        DECEMBER 31,    December 31,    December 31, 
                                                                            1997            1996            1995     
                                                                      --------------  --------------  -------------- 
      <S>                                                             <C>             <C>             <C>            
      Pro forma net income (loss)                                       $(2,670,975)    $(1,578,296)        $564,110 
                                                                        ===========     ===========         ======== 
      Pro forma basic net income (loss) per share                       $      (.28)    $      (.23)        $    .15 
                                                                        ===========     ===========         ======== 
      Pro forma diluted net income (loss) per share                     $      (.28)    $      (.23)        $    .14 
                                                                        ===========     ===========         ========  
</TABLE>

     (c) Warrants

     In connection with the technology purchase discussed in Note 3(a), the
     Company issued warrants to purchase 111,818 shares of common stock at $2.15
     per share. The warrants are fully exercisable and expire ten years from the
     date of grant.

     In February 1996, the Company issued warrants to purchase 164,439 shares of
     common stock at $4.26 per share to placement agents in connection with a
     private placement of the Company's convertible preferred stock. In April
     1997, 64,779 of these warrants were exercised.

     In April 1996, the Company issued a warrant to purchase 5,263 shares of
     common stock at $.02 per share in connection with a patent license
     agreement. The warrant is fully exercisable and expires ten years from the
     date of grant.

     (d) Employee Stock Purchase Plan

     Effective October 1, 1997, the Company's shareholders approved an employee
     stock purchase plan (the Stock Plan). The Stock Plan allows eligible
     employees to purchase common stock of the Company through payroll
     deductions at a price that is 85% of the lower of the closing price of the
     Company's stock on the either the beginning or ending of the six month
     offering period. The Company has reserved 90,000 of its $.001 par value
     common stock for issuance under this Stock Plan.

                                      A-25
<PAGE>
 
              NITINOL MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                                        

(12) TECHNOLOGY PURCHASE AGREEMENT

     Pursuant to a technology purchase agreement (TPA), the Company purchased
     from a stockholder/founder the proprietary rights to the primary patent for
     the SNF and related technology. Under the terms of the TPA, the Company
     made an initial payment of $15,000 and agreed to pay royalties based upon
     various rates of cumulative net sales, as defined, with minimum royalties
     payable of $15,000 per year. Royalties are payable over the life of the
     primary patent and commenced after FDA approval. The Company has granted
     the stockholder/founder a security interest in substantially all
     proprietary rights acquired by the Company. In the event of unsecured
     defaults, as set forth in the TPA, the Company has agreed to immediately
     pay the stockholder/founder damages of $100,000.

(13) RELATED PARTY TRANSACTIONS

     Three stockholders of the Company and related entities provide management
     consulting services to the Company. Total payments made during the years
     ended December 31, 1997, 1996 and 1995 in connection with such services
     were approximately $196,000, $256,000 and $242,000, respectively. Beginning
     January 1, 1998 only one shareholder provides consulting services to the
     Company, at a rate of $100,000 per annum.

(14) ACCRUED EXPENSES:

     Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                             At December 31,
                                           1997           1996
                                           ----           ----
<S>                                   <C>             <C>
     Payroll and payroll related         $252,425       $231,211
     Leasehold improvements                48,553        108,553
     Royalties                            116,012         75,520
     Other accrued expenses               569,138        262,880
                                         --------       --------
        Total accrued expenses           $986,128       $678,164
                                         ========       ========
</TABLE>
                                                                                

                                      A-26
<PAGE>
 

                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Image Technologies Corporation:

We have audited the accompanying balance sheet of Image Technologies Corporation
(a Delaware corporation in the development stage) as of December 31, 1997, and 
the related statements of operations, stockholders' equity (deficit) and cash 
flows for the year then ended, and for the period from inception (November 17, 
1995) to December 31, 1997.  These financial statements are the responsibility 
of the Company's management.  Our responsibility is to express an opinion on 
these financial statements based on our audit.

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

In our opinion, the financial statements referred to above present fairly, in 
all material respects, the financial position of Image Technologies Corporation 
as of December 31, 1997, and the results of its operations and cash flows for 
the year then ended and for the period from inception (November 17, 1995) to 
December 31, 1997, in conformity with generally accepted accounting principles. 

The accompanying financial statements have been prepared assuming that the 
Company will continue as a going concern.  As discussed in Note 1 to the 
financial statements, the Company has suffered recurring losses from operations 
and has a net capital deficiency that raises substantial doubt about its ability
to continue as a going concern.  Management's plans in regard to these matters 
are also described in Note 1. The financial statements do not include any 
adjustments that might result from the outcome of this uncertainty.

                                                             Arthur Andersen LLP

Boston, Massachusetts
February 9, 1998

                                     A-27
<PAGE>
 
                        IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)
                                        
                                 BALANCE SHEET
<TABLE>
<CAPTION>
                                                                     AT DECEMBER 31,
                                                                          1997
                                                                     ---------------
ASSETS
 
Current assets:
<S>                                                                 <C>
  Cash and cash equivalents                                              $   840,652
  Prepaid expenses and other current assets                                   43,114
                                                                         -----------
     Total current assets                                                    883,766
                                                                         -----------
Property and equipment, at cost:
  Equipment under capital lease                                              221,138
  Laboratory and computer equipment                                           40,295
       Leasehold improvements                                                 36,987
  Office furniture and equipment                                              31,550
                                                                         -----------
                                                                             329,970
  Less--Accumulated depreciation and amortization                             24,016
                                                                         -----------
                                                                             305,954
                                                                         -----------
 
Other assets                                                                  34,667
                                                                         -----------
                                                                         $ 1,224,387
                                                                         ===========
 
     LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
 
Current liabilities:
  Accounts payable                                                       $    36,141
  Accrued expenses                                                            55,567
  Current portion of capital lease obligation                                 48,818
                                                                         -----------
     Total current liabilities                                               140,526
                                                                         -----------
Capital lease obligation, net of current portion                             153,211
                                                                         -----------
 
Commitments and contingencies (Note 5)
 
Series A Redeemable Convertible Preferred stock, $.01 par value--
     Authorized--1,000,000 shares
     Issued and outstanding--345,722 shares
       (liquidation preference of $2,300,000)                               2,300,000
 
Stockholders' equity (deficit):
  Common stock, $.01 par value--
    Authorized--5,000,000 shares
    Issued and outstanding--1,139,680 shares                                  11,397
  Additional paid-in capital                                                 541,603
  Accumulated deficit                                                     (1,922,350)
                                                                         -----------
     Total stockholders' deficit                                          (1,369,350)
                                                                         -----------
                                                                         $ 1,224,387
                                                                         ===========
</TABLE>
                                                                                
   The accompanying Notes are an integral part of these Financial Statements.

                                      A-28
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)
                                        
                            STATEMENTS OF OPERATIONS



<TABLE>
<CAPTION>
                                                                FROM INCEPTION
                                            FOR THE YEAR     (NOVEMBER 17, 1995)
                                         ENDED DECEMBER 31,     TO DECEMBER 31,
                                                1997                1997      
                                      -------------------     ----------------
<S>                                   <C>                     <C>             
Expenses:                                                                     
  Research and development                   $   327,569          $   689,482 
  General and administrative                     831,725            1,111,451 
                                             -----------          ----------- 
     Loss from operations                     (1,159,294)          (1,800,933)
                                             -----------          ----------- 
Interest expense                                  (7,366)             (22,066)
Interest income                                   38,120               38,120 
                                             -----------          ----------- 
                                                  30,754               16,054 
                                             -----------          ----------- 
     Net Loss                                $(1,128,540)         $(1,784,879)
                                             ===========          ===========  
Basic loss per common share                        $(.99)
                                             ===========
Weighted average common and common             1,136,315
 equivalent shares outstanding               ===========
 
</TABLE>

   The accompanying Notes are an integral part of these Financial Statements.

                                      A-29
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
 
                                                       
                                          Common Stock
                                  -------------------------                                            Total
                                   Number            $.01        Paid-in           Accumulated      Stockholders'
                                  of Shares       Par Value      Capital             Deficit       Equity/(Deficit)
                                  ---------         -------   -------------   ------------------   ---------------
<S>                            <C>            <C>             <C>             <C>                  <C>
Initial issuance of common
        stock                       825,908         $ 8,259       $  46,741        $          --       $    55,000
     Net loss                            --              --              --             (248,582)         (248,582)
                                  ---------         -------       ---------        -------------       -----------
Balance, December 31, 1995          825,908           8,259          46,741             (248,582)         (193,582)
        (unaudited)
     Issuance of common
        stock                       285,204           2,852         487,148                   --           490,000
     Net loss                            --              --              --             (407,757)         (407,757)
                                  ---------         -------       ---------        -------------       -----------
Balance, December  31, 1996       1,111,112          11,111         533,889             (656,339)         (111,339)
        (unaudited)
     Issuance of common
        stock                        73,662             737         499,263                   --           500,000
     Redemption of common
        stock                       (45,094)           (451)       (299,549)                  --          (300,000)
     Accretion of redeemable
        convertible stock
        discount                         --              --              --             (137,471)         (137,471)
     Distribution to common
        shareholders                     --              --        (192,000)                  --          (192,000)
     Net loss                            --              --              --           (1,128,540)       (1,128,540)
                                  ---------         -------       ---------        -------------       -----------
Balance, December  31, 1997       1,139,680         $11,397       $ 541,603         ($ 1,922,350)      $(1,369,350)
                                  =========         =======       =========        =============       ===========
</TABLE>
   The accompanying Notes are an integral part of these Financial Statements.

                                      A-30
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                            STATEMENTS OF CASH FLOWS



<TABLE>
<CAPTION>
                                                                         FOR THE            FROM INCEPTION
                                                                        YEAR ENDED       (NOVEMBER 17, 1995)
                                                                        DECEMBER 31,        TO DECEMBER 31,
                                                                            1997                 1997
                                                                       -------------     -------------------
<S>                                                                     <C>                  <C>
Cash flows from operating activities:
  Net loss                                                                $(1,128,540)         $(1,784,879)
  Adjustments to reconcile net loss to net cash used
   in operating activities--
    Depreciation and amortization                                              25,226               25,226
    Changes in assets and liabilities--
      Prepaid expenses and other current assets                               (43,114)             (43,114)
      Accounts payable                                                         24,991               36,141
      Accrued expenses                                                         55,567               55,567
                                                                          -----------          -----------
         Net cash used in operating activities                             (1,065,870)          (1,711,059)
                                                                          -----------          -----------
Cash flows from investing activities:
  Purchases of property and equipment                                        (103,502)            (108,832)
  Increase in other assets                                                    (28,540)             (35,877)
                                                                          -----------          -----------
         Net cash used in investing activities                               (132,042)            (144,709)
                                                                          -----------          -----------
Cash flows from financing activities:
  Net proceeds from issuance of redeemable convertible
      preferred stock                                                       2,162,529            2,162,529
  Proceeds from issuance of common stock                                      500,000            1,045,000
  Redemption of common stock                                                 (300,000)            (300,000)
  Distribution to shareholders                                               (192,000)            (192,000)
  Payment of debt obligation, net of borrowings                              (113,300)                  --
  Payments of capital lease obligations                                       (19,109)             (19,109)
                                                                          -----------          -----------
         Net cash provided by financing activities                          2,038,120            2,696,420
                                                                          -----------          -----------
Net increase in cash and cash equivalents                                     840,208              840,652
Cash and cash equivalents, beginning of period                                    444                   --
                                                                          -----------          -----------
Cash and cash equivalents, end of period                                  $   840,652          $   840,652
                                                                          ===========          ===========
Supplemental disclosure of cash flow information:
  Cash paid during the period for--
    Interest                                                              $     7,366          $    22,066
                                                                          ===========          ===========
    Taxes                                                                 $        --          $        --
                                                                          ===========          ===========
Supplemental disclosure of non-cash investing and financing
 transactions:
 Equipment acquired under capital lease obligations                       $   221,138          $   221,138
                                                                          ===========          ===========
</TABLE>

   The accompanying Notes are an integral part of these Financial Statements.

                                      A-31
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                         NOTES TO FINANCIAL STATEMENTS
                                        

  (1) OPERATIONS

      Image Technologies Corporation (ITC), a Delaware corporation in the
      development stage, was originally incorporated in Texas on November 17,
      1995(see Note 7(a)). ITC is in the development stage and was organized for
      the design and development of advanced endoscopic imaging products for
      minimally invasive surgery which require less equipment, are easier to
      use, reduce procedure time and personnel requirements, improve operating
      room efficiency and reduce overall treatment costs. The Company is
      spending primarily all of its efforts developing such products at December
      31, 1997.

      ITC's product development efforts are subject to the risks inherent in the
      development of products based on innovative technologies. These risks
      include the possibilities that ITC's products under development will be
      found to be ineffective or unsafe, or will otherwise fail to receive
      necessary regulatory approvals; that the products, if safe and effective,
      will be difficult to manufacture on a large scale or be uneconomical to
      market; that the proprietary rights of third parties will interfere with
      ITC's product development; or that third parties will market superior or
      equivalent products which achieve greater market acceptance.

      The accompanying financial statements have been prepared assuming that ITC
      will continue as a going concern. ITC is in the development stage and has
      incurred operating losses since inception. Given the uncertainty regarding
      ITC's ability to raise the capital necessary to fund operations, there is
      substantial doubt about ITC's ability to continue as a going concern (see
      Note 3).

  (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      (a) Management Estimates

      The preparation of accrual-based financial statements in conformity with
      generally accepted accounting principles requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the
      date of the financial statements and the reported amounts of revenues and
      expenses during the reporting periods. Actual results could differ from
      those estimates.

                                      A-32
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)


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

     (b) Cash and Cash Equivalents

     ITC considers all investments with an original maturity of 90 days or less
     to be cash equivalents. Cash and cash equivalents of ITC consist of money
     market accounts.

     (c) Financial Instruments

     The estimated fair values of ITC's financial instruments, which include
     cash and cash equivalents and capital lease obligations approximate their
     reported amounts.

     (d) Depreciation and Amortization

     ITC provides for depreciation and amortization by charges to operations
     using the straight-line method, which allocates the cost of property and
     equipment over the following estimated useful lives:

<TABLE>
<CAPTION>
                                                      ESTIMATED 
              ASSET CLASSIFICATION                    USEFUL LIFE
              --------------------                    -----------
<S>                                                  <C>
         Equipment under capital lease               Life of Lease 
         Laboratory and computer equipment           5-7 Years    
         Leasehold improvements                      Life of Lease
         Office furniture and equipment              5-10 Years   
</TABLE>

     (e) Net Loss per Common and Common Equivalent Share

     ITC computed net loss per common share in accordance with Statement of
     Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. Under
     the provisions of SFAS No. 128, basic loss per common and common equivalent
     share is based on the weighted-average number of shares of common stock
     outstanding during the respective periods. Diluted loss per share has not
     been presented as the inclusion of convertible preferred stock and stock
     options would be antidilutive.

                                      A-33
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                       (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
                                        

(3)  INVESTMENT BY NITINOL MEDICAL TECHNOLOGIES, INC.

     On May 29, 1997, ITC entered into an agreement with Nitinol Medical
     Technologies, Inc. (NMT) whereby NMT invested $2.3 million in ITC in
     exchange for 345,722 shares of ITC's $.01 par value Series A convertible
     preferred stock (Series A Preferred Stock), representing a 23% ownership
     interest in ITC. In conjunction with this agreement with NMT, ITC issued
     and subsequently redeemed 45,094 shares of $.01 par value common stock for
     $300,000, made distributions to shareholders for $192,000, and paid
     issuance costs of approximately $137,000. 

     Under the terms of this agreement, NMT has extended ITC a credit line of up
     to $2 million of senior debt, convertible to convertible preferred stock at
     the option of NMT and equivalent to up to an additional 20% ownership of
     ITC. ITC may draw against this line of credit based upon meeting its
     approved business plan. NMT, however, has the right to advance all of the
     line and convert to convertible preferred stock at its option (see Note
     6(a)). NMT also has a 24 month option to purchase the remaining 57% of ITC
     for $24.5 million of which up to $7.84 million may be payable in cash. The
     option may be extended for an additional six months under certain
     conditions.

(4)  INCOME TAXES

     ITC provides for income taxes in accordance with the liability method under
     the provisions of SFAS No. 109, Accounting for Income Taxes. Under SFAS No.
     109, deferred tax assets or liabilities are computed based on the
     differences between the financial statement and income tax bases of assets
     and liabilities using the enacted marginal rate. No income taxes were
     provided for the year ended December 31, 1997 as a result of ITC incurring
     an operating loss for such year. ITC has net operating loss carryforwards
     of $1.4 million. The carryforwards expire through 2012 and are subject to
     possible adjustments by tax authorities. ITC has recorded a full valuation
     allowance against its deferred tax asset of $560,000. The principal
     components of the deferred tax asset are the net operating loss
     carryforwards.

                                      A-34
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                       (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

                                        
(5) COMMITMENTS, CONTINGENCIES AND CAPITAL LEASE COMMITMENTS

    (a)  Operating Leases

    In May 1997, ITC entered into an operating lease for office and laboratory
    space. This lease expires through 2002. The lease requires payment of all
    related operating expenses of the building, including real estate taxes and
    utilities in excess of base year amounts. The lease is guaranteed by NMT
    (see Note 3).

    Future minimum rental payments due under operating lease agreements as of
    December 31, 1997 are approximately as follows:

<TABLE>
<CAPTION>

                   Year Ending              Amount 
                   -----------              ------ 
<S>                                        <C>     
                      1998                 $195,000
                      1999                  169,000
                      2000                  169,000
                      2001                  169,000
                      2002                  127,000
                                           --------
                                           $829,000
                                           ======== 
</TABLE>

    Rent expense for the year ended December 31, 1997 was approximately $66,000.

    (b) Capital Leases

    As part of NMT's investment in ITC (see Note 3), ITC has entered into a
    joint NMT/ITC $1.0 million lease finance facility agreement with a bank
    under which ITC leases equipment at an interest rate that is 200 basis
    points above the bank's cost of funds. Leases under this agreement are
    payable in equal monthly installments over a period of 36-60 months and
    expire through September 2002. Borrowings of $221,000 were made under this
    agreement of which $202,000 was outstanding as of December 31, 1997. The
    agreement expires on March 31, 1998 and outstanding leases under this
    agreement are guaranteed by NMT.

                                      A-35
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
                                        

(5) COMMITMENTS, CONTINGENCIES AND CAPITAL LEASE COMMITMENTS--(CONTINUED)

    (b) Capital Leases--(continued)

    Future minimum lease payments under the capital lease obligation of ITC as
    of December 31, 1997 are approximately as follows:

<TABLE>
<CAPTION>

       Year Ending                    Amount
       -----------                    ------
<S>                                 <C>
          1998                                    $ 64,383
          1999                                      64,383
          2000                                      52,584
          2001                                      34,042
          2002                                      22,695
                                                  --------
              Total minimum lease payments         238,087
          Less--Amount representing interest        36,058
                                                  --------
                                                   202,029
          Less--Current portion                     48,818
                                                  --------
                                                  $153,211
                                                  ========
</TABLE>
                                                                                

    (c)  Management Services Agreement

    As part of ITC's agreement with NMT dated May 29, 1997, (see Note 3) ITC
    uses certain facilities, management, administrative, and other services of
    NMT. Under this agreement ITC is to pay NMT $216,000 per annum for two
    years. During the year ended December 31, 1997, ITC's management service
    fees amounted to $126,000.

    (d)  Other Agreements

    ITC has employment agreements with certain key employees which in addition
    to setting forth the terms of employment, also provide for severance
    payments of up to one year's salary and fringe benefits, depending on the
    termination circumstances, and prohibit the employees from conducting
    business that is in direct competition with ITC for one year following
    termination.

                                      A-36
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

                                        
(6) SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK

    ITC has authorized 1,000,000 shares of $.01 par value Series A redeemable
    convertible preferred stock of which 345,722 shares are outstanding as of
    December 31, 1997. Series A redeemable convertible preferred stock is
    convertible, at any time at the option of the holder, into shares of the
    Company's $.01 par value common stock at a rate of one common share for each
    redeemable convertible preferred share, subject to certain adjustments.
    Prior to the expiration of NMT's option to purchase the remaining 57% of ITC
    (see Note 3), any dividends declared on Series A redeemable convertible
    preferred stock accrue at 8% per annum and are non-cumulative. As of
    December 31, 1997, no such dividends have been declared. Commencing on the
    expiration date of NMT's option, such dividends shall accrue and shall be
    cumulative whether or not declared. In addition, in the event NMT does not
    exercise its aforementioned option, the Series A preferred stockholders have
    the right to require redemption of their shares at any time commencing on
    the earlier of (1) the closing of any debt or equity financing resulting in
    at least $8 million of gross proceeds to ITC, or (2) the merger or
    consolidation of ITC into or with another corporation or the sale of
    substantially all of the assets of ITC, or (3) May 29, 2003. The right to
    redemption terminates upon the closing of a public offering, as defined
    below.

    The Series A redeemable convertible preferred stock automatically converts
    to common stock upon the closing of a public offering providing ITC with
    gross proceeds of at least $15 million and initial public offering price of
    at least $15.00 per share. The right of the holders of Series A redeemable
    convertible preferred stock to redeem their shares terminates upon the
    commencement of such offering.

    Upon liquidation of ITC, the Series A preferred stockholders are entitled,
    before any distribution is made to the common stockholders, to be paid the
    greater of $6.65 per share plus accrued dividends or such amount per share
    as would have been payable had each share been converted into common stock.
    The Series A preferred stockholders vote, together with the common
    stockholders, as a single class based on the number of shares of common
    stock into which the Series A preferred shares convert. The Series A
    preferred stockholders are entitled, as a separate class, to elect the
    minimum number of directors that constitute at least 40% of the total number
    of directors of ITC, with the common stockholders, as a separate class,
    electing the remainder.

                                      A-37
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

                                        
(7) STOCKHOLDERS' EQUITY

    (a) Common Stock

    On May 27, 1997, ITC reincorporated in Delaware and merged its previous
    Texas corporation into the Delaware corporation. ITC has 5,000,000 shares of
    authorized common stock, $.01 par value, of which 1,139,680 shares are
    issued and outstanding and 200,000 shares are reserved for issuance under
    ITC's 1997 Stock Option Plan as of December 31, 1997.

    (b)  Stock Option Plan

    On May 29, 1997, the Board of Directors and stockholders approved the 1997
    Stock Option Plan (the 1997 Plan), which authorizes ITC to issue options to
    purchase up to 200,000 shares of common stock. ITC may grant options to
    officers, key employees, directors and consultants of the Company at an
    exercise price not less than fair market value as determined by the Board of
    Directors. The options under the 1997 Plan vest in equal installments of 25%
    per year over four years and expire ten years from the date of grant with no
    options vesting or becoming exercisable at any time while NMT's option to
    purchase the remaining 57% of ITC (see Note 3) remains outstanding. Upon the
    expiration or exercise of NMT's option to purchase ITC, the options granted
    under the 1997 Plan will be vested from the date of grant.

    During the year ended December 31, 1997, ITC granted options to purchase
    93,500 shares of common stock at an exercise price of $6.65 per share.
    Subsequent to December 31, 1997, ITC issued an additional 6,000 options at
    $6.65 per share.

    ITC accounts for its stock-based compensation plans under APB Opinion No.
    25, Accounting for Stock Issued to Employees. In October 1995, the Financial
    Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based
    Compensation, which is effective for fiscal years beginning after December
    15, 1995. SFAS No. 123 establishes a fair-value based method of accounting
    for stock-based compensation plans. ITC has adopted the disclosure-only
    alternative under SFAS No. 123, which requires disclosure of the pro forma
    effects on earnings and earnings per share as if SFAS No. 123 had been
    adopted, as well as certain other information.

                                      A-38
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

                                        
(7) STOCKHOLDERS' EQUITY

    (b)  Stock Option Plan--(continued)

    ITC has computed the pro forma disclosures required under SFAS No. 123 for
    all employee stock options granted in 1997 using the Black-Scholes option
    pricing model prescribed by SFAS No. 123.

    The assumptions used and the weighted average information for the year ended
    December 31, 1997 are as follows:

<TABLE>
<CAPTION>
                                                                         DECEMBER 31,
                                                                            1997     
                                                                      --------------- 
<S>                                                           <C>
    Risk-free interest rates                                                6.29%
    Expected dividend yield                                                   --
    Expected lives                                                       7 years 
    Expected volatility                                                       -- 
    Weighted average grant-date fair value of options                            
          granted during the period                                        $2.37 
    Weighted average exercise price                                        $6.65 
    Weighted average remaining contractual life of options                       
          outstanding                                                    9 years 

                                                                                 
    The effect of applying SFAS No. 123 would be as follows:                   

                                                                       DECEMBER 31,
                                                                           1997
                                                                     --------------
    Pro forma net loss                                                $(1,145,362) 
                                                                      ===========  
    Pro forma net loss per share                                      $     (1.01) 
                                                                      ===========  
    </TABLE>                     
    The aggregate fair value of options granted in 1997 was approximately      
    $221,500.                                                                  
    
    (c) Warrants                                                               
    
    In connection with the investment by NMT (see Note 3), ITC issued warrants 
    to a financial advisor to purchase 17,737 shares of common stock at $6.65  
    per share. The warrants are fully exercisable and expire on May 28, 2002.   

                                      A-39
<PAGE>
 
                         IMAGE TECHNOLOGIES CORPORATION
                        (A DEVELOPMENT-STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

<TABLE>
<CAPTION>
 

(8)    ACCRUED EXPENSES

   Accrued expenses consist of the following as of December 31, 1997:

                                     Amount
                                     ------
<S>                                 <C>
          Accrued bonuses           $11,000
          Accrued legal               8,686
          Accrued other              35,881
                                    -------
                                    $55,567
                                    =======
</TABLE>
                                                                                

                                      A-40
<PAGE>
 
                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit No.                   Description of Exhibit
-------------                 ----------------------
<C>            <S>  
    3.1        Amended and Restated Certificate of Incorporation. (1)

    3.1.1      Certificate of Amendment of the Amended and Restated Certificate of
               Incorporation. (1)

    3.2        Amended and Restated By-laws. (1)

    4.1        Form of Common Stock Certificate.  (1)

   10.1        Stock Purchase Agreement by and among the Company, Whitney Equity
               Partners, L.P., Boston Scientific Corporation, David J. Morrison, Corporate
               Decisions, Inc., dated as of February 16, 1996. (1)

   10.2        Registration Rights Agreement by and among the Company, Whitney
               Equity Partners, L.P., Boston Scientific Corporation, David J. Morrison,
               Corporate Decisions, Inc., dated as of February 16, 1996. (1)

   10.3        Agreement and Plan of Merger by and among the Company, NMT Heart,
               Inc., InnerVentions, Inc. and Fletcher Spaght, Inc., dated as of January 25,
               1996. (1)

   10.4        Stock Purchase Warrant by and between the Company and Fletcher
               Spaght, Inc., dated February 14, 1996. (1)

   10.5        Pledge Agreement by and between the Company and Fletcher Spaght,
               Inc., dated February 14, 1996. (1)

   10.6        Registration Rights Agreement by and between the Company and Fletcher
               Spaght, Inc., dated as of February 14, 1996. (1)

   10.7        Distribution Agreement by and between the Company and the Bard
               Radiology division of C.R. Bard, Inc., dated May 19, 1992, as amended on
               February 1, 1993 and October 1, 1995. (1)(2)

   10.8        International Distribution Agreement by and between the Company and
               Bard International, Inc., dated as of November 30, 1995. (1)(2)

   10.9        License and Development Agreement by and between the Company and
               Boston Scientific Corporation, dated as of November 22, 1994. (1)(2)

   10.10       Manufacturing Agreement by and between the Company and Lake
               Region Manufacturing Company, Inc., dated February 15, 1996. (1)(2)
</TABLE>
<PAGE>
 
<TABLE>
<S>            <C> 
   10.11       Technology Purchase Agreement by and between the Company and
               Morris Simon, M.D., dated as of April 14, 1987. (1)(2)

   10.12       Asset and Technology Donation and Transfer Agreement by and between
               C.R. Bard, Inc. and Children's Medical Center Corporation dated as of
               May 12, 1995. (1)

   10.13       Stock Transfer Agreement by and between Children's Medical Center
               Corporation and InnerVentions, Inc., dated as of June 19, 1995. (1)

   10.14       License Agreement by and between Children's Medical Center
               Corporation and InnerVentions, Inc., dated June 19, 1995. (1)(2)

   10.15       Sublicense Agreement by and between Children's Medical Center
               Corporation and InnerVentions, Inc., dated June 19, 1995. (1)

   10.16       Assignment Agreement by and between the Company and The Beth Israel
               Hospital Association, dated June 30, 1994. (1)

   10.17       License Agreement by and between the Company and Lloyd A. Marks,
               dated as of April 15, 1996. (1)(2)

   10.18       Share Purchase Warrant by and between the Company and Lloyd A.
               Marks, dated April 15, 1996. (1)

   10.19       Registration Rights Agreement by and between the Company and Lloyd
               A. Marks, dated as of April 15, 1996. (1)

   10.20       Employment Agreement by and between the Company and Thomas M.
               Tully, dated February 13, 1996. (1)(**)

   10.21       Registration Rights Agreement by and between the Company and Thomas
               M. Tully, dated as of February 13, 1996. (1)

   10.22       Employment Agreement by and between the Company and David
               Chazanovitz, dated February 13, 1996, as amended as of June 15, 1996.
               (1)(**)

   10.22.1     Amendment to Employment Agreement by and between the Company
               and David Chazanovitz, dated July 9, 1996. (1)(**)

   10.23       Employment Agreement by and between the Company and Jason Harry,
               dated as of July 1, 1994. (1)(2)(**)

   10.24       Employment Agreement by and between the Company and Stephen J.
               Kleshinski, dated July 22, 1993, as supplemented by agreement dated as of
               June 1, 1994. (1)(2)(**)

   10.25       Employment Agreement by and between the Company and Theodore I.
               Pincus, dated as of May 17, 1996. (1)(**)
</TABLE>
<PAGE>
 
<TABLE> 
<S>            <C> 
    10.26      Form of Registration Rights Agreement between the Company and certain
               of its existing stockholders, dated as of February 14, 1996. (1)

    10.27      Agreement of Lease by and between the Company and the Trustees of
               Wormwood Realty, dated as of May 8, 1996. (1)

    10.28      Company 1994 Stock Option Plan. (1)(**)

    10.29      Company 1996 Stock Option Plan. (1)(**)

    10.30      Company 1996 Stock Option Plan for Non-Employee Directors. (1)(**)

    10.31      Registration Rights Agreement between the Company and Junewicz &
               Co., Inc. dated as of February 16, 1996. (1)

    10.32      Registration Rights Agreement between the Company and Furman Selz,
               LLC, dated as of February 16, 1996. (1)

    10.33      Stockholders' Option Agreement, dated May 29, 1997, by and among the
               Company, Image Technologies Corporation and the holders of common
               stock and warrants to purchase shares of common stock of Image
               Technologies Corporation listed on Schedule A thereto.  (3)

    10.34      Loan and Security Agreement, dated May 29, 1997, by and between the
               Company and Image Technologies Corporation.  (3)

    10.35      Amendment No. 1, dated August 4, 1997, to the Loan and Security
               Agreement, dated May 29, 1997, by and between the Company and Image
               Technologies Corporation.  (3)

    10.36      Amendment No. 1, dated May 29, 1997, to the Pledge Agreement by and
               between the Company and Fletcher Spaght, Inc., dated as of February 14,
               1996.

    11.1       Computation of Earnings per Share.

    21.1       Subsidiaries of the Registrant.

    23.1       Consent of Arthur Anderson LLP

    27.1       Financial Data Schedule.

    27.2       Restated Financial Data Schedule for the Fiscal Quarter Ended 
               September 30, 1996.

    27.3       Restated Financial Data Schedule for the Fiscal Year Ended 
               December 31, 1996.

    27.4       Restated Financial Data Schedule for the Fiscal Quarter Ended 
               March 31, 1997.

    27.5       Restated Financial Data Schedule for the Fiscal Quarter Ended 
               June 30, 1997.

    27.6       Restated Financial Data Schedule for the Fiscal Quarter Ended 
               September 30, 1997.

    27.7       Restated Financial Data Schedule for the Fiscal Year Ended 
               December 31, 1995 and the six months ended June 30, 1996.

</TABLE> 
        ________________________
(1)     Incorporated by reference to Exhibits to the Registrant's Registration
        Statement on Form S-1 (File No. 333-06463).
(2)     Confidential treatment requested as to certain portions, which portions
        are omitted and filed separately with the Commission.
(3)     Incorporated by reference to Exhibits to the Registrant's Quarterly
        Report on Form 10-Q for the quarter ended June 30, 1997.
(**)    Management contract or compensatory plan or arrangement required to be
        filed as an Exhibit to this Annual Report on Form 10-K.