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                      SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C. 20549
                                         

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

                                  FORM 10-K
                                -------------
                                         
(Mark One)
[x]   Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
      Act of 1934.  For the fiscal year ended December 31, 1996
                                      OR
[ ]   Transition report Pursuant to Section 13 or 15(d) of the Securities 
      Exchange Act of 1934

        For the transition period from ______________ to ______________

                        Commission file number 0-28266

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

                 DELAWARE                                94-3222307
        (State or Other Jurisdiction of               (I.R.S. Employer 
         Incorporation or Organization)             Identification Number)

                   200 CHESAPEAKE DRIVE, REDWOOD CITY, CA  94063
                 Address of Principal Executive Offices) (Zip Code)

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

                                (415) 306-7900
                Registrant's Telephone Number, Including Area Code

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

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

      Securities registered pursuant to Section 12(g) of the Act:COMMON STOCK

                                                               (Title of Class)

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

      The aggregate market value of the voting stock held by non-affiliates 
of the registrant as of March 14, 1997: approximately $324 million (based on 
the last reported sale price of $27.25 per share on March 14, 1997 on the 
Nasdaq National Market).

      The number of shares of Common Stock outstanding as of March 14, 1997 
was 24,567,738.

                       DOCUMENTS INCORPORATED BY REFERENCE

                DOCUMENT                             FORM 10-K REFERENCE
                --------                             -------------------
Proxy Statement for Registrant's Annual Meeting      Part III, Items 11-13
to be held on May 28, 1997

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                              TABLE OF CONTENTS
                                                                           PAGE
                                                                           ----
Part I
     Item 1.   Business...............................................     1
     Item 2.   Properties.............................................    24
     Item 3.   Legal Proceedings......................................    24

Part II
     Item 4.   Submission of Matters to a Vote of Security Holders....    24
     Item 5.   Market for Registrant's Common Equity and Related 
                 Stockholder Matters..................................    25
     Item 6.   Selected Financial Data................................    26
     Item 7.   Management's Discussion and Analysis of Financial 
                 Condition and Results of Operations..................    27
     Item 8.   Financial Statements and Supplementary Data............   F-1

Part III
     Item 9.   Changes in and Disagreements with Accountants on 
                 Accounting and Financial Disclosure.................. III-1
     Item 10.  Directors and Executive Officers of the Registrant..... III-1
     Item 11.  Executive Compensation................................. III-3
     Item 12.  Security Ownership of Certain Beneficial Owners and 
                 Management........................................... III-3
     Item 13.  Certain Relationships and Related Transactions......... III-4

Part IV
     Item 14.  Exhibits, Financial Statement Schedules, and Reports 
                 on Form 8-K..........................................  IV-1


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PART I

ITEM 1.BUSINESS.

      The discussion in this Item and elsewhere in this Annual Report on Form 
10-K contains forward-looking statements that involve risks and 
uncertainties.  The Company's actual results may differ materially from the 
results discussed in the forward-looking statements.  Factors that might 
cause such a difference include, but are not limited to, those discussed in 
"Risk Factors."

INTRODUCTION

      Heartport, Inc. ("Heartport" or the "Company") has developed and is 
marketing proprietary systems and novel procedures that are designed to 
enable cardiac surgeons to perform a wide range of heart surgeries in a 
minimally invasive manner through small incisions, or "ports," without the 
need to crack open the chest as required in conventional heart surgery. 
Although fundamentally changing the means of providing access to the heart, 
the Company's Port-Access-TM- surgical procedures closely parallel the 
conventional procedures that have been used in heart surgery since the 
mid-1950s. The Company believes that its systems and procedures have the 
potential to offer efficacy equal to that of conventional heart surgery, but 
with the benefits of reduced trauma and complications, reduced pain and 
suffering, shorter hospital stays, reduced convalescence time, and lower 
overall cost. As of March 21, 1997, to the Company's knowledge, the Company's 
systems have been used to complete 211 Port-Access coronary artery bypass 
graft ("CABG") procedures (143 single vessel, 46 double vessel, 19
triple vessel and 3 quadruple vessel) and 176 Port-Access mitral valve 
procedures (79 repairs and 97 replacements). The Company believes that 
its Port-Access systems and procedures will have a significant impact on the 
field of heart surgery in the same way that minimally invasive surgical 
procedures such as laparoscopy impacted general surgery and arthroscopy 
impacted orthopedic surgery. 

      The Company markets its Port-Access systems with a direct sales force 
in the United States and Europe. Once a purchase order from a hospital or 
medical center is received, the Company trains the surgical team in 
Port-Access systems and procedures. As of March 21, 1997, 70 teams have 
completed Port-Access training and 43 have initiated human cases. The 
Company has a 50,000 sq. ft. cardiovascular research and training facility in 
Salt Lake City, Utah for training U.S. surgical teams. European surgical 
teams are trained at a contract facility near Uppsala, Sweden. 

BACKGROUND

      Cardiovascular disease is the leading cause of death in the United 
States and many other developed countries. Two of the principal types of 
cardiovascular disease are coronary artery disease ("CAD") and valvular heart 
disease ("VHD"). In CAD, one or more coronary arteries are narrowed, 
resulting in the risk of insufficient blood flow to the heart muscle. In VHD, 
one or more heart valves are dysfunctional, resulting in suboptimal pumping 
of blood. Conventional open-chest heart surgery (commonly referred to as 
"open-heart" surgery) is one of the leading methods of treating CAD, VHD, and 
other types of cardiovascular disease. 

      Heart surgery is widely regarded as one of the most important medical 
advances of the twentieth century. This field of surgery was made possible 
during the 1950s by the development of technology that enabled physicians to 
perform cardiopulmonary bypass ("CPB") and stop the heart during surgery. CPB 
protects the patient by taking over the function of the heart in circulating 
oxygenated blood throughout the patient's organs and tissues, thereby 
permitting the heart to be safely stopped. The procedure of placing the 
patient on CPB and stopping the heart is the standard of care in heart 
surgery because it offers several critical advantages. First, stopping the 
heart allows the surgeon to achieve a high degree of surgical accuracy and 
precision, which is directly related to the length and quality of the 
patient's life following surgery. Second, stopping the heart protects the 
heart muscle during surgery. The stopped heart requires virtually no blood 
flow, whereas the beating heart requires a constant supply of oxygenated 
blood and will sustain damage if that supply is interrupted. Third, the 
majority of cardiac surgery procedures are extremely difficult to perform if 
the heart is not stopped. For example, in most multi-vessel coronary artery 
bypass surgeries, the heart must be turned and manipulated to access the 
three major vascular beds of the heart and to operate upon the various 
coronary arteries, a nearly impossible task while the heart is beating. In 
valve repair and replacement, the heart itself must be opened to repair or 
replace the diseased valve since the valves are located inside the heart. 
Opening a beating heart poses a high risk of death. Thus, placing the patient 
on CPB and stopping 


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the heart is necessary to enable surgeons to safely and accurately perform 
the full range of surgical procedures anywhere on the surface or the interior 
of the heart. 

      Since heart surgery was pioneered in the mid-1950s, remarkable advances 
have occurred in the surgical treatment of cardiovascular disease. CAD is 
most effectively treated by CABG procedures, in which an artery or vein is 
used to bypass the narrowing in a coronary artery and restore blood flow 
downstream of the narrowing. The treatment for VHD involves either repairing 
the diseased heart valve, most commonly with the implantation of a prosthetic 
annuloplasty ring, or replacing it with a prosthetic mechanical or tissue 
valve. Until the introduction of Heartport's technology, CABG and valve 
repair and replacement procedures were virtually always performed in a highly 
invasive surgery in which the patient's chest is opened widely to gain access 
to the heart, the patient is placed on CPB, and the patient's heart is 
stopped. Worldwide, approximately 800,000 CABG and valve procedures are 
performed each year in this manner. The Company estimates that over 15 
million open-chest heart surgeries of this type have been performed since the 
advent of heart surgery in the 1950s. 

      Although highly efficacious, open-chest heart surgery is extremely 
traumatic and painful, typically requires a lengthy period of convalescence, 
and is expensive. The heart sits in the middle of the chest, protected by 
skeletal armor consisting of the sternum or "breast bone," the rib cage, and 
the spine. In conventional heart surgery, the heart is accessed by means of a 
sternotomy, whereby a surgeon makes a 12- to 18-inch incision in the 
patient's chest, the sternum is cut in half with a bone saw, and the rib cage 
is then spread open with a steel retractor. The procedure is highly 
traumatic, resulting in a lengthy and painful recovery period. In 1995, 
open-chest heart surgery patients in the United States remained in the 
hospital for an average of ten days and required a significant period of 
convalescence following discharge. Conventional cardiac surgery is also 
expensive, and in-patient costs on average for a CABG procedure are 
approximately $40,000 per patient and for a valve procedure are approximately 
$50,000 per patient. In addition, substantial costs are incurred during 
convalescence. With approximately 400,000 open-chest heart surgeries 
performed in the United States each year, the total cost to the U.S. 
healthcare system is substantial. 

      The development and widespread adoption of minimally invasive surgical 
approaches have revolutionized many surgical fields, including general 
surgery, orthopedics, gynecology, urology, and neurosurgery. Notable examples 
include laparoscopic procedures in the field of general surgery and 
arthroscopic procedures in the field of orthopedic surgery. Such procedures 
are designed to be as efficacious as conventional surgery, but with 
substantially reduced trauma, thereby decreasing complications, reducing pain 
and suffering, speeding recovery, and decreasing costs associated with many 
aspects of patient care. This movement toward minimally invasive surgery has 
been driven by advances in both device technology and surgical technique. A 
minimally invasive approach is most advantageous in cases in which 
significant trauma results from gaining surgical access to an affected organ 
or site. Cardiac surgery represents a particularly significant opportunity 
for a minimally invasive approach due to the extreme trauma associated with 
opening the chest. Heartport has demonstrated that its Port-Access minimally 
invasive surgical approach has the potential to significantly reduce 
complications, pain and suffering, convalescence, and expense, while 
maintaining the high efficacy of conventional open-chest surgery. 

      Less-invasive alternatives to conventional heart surgery began to 
emerge in the early 1980s. For example, percutaneous transluminal coronary 
angioplasty ("PTCA"), or balloon angioplasty, was developed as an alternative 
to CABG surgery. In a PTCA procedure, the cardiologist inserts a small 
balloon catheter into the narrowed coronary artery and inflates the balloon 
to expand the narrowed section, thereby increasing the internal diameter of 
the vessel to increase blood flow. A PTCA procedure is less traumatic, 
requires less time in the hospital, and involves a shorter recuperation 
period than a conventional open-chest CABG procedure. As a result, a PTCA 
procedure in the United States is less expensive on a per-procedure basis, 
with costs of approximately $16,000 in 1994. In 1995, 460,000 PTCA procedures 
were performed in the United States, and an additional 275,000 such 
procedures were performed elsewhere in the world. 

      Although PTCA is less invasive than conventional CABG, a major drawback 
of PTCA is the high rate of restenosis, or renarrowing of the blood vessel at 
the treatment site. Restenosis within six months following a PTCA procedure 
occurs at rates ranging from 25% to 50%. The majority of PTCA patients 
eventually undergo another PTCA procedure or require CABG surgery. Although 
the cost of a single PTCA procedure may be substantially less than a 
conventional CABG procedure, a recent study indicated that three years after 
the procedure, PTCA has no cost advantage over conventional open-chest CABG 
due to the need for subsequent interventions. Furthermore, 


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another recent study concluded that the quality of life, post intervention, 
is higher for conventional open-heart surgery patients because of the 
follow-up interventions required in PTCA. The Company believes that the 
dramatic reduction in trauma associated with the Port-Access approach will 
magnify this advantage. More recently, clinicians have begun to employ 
mechanical coronary artery stents, metal prostheses designed to hold open 
arteries, as a means of preventing restenosis. Although long-term clinical 
data is not yet available, stents appear to reduce but not eliminate the 
problem of restenosis associated with non-surgical treatment of CAD. 

      Restenosis rates for conventional open-chest CABG are significantly 
lower than those for non-surgical approaches. Studies indicate that 
open-chest coronary artery bypass grafts have 17-year patency rates (the 
maintenance of sufficient blood flow through the affected artery) of 92% when 
the left internal mammary artery ("IMA") graft is used, 85% when the right 
IMA graft is used, and 10-year patency rates of approximately 60% when a 
saphenous vein graft from the patient's leg is used. In addition, a Duke 
University study suggests that patients with three-vessel CAD and patients 
with severe two-vessel CAD have improved survival after conventional 
open-chest CABG surgery in comparison to PTCA and other medical treatments. 
Thus, conventional open-chest CABG remains the preferred treatment for severe 
CAD because of these higher long-term success rates. 

      Another less-invasive alternative to conventional open-chest CABG 
surgery has recently been developed by a small number of cardiac surgeons. In 
a limited number of cases, these surgeons have been using low-technology 
surgical tools to perform minimally invasive CABG surgery on the beating 
heart. This technique subjects the patient to the risk of several types of 
cardiovascular stress. Open-chest CABG surgery without CPB on the beating 
heart has been available since the advent of open-chest heart surgery forty 
years ago, but has very rarely been practiced. Such beating heart surgery, 
whether open-chest or minimally invasive, has generally been, and the Company 
believes is likely to continue to be, limited to the small percentage of 
cases in which the heart does not need to be opened, turned, or manipulated 
and in which the patient is able to tolerate the stress of undergoing heart 
surgery without the support of CPB and the benefits resulting from stopping 
the heart. 

      The Company believes that to achieve the high efficacy and patient 
safety and broad scope of conventional open-chest cardiac surgery, the 
patient must be placed on CPB and the heart stopped. As a result, 
conventional open-chest heart surgery represents the standard of care for the 
treatment of CAD, VHD, and other cardiac conditions. To date, the only way to 
place the patient on CPB and stop the heart has been to crack the patient's 
chest. Heartport was formed with the objective of developing a minimally 
invasive approach to cardiac surgery that would permit surgeons to perform 
the full range of highly efficacious cardiac surgeries, with the patient on 
CPB and the heart stopped, but without the trauma associated with a 
sternotomy and reducing the complications associated with traditional CPB. 

THE HEARTPORT SOLUTION

      Heartport has developed proprietary systems for performing several 
different types of minimally invasive heart surgery. These systems and 
devices have been cleared or exempted by the Food and Drug Administration 
("FDA") for commercial sale in the United States and by a Notified Body in 
Europe. Heartport's core platform is an endovascular cardiopulmonary bypass 
("EndoCPB") system, which allows surgeons to place the patient on CPB and 
stop and protect the patient's heart without the need for a sternotomy. Using 
the Company's EndoCPB-TM- platform and procedure-specific application 
systems, the surgeon is able to perform cardiac surgery by accessing the 
heart through one or more small incisions, or "ports," placed between the 
patient's ribs. The Company's first several application systems comprise 
reusable and disposable devices for Port-Access CABG and for Port-Access 
mitral valve repair and mitral valve replacement (collectively, "MVR") 
surgeries. Application systems for performing additional cardiac surgery 
procedures, including Port-Access aortic valve replacement ("AVR"), are also 
under development. These future systems will require regulatory clearances or 
exemptions prior to commercial distribution. Although fundamentally changing 
the means of providing access to the heart, the Port-Access surgical 
procedures closely parallel the conventional procedures that have been used 
in heart surgery since the mid-1950s. The Company believes that its systems 
and procedures have the potential to offer efficacy equal to that of 
conventional open-chest surgery, but with the benefits of reduced trauma and 
complications, reduced pain and suffering, shorter hospital stays, reduced 
convalescence time, and lower overall cost. See "Risk Factors -- No Assurance 
of Market Acceptance" and "--No Assurance of Regulatory Clearance or 
Approval; Significant Domestic and International Regulation."

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MARKETS AND APPLICATIONS

      Cardiovascular disease is the leading cause of death in the United 
States and other developed countries. In the United States, it causes 
approximately one million deaths per year, which represents over 40% of all 
deaths. CAD is one of the most common forms of cardiovascular disease, 
affecting more than 11 million people in the United States. If untreated, CAD 
can cause a myocardial infarction or "heart attack." Each year, approximately 
1.5 million people experience heart attacks in the United States, resulting 
in approximately 500,000 deaths. Each year on a worldwide basis, 
approximately 600,000 CAD patients undergo conventional open-chest CABG 
surgery, over 700,000 CAD patients undergo PTCA or other non-surgical 
interventions, and approximately 200,000 VHD patients undergo open-chest 
valve repair or replacement procedures. MVRs represent approximately 40% and 
AVRs represent approximately 60% of valve surgery procedures. The per-patient 
cost of these heart surgery procedures in the United States averages 
approximately $16,000 for PTCA, $40,000 for conventional CABG, and $50,000 
for conventional valve surgery. The Company has demonstrated that its 
Port-Access EndoCPB platform and procedure-specific Port-Access application 
systems provide a minimally invasive surgical alternative for CABG and MVR 
procedures.

      CORONARY ARTERY BYPASS GRAFTING--CABG.  Currently, the most efficacious 
treatment for CAD is conventional open-chest CABG surgery. In a conventional 
open-chest CABG, a 12- to 18-inch incision is made in the patient's chest, 
the patient's sternum is cut in half with a bone saw, and the rib cage is 
spread open with a steel retractor. Blood is re-routed past a narrowing in 
one or more coronary arteries by either grafting an artery from the chest 
wall to the coronary artery below the narrowing, or grafting a section of 
artery or vein from another part of the body both to the aorta (which serves 
as a source of oxygenated blood) and to a point below the narrowed segment on 
the affected coronary artery, or both. Using the IMA from the chest wall is 
the most efficacious procedure given its long term patency in such open-chest 
procedures. The IMA is dissected free from the chest wall and prepared for 
grafting to the coronary artery. Large tubes, or cannulae, are inserted 
directly through the walls of the heart and the aorta in order to place the 
patient on CPB, the aorta is compressed closed with an external cross-clamp, 
and a catheter is used to administer the cardioplegic solution that stops the 
heart. The artery from the chest wall is then sutured in place on the 
affected coronary artery, which sits motionless atop the stopped heart, 
enabling the highest degree of surgical accuracy and precision. The patient's 
chest is closed and the sternum is held together with steel wire. Afterward, 
the patient has a long and painful recovery. In the United States, open-chest 
CABG patients spend an average of ten days in the hospital, and the Company 
estimates that up to two or more days are spent in the intensive care unit 
("ICU"). For some period following surgery, a ventilator breathes for the 
patient because the trauma to the rib cage and sternum makes unassisted 
breathing extremely painful. 

      Each step in the Company's Port-Access CABG procedure parallels a 
corresponding step in conventional CABG. Instead of accessing the heart 
through a 12- to 18-inch opening in the chest, however, the procedure is 
accomplished through ports between the patient's ribs. During the procedure, 
the Company's EndoCPB System, a series of proprietary catheters inserted via 
certain of the patient's peripheral vessels, circulates oxygenated blood 
throughout the body and stops and protects the heart. The Company's 
Port-Access-TM- CABG System is designed to enable the surgeon to access the 
heart and its associated vessels, visualize the interior of the thoracic 
cavity, access and prepare the arterial or venous grafts, attach the grafts 
to the diseased coronary artery resting motionless atop the stopped heart, 
and do various other supporting activities. Upon completion of the surgical 
procedure, the heart is allowed to spontaneously resume normal activity and 
CPB is discontinued. The patient leaves the operating room with the heart 
revascularized in the same manner as in a conventional open-chest CABG 
procedure, but with the port incisions sutured closed rather than with the 
chest held together with steel wire. 

      VALVE REPAIR AND REPLACEMENT.  A leading treatment for VHD is the 
surgical replacement or repair of the diseased heart valve. In conventional 
open-chest MVR surgery, the heart is accessed via a sternotomy, the patient 
is placed on CPB, the patient's heart is stopped, and the heart is drained of 
blood. The diseased valve is then accessed through an incision in the left 
atrium, one of the upper chambers of the heart, and the valve is either 
repaired, most commonly with the implantation of a prosthetic annuloplasty 
ring, or is removed and replaced with a mechanical or tissue prosthetic 
valve. 

      Similar to Port-Access CABG, each step in the Company's Port-Access MVR 
procedure closely parallels the corresponding step in a conventional MVR 
procedure, but no sternotomy is required. The Company's Port-Access-TM- MVR 
System utilizes the EndoCPB system to place the patient on CPB, stop and 
protect the heart, and empty the 


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heart of blood. The Company's Port-Access MVR System is designed to permit 
the surgeon to visualize the interior of the thoracic cavity, open the left 
atrium of the heart to gain access to the mitral valve, visualize the 
interior of the heart, assess valve function, repair or remove the diseased 
valve, size the prosthesis (either a prosthetic heart valve or annuloplasty 
ring), deliver and attach the prosthesis, close the heart, allow the heart to 
spontaneously resume normal activity, and then discontinue CPB. The patient 
leaves the operating room with the heart valve repaired or replaced in the 
same manner as in a conventional, open-chest MVR procedure, but with the port 
incisions sutured closed rather than the chest held together with steel wire. 

      OTHER PROCEDURES.  The Company believes that its Port-Access technology 
and approach to cardiac surgery may also enable it to develop systems to 
treat a range of cardiovascular disease in addition to CAD and mitral valve 
diseases. The Company is currently developing Port-Access systems to treat 
aortic valve disease and other cardiac diseases. 

STRATEGY

      The Company's objective is to become the global leader in research, 
development, and commercialization of systems for minimally invasive cardiac 
surgery. Key elements of the Company's strategy include: 

      ESTABLISH PORT-ACCESS MINIMALLY INVASIVE CARDIAC SURGERY AS A STANDARD 
OF CARE FOR CAD AND VHD.  The Company believes that it is the first to 
design, develop, and receive FDA-clearance for devices and systems for the 
minimally invasive surgical treatment of CAD and VHD. The Company is 
currently introducing its proprietary technology to leading cardiac surgery 
centers in the United States and Europe. Prior to shipment, the Company 
provides its customers with extensive training on the EndoCPB, Port-Access 
CABG System and Port-Access MVR System and procedures at either the 
Heartport Research and Training Center ("HRTC") in Salt Lake City, Utah or at 
Assist Medical near Uppsala, Sweden. As of March 21, 1997, 70 surgical teams 
have been through the Company's training program, of which 43 have begun 
performing procedures. In addition, the Company intends to support clinically 
driven research efforts to prove the efficacy and benefits of Port-Access 
minimally invasive cardiac surgery. 

      MARKET TO HIGH VOLUME CARDIAC SURGERY CENTERS WITH DIRECT SALES FORCE.  
The cardiac surgery market in the United States and Europe is highly 
concentrated, with 300 centers responsible for over 50% of the more than 
500,000 open-chest surgeries performed annually in the two geographies. The 
Company believes that rapid penetration of these high volume centers is 
achievable with a relatively small direct sales force. As of March 21, 1997 
the Company has 12 cardiovascular sales specialists in the United States and 
5 cardiovascular sales specialists in Europe with an average of over ten 
years experience selling cardiac surgery and cardiology products.

      PROMOTE PORT-ACCESS PARTNERSHIPS.  The Company has developed a 
procedural selling approach to market its systems to cardiac surgeons, called 
the Port-Access Partnership-SM-.  The Company intends to utilize its 
Port-Access Partnership to promote customer loyalty.  In the partnership, in 
exchange for a substantial purchase order for Port-Access disposable 
products, Heartport trains the center's surgical team, supplies patient and 
referring physician educational materials, supports local-market media 
efforts and furnishes proprietary reusable devices enabling Port-Access 
procedures.

      EXPAND PORT-ACCESS APPLICATIONS BY LEVERAGING CORE TECHNOLOGY.  The 
Company has developed its EndoCPB System to enable minimally invasive 
Port-Access CABG, Port-Access MVR, Port-Access AVR, and other Port-Access 
heart surgeries, with the patient on CPB and the heart stopped. The Company 
intends to expand the use of its EndoCPB platform to address other types of 
heart surgery. See "Risk Factors--No Assurance of Market Acceptance" and 
"--No Assurance of Regulatory Clearance or Approval; Significant Domestic and 
International Regulation." 

      TARGET INTERNATIONAL MARKETS.  The Company intends to continue to 
devote resources to penetrate international markets given the substantial 
size and economic attractiveness of these markets. The Company has received 
the necessary regulatory approvals in Europe, and is pursuing approvals in 
Canada, Australia, and Asia to market its EndoCPB and Port-Access systems. In 
addition, the Company has trained surgical teams from leading centers in 
England, Scotland, Germany, France, Spain, Belgium, Sweden, Canada, 
Australia, and Malaysia in the use of Port-Access techniques. 

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      PROTECT AND ENHANCE PROPRIETARY POSITION.  The Company currently holds 
issued and allowed patents covering a number of fundamental aspects of the 
Company's EndoCPB System and procedure-specific Port-Access systems. As of 
March 14, 1997, the Company owns 25 issued or allowed United States patents, 
and owns an exclusive field of use license on one issued United States patent 
and on one issued foreign patent. In addition, as of March 14, 1997, the 
Company has 84 pending United States patent applications and has filed 37 
patent applications that are currently pending in Europe, Japan, Australia, 
and Canada. In addition, in 1996, the Company acquired certain intellectual 
property assets of Endosurgical Development Corporation ("EDC"). The Company 
intends to continue to pursue its patent filing strategy and to vigorously 
defend its intellectual property position against infringement. See "Risk 
Factors--Uncertainty Regarding Patents and Protection of Proprietary 
Technology; Risks of Future Litigation." 

      COMPLEMENT INTERNAL PRODUCT DEVELOPMENT WITH STRATEGIC ALLIANCES.  The 
Company intends to leverage its technology platform through strategic 
alliances with corporate partners. In September, 1995, the Company formed a 
strategic relationship with St. Jude Medical, Inc. ("St. Jude Medical"), the 
world's leading producer of prosthetic heart valves, for the joint 
development of prosthetic valve and annuloplasty ring delivery systems for 
Port-Access procedures. Pursuant to the terms of this alliance, as amended in 
January, 1997, the Company will receive royalties from St. Jude Medical when 
valve/annuloplasty ring delivery systems incorporating Heartport technology 
are sold. The Company expects to pursue additional strategic relationships 
with corporations and research institutions with respect to the research, 
development, regulatory approval, manufacturing and marketing of certain of 
its potential products and procedures. See "Strategic Relationships." 

TECHNOLOGY

      The Company believes it is currently the only company marketing a 
technology designed to permit minimally invasive cardiac surgery to be 
performed on a stopped heart with CPB support. The Company's systems for 
minimally invasive cardiac surgery consist of a common platform, the EndoCPB 
System, and procedure-specific application systems comprising proprietary 
reusable, disposable and implantable devices. 

      ENDOVASCULAR CARDIOPULMONARY BYPASS.  The EndoCPB System is a series of 
proprietary catheters used to place the patient on CPB and to stop and 
protect the heart during cardiac surgery, without performing a sternotomy. 
There are five key components: the Endoaortic Clamp-TM-, a saline-filled 
balloon catheter, occludes the ascending aorta, stops and cools the heart via 
delivery of cardioplegic solution, monitors aortic root pressures, and drains 
excess blood from the heart; the Endovenous Drainage-TM- cannula removes 
deoxygenated blood from the body; the Endoarterial Return-TM- cannula returns 
oxygenated blood to the body; the Endopulmonary Vent-TM- drains excess blood 
from the heart via the pulmonary artery; and the Endocoronary Sinus-TM- 
Catheter provides an alternative route for delivery of cardioplegic solution. 
Each component of the EndoCPB System is positioned within the vascular system 
via peripheral vascular access. 

      PORT-ACCESS CORONARY ARTERY BYPASS GRAFTING.  The Port-Access CABG 
System currently consists of 25-30 reusable and disposable devices designed 
to perform the entire CABG procedure in a minimally invasive manner. The 
system includes devices for accessing the heart and its associated vessels, 
visualizing the interior of the thoracic cavity, accessing and preparing the 
arterial and venous grafts, attaching the grafts to the diseased coronary 
artery, and various other supporting activities. The devices are designed to 
permit the surgeon to operate through ports with the same surgical precision 
and accuracy as is possible using conventional cardiac surgical instruments 
through a sternotomy. 

      PORT-ACCESS MITRAL VALVE REPAIR AND MITRAL VALVE REPLACEMENT.  The 
Port-Access MVR System currently consists of 25-30 reusable and disposable 
devices. This system is designed to be compatible with existing implantable 
prosthetic heart valves and prosthetic annuloplasty rings. They permit the 
surgeon to perform mitral valve surgery in a minimally invasive manner, and 
offer the surgeon the ability to visualize the interior of the thoracic 
cavity, open the left atrium of the heart to gain access to the mitral valve, 
visualize the interior of the heart, assess valve function, repair or remove 
the diseased valve, size the prosthesis (either a prosthetic heart valve or 
annuloplasty ring), deliver and attach the prosthesis and close the heart. 
The Port-Access MVR System is designed to permit precise and accurate surgery 
to be performed through small ports. 


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<PAGE>

      PORT-ACCESS AORTIC VALVE REPLACEMENT AND OTHER PROCEDURES.  The Company 
is in the process of developing a Port-Access AVR system. In addition, the 
Company is actively developing systems for performing other Port-Access 
cardiac surgery procedures. There can be no assurance, however, that any such 
systems will be successfully developed, be granted required regulatory 
clearances or approvals, or achieve any significant level of market 
acceptance. 

REGULATORY STATUS

UNITED STATES

      In October, 1996, the Company received 510(k) clearance from the FDA to 
market its EndoCPB system and several proprietary Class II disposable 
surgical devices for its Port-Access surgery systems. In addition, the 
Company received pre-market notification exemptions clearing its core 
reusable and disposable surgical devices to be labeled and used for minimally 
invasive cardiovascular surgery. These clearances and exemptions allowed the 
Company to commercially launch its Port-Access CABG System and Port-Access 
MVR System in early 1997. 

      The Company has also submitted 510(k) notifications for enhancements to 
its EndoCPB System and for additional specialty disposable devices to further 
enhance performance of the Port-Access CABG and MVR procedures. Additional 
510(k) submissions are planned for 1997 for devices to facilitate Port-Access 
procedures other than CABG and MVR. There can be no assurance that the FDA 
will act favorably or quickly on the Company's 510(k) submissions, and 
significant difficulties and costs may be encountered by the Company in its 
efforts to obtain these additional FDA clearances that could delay or 
preclude the Company from marketing and selling products for additional 
procedures. See "Risk Factors--No Assurance of Regulatory Clearance or 
Approval; Significant Domestic and International Regulations," and 
"Government Regulation."

INTERNATIONAL

      In January, 1997, the Company received CE Mark clearance for its 
EndoCPB System which allows the sale of its Port-Access CABG and MVR systems 
in all countries of the European Union.  The Company has also submitted 
amendments to its Product Dossiers for enhancements to its EndoCPB System to 
further enhance performance of the Port-Access CABG and MVR procedures. 
Additional CE Mark submissions are planned for 1997 for devices to facilitate 
Port-Access procedures other than CABG and MVR. See "Risk Factors--No 
Assurance of Regulatory Clearance or Approval; Significant Domestic and 
International Regulations," and "Government Regulation." 


                                      7
<PAGE>

SCIENTIFIC ADVISORY BOARD

      The Company has established a Scientific Advisory Board composed of 
individuals with expertise in the field of cardiac surgery. The Scientific 
Advisory Board periodically reviews the Company's clinical progress and 
product development plans and identifies potential applications of the 
Company's technology. In addition, members of the Scientific Advisory Board 
will be available on an individual basis to consult with the Company as 
needed. The members of the Scientific Advisory Board are consultants to the 
Company and have substantial constraints on the amount of time they can 
devote to Company matters. The members of the Scientific Advisory Board are 
as follows: 


NAME                           OCCUPATION/TITLE

William A. Baumgartner, M.D.   Professor of Surgery, Cardiac Surgeon In-Charge,
                               Johns Hopkins Hospital

Lawrence H. Cohn, M.D.         Professor of Surgery,
                               Harvard Medical School,
                               Chief, Division of Cardiac Surgery,
                               Brigham and Women's Hospital

Delos M. Cosgrove, M.D.        Chairman, Department of Thoracic and 
                               Cardiovascular Surgery, 
                               The Cleveland Clinic Foundation

James L. Cox, M.D.             Evarts C. Graham Professor of Surgery,
                               Vice-Chairman, Department of Surgery,
                               Chief, Division of Cardiothoracic Surgery,
                               Washington University School of Medicine

Bruce A. Reitz, M.D.           Professor and Chairman,
                               Department of Cardiothoracic Surgery,
                               Stanford University School of Medicine

STRATEGIC RELATIONSHIPS

      The Company intends to pursue strategic relationships with corporations 
and research institutions with respect to the research, development, 
regulatory approval, manufacturing, and marketing of certain of its potential 
products and procedures. The Company has formed a strategic relationship with 
St. Jude Medical, the world's leading producer of prosthetic heart valves, 
for the joint development of prosthetic valve and annuloplasty ring delivery 
systems for Port-Access MVR and a prosthetic valve system for Port-Access 
AVR.  Under the terms of an agreement entered into in September, 1995 and 
amended in January, 1997, the Company granted St. Jude Medical a 
non-exclusive, worldwide, royalty bearing license to make, use, and sell a 
minimally invasive prosthetic valve system incorporating a Port-Access 
delivery system and a St. Jude Medical valve or annuloplasty ring prosthesis 
for use in Port-Access heart valve repair and replacement procedures. St. 
Jude Medical has no minimum purchase obligations under the agreement. In 
addition, the Company borrowed $3.0 million from St. Jude Medical. As of 
December 31, 1996, the entire amount of the loan had been converted to 
prepaid royalty payments. See Note 4 of Notes to Financial Statements. 
Although the Company intends to pursue additional strategic relationships in 
the future, there can be no assurance that the Company will be successful in 
establishing or maintaining any such relationships or that any such 
relationship will be successful. See "Risk Factors--Reliance on Strategic 
Relationships." 

RESEARCH AND DEVELOPMENT

      The Company believes that its future success will depend in large part 
on its ability to develop and introduce clinically advanced Port-Access 
minimally invasive cardiac surgery systems that are effective, easy to use, 
safe, and reliable. The Company's research and development department focuses 
upon the continued development and refinement of its existing Port-Access 
devices, systems, and procedures as well as upon the development of new 
devices, systems, and procedures for treating other cardiac diseases. 

      To date, the Company has developed systems for Port-Access CABG and 
Port-Access MVR surgery. A system for Port-Access aortic valve replacement is 
currently under development.  In collaboration with its clinical 


                                      8
<PAGE>

advisory board and consultants, the Company is actively developing methods 
and devices for future Port-Access surgical procedures, as well as continuing 
development of reusable, disposable, and implantable devices to further 
refine current Port-Access procedures. The Company believes that its EndoCPB 
and Port-Access technologies are potentially applicable to a wide variety of 
other cardiac surgical procedures. There can be no assurance, however, that 
the Company will be successful in developing devices or systems for such 
procedures, or that such devices or systems, if any, will be granted required 
regulatory clearances or approvals, or achieve any significant level of 
market acceptance.  See "Risk Factors--No Assurance of Market Acceptance" 
and "--Significant Competition; Rapid Technological Change."

MANUFACTURING

      The Company is committed to producing high-quality products and expects 
to internally manufacture the most proprietary, value-added components and 
products and outsource less critical manufacturing jobs.  The Company 
manufactures its products at its Redwood City, California, facilities. The 
Company believes that its facilities have sufficient capacity to meet the 
Company's anticipated manufacturing needs through the end of 1997. 

      The Company manufactures its products based on forecasted product 
orders, and purchases subassemblies and components prior to receipt of 
purchase orders from customers. Lead times for materials and components 
ordered by the Company vary significantly, and depend on factors such as the 
business practices of the specific supplier, contract terms, and general 
demand for a component at a given time. Certain components used in the 
Company's products have long lead times. As a result, there is a risk of 
excess or inadequate inventory if orders do not match forecasts. 

      To meet anticipated demand, the Company must increase the rate by which 
it manufactures its products. Until recently, the Company's manufacturing 
activities have consisted primarily of manufacturing limited quantities of 
products for use in laboratory testing, clinical trials and initial low 
volume commercial sales. The manufacture of the Company's products is 
complex, involving a number of separate processes and components. The Company 
does not have experience in manufacturing its products in commercial 
quantities. Although the Company is scaling up its capacity to produce 
products in volume to support its commercial launch, there can be no 
assurance that it will be able to make the transition to commercial 
production successfully. In addition, the Company believes that cost 
reductions in its manufacturing operations will be required for it to 
commercialize its systems on a profitable basis. Certain manufacturing 
processes are labor-intensive, and achieving significant cost reductions will 
depend, in part, upon reducing the time required to complete these processes. 
Manufacturers often encounter difficulties in scaling up manufacturing of new 
products, including problems involving product yields, quality control and 
assurance, component and service availability, adequacy of control policies 
and procedures, lack of qualified personnel, compliance with FDA regulations, 
and the need for further FDA approval of new manufacturing processes and 
facilities. The Company has considered and will continue to consider as 
appropriate the internal manufacture of components currently provided by 
third parties, as well as the implementation of new production processes. 
There can be no assurance that manufacturing yields or costs will not be 
adversely affected by the transition to in-house production or to new 
production processes when such efforts are undertaken, or that FDA Good 
Manufacturing Practices ("GMP") requirements can be met, and that such a 
transition would not materially and adversely affect the Company's business, 
financial condition, and results of operations. 

      The Company uses or relies on certain components and services used in 
its devices that are provided by sole source suppliers. The qualification of 
additional or replacement vendors for certain components or services is a 
lengthy process. Any significant supply interruption would have a material 
adverse effect on the Company's ability to manufacture its products and, 
therefore, a material adverse effect on its business, financial condition, 
and results of operations.  See "Risk Factors--Limited Manufacturing 
Experience; Dependence on Key Suppliers."

      The regulatory clearances received to date by the Company require 
compliance with FDA regulations for GMP. Even after the FDA has cleared or 
approved a device, it will periodically inspect the manufacturing facilities 
and processes for compliance with GMP. In addition, in the event that 
additional manufacturing sites are added or manufacturing processes are 
changed, such new facilities and processes are also subject to FDA inspection 
for compliance with GMP. The Company's manufacturing facilities and processes 
have not yet been inspected by the 


                                      9
<PAGE>

FDA for compliance with GMP.  See "Risk Factors--No Assurance of Regulatory 
Clearance or Approval; Significant Domestic and International Regulation." 

SALES, MARKETING, TRAINING, AND DISTRIBUTION

      The Company's EndoCPB and Port-Access systems in the United States are 
marketed both to cardiac surgeons and to cardiac surgery centers. In the 
United States, there are approximately 900 cardiac surgery centers and 
approximately 2,500 cardiac surgeons. The Company believes it can market its 
products in the United States with a moderately sized direct sales 
organization. Outside the United States, there are approximately 2,500 
cardiac surgeons. In Europe, the Company is building a direct sales force, 
and in other geographic regions the Company will evaluate direct and indirect 
sales channels as appropriate. The Company currently has a limited sales and 
marketing organization in the United States and Europe.  Establishment of a 
sales force capable of effectively commercializing the Company's EndoCPB and 
Port-Access systems will require substantial efforts and require significant 
management and financial resources. There can be no assurance that the 
Company will be able to establish such a sales capability on a timely basis, 
if at all. See "Risk Factors--Limited Sales, Marketing, and Distribution 
Experience." 

      The Company has developed a procedural selling approach to market its 
systems to cardiac surgeons, called the Port-Access Partnership-TM-. The 
Company intends to utilize its Port-Access Partnership to promote customer 
loyalty.  In the partnership, in exchange for a substantial purchase order 
for Port-Access disposable products, Heartport trains the center's surgical 
team, supplies patient and referring physicians educational materials, 
supports local-market media efforts and furnishes proprietary reusable 
devices enabling Port-Access procedures.

      The Company's sales and marketing strategy includes developing and 
maintaining a close working relationship with its customers in order to 
assess and satisfy their needs for products and services. The Company intends 
to meet with its Scientific Advisory Board and other clinical consultants 
periodically to share ideas regarding the marketplace, existing products, 
products under development, and existing or proposed research projects. 

      The effective and rapid training of surgical teams in the use of 
Heartport's systems and devices is critical to the Company's efforts to 
develop its business. To that end, in October, 1996 the Company acquired 
substantially all of the assets of Utah Biomedical Test Laboratory ("UBTL").  
UBTL's Salt Lake City facility was established in the early 1970s to be the 
home of the United States government's artificial heart program.  This 50,000 
square foot facility, now called the Heartport Research and Training Center 
("HRTC"), is currently in the process of being converted into a 
state-of-the-art cardiovascular research and training center. Surgical teams 
began training at HRTC in January,  1997. In addition, the Company has a 
relationship with Assist Medical near Uppsala, Sweden where it trains 
European surgical teams. The Company also plans to work with selected cardiac 
surgery centers to enhance the Company's technology and broaden its 
applicability to treat CAD, VHD, and other cardiovascular diseases. In 
addition, the Company intends to support rigorous, clinically driven research 
efforts to prove the efficacy and benefits of Port-Access minimally invasive 
cardiac surgery. Finally, the Company anticipates there will be presentations 
on Port-Access procedures by investigators at national and international 
meetings and the publication of scholarly reports in peer-reviewed 
publications. 

COMPETITION

      The Company expects that the market for minimally invasive cardiac 
surgery, which is currently in the early stages of development, will become 
intensely competitive. Competitors are likely to include a variety of 
different companies that currently specialize in devices for conventional 
cardiac surgery, as well as those that specialize in non-cardiac minimally 
invasive surgery. The Company believes that a number of large companies, 
including the Ethicon Endosurgery division of Johnson & Johnson, United 
States Surgical Corporation, Medtronic, Inc., Baxter International, Genzyme 
Corporation, Guidant Corporation and others with significantly greater 
financial, manufacturing, marketing, distribution, and technical resources 
and experience than the Company, may be focusing on the development of 
minimally invasive cardiac surgery technology. In addition, new companies 
have been and are likely to continue to be started to pursue opportunities in 
this market. Several companies have announced interest in and development of 
products for the minimally invasive cardiac surgery field. For example, there 
are companies 


                                      10
<PAGE>

pursuing minimally invasive cardiac surgery on a beating heart, which, if 
successful, could materially adversely affect the Company's ability to 
establish a market for its technology. 

      Cardiovascular diseases that can be treated with the Company's 
Port-Access systems can also be treated by pharmaceuticals or other medical 
devices and procedures, including PTCA, intravascular stents, atherectomy 
catheters and lasers. Many of these alternative treatments are widely 
accepted in the medical community and have a long history of use. In 
addition, technological advances with other therapies for heart disease such 
as drugs or future innovations in cardiac surgery techniques could make such 
other therapies more effective or lower in cost than the Company's 
Port-Access procedures and could render the Company's technology obsolete. 
There can be no assurance that physicians will use Port-Access procedures to 
replace or supplement established treatments, such as conventional open-chest 
heart surgery and PTCA, or that the Company's Port-Access systems will be 
competitive with current or future technologies. Such competition could have 
a material adverse effect on the Company's business, financial condition, and 
results of operations. Any product developed by the Company that gains 
regulatory approval will have to compete for market acceptance and market 
share. An important factor in such competition may be the timing of market 
introduction of competitive products. Accordingly, the relative speed with 
which the Company can develop products, complete clinical testing and 
regulatory approval processes, train physicians in the use of its products, 
gain reimbursement acceptance, and supply commercial quantities of the 
product to the market are expected to be important competitive factors. In 
addition, the Company believes that the primary competitive factors in the 
market for Port-Access systems will be safety, efficacy, ease of use, quality 
and reliability, cost-effectiveness, training support, innovation, breadth of 
product line, and price. The Company also believes that physician 
relationships and customer support are important competitive factors. The 
Company has experienced delays in completing the development and introduction 
of new products, product variations and product features, and there can be no 
assurance that such delays will not continue or recur in the future. Such 
delays could result in a loss of market acceptance and market share. There 
can be no assurance that the Company will be able to compete successfully 
against current and future competitors. Failure to do so would have a 
material adverse effect upon the Company's business, financial condition, and 
results of operations. See "Risk Factors--Significant Competition; Rapid 
Technological Change." 

GOVERNMENT REGULATION 

UNITED STATES 

      The Company's Port-Access systems are regulated in the United States as 
medical devices. As such, the Company is subject to extensive regulation by 
the FDA. Pursuant to the Federal Food, Drug, and Cosmetic Act of 1938, as 
amended, and the regulations promulgated thereunder (the "FDC Act"), the FDA 
regulates the clinical testing, manufacture, labeling, distribution and 
promotion of medical devices. Noncompliance with applicable requirements can 
result in, among other things, fines, injunctions, civil penalties, recall or 
seizure of products, total or partial suspension of production, failure of 
the government to grant premarket clearance or premarket approval for 
devices, withdrawal of marketing approvals, a recommendation by the FDA that 
the Company not be permitted to enter into government contracts and criminal 
prosecution. The FDA also has the authority to request repair, replacement or 
refund of the cost of any device manufactured or distributed by the Company. 

      In the United States, medical devices 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. Class I 
devices are subject to general controls (e.g., labeling, premarket 
notification and adherence to GMPs). Class II devices are subject to general 
controls and to special controls (e.g., performance standards, postmarket 
surveillance, patient registries, and FDA guidelines). Generally, Class III 
devices are those that must receive premarket 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 substantially 
equivalent to legally marketed devices), and require clinical testing to 
ensure safety and effectiveness and FDA approval prior to marketing and 
distribution. A PMA application must be filed if the 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. 

      Before a new device can be introduced into the market, the manufacturer 
must generally obtain marketing clearance through a premarket notification 
under Section 510(k) of the FDC Act or a PMA application under 


                                      11
<PAGE>

Section 515 of the FDC Act. A 510(k) clearance typically will be granted if 
the submitted information establishes that the device is "substantially 
equivalent" to a legally marketed Class I or II medical device or to a Class 
III medical device for which the FDA has not called for PMAs. A 510(k) 
notification must contain information to support a claim of substantial 
equivalence, which may include laboratory test results or the results of 
clinical studies of the device in humans. Commercial distribution of a device 
for which a 510(k) notification is required can begin only after the FDA 
issues an order finding the device to be "substantially equivalent" to a 
predicate device. The FDA has recently been requiring a more rigorous 
demonstration of substantial equivalence than in the past and is more likely 
to require the submission of human clinical trial data. It generally takes 
from four to twelve months from the date of submission to obtain a 510(k) 
notification, but it may take longer. The FDA may determine that a proposed 
device is not substantially equivalent to a legally marketed device, or that 
additional information is needed before a substantial equivalence 
determination can be made. A PMA application must be filed if a proposed 
device is not substantially equivalent to a legally marketed Class I or Class 
II device or if it is a Class III device for which the FDA has called for 
PMAs. A PMA application must be supported by valid scientific evidence that 
typically includes extensive data, including preclinical and human clinical 
trial data to demonstrate the safety and efficacy of the device. A "not 
substantially equivalent" determination, or a request for additional 
information, could delay the market introduction of new products that fall 
into this category. See "Risk Factors--No Assurance of Regulatory Clearance 
or Approval; Significant Domestic and International Regulation." 

      If human clinical trials of a device are required in support of either 
a 510(k) notification or a PMA application, and the device presents a 
"significant risk," the sponsor of the trial (usually the manufacturer or the 
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 including the results of animal and laboratory 
testing. If the IDE application is approved by the FDA and one or more 
appropriate institutional review boards ("IRBs"), human clinical trials may 
begin at a specific number of investigational sites with a specific number of 
patients, as approved by the FDA. If the device presents a "nonsignificant 
risk" to the patient, a sponsor may begin the clinical trial after obtaining 
approval for the study by one or more appropriate IRBs, but not the FDA. 
Sponsors of clinical trials are permitted to sell those devices distributed 
in the course of the study provided such compensation does not exceed 
recovery of the costs of manufacture, research, development and handling. An 
IDE supplement must be submitted to and approved by the FDA before a sponsor 
or an investigator may make a change to the investigational plan that may 
affect its scientific soundness or the rights, safety or welfare of human 
subjects. 

      A PMA application must also contain the results of all relevant bench 
tests, laboratory and animal studies, a complete description of the device 
and its components, and a detailed description of the methods, facilities and 
controls used to manufacture the device. In addition, the submission must 
include the proposed labeling, advertising literature and training methods 
(if required). Upon receipt of a PMA application, the FDA makes a threshold 
determination as to whether the application is sufficiently complete to 
permit a substantive review. If the FDA determines that the PMA application 
is sufficiently complete to permit a substantive review, the FDA will accept 
the application for filing. Once the submission is accepted for filing, the 
FDA begins an in-depth review of the PMA application. An FDA review of a PMA 
application generally takes one to three years from the date the PMA 
application is accepted for filing, but may take significantly longer. The 
review time is often significantly extended by the FDA asking for more 
information or clarification of information already provided in the 
submission. During the review period, an advisory committee, typically a 
panel of clinicians, will likely be convened to review and evaluate the 
application and provide recommendations to the FDA as to whether the device 
should be approved. The FDA is not bound by the recommendations of the 
advisory panel. Toward the end of the PMA application review process, the FDA 
generally will conduct an inspection of the manufacturer's facilities to 
ensure that the facilities are in compliance with the applicable GMP 
requirements. 

      If the FDA's evaluations of both the PMA application and the 
manufacturing facilities are favorable, the FDA will either issue an approval 
letter or an "approvable letter" containing a number of conditions which must 
be met in order to secure final approval of the PMA application. When and if 
those conditions have been fulfilled to the satisfaction of the FDA, the 
agency will issue a PMA, authorizing commercial marketing of the device for 
certain indications. If the FDA's evaluation of the PMA application or 
manufacturing facilities is not favorable, the FDA will deny approval of the 
PMA application or issue a "not approvable letter." The FDA may also 
determine that additional clinical trials are necessary, in which case the 
PMA could be delayed for several years while additional clinical trials are 
conducted and submitted in an amendment to the PMA application. The PMA 
process can be 


                                      12
<PAGE>

expensive, uncertain, and lengthy, and a number of devices for which FDA 
approval has been sought by other companies have never been approved for 
marketing. 

      Use of a medical device for applications not covered in a 510(k) 
notification or a PMA, or modifications to a device that has been cleared to 
market through a 510(k) notification or an approved PMA, its labeling, or its 
manufacturing process, may require submission of a new 510(k) notification, a 
new PMA application, or a PMA application supplement. New 510(k) 
notifications, PMA applications, or PMA supplements often require the 
submission of the same type of information required for the original 
submission except that it is generally limited to that information needed to 
support the proposed change from the product covered by the original 
submission. 

      Any products manufactured or distributed by the Company pursuant to FDA 
clearances or approvals are subject to pervasive and continuing regulation by 
the FDA, including record-keeping requirements and reporting of adverse 
experiences with the use of the device. Device manufacturers are required to 
register their establishments and list their devices with the FDA and certain 
state agencies, and are subject to periodic inspections by the FDA and 
certain state agencies. The FDC Act requires devices to be manufactured in 
accordance with GMP regulations that impose certain procedural and 
documentation requirements upon the Company with respect to manufacturing and 
quality assurance activities. Toward the end of the clearance or approval 
process, the FDA generally will conduct an inspection of the manufacturer's 
facilities to ensure that the facilities are in compliance with the 
applicable GMP requirements. The FDA has proposed changes to the GMP 
regulations that would, among other things, require design controls and 
maintenance of service records, which, if finalized, would likely increase 
the cost of complying with GMP requirements.

      Labeling and promotion activities are subject to scrutiny by the FDA 
and in certain instances, by the Federal Trade Commission. The FDA actively 
enforces regulations prohibiting marketing of products for unapproved uses. 
The Company and its products are also subject to a variety of state laws and 
regulations in those states or localities where its products are or will be 
marketed. Any applicable state or local regulations may hinder the Company's 
ability to market its products in those states or localities. The Company is 
also subject to numerous federal, state and local laws relating to such 
matters as safe working conditions, manufacturing practices, environmental 
protection, fire hazard control, and disposal of hazardous or potentially 
hazardous substances. There can be no assurance that the Company will not be 
required to incur significant costs to comply with such laws and regulations 
now or in the future.

       Changes in existing requirements or adoption of new requirements or 
policies could adversely affect the ability of the Company to comply with 
regulatory requirements. Failure to comply with regulatory requirements could 
have a material adverse effect on the Company's business, financial 
condition, and results of operations. There can be no assurance that the 
Company will not be required to incur significant costs to comply with laws 
and regulations in the future. See "Risk Factors--No Assurance of Regulatory 
Clearance or Approval; Significant Domestic and International Regulation."

INTERNATIONAL

      In order for the Company to market Port-Access systems in Europe and 
certain other foreign jurisdictions, the Company must obtain required 
regulatory approvals and clearances and otherwise comply with extensive 
regulations regarding safety and manufacturing processes and quality. These 
regulations, including the requirements for approvals or clearance to market 
and the time required for regulatory review, vary from country to country. 
There can be no assurance that the Company will obtain regulatory approvals 
in such countries or that it will not be required to incur significant costs 
in obtaining or maintaining its foreign regulatory approvals. Delays in 
receipt of approvals to market the Company's products, failure to receive 
these approvals or future loss of previously received approvals could have a 
material adverse effect on the Company's business, financial condition, and 
results of operations. 

      The time required to obtain approval for sale in foreign countries may 
be longer or shorter than that required for FDA approval, and the 
requirements may differ. In addition, there may be foreign regulatory 
barriers other than premarket approval, and the FDA must approve exports of 
devices that require a PMA but are not yet approved domestically. The current 
rules provide that, in order to obtain FDA export approval, the Company must 
provide the 


                                      13
<PAGE>

FDA with documentation from the medical device regulatory authority of the 
importing country stating that the import of the device is not a violation of 
that country's medical device laws. 

      The European Community has promulgated rules that require that medical 
products receive by mid-1998 the right to affix the CE Mark, an international 
symbol of adherence to quality assurance standards and compliance with 
applicable European medical device directives. The Company received the CE 
Mark in January, 1997, which allows it to sell its Port-Access CABG System 
and Port-Access MVR System in member countries of the European Union. 

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

      The Company believes that its competitive position will be dependent in 
significant part on its ability to protect its intellectual property. The 
Company's policy is to seek to protect its proprietary position by, among 
other methods, filing United States and foreign patent applications related 
to its technology, inventions and improvements that are important to the 
development of its business. As of March 14, 1997, the Company owns 25 issued 
or allowed United States patents, and owns an exclusive field of use license 
on one issued United States patent and on one issued foreign patent. In 
addition, as of March 14, 1997 the Company has 84 pending United States 
patent applications, and has filed 37 patent applications that are currently 
pending in Europe, Japan, Australia, and Canada. There can be no assurance 
that the Company's issued United States patents, or any patents that may be 
issued in the future, will effectively protect the Company's technology or 
provide a competitive advantage. There can be no assurance that any of the 
Company's patents or patent applications will not be challenged, invalidated, 
or circumvented in the future. In addition, there can be no assurance that 
competitors, many of which have substantially more resources than the Company 
and have made substantial investments in competing technologies, will not 
seek to apply for and obtain patents that will prevent, limit or interfere 
with the Company's ability to make, use, or sell its products either in the 
United States or internationally. 

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

      Patent applications in the United States are maintained in secrecy 
until patents issue, and patent applications in foreign countries are 
maintained in secrecy for a period after filing. Publication of discoveries 
in the scientific or patent literature tends to lag behind actual discoveries 
and the filing of related patent applications. Patents issued and patent 
applications filed relating to medical devices are numerous and there can be 
no assurance that current and potential competitors and other third parties 
have not filed or in the future will not file applications for, or have not 
received or in the future will not receive, patents or obtain additional 
proprietary rights relating to products or processes used or proposed to be 
used by the Company. The Company is aware of patents issued to third parties 
that contain subject matter related to the Company's technology. Based, in 
part, on advice of its patent counsel, the Company believes that the 
technologies employed by the Company in its devices and systems do not 
infringe the claims of any such patents. There can be no assurance, however, 
that third parties will not seek to assert that the Company's devices and 
systems infringe their patents or seek to expand their patent claims to cover 
aspects of the Company's technology. 

      The medical device industry in general, and the industry segment that 
includes products for the treatment of cardiovascular disease in particular, 
has been characterized by substantial competition and litigation regarding 
patent and other intellectual property rights. Any such claims, whether with 
or without merit, could be time-consuming and expensive to respond to and 
could divert the Company's technical and management personnel. The Company 
may be involved in litigation to defend against claims of infringement by 
other patent holders, to enforce patents issued to the Company, or to protect 
trade secrets of the Company. If any relevant claims of third-party patents 
are upheld as valid and enforceable in any litigation or administrative 
proceeding, the Company could be prevented from practicing the subject matter 
claimed in such patents, or would be required to obtain licenses from the 
patent owners 


                                      14
<PAGE>

of each such patent, or to redesign its products or processes to avoid 
infringement. There can be no assurance that such licenses would be available 
or, if available, would be available on terms acceptable to the Company or 
that the Company would be successful in any attempt to redesign its products 
or processes to avoid infringement. Accordingly, an adverse determination in 
a judicial or administrative proceeding or failure to obtain necessary 
licenses could prevent the Company from manufacturing and selling its 
products, which would have a material adverse effect on the Company's 
business, financial condition, and results of operations. The Company intends 
to vigorously protect and defend its intellectual property. Costly and 
time-consuming litigation brought by the Company may be necessary to enforce 
patents issued to the Company, to protect trade secrets or know-how owned by 
the Company or to determine the enforceability, scope and validity of the 
proprietary rights of others. See "Risk Factors--Uncertainty Regarding 
Patents and Protection of Proprietary Technology; Risks of Future 
Litigation." 

THIRD-PARTY REIMBURSEMENT

      The Company expects that sales volumes and prices of the Company's 
products will be heavily dependent on the availability of reimbursement from 
third-party payors and that individuals seldom, if ever, will be willing or 
able to pay directly for the costs associated with the use of the Company's 
products. The Company's products typically are purchased by doctors, clinics, 
hospitals, and other users, which bill various third-party payors, such as 
governmental programs and private insurance plans, for the healthcare 
services provided to their patients. Third-party payors carefully review and 
increasingly challenge the prices charged for medical products and services. 
Reimbursement rates from private companies vary depending on the procedure 
performed, the third-party payor, the insurance plan, and other factors. 
Medicare reimburses hospitals a prospectively determined fixed amount for the 
costs associated with an in-patient hospitalization based on the patient's 
discharge diagnosis, and reimburses physicians a prospectively determined 
fixed amount based on the procedure performed, regardless of the actual costs 
incurred by the hospital or physician in furnishing the care and unrelated to 
the specific devices used in that procedure. Medicare and other third-party 
payors are increasingly scrutinizing the level of reimbursement for covered 
products and whether to cover new products at all. 

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

      The Company believes that reimbursement in the future will be subject 
to increased restrictions such as those described above, both in the United 
States and in foreign markets. The Company believes that the overall 
escalating cost of medical products and services has led to and will continue 
to lead to increased pressures on the health care industry, both foreign and 
domestic, to reduce the cost of products and services, including products 
offered by the Company. There can be no assurance as to either United States 
or foreign markets that third-party reimbursement and coverage will be 
available or adequate, that current reimbursement amounts will not be 
decreased in the future or that future legislation, regulation, or 
reimbursement policies of third-party payors will not otherwise adversely 
affect the demand for the Company's products or its ability to sell its 
products on a profitable basis, particularly if the Company's systems are 
more expensive than competing cardiac surgery procedures. If third-party 
payor coverage or reimbursement is unavailable or inadequate, the Company's 
business, financial condition, and results of operations could be materially 
adversely affected. See "Risk Factors--Limitations on Third-Party 
Reimbursement." 

EMPLOYEES

      As of December 31, 1996, the Company had a total of 275 employees, 
including 56 in research and development, 70 in manufacturing, 63 in clinical 
affairs, 19 in regulatory affairs and quality assurance, 31 in sales and 
marketing, 5 in intellectual property and 31 in finance and administration. 
The Company maintains compensation, benefit, equity participation, and work 
environment policies intended to assist in attracting and retaining qualified 
personnel. The Company believes that the success of its business will depend, 
in significant part, on its ability to attract and retain such personnel. 
None of the Company's employees is represented by a collective 


                                      15
<PAGE>

bargaining agreement, nor has the Company experienced any work stoppage. The 
Company considers its relations with its employees to be good. 

RISK FACTORS

      This Annual Report on Form 10-K contains forward-looking statements 
that involve risks and uncertainties.  The Company's actual results may 
differ materially from those discussed in the forward-looking statements.  
Factors that might cause such a difference include, but are not limited to, 
the following:

EARLY STAGE OF UTILIZATION; NO ASSURANCE OF SAFETY AND EFFICACY

The Company's EndoCPB System, Port-Access CABG System, and Port-Access MVR 
System and related devices are at an early stage of clinical utilization, and 
there can be no assurance as to their clinical safety and efficacy. As of 
March 21, 1997, to the Company's knowledge, clinicians have completed only 
211 Port-Access CABG procedures and only 176 Port-Access MVR procedures using 
Heartport's systems and devices. Port-Access minimally invasive cardiac 
surgery has many of the risks of open-chest heart surgery, including bleeding 
from the wound or internal organs, irregular heartbeat, formation of blood 
clots and related complications, infection, heart attack, heart failure, 
stroke, and death.  Port-Access minimally invasive cardiac surgery also has 
additional risks compared to open-chest surgery, including tearing or 
splitting of major blood vessels, damage to blood vessels in the groin, and 
groin pain.  Although there can be no assurance in this regard, the Company 
believes, based on the limited clinical experience to date, that mortality 
and morbidity rates associated with Port-Access surgical procedures should be 
comparable to mortality and morbidity rates experienced with conventional 
open-chest procedures. If, with further experience, any of the Company's 
systems do not prove to be safe and effective or if the Company is otherwise 
unable to commercialize them successfully, the Company's business, financial 
condition, and results of operations will be materially adversely affected 
and the Company's business could cease.

NO ASSURANCE OF MARKET ACCEPTANCE

      There can be no assurance that the Company's EndoCPB and Port-Access 
systems will gain any significant degree of market acceptance among 
physicians, patients, and health care payors, even if necessary regulatory 
and reimbursement clearances and approvals are obtained. The Company believes 
that physicians' acceptance and healthcare payors' reimbursement of 
Port-Access procedures will be essential for market acceptance of its 
systems, and there can be no assurance that any such recommendations or 
approvals will be obtained. Physicians will not recommend Port-Access 
procedures unless they conclude, based on clinical data and other factors, 
that Port-Access procedures are an attractive alternative to other treatments 
for cardiovascular disease. Most patients with cardiovascular disease first 
consult with a cardiologist, who may treat the patient with pharmaceuticals 
or non-surgical interventions such as percutaneous transluminal coronary 
angioplasty ("PTCA") and intravascular stents, or may refer the patient to a 
cardiac surgeon for open-chest CABG surgery. Cardiologists may not recommend 
Port-Access procedures until such time, if any, as Port-Access CABG can be 
successfully demonstrated to be as safe and cost-effective as other accepted 
treatments. In addition, cardiac surgeons may elect not to recommend 
Port-Access procedures until such time, if any, as the efficacy of the 
Company's Port-Access procedures can be successfully demonstrated as compared 
to conventional, open-chest surgery methods, which have become widely adopted 
by cardiac surgeons since the initial use of such surgery in the mid-1950s. 
Even if the clinical efficacy of Port-Access procedures is established, 
cardiologists, cardiac surgeons, and other physicians may elect not to 
recommend the procedures for any number of other reasons. Failure of the 
Company's products to achieve significant market acceptance would have a 
material adverse effect on the Company's business, financial condition, and 
results of operations. 

FLUCTUATIONS IN OPERATING RESULTS

      Results of operations may vary significantly from quarter to quarter 
depending upon numerous factors, including the following: demand for the 
Company's products; the number of cardiac surgery teams trained in the  use 
of the Company's systems; the number of hospitals that begin using the 
Company's products; the ability of the


                                      16
<PAGE>

Company to manufacture, test and deliver its products in commercial volumes; 
health care reform and reimbursement policies; delays associated with the FDA 
and other regulatory approval processes; changes in pricing policies by the 
Company or its competitors; the number, timing, and significance of product 
enhancements and new product announcements by the Company and its 
competitors; the ability of the Company to develop, introduce, and market new 
and enhanced versions of the Company's products on a timely basis; customer 
order deferrals in anticipation of enhancements or new products offered by 
the Company or its competitors; product quality problems; personnel changes; 
and the level of international sales. In addition, the Company has begun to 
develop both a domestic and an international direct sales force. The timing 
of such development and the rate at which new sales people become productive 
could also cause material fluctuations in the Company's quarterly operating 
results. 

      Operating results have been and will continue to be difficult to 
forecast. Future revenue, if any, is also difficult to forecast because the 
market for minimally invasive cardiac surgery systems is rapidly evolving, 
and due to the inherent risks associated with new medical device technology. 
Accordingly, the Company believes that period-to-period comparisons of its 
operating results are not necessarily meaningful and should not be relied 
upon as indications of future performance. Failure by the Company, for any 
reason, to achieve additional regulatory approvals and to begin to generate 
and increase revenue from sales of its products would have a material adverse 
effect on the Company's business, operating results, and financial condition. 
Due to the foregoing factors, it is likely that in some future quarter the 
Company's operating results will be below the expectations of public market 
analysts and investors. In such event, the price of the Company's Common 
Stock would likely be materially adversely affected. See "Management's 
Discussion and Analysis of Financial Condition and Results of Operations," 
and "Research and Development," "Manufacturing," "Competition," 
"Government Regulation," and "Third-Party Reimbursement." 

RISKS ASSOCIATED WITH NEW SURGICAL PROCEDURE; EXTENSIVE TRAINING REQUIREMENTS

      Use of the Company's EndoCPB System, Port-Access CABG System, and 
Port-Access MVR System to date has shown that, as with any novel surgical 
procedure, there is a significant learning process involved for surgeons and 
other members of the cardiac surgery team to become proficient. In addition, 
certain  patients requiring heart surgery cannot be treated with the present 
Port-Access systems, depending upon what kind of condition they have and how 
severe it is.  These patients include people with severe peripheral vascular 
disease (arteriosclerosis), a poorly functioning aortic valve, an enlarged 
heart, or certain types of chest scarring. Broad use of the Company's systems 
will require extensive training of numerous physicians, and the time required 
to begin and complete such training could adversely affect market acceptance. 
Although the Company has begun to train physicians at its Salt Lake City, 
Utah facility and at its contract facility near Uppsala, Sweden, there can be 
no assurance that the Company will be able to rapidly train physicians in 
numbers sufficient to generate adequate demand for the Company's products and 
systems. Any delay in training would have a material adverse effect on the 
demand for the Company's products and systems and, therefore, a material 
adverse effect on its business, financial condition, and results of 
operations. 

LIMITED MANUFACTURING EXPERIENCE; DEPENDENCE ON KEY SUPPLIERS

      To meet anticipated demand, the Company must increase the rate by which 
it manufactures its products. To date, the Company's manufacturing activities 
have consisted primarily of manufacturing limited quantities of products for 
use in laboratory testing, clinical trials and initial low-volume commercial 
sales. The manufacture of the Company's products is complex, involving a 
number of separate processes and components. The Company does not have 
experience in manufacturing its products in commercial quantities. Although 
the Company is scaling up its capability to produce products in volume to 
support its commercial launch, there can be no assurance that it will be able 
to make the transition to commercial production successfully. In addition, 
the Company believes that cost reductions in its manufacturing operations 
will be required for it to commercialize its systems on a profitable basis. 
Certain manufacturing processes are labor-intensive, and achieving 
significant cost reductions will depend, in part, upon reducing the time 
required to complete these processes. Manufacturers often encounter 
difficulties in scaling up manufacturing of new products, including problems 
involving product yields, quality control and assurance, component and 
service availability, adequacy of control policies and procedures, lack of 
qualified personnel, 


                                      17
<PAGE>

compliance with FDA regulations, and the need for further FDA approval of new 
manufacturing processes and facilities. The Company has considered and will 
continue to consider as appropriate the internal manufacture of components 
currently provided by third parties, as well as the implementation of new 
production processes. There can be no assurance that manufacturing yields or 
costs will not be adversely affected by the transition to in-house production 
or to new production processes when such efforts are undertaken, or that FDA 
GMP requirements can be met, and that such a transition would not materially 
and adversely affect the Company's business, financial condition, and results 
of operations.  See "Manufacturing." 

      The Company uses or relies on certain components and services used in 
its devices that are provided by sole source suppliers. The qualification of 
additional or replacement vendors for certain components or services is a 
lengthy process. Any significant supply interruption would have a material 
adverse effect on the Company's ability to manufacture its products and, 
therefore, a material adverse effect on its business, financial condition, 
and results of operations. 

      The Company manufactures its products based on forecasted product 
orders, and purchases subassemblies and components prior to receipt of 
purchase orders from customers. Lead times for materials and components 
ordered by the Company vary significantly, and depend on factors such as the 
business practices of the specific supplier, contract terms, and general 
demand for a component at a given time. Certain components used in the 
Company's products have long lead times. As a result, there is a risk of 
excess or inadequate inventory if orders do not match forecasts. 

SIGNIFICANT COMPETITION; RAPID TECHNOLOGICAL CHANGE

      The Company expects that the market for minimally invasive cardiac 
surgery, which is currently in the early stages of development, will be 
intensely competitive. Competitors are likely to include a variety of 
different companies that currently specialize in devices for conventional 
cardiac surgery, as well as those that specialize in non-cardiac minimally 
invasive surgery. The Company believes that a number of large companies, 
including the Ethicon Endosurgery division of Johnson & Johnson, United 
States Surgical Corporation, Medtronic, Inc., Baxter International, Genzyme 
Corporation, Guidant Corporation and others with significantly greater 
financial, manufacturing, marketing, distribution, and technical resources 
and experience than the Company, may be focusing on the development of 
minimally invasive cardiac surgery technology. In addition, new companies 
have been and will continue to be started to pursue opportunities in this 
market. Several companies have announced interest in and development of 
products for the minimally invasive cardiac surgery field. For example, there 
are companies pursuing minimally invasive cardiac surgery on a beating heart, 
which, if successful, could materially adversely affect the Company's ability 
to establish a market for its technology. 

      Cardiovascular diseases that can be treated with the Company's 
Port-Access systems can also be treated by pharmaceuticals or other medical 
devices and procedures including PTCA, intravascular stents, atherectomy 
catheters and lasers. Many of these alternative treatments are widely 
accepted in the medical community and have a long history of use. In 
addition, technological advances with other therapies for heart disease such 
as drugs or future innovations in cardiac surgery techniques could make such 
other therapies more effective or lower in cost than the Company's 
Port-Access procedures and could render the Company's technology obsolete. 
There can be no assurance that physicians will use Port-Access procedures to 
replace or supplement established treatments, such as conventional open-chest 
heart surgery, PTCA, or intravascular stents, or that the Company's 
Port-Access systems will be competitive with current or future technologies. 
Such competition could have a material adverse effect on the Company's 
business, financial condition, and results of operations. Any product 
developed by the Company that gains regulatory clearance or approval will 
have to compete for market acceptance and market share. An important factor 
in such competition may be the timing of market introduction of competitive 
products. Accordingly, the relative speeds with which the Company can develop 
products, complete clinical testing and regulatory approval processes, train 
physicians in the use of its products, gain reimbursement acceptance, and 
supply commercial quantities of the product to the market are expected to be 
important competitive factors. The Company has experienced delays in 
completing the development and introduction of new products, product 
variations and product features, and there can be no assurance that such 
delays will not continue or recur in the future. Such delays could result in 
a loss of market acceptance and market share. There can be no assurance that 
the Company will be able to 


                                      18
<PAGE>

compete successfully against current and future competitors. Failure to do so 
would have a material adverse effect upon the Company's business, financial 
condition, and results of operations. See "Competition." 

SUBSTANTIAL FUTURE LOSSES AND FUTURE CAPITAL REQUIREMENTS

      Since its inception in May, 1991, the Company has been engaged in the 
research and development of minimally invasive cardiac surgery systems and 
related technology. The Company only recently began to generate revenue from 
the sale of products and has been unprofitable since inception. For the 
period from inception to December 31, 1996, the Company has incurred 
cumulative net losses of approximately $50.6 million. For at least the next 
year, the Company expects to continue to incur substantial and increasing 
losses. Furthermore, the Company expects its expenses to increase as its 
product commercialization and other business activities expand. There can be 
no assurance that the Company will achieve or sustain profitability in the 
future. Failure to achieve significant commercial revenues or profitability 
would have a material adverse effect on the Company's business, financial 
condition, and results of operations. 

      The Company believes that it may require additional financing. The 
Company's future liquidity and capital requirements will depend upon numerous 
factors, including the following: the extent to which the Company's products 
gain market acceptance; the timing and costs of product introductions; the 
extent of the Company's ongoing research and development programs; the costs 
of training physicians to become proficient in the use of the Company's 
products and procedures; the costs of expanding manufacturing capacity; the 
costs of developing marketing and distribution capabilities; the progress and 
scope of clinical trails required for any future products; the timing and 
costs of filing future regulatory submissions; the timing and costs required 
to receive both domestic and international governmental approvals for any 
future products; and the costs of protecting and defending its intellectual 
property. Issuance of additional equity securities could result in dilution 
to stockholders. There can be no assurance that additional financing will be 
available on terms acceptable to the Company, or at all. The Company's 
inability to fund its capital requirements would have a material adverse 
effect on the Company's business, financial condition, and results of 
operations. See "Management's Discussion and Analysis of Financial Condition 
and Results of Operations." 

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

      The Company believes that its competitive position will be dependent in 
significant part on its ability to protect its intellectual property. The 
Company's policy is to seek to protect its proprietary position by, among 
other methods, filing United States and foreign patent applications related 
to its technology, inventions, and improvements that are important to the 
development of its business. As of March 14, 1997, the Company owns 25 issued 
or allowed United States patents, and owns an exclusive field of use license 
on one issued United States patent and on one issued foreign patent. In 
addition, as of March 14, 1997, the Company has 84 pending United States 
patent applications and has filed 37 patent applications that are currently 
pending in Europe, Japan, Australia, and Canada. There can be no assurance 
that the Company's issued United States patents, or any patents that may be 
issued in the future, will effectively protect the Company's technology or 
provide a competitive advantage. There can be no assurance that any of the 
Company's patents or patent applications will not be challenged, invalidated, 
or circumvented in the future. In addition, there can be no assurance that 
competitors, many of which have substantially more resources than the Company 
and have made substantial investments in competing technologies, will not 
seek to apply for and obtain patents that will prevent, limit, or interfere 
with the Company's ability to make, use, or sell its products either in the 
United States or internationally. 

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


                                      19
<PAGE>

      Patent applications in the United States are maintained in secrecy 
until patents issue, and patent applications in foreign countries are 
maintained in secrecy for a period after filing. Publication of discoveries 
in the scientific or patent literature tends to lag behind actual discoveries 
and the filing of related patent applications. Patents issued and patent 
applications filed relating to medical devices are numerous and there can be 
no assurance that current and potential competitors and other third parties 
have not filed or in the future will not file applications for, or have not 
received or in the future will not receive, patents or obtain additional 
proprietary rights relating to products or processes used or proposed to be 
used by the Company. The Company is aware of patents issued to third parties 
that contain subject matter related to the Company's technology. Based, in 
part, on advice of its patent counsel, the Company believes that the 
technologies employed by the Company in its devices and systems do not 
infringe the claims of any such patents. There can be no assurance, however, 
that third parties will not seek to assert that the Company's devices and 
systems infringe their patents or seek to expand their patent claims to cover 
aspects of the Company's technology. 

      The medical device industry in general, and the industry segment that 
includes products for the treatment of cardiovascular disease in particular, 
has been characterized by substantial competition and litigation regarding 
patent and other intellectual property rights. Any such claims, whether with 
or without merit, could be time-consuming and expensive to respond to and 
could divert the Company's technical and management personnel. The Company 
may be involved in litigation to defend against claims of infringement by 
other patent holders, to enforce patents issued to the Company, or to protect 
trade secrets of the Company. If any relevant claims of third-party patents 
are upheld as valid and enforceable in any litigation or administrative 
proceeding, the Company could be prevented from practicing the subject matter 
claimed in such patents, or would be required to obtain licenses from the 
patent owners of each such patent, or to redesign its products or processes 
to avoid infringement. There can be no assurance that such licenses would be 
available or, if available, would be available on terms acceptable to the 
Company or that the Company would be successful in any attempt to redesign 
its products or processes to avoid infringement. Accordingly, an adverse 
determination in a judicial or administrative proceeding or failure to obtain 
necessary licenses could prevent the Company from manufacturing and selling 
its products, which would have a material adverse effect on the Company's 
business, financial condition, and results of operations. The Company intends 
to vigorously protect and defend its intellectual property. Costly and 
time-consuming litigation brought by the Company may be necessary to enforce 
patents issued to the Company, to protect trade secrets or know-how owned by 
the Company, or to determine the enforceability, scope, and validity of the 
proprietary rights of others. See "Intellectual Property and Other 
Proprietary Rights" and "Competition." 

MANAGEMENT OF EXPANDING OPERATIONS; ACQUISITIONS

      The Company has recently experienced rapid expansion of its operations, 
which has placed, and is expected to continue to place, significant demands 
on the Company's administrative, operational and financial personnel and 
systems. In this respect, the Company hired a significant number of new 
employees in the second half of 1996 and expects to continue hiring during 
1997. In order to compete effectively against current and future competitors, 
the Company believes that it must continue to expand its operations, 
particularly in the areas of research and development, clinical affairs, 
manufacturing and sales and marketing. If the Company were to experience 
significant growth in the future, such growth would likely result in new and 
increased responsibilities for management personnel and place significant 
strain upon the Company's management, operating, and financial systems and 
resources. To accommodate such growth and compete effectively, the Company 
must continue to implement and improve information systems, procedures, and 
controls, and to expand, train, motivate, and manage its work force. The 
Company is currently in the process of implementing an integrated financial, 
manufacturing, and inventory information system. Implementing such a system 
can be time-consuming and expensive and requires significant management 
resources. There can be no assurance that such system will be implemented on 
a timely basis. Although the Company has recently hired several new members 
of management, all of the foregoing demands will require additional 
management personnel as well. The Company's future success will depend to a 
significant extent on the ability of its current and future management 
personnel to operate effectively, both independently and as a group. There 
can be no assurance that the Company's personnel, systems, procedures, and 
controls will be adequate to support the Company's future operations. Any 
failure to implement and improve the Company's operational, financial, and 
management systems or to expand, train, motivate, or manage employees could 
have a material adverse effect on the Company's business, financial 
condition, and results of operations. See "Management's Discussion and 
Analysis of Financial Condition and Results of Operations."


                                      20
<PAGE>

      The Company may make acquisitions in the future, and the Company 
regularly evaluates such opportunities.  Product and technology acquisitions 
entail numerous risks, including difficulties in the assimilation of acquired 
operations and products, diversion of management's attention to other 
business concerns, amortization of acquired intangible assets and potential 
loss of key employees of acquired companies. The Company's management has had 
limited experience in assimilating acquired organizations and products into 
the Company's operations. No assurance can be given as to the ability of the 
Company to integrate successfully any operations, personnel or products that 
might be acquired in the future, and the failure of the Company to do so 
could have a material adverse effect on the Company's results of operations.  

RELIANCE ON STRATEGIC RELATIONSHIPS

      The Company intends to pursue strategic relationships with corporations 
and research institutions with respect to the research, development, 
regulatory approval, and marketing of certain of its potential products and 
procedures. The Company's future success may depend, in part, on its 
relationships with third parties, including, for example, the Company's 
relationship with St. Jude Medical, Inc., their strategic interest in the 
potential products or procedures under development and, eventually, their 
success in marketing such products or procedures or willingness to purchase 
any such products. The Company anticipates that these third parties may have 
the unilateral right to terminate any such relationship without significant 
penalty. There can be no assurance that the Company will be successful in 
establishing or maintaining any such strategic relationships in the future or 
that any such relationships will be successful. See "Strategic 
Relationships." 

RISK OF PRODUCT LIABILITY

      The Company faces an inherent and significant business risk of exposure 
to product liability claims in the event that the use of its products results 
in personal injury or death and there can be no assurance that the Company 
will not experience any material product liability losses in the future. 
Also, in the event that any of the Company's products prove to be defective, 
the Company may be required to recall or redesign such products. The Company 
maintains limited insurance against certain product liability claims, but 
there can be no assurance that such coverage will continue to be available on 
terms acceptable to the Company or that such coverage will be adequate for 
any liabilities actually incurred. A successful claim brought against the 
Company in excess of available insurance coverage, or any claim or product 
recall that results in significant adverse publicity against the Company, may 
have a material adverse effect on the Company's business, financial 
condition, and results of operations. 

LIMITED SALES, MARKETING, AND DISTRIBUTION EXPERIENCE

      The Company currently has a limited sales and marketing organization in 
the United States and Europe. The Company plans to market its approved 
systems through a direct sales force in the United States and through a 
combination of direct and indirect sales channels internationally. 
Establishment of a sales force capable of effectively commercializing the 
Company's EndoCPB and Port-Access systems will require substantial efforts 
and require significant management and financial resources. There can be no 
assurance that the Company will be able to establish such a sales capability 
on a timely basis, or at all. See "Sales, Marketing, Training, and 
Distribution." 

DEPENDENCE ON KEY PERSONNEL

      The Company's future business and operating results depend in 
significant part upon the continued contributions of its key technical and 
senior management personnel, many of whom would be difficult to replace and 
certain of whom perform important functions for the Company beyond those 
functions suggested by their respective job titles or descriptions. The 
Company's business and future operating results also depend in significant 
part upon its ability to attract and retain qualified management, 
manufacturing, technical, marketing, and sales and support personnel for its 
operations. Competition for such personnel is intense, and there can be no 
assurance that the Company will be successful in attracting or retaining such 
personnel. The loss of any key employee, the failure of any key employee to 
perform in his or her current position, or the Company's inability to attract 
and retain skilled employees, as needed, could materially adversely affect 
the Company's business, financial condition, and results of operations.


                                      21
<PAGE>

NO ASSURANCE OF REGULATORY CLEARANCE OR APPROVAL; SIGNIFICANT DOMESTIC AND 
INTERNATIONAL REGULATION

      The Company's individual devices are subject to regulatory clearances 
or approvals by the FDA. The Company believes that most of its devices and 
systems will be subject to United States regulatory clearance through the 
510(k) premarket notification process rather than a more extensive pre-market 
approval ("PMA") submission. Although the Company has received clearance from 
the FDA to market the EndoCPB System in the United States, securing FDA 
approvals and clearances for additional Port-Access devices and other 
products under development by the Company will require submission to the FDA 
of extensive technical information and may require submission of extensive 
clinical data. There can be no assurance that the FDA will act favorably or 
quickly on the Company's 510(k) or other submissions, and significant 
difficulties and costs may be encountered by the Company in its efforts to 
obtain FDA clearance that could delay or preclude the Company from marketing 
and selling its products in the United States. Furthermore, there can be no 
assurance that the FDA will not request additional data, require that the 
Company conduct further clinical studies, or require a more extensive PMA 
submission, causing the Company to incur substantial costs and delays. The 
Company's business, financial condition, and results of operations are 
critically dependent upon FDA clearance or approval of the Company's systems. 
Failure to obtain such clearance or approval, or to obtain such clearance or 
approval on a timely basis, would have a material adverse effect on the 
Company's business, financial condition, and results of operations, and could 
result in postponement of the commercialization of the Company's products or 
even cessation of the Company's business in the United States. 

      Sales of medical devices outside of the United States are subject to 
foreign regulatory requirements that vary widely from country to country. The 
time required to obtain approval for sale in foreign countries may be longer 
or shorter than that required for FDA clearance or approval, and the 
requirements may differ. In addition, if the FDA were to require a PMA 
submission for any of the Company's products, the Company would be required 
to obtain FDA approval to export such devices and systems to international 
markets prior to their approval by the FDA for commercialization in the 
United States. Although the Company has received approval to market the 
EndoCPB System in Europe, securing approvals for additional Port-Access 
devices and other products under development by the Company will require 
additional approvals and there can be no assurance that such approvals will 
be received on a timely basis, or at all. Most other countries in which the 
Company intends to operate either do not currently regulate medical systems 
or have minimal regulatory requirements, although these countries may adopt 
more extensive regulations in the future that could impact the Company's 
ability to market its systems. In addition, significant costs and requests 
for additional information may be encountered by the Company in its efforts 
to obtain regulatory approvals. Any such events could substantially delay or 
preclude the Company from marketing its systems internationally. 

      In addition, the FDA and certain foreign regulatory authorities impose 
numerous other requirements with which medical device manufacturers must 
comply. Product approvals can be withdrawn for failure to comply with 
regulatory standards or the occurrence of unforeseen problems following 
initial marketing. The Company will also be required to adhere to applicable 
FDA regulations setting forth current Good Manufacturing Practices ("GMP") 
requirements, which include testing, control, and documentation requirements. 
Ongoing compliance with GMP and other applicable regulatory requirements is 
monitored through periodic inspections by state and federal agencies, 
including the FDA, and by comparable agencies in other countries. Failure to 
comply with applicable regulatory requirements can result in fines, 
injunctions, civil penalties, recall or seizure of products, total or partial 
suspension of production, denial or withdrawal of premarket clearance or 
premarket approval for devices, and criminal prosecution. Furthermore, 
changes in existing regulations or adoption of new regulations or policies 
could delay or even prevent the Company from obtaining future regulatory 
approvals or clearances. For example, the FDA is currently considering major 
revisions to its GMP regulations. Such revisions could have a material 
adverse effect on the Company's business, financial condition, and results of 
operations. See "Government Regulation." 

LIMITATIONS ON THIRD-PARTY REIMBURSEMENT

      The Company expects that sales volumes and prices of the Company's 
products will be heavily dependent on the availability of reimbursement from 
third-party payors and that individuals seldom, if ever, will be willing or 
able to pay directly for the costs associated with the use of the Company's 
products. The Company expects that its products typically will be purchased 
by doctors, clinics, hospitals, and other users, which bill various 
third-party payors, such as governmental programs and private insurance 
plans, for the healthcare services provided to their 


                                      22
<PAGE>

patients. Third-party payors carefully review and increasingly challenge the 
prices charged for medical products and services. Reimbursement rates from 
private companies vary depending on the procedure performed, the third-party 
payor, the insurance plan, and other factors. Medicare reimburses hospitals  
a prospectively determined fixed amount for the costs associated with an 
in-patient hospitalization based on the patient's discharge diagnosis, and 
reimburses physicians a prospectively determined fixed amount based on the 
procedure performed, regardless of the actual costs incurred by the hospital 
or physician in furnishing the care and unrelated to the specific devices 
used in that procedure. Medicare and other third-party payors are 
increasingly scrutinizing whether to cover new products and the level of 
reimbursement for covered products. 

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

      The Company believes that reimbursement in the future will be subject 
to increased restrictions such as those described above, both in the United 
States and in foreign markets. The Company believes that the overall 
escalating cost of medical products and services has led to and will continue 
to lead to increased pressures on the health care industry, both foreign and 
domestic, to reduce the cost of products and services, including products 
offered by the Company. There can be no assurance as to either United States 
or foreign markets that third-party reimbursement and coverage will be 
available or adequate, that current reimbursement amounts will not be 
decreased in the future or that future legislation, regulation, or 
reimbursement policies of third-party payors will not otherwise adversely 
affect the demand for the Company's products or its ability to sell its 
products on a profitable basis, particularly if the Company's systems are 
more expensive than competing cardiac surgery procedures. If third-party 
payor coverage or reimbursement is unavailable or inadequate, the Company's 
business, financial condition, and results of operations could be materially 
adversely affected. See "Third-Party Reimbursement." 

VOLATILITY OF STOCK PRICE

      The Company's stock price has been, and is likely to continue to be, 
highly volatile. The market price of the Company's Common Stock has 
fluctuated substantially in recent periods, rising from $21.00 at the 
Company's initial public offering on April 25, 1996, to a high of $43.75 on 
May 15, 1996, and to a low of $18.375 on July 16, 1996.  On March 14, 1997 
the price of the Company's Common Stock was $27.25.  The market price of the 
shares of Common Stock may be significantly affected by factors such as 
actual or anticipated fluctuations in the Company's operating results, 
announcements of technological innovations, new products or new contracts by 
the Company or its competitors, developments with respect to patents or 
proprietary rights, conditions and trends in the medical device and other 
technology industries, adoption of new accounting standards affecting the 
medical device industry, changes in financial estimates by securities 
analysts, general market conditions, and other factors. In addition, the 
stock market has from time to time experienced significant price and volume 
fluctuations that have particularly affected the market prices for the common 
stocks of early stage companies. These broad market fluctuations may 
adversely affect the market price of the Company's Common Stock, and there 
can be no assurance that the market price of the Common Stock will not 
decline below the public offering price. In the past, following periods of 
volatility in the market price of a particular company's securities, 
securities class action litigation has often been brought against that 
company. Such litigation, if brought against the Company, could result in 
substantial costs and a diversion of management's attention and resources.

CONTROL BY PRINCIPAL STOCKHOLDERS, OFFICERS AND DIRECTORS

      The present directors, executive officers, and principal stockholders 
of the Company and their affiliates beneficially own approximately 51.6% of 
the outstanding Common Stock. As a result, these stockholders will be able to 
continue to exert significant influence over all matters requiring 
stockholder approval, including the election of directors and approval of 
significant corporate transactions. Such concentration of ownership may have 
the effect of delaying or preventing a change in control of the Company.


                                      23
<PAGE>

EFFECT OF CERTAIN CHARTER PROVISIONS; ANTITAKEOVER EFFECTS OF RIGHTS PLAN, 
CERTIFICATE OF INCORPORATION, BYLAWS, AND DELAWARE LAW

      The Company's Board of Directors has the authority to issue up to 
20,000,000 shares of Preferred Stock and to determine the price, rights, 
preferences, privileges and restrictions, including voting and conversion 
rights of such shares, without any further vote or action by the Company's 
stockholders. The rights of the holders of Common Stock will be subject to, 
and may be adversely affected by, the rights of the holders of any Preferred 
Stock that may be issued in the future. The issuance of Preferred Stock could 
have the effect of making it more difficult for a third party to acquire a 
majority of the outstanding voting stock of the Company. Other than the 
Series A Preferred Stock issuable under the stockholder rights plan, the 
Company has no current plans to issue shares of Preferred Stock. In addition, 
the Company's Certificate of Incorporation provides for a classified Board of 
Directors such that approximately only one-third of the members of the Board 
are elected at each annual meeting of stockholders. Classified Boards may 
have the effect of delaying, deferring, or discouraging changes in control of 
the Company. Further, the Company has adopted a stockholder rights plan that, 
in conjunction with certain provisions of the Company's Certificate of 
Incorporation and Bylaws and of Delaware law, could delay or make more 
difficult a merger, tender offer, or proxy contest involving the Company. 

ITEM 2.PROPERTIES.

      The Company's principal administrative, sales, manufacturing, and 
research and development facility occupies approximately 70,000 square feet 
in three adjacent buildings in an office park in Redwood City, California, 
pursuant to leases which expire between April, 1999 and July, 1999.  The 
Company is currently negotiating for approximately an additional 15,000 
square feet of manufacturing and office space in another building in the same 
office park.  The Company believes its facilities will be adequate through 
the end of 1997, but the Company will need additional space thereafter. The 
Heartport Research and Training Center occupies approximately 50,000 square 
feet in Salt Lake City, Utah. The initial term of the lease on this facility 
expires in December, 2001. 

ITEM 3.LEGAL PROCEEDINGS.

      None.

PART II

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

      None.


                                      24
<PAGE>

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

      The Company's Common Stock has traded publicly on the Nasdaq National 
Market under the symbol "HPRT" since April 25, 1996. The Company's initial 
public offering price was $21.00 per share. The following table sets forth, 
for the periods indicated, the high and low closing sale prices for the 
Company's Common Stock as reported by the Nasdaq National Market. 


                                                           HIGH       LOW
                                                           ----       ---
YEAR ENDED DECEMBER 31, 1996:
    Second Quarter (from April 26, 1996, the first 
      trading date).....................................  $41.00     $26.875
    Third Quarter.......................................   30.25      21.250
    Fourth Quarter......................................   36.50      22.875

YEAR ENDED DECEMBER 31, 1997:
    First Quarter (through March 14, 1997)..............   32.69      21.375

      On March 14, 1997, the last sale price of the Company's Common Stock as 
reported by the Nasdaq National Market was $27.25 per share. There were 
approximately 328 holders of record of the Company's Common Stock as of March 
14, 1997. See "Risk Factors--Volatility of Stock Price."

      The Company has never declared or paid cash dividends on its Common 
Stock and currently does not anticipate paying cash dividends in the 
foreseeable future. In addition, the Company's debt facility restricts the 
ability to pay cash dividends.


                                      25
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA.

      The following selected financial data should be read in conjunction 
with the Company's financial statements and related notes thereto and 
"Management's Discussion and Analysis of Financial Condition and Results of 
Operations" included elsewhere herein. The statement of operations data for 
the three years in the period ended December 31, 1996, and the balance sheet 
data at December 31, 1995 and 1996 are derived from the audited financial 
statements included elsewhere herein. The statement of operations data for 
the period from May 17, 1991 (inception) to December 31, 1992 and for the 
year ended December 31, 1993, and the balance sheet data at December 31, 
1992, 1993 and 1994 are derived from audited financial statements not 
included herein. 

<TABLE>
<CAPTION>
                                                                               PERIOD FROM
                                     1996       1995      1994      1993      MAY 17, 1991
                                     ----       ----      ----      ----     (INCEPTION) TO
                                           YEAR ENDED DECEMBER 31,           DECEMBER 31, 1992
                                  -------------------------------------      -----------------
                                  (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                <C>       <C>          <C>       <C>             <C>
STATEMENT OF OPERATIONS DATA:
Net sales........................  $    624    $    --    $    --   $    --         $  --
Cost of goods sold...............       561         --         --        --            --
                                   --------    -------    -------   -------         -----
Gross profit                             63         --         --        --            --

Operating expenses:
  Research and development.......    21,059      8,477      4,207     1,493           428
  Selling, general and
    administrative...............    11,223      1,229        734       364           210
Patent acquisition...............     5,216         --         --        --            --
                                   --------    -------    -------   -------         -----
Loss from operations.............   (37,435)    (9,706)    (4,941)   (1,857)         (638)
Interest income..................     3,973        542        120        58            66
Interest expense.................      (592)      (189)        --        --            --
                                   --------    -------    -------   -------         -----
Net loss                           $(34,054)   $(9,353)   $(4,821)  $(1,799)        $(572)
                                   --------    -------    -------   -------         -----
Pro forma net loss per share(1)..  $  (1.50)   $  (.47)   
                                   --------    -------              -------         -----
Shares used in calculation 
   of proforma net loss per 
   share(1)......................    22,771     19,782
                                   --------    -------
</TABLE>

<TABLE>
<CAPTION>
                                                         DECEMBER 31,
                                       ---------------------------------------------------
                                       1996       1995       1994        1993       1992
                                       ----       ----       ----        ----       ----
                                                         (in thousands)
<S>                                 <C>         <C>        <C>         <C>         <C>
BALANCE SHEET DATA:
Current assets...................   $ 94,226    $ 12,692   $ 1,721     $   696     $2,447
Working capital..................     87,561      11,234     1,089         505        237
Total assets.....................    101,852      14,266     2,621         983      2,600
Long-term obligations, less 
   current portion...............      4,717       4,034        61          10          5
Accumulated deficit..............    (50,599)    (16,545)   (7,192)     (2,371)      (572)
Total stockholders' equity.......     90,470       8,775     1,928         781      2,517
</TABLE>
___________________
(1)    Shares of Common Stock issuable upon exercise of outstanding options 
       and warrants are excluded from the computations as their effect is 
       antidilutive, except that such securities issued during the 
       twelve-month period prior to the Company's initial public offering 
       at prices below the initial public offering price have been included 
       in the calculation as if they were outstanding. See Note 1 of Notes to 
       Financial Statements. 


                                      26
<PAGE>

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

OVERVIEW

      Since its inception in May, 1991, the Company has been engaged in the 
research and development of Port-Access minimally invasive cardiac surgery 
systems and related technology. The Company only recently began to generate 
revenue from the sale of products, and it has been unprofitable since 
inception. For the period from inception to December 31, 1996, the Company 
has incurred cumulative net losses of approximately $50.6 million. For at 
least the next year, the Company expects to continue to incur substantial and 
increasing losses. Over that period, the Company expects its expenses to 
increase substantially, particularly its selling, general and administrative 
expenses relating to training surgical teams and building a sales force. 

      The Company has hired a significant number of employees each year to 
conduct and support its research and development and commercialization 
activities. At December 31, 1996, 1995, and 1994, the Company had 275, 73, 
and 44 employees, respectively. The Company anticipates that its workforce 
will continue to grow rapidly in the next several years to support product 
development, clinical affairs, manufacturing, and sales and marketing.

      The research and development, manufacture, sale, and distribution of 
the EndoCPB, Port-Access CABG, and Port-Access MVR systems are subject to 
numerous regulations imposed by governmental authorities, principally the FDA 
and corresponding state and foreign agencies. The regulatory process is 
lengthy, expensive, and uncertain. Prior to commercial sale in the United 
States, most medical devices must be approved or cleared by the FDA. In 
October, 1996, the Company received clearance from the FDA to market the 
EndoCPB System and also received pre-market notification exemptions clearing 
its core reusable and disposable surgical devices to be labeled and used for 
minimally invasive cardiac surgery. Securing FDA approvals and clearances for 
additional Port-Access devices and other products under development by the 
Company will require submission to the FDA of extensive technical information 
and may require submission of extensive clinical data. There can be no 
assurance that the Company will receive FDA clearance or approval of any such 
additional devices or products. Many foreign governments and the European 
Community also have review processes for medical devices. 

      There can be no assurance that the Company's research and development 
efforts will be successfully completed, and there can be no assurance that 
the EndoCPB, Port-Access CABG, and Port-Access MVR systems will prove to be 
safe and effective. There can be no assurance that the Company's EndoCPB, 
Port-Access CABG, or Port-Access MVR systems or any other product developed 
by the Company will be successfully introduced or achieve market acceptance. 
There can be no assurance that the Company will ever achieve significant 
revenue from sales of the EndoCPB, Port-Access CABG, or Port-Access MVR 
systems or any other potential products or will ever achieve profitability. 

      The foregoing and the discussion appearing elsewhere in this 
"Management's Discussion and Analysis of Financial Condition and Results of 
Operations" contain forward-looking statements that involve risks and 
uncertainties. The Company's actual results may differ materially from the 
results discussed in the forward-looking statements. Factors that might cause 
such a difference include, but are not limited to, those discussed in "Risk 
Factors."

RESULTS OF OPERATIONS

      NET SALES.  Net sales consist of initial sales of the Company's 
EndoCPB, Port-Access CABG and Port-Access MVR systems.  The Company 
recognizes revenue upon product shipment. In 1996, net sales were $624,000, 
all of which was recognized in the fourth quarter.  

      COST OF GOODS SOLD.  Cost of goods sold of $561,000 in 1996 consisted 
primarily of material, labor and overhead costs associated with  
manufacturing the Company's EndoCPB, Port-Access CABG, and Port-Access MVR 
systems sold. 

      RESEARCH AND DEVELOPMENT EXPENSES.  Research and development expenses 
consist primarily of personnel costs, consulting fees and other costs in 
support of product development, clinical trials, physician training, and 


                                      27
<PAGE>

regulatory submissions, as well as costs incurred in producing products for 
research and development activities, physician training, and clinical trials, 
and the cost of prosecuting United States and foreign patent applications 
relating to the Company's technology. Research and development expenses 
increased to $21.1 million in 1996 from $8.5 million in 1995 and $4.2 million 
in 1994. The increase in all periods was primarily attributable to the hiring 
of additional personnel required to support expanded clinical trials, 
physician training, and product development activities, and to the cost of 
producing products for physician training and research and development 
activities. The Company anticipates that it will continue to devote 
substantial resources to research and development.  However, the Company 
anticipates that research and development expenses will remain flat in 1997 
as start-up costs for manufacturing and physician training incurred during 
the Company's development phase will not recur in 1997.

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.  Selling, general and 
administrative expenses consist primarily of costs for administrative, sales 
and marketing personnel, as well as legal, accounting and other professional 
fees. Selling, general and administrative expenses increased to $11.2 million 
in 1996 from $1.2 million in 1995 and $734,000 in 1994. These increases were 
primarily due to increased staffing and associated expenses necessary to 
manage and support the Company's increased scale of operations and to prepare 
for commercialization of certain products. The Company believes that its 
selling, general and administrative expenses will continue to increase 
substantially as it expands its physician training activities, builds its 
sales force, marketing staff and administrative staff, and incurs other costs 
in connection with commercialization of its products and the support of its 
growing operations.

      PATENT ACQUISITION EXPENSE.  Patent acquisition expense of $5.2 million 
consists of the cost to acquire a United States patent, several pending U.S. 
patent applications, and related rights from Endosurgical Development 
Corporation in July, 1996 for consideration consisting of shares of Common 
Stock and cash. 

      INTEREST INCOME.  Interest income primarily represents interest earned 
by the Company on its cash and short-term investments. Interest income 
increased to $4.0 million in 1996 from $542,000 in 1995 and $120,000 in 1994. 
The increase in each period was primarily due to the Company's higher average 
investment balances resulting from cash received in venture capital 
financings in 1995 and the Company's initial public offering in 1996. 

      INTEREST EXPENSE.  Interest expense represents interest on long-term 
debt. Interest expense increased to $592,000 in 1996 from $189,000 in 1995.  

      INCOME TAXES.  The Company has not generated any net income to date and 
therefore has not paid any federal income taxes since its inception. The 
provision for income taxes consists solely of state minimum taxes. 

      Realization of deferred tax assets is dependent on future earnings, if 
any, the amount and timing of which are uncertain. Accordingly, a valuation 
allowance has been established in an amount equal to the net deferred tax 
assets of the Company to reflect these uncertainties. 

      At December 31, 1996, the Company had net operating loss carryforwards 
for income tax purposes of approximately $43.0 million for federal and $39.0 
million for state, which will expire at various dates through 2011, if not 
utilized. The principal differences between financial reporting losses and 
losses for tax purposes are the result of capitalizing research and 
development expenses and start-up costs for tax purposes. The Company also 
has research and development credits available to reduce future federal and 
state income taxes, if any, of approximately $550,000 and $500,000, 
respectively. The Tax Reform Act of 1986 and state tax statutes contain 
provisions that may limit the net operating loss carryforwards and research 
and development credits available for use in any given year should certain 
events occur, including additional sales of equity securities and other 
changes in ownership. Such events could limit the eventual utilization of 
these carryforwards. 

LIQUIDITY AND CAPITAL RESOURCES

      Since inception, the Company has funded its operations and investments 
in property and equipment primarily through the private sale of preferred 
stock, totaling approximately $25.1 million, and through an initial public 
offering of Common Stock in April, 1996, totaling approximately $110.8 
million. The Company also has a $15.0 million debt facility with a commercial 
bank. No amount was outstanding under this facility at December 31, 1996. 


                                      28
<PAGE>

      Net cash used in operating activities was approximately $27.5 million, 
$8.3 million, and $4.5  million in 1996, 1995, and 1994, respectively. For 
such periods, net cash used in operating activities resulted primarily from 
increasing net losses. Net cash used in investing activities was 
approximately $58.3 million, $5.1 million, and $1.9  million in 1996, 1995, 
and 1994, respectively. The net cash used in investing activities was 
primarily attributable to the purchase of short-term investments and the 
purchase of property and equipment. Net cash provided by financing activities 
was approximately $111.9 million, $20.4 million, and $6.0  million in 1996, 
1995, and 1994, respectively. The net cash provided in 1996 was primarily 
attributable to the initial public offering of Common Stock and the net cash 
provided in 1995 and 1994 was primarily attributable to the sale of preferred 
stock and proceeds from long-term borrowings.

      Capital expenditures for equipment and leasehold improvements to 
support the Company's expanded operations were approximately $6.1 million, 
$875,000, and $703,000 in 1996, 1995, and 1994, respectively. The Company 
expects that its capital expenditures will continue to grow as the Company's 
employee base and manufacturing operations expand.  In addition, the Company 
presently plans to spend approximately $5.0 million in 1997 renovating the 
Heartport Research and Training Center, which was acquired in October 1996.  
At December 31, 1996, the Company had approximately $89.9 million in cash, 
cash equivalents, and short-term investments and approximately $87.6 million 
in working capital. 

      The Company expects to continue to incur substantial expense to fund 
additional research and development activities, clinical affairs, physician 
training, manufacturing expansion, the expansion of its sales and marketing 
organization, full-scale market launch of its Port-Access CABG and 
Port-Access MVR systems in 1997, and ongoing administrative activities. The 
Company believes that its existing cash, cash equivalents, and short-term 
investments and borrowings available under its debt facility will be adequate 
to meet its cash needs at least through 1997.  Thereafter, the Company may 
require additional funds to support its operating requirements or for other 
purposes and may seek to raise such additional funds through public or 
private equity financings or from other sources. There can be no assurance 
that additional financing will be available at all or that, if available, 
such financing would be obtainable on terms favorable to the Company and 
would not be dilutive.


                                      29
<PAGE>
                                HEARTPORT, INC.
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                                                PAGE
                                                                                                             -----------
<S>                                                                                                          <C>
Report of Ernst & Young LLP, Independent Auditors..........................................................         F-2
Consolidated Balance Sheets................................................................................         F-3
Consolidated Statements of Operations......................................................................         F-4
Consolidated Statements of Stockholders' Equity............................................................         F-5
Consolidated Statements of Cash Flows......................................................................         F-6
Notes to Consolidated Financial Statements.................................................................         F-7
</TABLE>
 
                                      F-1
<PAGE>
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Heartport, Inc.
 
We have audited the accompanying consolidated balance sheets of Heartport, Inc.
as of December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14(d). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Heartport, Inc. at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996 in conformity
with generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
 
                                                               ERNST & YOUNG LLP
 
San Jose, California
January 24, 1997
 
                                      F-2
<PAGE>
                                HEARTPORT, INC.
                          CONSOLIDATED BALANCE SHEETS
 
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                                                              DECEMBER 31,
                                                                                                      ----------------------------
                                                                                                          1996           1995
                                                                                                      -------------  -------------
<S>                                                                                                   <C>            <C>
Current assets:
  Cash and cash equivalents.........................................................................  $      33,445  $       7,412
  Short-term investments............................................................................         56,407          5,198
  Accounts receivable, net of allowance for doubtful accounts of $33 in 1996........................            550       --
  Inventories.......................................................................................          2,107       --
  Prepaid expenses and other........................................................................          1,717             82
                                                                                                      -------------  -------------
Total current assets................................................................................         94,226         12,692
Property and equipment:
  Equipment.........................................................................................          4,908          1,389
  Furniture and fixtures............................................................................          1,372            262
  Leasehold improvements............................................................................          1,699            224
                                                                                                      -------------  -------------
                                                                                                              7,979          1,875
  Accumulated depreciation and amortization.........................................................          1,584            507
                                                                                                      -------------  -------------
                                                                                                              6,395          1,368
Deposits, intangibles and other assets, net.........................................................          1,231            206
                                                                                                      -------------  -------------
Total assets........................................................................................  $     101,852  $      14,266
                                                                                                      -------------  -------------
                                                                                                      -------------  -------------
                                               LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..................................................................................  $       4,570  $         812
  Accrued compensation and related benefits.........................................................          1,433            173
  Accrued clinical trial costs......................................................................       --                   79
  Current portion of long-term debt.................................................................            662            394
                                                                                                      -------------  -------------
Total current liabilities...........................................................................          6,665          1,458
Noncurrent liabilities:
  Long-term debt, less current portion..............................................................          1,334          3,913
  Other long-term liabilities.......................................................................            383            120
  Deferred royalty income...........................................................................          3,000       --
                                                                                                      -------------  -------------
Total noncurrent liabilities........................................................................          4,717          4,033
Commitments
Stockholders' equity:
  Convertible preferred stock, $0.001 par value, issuable in series, 10,240 shares authorized
    Issued and outstanding shares -- none in 1996, and 9,237 in 1995................................       --                    9
  Preferred stock, $0.001 par value; 20,000 shares authorized, none issued and outstanding..........       --             --
  Common stock, $0.001 par value:
    Authorized shares -- 100,000
    Issued and outstanding shares -- 24,415 in 1996, and 9,084 in 1995..............................             24              9
  Additional paid-in capital........................................................................        142,018         26,395
  Notes receivable from stockholders................................................................           (973)        (1,093)
  Accumulated deficit...............................................................................        (50,599)       (16,545)
                                                                                                      -------------  -------------
Total stockholders' equity..........................................................................         90,470          8,775
                                                                                                      -------------  -------------
Total liabilities and stockholders' equity..........................................................  $     101,852  $      14,266
                                                                                                      -------------  -------------
                                                                                                      -------------  -------------
</TABLE>
 
                            SEE ACCOMPANYING NOTES.
 
                                      F-3
<PAGE>
                                HEARTPORT, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                                                   YEARS ENDED DECEMBER 31,
                                                                                            --------------------------------------
                                                                                               1996         1995          1994
                                                                                            -----------  -----------  ------------
<S>                                                                                         <C>          <C>          <C>
Net sales.................................................................................  $       624  $   --       $    --
Cost of goods sold........................................................................          561      --            --
                                                                                            -----------  -----------  ------------
Gross profit..............................................................................           63      --            --
Operating expenses:
  Research and development................................................................       21,059        8,477         4,207
  Selling, general and administrative.....................................................       11,223        1,229           734
  Patent acquisition......................................................................        5,216      --            --
                                                                                            -----------  -----------  ------------
Loss from operations......................................................................      (37,435)      (9,706)       (4,941)
 
Interest income...........................................................................        3,973          542           120
Interest expense..........................................................................         (592)        (189)      --
                                                                                            -----------  -----------  ------------
Net loss..................................................................................  $   (34,054) $    (9,353) $     (4,821)
                                                                                            -----------  -----------  ------------
                                                                                            -----------  -----------  ------------
Pro forma net loss per share..............................................................  $     (1.50) $      (.47)
                                                                                            -----------  -----------
                                                                                            -----------  -----------
Shares used in calculation of pro forma net loss per share................................       22,771       19,782
                                                                                            -----------  -----------
                                                                                            -----------  -----------
</TABLE>
 
                            SEE ACCOMPANYING NOTES.
 
                                      F-4
<PAGE>
                                HEARTPORT, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                   CONVERTIBLE PREFERRED
                                           STOCK                  COMMON STOCK        ADDITIONAL
                                  ------------------------  ------------------------    PAID-IN       NOTES     ACCUMULATED
                                    SHARES       AMOUNT       SHARES       AMOUNT       CAPITAL    RECEIVABLE     DEFICIT
                                  -----------  -----------  -----------  -----------  -----------  -----------  ------------
<S>                               <C>          <C>          <C>          <C>          <C>          <C>          <C>
Balance at December 31, 1993....       5,080    $       5        6,093    $       6    $   3,204    $     (63)   $   (2,371)
  Issuances of convertible
    preferred stock.............       1,591            2       --           --            5,947       --            --
  Issuances of common stock.....      --           --              187       --               15          (11)       --
  Exercises of common stock
    options.....................      --           --               62       --               11           (9)       --
  Payments of stockholders'
    notes receivable............      --           --           --           --           --               15        --
  Repurchases of common stock...      --           --             (383)      --              (26)          24        --
  Net loss......................      --           --           --           --           --           --            (4,821)
                                  -----------  -----------  -----------  -----------  -----------  -----------  ------------
Balance at December 31, 1994....       6,671            7        5,959            6        9,151          (44)       (7,192)
  Issuances of convertible
    preferred stock.............       2,566            2       --           --           15,982       --            --
  Issuances of preferred stock
    warrants....................      --           --           --           --               29       --            --
  Exercises of common stock
    options.....................      --           --            3,093            3        1,211       (1,049)       --
  Issuances of common stock.....      --           --               32       --               22       --            --
  Net loss......................      --           --           --           --           --           --            (9,353)
                                  -----------  -----------  -----------  -----------  -----------  -----------  ------------
Balance at December 31, 1995....       9,237            9        9,084            9       26,395       (1,093)      (16,545)
  Conversion of convertible
    preferred stock into common
    stock.......................      (9,237)          (9)       9,237            9       --           --            --
  Repurchases of common stock...      --           --             (184)      --              (69)          69        --
  Payments of stockholders'
    notes receivable............      --           --           --           --           --               51        --
  Exercises of common stock
    options.....................      --           --              327       --               67       --            --
  Issuances of common stock.....      --           --            5,951            6      115,425       --            --
  Issuances of warrants.........      --           --           --           --              200       --            --
  Net loss......................      --           --           --           --           --           --           (34,054)
                                  -----------  -----------  -----------  -----------  -----------  -----------  ------------
Balance at December 31, 1996....      --        $  --           24,415    $      24    $ 142,018    $    (973)   $  (50,599)
                                  -----------  -----------  -----------  -----------  -----------  -----------  ------------
                                  -----------  -----------  -----------  -----------  -----------  -----------  ------------
 
<CAPTION>
 
                                      TOTAL
                                  STOCKHOLDERS'
                                     EQUITY
                                  -------------
<S>                               <C>
Balance at December 31, 1993....    $     781
  Issuances of convertible
    preferred stock.............        5,949
  Issuances of common stock.....            4
  Exercises of common stock
    options.....................            2
  Payments of stockholders'
    notes receivable............           15
  Repurchases of common stock...           (2)
  Net loss......................       (4,821)
                                  -------------
Balance at December 31, 1994....        1,928
  Issuances of convertible
    preferred stock.............       15,984
  Issuances of preferred stock
    warrants....................           29
  Exercises of common stock
    options.....................          165
  Issuances of common stock.....           22
  Net loss......................       (9,353)
                                  -------------
Balance at December 31, 1995....        8,775
  Conversion of convertible
    preferred stock into common
    stock.......................       --
  Repurchases of common stock...       --
  Payments of stockholders'
    notes receivable............           51
  Exercises of common stock
    options.....................           67
  Issuances of common stock.....      115,431
  Issuances of warrants.........          200
  Net loss......................      (34,054)
                                  -------------
Balance at December 31, 1996....    $  90,470
                                  -------------
                                  -------------
</TABLE>
 
                            SEE ACCOMPANYING NOTES.
 
                                      F-5
<PAGE>
                                HEARTPORT, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                                                         YEARS ENDED
                                                                                                         DECEMBER 31,
                                                                                            --------------------------------------
                                                                                               1996         1995          1994
                                                                                            -----------  -----------  ------------
<S>                                                                                         <C>          <C>          <C>
OPERATING ACTIVITIES
Net loss..................................................................................  $   (34,054) $    (9,353) $     (4,821)
Adjustments to reconcile net loss to net cash used in operating activities:
  Depreciation and amortization...........................................................        1,084          330           151
  Common stock and warrants issued for services rendered and certain technology...........        4,355      --                  4
  Compensation related to stock options...................................................          183      --            --
  Changes in operating assets and liabilities:
    Accounts receivable...................................................................         (550)     --            --
    Inventories...........................................................................       (2,107)     --            --
    Prepaid expenses and other............................................................       (1,635)         182          (243)
    Accounts payable, accrued expenses, and deposit.......................................        5,201          541           443
                                                                                            -----------  -----------  ------------
Net cash used in operating activities.....................................................      (27,523)      (8,300)       (4,466)
INVESTING ACTIVITIES
Purchases of short-term investments.......................................................     (120,629)      (5,198)       (1,092)
Maturities of short-term investments......................................................       69,420        1,092       --
Purchases of property and equipment.......................................................       (6,104)        (875)         (703)
Proceeds from sale of equipment...........................................................      --           --                 18
Increase in deposits, intangibles and other assets........................................       (1,031)         (79)          (80)
                                                                                            -----------  -----------  ------------
Net cash used in investing activities.....................................................      (58,344)      (5,060)       (1,857)
FINANCING ACTIVITIES
Proceeds from issuances of preferred stock................................................      --            15,984         5,949
Proceeds from issuances of common stock...................................................      111,159          165             2
Proceeds from payment of stockholders' notes receivable...................................           51      --                 15
Repurchase of common stock................................................................      --           --                 (2)
Proceeds from long-term borrowings........................................................        1,155        4,519            50
Repayment of long-term borrowings.........................................................         (465)        (261)           (1)
                                                                                            -----------  -----------  ------------
Net cash provided by financing activities.................................................      111,900       20,407         6,013
                                                                                            -----------  -----------  ------------
Net increase (decrease) in cash and cash equivalents......................................       26,033        7,047          (310)
Cash and cash equivalents at beginning of year............................................        7,412          365           675
                                                                                            -----------  -----------  ------------
Cash and cash equivalents at end of year..................................................  $    33,445  $     7,412  $        365
                                                                                            -----------  -----------  ------------
                                                                                            -----------  -----------  ------------
SUPPLEMENTAL DISCLOSURES OF CASH INFORMATION
Cash paid for interest....................................................................  $       346  $       182  $    --
NONCASH FINANCING ACTIVITIES
Issuance of preferred stock warrants in connection with debt financing....................  $   --       $        29  $    --
Issuance of common stock for notes receivable.............................................  $   --       $     1,049  $         20
Issuance of common stock for technology...................................................  $     4,155  $        22  $    --
Repurchase of common stock through forgiveness of notes receivable from stockholders......  $        69  $   --       $         24
Conversion of long-term debt to deferred royalty income...................................  $     3,000  $   --       $    --
Conversion of preferred stock to common stock.............................................  $         9  $   --       $    --
</TABLE>
 
                            SEE ACCOMPANYING NOTES.
 
                                      F-6
<PAGE>
                                HEARTPORT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
    BASIS OF PRESENTATION
 
    Heartport, Inc. (the Company) is engaged principally in the research,
development, manufacturing and sale of minimally invasive cardiac surgery
systems and related technology. The Company's customers are cardiac surgery
centers in the United States and Europe. The consolidated accounts include the
accounts of Heartport, Inc. and its wholly owned subsidiaries. Significant
intercompany accounts and transactions have been eliminated. During 1996, the
Company determined that it is no longer in the development stage.
 
    USE OF ESTIMATES
 
    The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
    CASH AND CASH EQUIVALENTS
 
    The Company considers all highly liquid investments with insignificant
interest rate risk and with an original maturity of three months or less when
purchased to be cash equivalents.
 
    REVENUE RECOGNITION
 
    The Company recognizes revenue upon shipment. Deferred royalty income
includes advances received but unearned under an agreement with St. Jude
Medical, Inc.
 
    CONCENTRATIONS OF CREDIT RISK
 
    Financial instruments that subject the Company to credit risk consist
principally of cash, cash equivalents, and short-term investments. By policy,
the Company places its cash, cash equivalents, and short-term investments only
with high credit quality financial institutions and corporations and, other than
its investments in U.S. Government Treasury instruments, limits the amounts
invested in any one institution or type of investment. In addition, the Company
performs credit evaluations of its customers' financial condition and generally
requires no collateral. During 1996, three customers accounted for approximately
20%, 17%, and 11% of net sales. During 1996, sales to European customers were
approximately 25% of net sales. All sales are denominated in U.S. dollars.
 
    FAIR VALUE OF FINANCIAL INSTRUMENTS
 
    The fair values for short-term investments are based on quoted market prices
or pricing models using current market rates.
 
    The fair value of the Company's long-term debt is estimated using a
discounted cash flow analysis based on the Company's current incremental
borrowing rate for similar types of borrowing arrangements.
 
    SHORT-TERM INVESTMENTS
 
    All investments are designated as available-for-sale. Available-for-sale
securities are carried at fair value with unrealized gains and losses, net of
tax, reported in a separate component of stockholders' equity. The amortized
cost of available-for-sale debt securities is adjusted for the amortization of
premiums and the accretion of discounts to maturity. Such amortization is
included in interest income. Realized gains and losses and declines in value
judged to be other-than-temporary on available-for-sale securities are included
in investment income. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.
 
                                      F-7
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
    INVENTORIES
 
    Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Inventories at December 31, 1996 were as follows:
 
<TABLE>
<CAPTION>
                                                                                      (IN
                                                                                  THOUSANDS)
<S>                                                                              <C>
Materials and purchased parts..................................................    $   1,625
Work in progress...............................................................           84
Finished goods.................................................................          398
                                                                                      ------
Total inventories..............................................................    $   2,107
                                                                                      ------
                                                                                      ------
</TABLE>
 
    PROPERTY AND EQUIPMENT
 
    Property and equipment are stated at cost. Depreciation is computed by the
straight-line method over the estimated useful lives of the assets, ranging from
three to five years, or over the term of the lease, if shorter. Amortization of
assets recorded under capital leases is included with depreciation expense.
 
    NET LOSS PER SHARE
 
    Except as noted below, historical net loss per share is computed using the
weighted average number of common shares outstanding. Common equivalent shares
from stock options, warrants and convertible preferred stock are excluded from
the computation as their effect is antidilutive, except that, pursuant to the
Securities and Exchange Commission (the SEC) Staff Accounting Bulletins, common
and common equivalent shares issued during the twelve-month period prior to the
Company's initial public offering in April, 1996, at prices below the initial
public offering price have been included in the calculation as if they were
outstanding for all periods presented prior to the offering (using the treasury
stock method and the public offering price for stock options and warrants and
the if-converted method for convertible preferred stock).
 
    Historical net loss per share information is as follows:
 
<TABLE>
<CAPTION>
                                                                        YEARS ENDED DECEMBER 31,
                                                                ----------------------------------------
                                                                    1996          1995          1994
                                                                ------------  ------------  ------------
<S>                                                             <C>           <C>           <C>
Net loss per share............................................  $      (1.66) $       (.71) $       (.37)
                                                                ------------  ------------  ------------
                                                                ------------  ------------  ------------
Shares used in computing net loss per share...................    20,494,000    13,110,000    13,181,000
                                                                ------------  ------------  ------------
                                                                ------------  ------------  ------------
</TABLE>
 
    PRO FORMA NET LOSS PER SHARE
 
    Pro forma net loss per share has been computed as described above and also
assumes the conversion of convertible preferred shares not included above that
automatically converted upon completion of the Company's initial public offering
(using the if-converted method) from the original date of issuance.
 
    ACCOUNTING FOR EMPLOYEE STOCK OPTIONS
 
    The Company accounts for stock options using the intrinsic value method in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees".
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the
Company has adopted the pro forma disclosure of accounting for options under the
fair value method.
 
2.  COMMITMENTS
 
    The Company leases its facilities under noncancelable operating leases that
expire in the years 1999 through 2001. The Company has various options on the
facilities leases that could extend them through 2010. Rental expense was
$959,000 (net of sublease income of $14,000), $435,000 (net of sublease income
 
                                      F-8
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
2.  COMMITMENTS (CONTINUED)
of $161,000), and $246,000 (net of sublease income of $64,000) for the years
ended December 31, 1996, and 1995 and 1994, respectively.
 
    The future minimum lease payments as of December 31, 1996 were as follows:
 
<TABLE>
<CAPTION>
                                                                                                (IN
                                                                                            THOUSANDS)
<S>                                                                                        <C>
1997.....................................................................................    $   1,154
1998.....................................................................................        1,167
1999.....................................................................................          891
2000.....................................................................................          318
2001.....................................................................................          328
                                                                                                ------
                                                                                             $   3,858
                                                                                                ------
                                                                                                ------
</TABLE>
 
3.  INVESTMENTS
 
    Investments as of December 31, including cash equivalents and short-term
investments, were as follows:
 
<TABLE>
<CAPTION>
                                                                           1996        1995
                                                                         ---------  ----------
                                                                            (IN THOUSANDS)
<S>                                                                      <C>        <C>
Money market funds.....................................................  $   7,959  $    7,415
Commercial paper.......................................................     18,289         998
Auction rate preferred stock...........................................      8,000       4,200
Corporate notes........................................................     35,462      --
U.S. government agency securities......................................     12,945      --
                                                                         ---------  ----------
Total available-for-sale investments...................................     82,655      12,613
Amounts classified as cash equivalents.................................    (26,248)     (7,415)
                                                                         ---------  ----------
Amounts included in short-term investments.............................  $  56,407  $    5,198
                                                                         ---------  ----------
                                                                         ---------  ----------
</TABLE>
 
    There were no material realized or unrealized gains or losses in any
category of investment in 1996, 1995, or 1994.
 
4.  DEBT AND DEFERRED ROYALTY INCOME
 
    Debt at December 31 was as follows:
 
<TABLE>
<CAPTION>
                                                                               1996       1995
                                                                             ---------  ---------
                                                                                (IN THOUSANDS)
<S>                                                                          <C>        <C>
Note payable due in 2000, at prime rate plus 1%............................  $  --      $   3,000
Equipment financing........................................................      1,966      1,267
Other debt.................................................................         30         40
                                                                             ---------  ---------
Total long-term debt.......................................................      1,996      4,307
Current portion of long-term debt..........................................       (662)      (394)
                                                                             ---------  ---------
Long-term debt, less current portion.......................................  $   1,334  $   3,913
                                                                             ---------  ---------
                                                                             ---------  ---------
</TABLE>
 
    In 1995, the Company entered into an agreement with St. Jude Medical, Inc.
whereby the Company agreed to license certain patents to St. Jude Medical, Inc.
In connection with the agreement, the Company borrowed $3,000,000 from St. Jude
Medical, Inc. in the form of a note. During 1996, upon reaching certain
milestones contained in the agreement, the entire note balance automatically
converted into deferred royalty income.
 
                                      F-9
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
4.  DEBT AND DEFERRED ROYALTY INCOME (CONTINUED)
    In 1995, the Company entered into a financing agreement with a leasing
company to finance up to $2,500,000 of fixed asset purchases. Borrowings under
the agreement are payable in monthly installments through 2001, bear interest at
rates from 11.8% to 14.3%, and are secured by the financed assets. The Company
issued the lender a warrant to purchase 18,800 shares of Series C convertible
preferred stock at $6.25 per share, which was exercised in 1996 in connection
with the initial public offering.
 
The carrying value of the Company's long-term debt approximates its fair value.
 
    As of December 31, 1996, aggregate debt maturities were as follows:
 
<TABLE>
<CAPTION>
                                                                                                (IN
                                                                                            THOUSANDS)
<S>                                                                                        <C>
1997.....................................................................................    $     662
1998.....................................................................................          805
1999.....................................................................................          407
2000.....................................................................................          110
Thereafter...............................................................................           12
                                                                                                ------
                                                                                             $   1,996
                                                                                                ------
                                                                                                ------
</TABLE>
 
    As of December 31, 1996, the Company has an unused credit facility with a
commercial bank of $15,000,000.
 
5.  STOCKHOLDERS' EQUITY
 
    CONVERTIBLE PREFERRED STOCK
 
    Convertible preferred stock at December 31, 1995 was as follows:
 
<TABLE>
<CAPTION>
                                                                            DESIGNATED    SHARES ISSUED AND
SERIES                                                                        SHARES         OUTSTANDING
--------------------------------------------------------------------------  -----------  -------------------
                                                                                     (IN THOUSANDS)
<S>                                                                         <C>          <C>
 A........................................................................       5,200            5,080
 B........................................................................       1,840            1,591
 C........................................................................       3,200            2,566
                                                                            -----------           -----
Total preferred stock.....................................................      10,240            9,237
                                                                            -----------           -----
                                                                            -----------           -----
</TABLE>
 
    The preferred stock was converted to Common Stock in connection with the
Company's initial public offering.
 
    COMMON STOCK
 
    At December 31, 1996, 2,620,000 shares of outstanding common stock owned by
employees of and consultants to the Company were subject to repurchase, at the
option of the Company, at the original purchase price in the event of the
termination of their employment or consulting relationship.
 
    STOCK OPTION PLANS
 
    Under the 1993 Stock Option Plan (the 1993 Plan), the Company may grant
incentive and nonstatutory stock options to purchase up to 6,720,000 shares of
common stock to directors, employees and consultants. Options may be granted at
an exercise price of not less than 85% of the fair value of the stock at the
date of grant for nonstatutory stock options and 100% of the fair value of the
stock at the date of grant for incentive stock options as determined by the
Board of Directors. Generally, options vest under such conditions as determined
by the Board of Directors, typically over a five year period, and expire after
ten years. During 1996, the Company adopted the 1996 Stock Option Plan (the 1996
Plan), under which the Company reserved 2,110,000 shares of common stock for
issuance to employees, consultants and directors of the Company in addition to
the 3,390,000 shares incorporated from the 1993 plan.
 
                                      F-10
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
5.  STOCKHOLDERS' EQUITY (CONTINUED)
    Activity under the Stock Option Plans is as follows:
 
<TABLE>
<CAPTION>
                                                                            OUTSTANDING OPTIONS
                                                                --------------------------------------------
                                                     SHARES                                       AGGREGATE
                                                    AVAILABLE    NUMBER OF                        EXERCISE
                                                    FOR GRANT     SHARES      PRICE PER SHARE       PRICE
                                                   -----------  -----------  ------------------  -----------
                                                           (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                <C>          <C>          <C>                 <C>
Balance at December 31, 1993.....................         850          430   $     0.063          $      27
  Shares authorized..............................       1,600       --       $       --              --
  Options granted................................      (1,243)       1,243   $  0.063 - $ 0.375         339
  Options exercised..............................      --              (62)  $  0.063 - $ 0.375         (11)
  Options canceled...............................          53          (53)  $  0.063 - $ 0.375         (16)
                                                   -----------  -----------                      -----------
 
Balance at December 31, 1994.....................       1,260        1,558   $  0.063 - $ 0.375         339
  Shares authorized..............................       3,840       --       $       --              --
  Options granted................................      (3,586)       3,586   $  0.375 - $ 0.781       1,565
  Options exercised..............................      --           (3,093)  $  0.063 - $ 0.781      (1,214)
  Options canceled...............................          48          (48)  $  0.063 - $ 0.375         (10)
                                                   -----------  -----------                      -----------
Balance at December 31, 1995.....................       1,562        2,003   $  0.063 - $ 0.781         680
  Shares authorized..............................       2,110       --       $       --              --
  Options granted................................      (2,160)       2,160   $  0.781 - $41.000      31,575
  Options exercised..............................      --             (327)  $   0.063 - $29.25         (67)
  Options canceled...............................         399         (399)  $   0.063 - $39.50      (1,045)
                                                   -----------  -----------                      -----------
Balance at December 31, 1996.....................       1,911        3,437   $   0.063 - $41.00   $  31,143
                                                   -----------  -----------                      -----------
                                                   -----------  -----------                      -----------
</TABLE>
 
    In addition, during 1996 the Company issued 940,000 nonstatutory options
outside of the plans to employees. These options have exercise prices ranging
from $21.75 to $25.625.
 
    The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1996:
 
<TABLE>
<CAPTION>
                               OPTIONS OUTSTANDING
                   -------------------------------------------    OPTIONS EXERCISABLE
                                   WEIGHTED                     ------------------------
                                    AVERAGE        WEIGHTED                    WEIGHTED
                                   REMAINING        AVERAGE                     AVERAGE
    RANGE OF         NUMBER       CONTRACTUAL      EXERCISE        NUMBER      EXERCISE
 EXERCISE PRICES    OF SHARES        LIFE            PRICE        OF SHARES      PRICE
-----------------  -----------  ---------------  -------------  -------------  ---------
                        (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                <C>          <C>              <C>            <C>            <C>
$   0.06 - $ 7.50       2,335            9.2       $   2.834            736    $   0.999
$   7.51 - $15.00         245            9.2       $  12.566              7    $  11.786
$  15.01 - $25.00       1,183            9.5       $  21.813             56    $  21.400
$  25.01 - $35.00         542            9.7       $  26.400              1    $  29.826
$  35.01 - $45.00          72            9.4       $  38.826              1    $  36.868
                                          --
                        -----                    -------------          ---    ---------
                        4,377            9.4       $  12.021            801    $   3.213
                                          --
                                          --
                        -----                    -------------          ---    ---------
                        -----                    -------------          ---    ---------
</TABLE>
 
    At December 31, 1995, options to purchase 845,000 shares of common stock
were exercisable.
 
    STOCK BASED COMPENSATION
 
    The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," (SFAS 123)
requires use of option
 
                                      F-11
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
5.  STOCKHOLDERS' EQUITY (CONTINUED)
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
 
    Pro forma information regarding net loss and net loss per share is required
by SFAS 123, which also requires that the information be determined as if the
Company had accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions for 1996
and 1995: Expected dividend yield of 0%, expected stock price volatility of 67%,
risk-free interest rate of 5.97%, and the expected life of options of 3 years.
 
    The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
 
    For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Had the
Company elected to recognize compensation expense based on the fair value of the
options granted at grant dates as prescribed by SFAS No. 123, net loss and loss
per share would have been increased to the pro forma amounts indicated in the
table below:
 
<TABLE>
<CAPTION>
                                                                                1996           1995
                                                                           --------------  -------------
<S>                                                                        <C>             <C>
Net loss -- as reported..................................................  $  (34,054,000) $  (9,353,000)
Net loss -- pro forma....................................................  $  (38,166,000) $  (9,501,000)
Loss per share -- as reported............................................  $        (1.50) $        (.47)
Loss per share -- pro forma..............................................  $        (1.68) $        (.48)
</TABLE>
 
    The weighted average fair value of options granted in 1996 and 1995 was
$7.41 and $0.22 per share, respectively. The weighted-average remaining
contractual life of all options outstanding at December 31, 1996 is 9.4 years.
 
    The pro forma effect on net income for 1996 is not representative of the pro
forma effect on net income in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
1995, and the compensation expense that will be recognized in future years as
the graded vesting periods become exercisable.
 
    STOCK PURCHASE PLAN
 
    Under the 1996 Employee Stock Purchase Plan (the Purchase Plan), employees
may purchase common stock at the lower of 85% of the fair market value of the
common stock at the beginning or end of each offering period of up to an
aggregate total of 240,000 shares of the Company's common stock. During the year
ended December 31, 1996, 19,000 shares were issued under the Purchase Plan.
 
    SHAREHOLDER RIGHTS PLAN
 
    On March 26, 1996, the Board of Directors of the Company declared a dividend
of one preferred share purchase right (a "Right") for each outstanding share of
common stock outstanding on the effective date of the Offering. Each Right will
entitle stockholders to purchase 1/1000 of a share of Series A Junior
participating preferred stock of the Company, a designated series of preferred
stock for which each 1/1000 of a share has economic attributes and voting rights
equivalent to one share of the Company's common
 
                                      F-12
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
5.  STOCKHOLDERS' EQUITY (CONTINUED)
stock, at an exercise price of $0.001 per share. The Rights only become
exercisable in certain limited circumstances involving acquisitions of or tender
offers for 20% or more of the Company's capital stock. At any time prior to the
announcement of any such acquisition or offer, the Rights are redeemable by the
Company at a price of $0.001 per Right. For a limited period of time after the
announcement of any such acquisition or offer, each Right becomes exercisable
or, at the discretion of Board, may be exchanged for one share of common stock
per Right. The Rights expire in the year 2006.
 
    COMMON STOCK RESERVED
 
    At December 31, 1996, the Company has reserved shares of common stock for
future issuances as follows:
 
<TABLE>
<CAPTION>
                                                                                 (IN THOUSANDS)
<S>                                                                              <C>
Stock option plans.............................................................         5,348
Stock options outside the plans................................................           940
Stock purchase plan............................................................           221
Stock warrants.................................................................            18
                                                                                        -----
 
  Total........................................................................         6,527
                                                                                        -----
                                                                                        -----
</TABLE>
 
    STOCK SPLIT
 
    On April 25, 1996, the Company effected a 1.6-for-1 split of the Company's
common stock. All outstanding share and per share amounts have been
retroactively adjusted to reflect the stock split.
 
6.  INCOME TAXES
 
    Due to operating losses and the inability to recognize the benefits
therefrom, there is no provision for income taxes for 1996, 1995, or 1994.
 
    Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets as of December 31, 1996 and 1995 are as
follows:
 
<TABLE>
<CAPTION>
                                                                                       1996       1995
                                                                                    ----------  ---------
                                                                                       (IN THOUSANDS)
<S>                                                                                 <C>         <C>
Deferred tax assets:
  Net operating loss carryforwards................................................  $   16,900  $   5,400
  Research credit carryforwards...................................................         900        430
  Capitalized research and development............................................         500        570
  Acquired patent.................................................................       1,800     --
  Other temporary differences.....................................................         600        430
                                                                                    ----------  ---------
    Total deferred tax assets.....................................................      20,700      6,830
Valuation allowance...............................................................     (20,700)    (6,830)
                                                                                    ----------  ---------
    Net deferred tax assets.......................................................  $   --      $  --
                                                                                    ----------  ---------
                                                                                    ----------  ---------
</TABLE>
 
    Realization of deferred tax assets is dependent upon future earnings, the
timing and amount of which are uncertain. Accordingly, a valuation allowance, in
an amount equal to the net deferred tax asset as of December 31, 1996 and 1995
has been established to reflect these uncertainties. The change in the valuation
allowance was a net increase of $13,870,000, $3,905,000, and $1,900,000 for
fiscal years 1996, 1995, and 1994, respectively.
 
                                      F-13
<PAGE>
                                HEARTPORT, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
6.  INCOME TAXES (CONTINUED)
    As of December 31, 1996, the Company had net operating loss carryforwards
for federal and California tax purposes of approximately $43,000,000 and
$39,000,000 respectively, which will expire from 1999 through 2011. As of
December 31, 1996, the Company also had research and development tax credit
carryforwards of approximately $550,000 and $500,000, respectively, for federal
and California tax purposes, which will expire in years 2007 through 2011, if
not used.
 
    Utilization of net operating loss and credit carryforwards may be subject to
an annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.
 
7.  PATENT ACQUISITION
 
    Patent acquisition expenses consist of the cost to acquire a United States
patent and related rights from Endosurgical Development Corporation for
consideration consisting of shares of Common Stock and cash, for a total expense
of $5,216,000.
 
8.  EMPLOYEE BENEFIT PLAN
 
    The Company has a savings plan, which qualifies under Section 401(k) of the
Internal Revenue Code. Under the plan, participating employees may defer up to
15% of their pre-tax salary, up to statutory limits. The Company currently does
not match employee contributions made to the savings plan.
 
                                      F-14
<PAGE>

PART III

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

      None.

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

OFFICERS AND DIRECTORS

      The officers and directors of the Company, and their ages as of 
December 31, 1996, are as follows:

          NAME                      AGE                POSITION
          ----                      ---                --------
Wesley D. Sterman, M.D.             36     President, Chief Executive Officer,
                                             Director, and Co-Founder

Richard B. Brewer                   45     Chief Operating Officer

David B. Singer                     34     Senior Vice President, Finance and 
                                             Chief Financial Officer

Bradford J. Shafer                  36     General Counsel and Secretary

Robert J. Chin, Ph.D.               51     Vice President of Regulatory Affairs
                                             and Quality Assurance

Hanson S. Gifford, III              36     Vice President of Research and
                                             Development

Timothy J. Haines                   39     Vice President and Managing 
                                             Director, Europe

Steven E. Johnson                   38     Vice President of Manufacturing

C. Richard Neely, Jr.               42     Vice President, Finance and 
                                             Controller

Lawrence C. Siegel, M.D.            39     Vice President of Clinical Affairs

Casey M. Tansey                     39     Vice President of Sales and 
                                             Marketing

Frank M. Fischer(1)                 55     Director

Robert V. Gunderson, Jr.(2)         45     Director

Joseph S. Lacob(2)                  41     Director

John H. Stevens, M.D.               36     Director and Co-Founder

Petri T. Vainio, M.D.(1)            37     Director

Steven C. Wheelwright, Ph.D.(1)(2)  53     Director
_____________
(1) Member of Compensation Committee 
(2) Member of Audit Committee 

      WESLEY D. STERMAN, M.D. founded the Company with Dr. Stevens in May, 
1991, and has served as the Company's President and Chief Executive Officer 
since that time. Prior to founding the Company, Dr. Sterman was founder, 
President and Chief Executive Officer of EndoVascular Technologies, Inc., a 
medical device manufacturer, from July, 1989 to September, 1991. Dr. Sterman 
has B.S. degrees both in Biology and in Chemistry from Stanford University. 
Dr. Sterman received an M.D. from the Stanford University School of Medicine 
and an M.B.A. from the Graduate School of Business at Stanford University, 
where he was an Arjay Miller Scholar. 

      RICHARD B. BREWER has been Chief Operating Officer of the Company since 
January 22, 1997 and served as Executive Vice President of Operations of the 
Company since February, 1996. Prior to joining the Company, Mr. Brewer served 
in various capacities with Genentech, Inc., a biotechnology company, from 
1984 to 1995, most recently as Senior Vice President, U.S. Sales and 
Marketing, Genentech Europe Ltd., and Genentech Canada, Inc. Mr. Brewer 
earned a B.S. from Virginia Polytechnic Institute and an M.B.A. from 
Northwestern University. 

      DAVID B. SINGER has been Senior Vice President, Finance and Chief 
Financial Officer of the Company since June, 1996. Prior to joining the 
Company, Mr. Singer served as President, Chief Executive Officer and a 
Director of Affymetrix, Inc., a genomics and diagnostic company. From 
November, 1990 to February, 1993, Mr. Singer served in various senior 
management roles of Affymax N.V., a biotechnology company, including Vice 
President, Finance and Treasurer. From 1988 to 1990, Mr. Singer was an 
assistant to various senior officers of Baxter Healthcare Corporation 
("Baxter"), a medical supply company. Mr. Singer serves on the Board of 
Directors of Affymetrix, Inc. Mr. Singer holds a B.A. from Yale University 
and an M.B.A. from the Graduate School of Business at Stanford University. 


                                     III-1
<PAGE>

      BRADFORD J. SHAFER has been General Counsel and Secretary of the 
Company since July, 1996. From July, 1985 until July, 1996, he was an 
attorney with the law firm of Brobeck, Phleger & Harrison LLP, where he was a 
partner since January, 1993. Mr. Shafer holds a B.A. from the University of 
the Pacific and a J.D. from the University of California, Hastings College of 
the Law. 

      ROBERT J. CHIN has been Vice President of Regulatory Affairs and 
Quality Assurance of the Company since January, 1995. He also served as Vice 
President of Clinical Affairs of the Company from January 1995 until 
November, 1996. From 1977 until April, 1994, Dr. Chin served in various 
capacities with Baxter. His most recent position at Baxter was Vice 
President, Quality Assurance and Regulatory Affairs for the Edwards C.V.S. 
Division, a manufacturer and supplier of heart valve therapies. From April, 
1994 until joining the Company in 1995, Dr. Chin served as Vice President, 
Regulatory and Clinical Affairs and Quality Assurance of Imagyn Medical, a 
medical device company. Dr. Chin earned a B.S. in Engineering, an M.S. in 
Chemical Engineering and a Ph.D in Electrochemical Engineering all from the 
University of California at Los Angeles. Dr. Chin is a Professional Engineer, 
and has received Regulatory Affairs Certification by the Regulatory Affairs 
Professional Society. 

      HANSON S. GIFFORD, III, has been Vice President of Research and 
Development of the Company since February, 1996. Prior to that time, Mr. 
Gifford served as the Company's Director of Research and Development 
beginning in July, 1993. From 1992 to 1993, he served as Managing Director of 
Bavaria Medizin Technologie, GmbH, a German medical device company. From 1990 
to 1991, he served as President of Cardiovascular Therapeutic Technologies, 
Inc., a medical device company. From 1985 to 1990, he served in various 
research and development, clinical research, and marketing capacities at 
Devices for Vascular Intervention, Inc., a medical device company. Mr. 
Gifford earned a B.S. in Mechanical Engineering from Cornell University. 

      TIMOTHY J.  HAINES has been the Managing Director, Europe since March, 
1997.  From July, 1993 until joining the Company, Mr. Haines was employed by 
Datascope Corporation where he was President of Intravascular, Inc., a 
vascular graft subsidiary, and subsequently President of the Patient 
Monitoring Division.  From September, 1990 until July, 1993 Mr. Haines was 
Vice President, Operations of Telectronics Inc. Mr. Haines received a B.S. in 
Economics from Exeter University (England) and an M.B.A. from INSEAD European 
School of Management (France).

      STEVEN E. JOHNSON has been Vice President of Manufacturing of the 
Company since August, 1994. Prior to joining the Company, Mr. Johnson served 
in various capacities with Advanced Cardiovascular Systems, Inc., a medical 
device company, from 1983 to 1994, most recently as Vice President, 
Manufacturing. Mr. Johnson earned a B.S. in Industrial Engineering from GMI 
Engineering and Management Institute. 

      C. RICHARD NEELY, JR. has been Vice President, Finance and Controller 
of the Company since December, 1996. Prior to joining the Company, Mr. Neely 
served as Vice President and Chief Financial Officer of Sanmina Corporation, 
an electronics manufacturing company, from April, 1996 to August, 1996.  Mr. 
Neely served in various capacities with Advanced Micro Devices, Inc., a 
semiconductor company, from 1980 to April, 1996, most recently as Director 
and Group Controller.  Mr. Neely earned a B.A. in Economics from Whitman 
College and a M.B.A. from the University of Chicago.

      LAWRENCE C. SIEGEL, M.D. has been Vice President of Clinical Affairs of 
the Company since November, 1996. Prior to joining the Company, Dr. Siegel 
served in various capacities with the Stanford University School of Medicine 
from 1986 to 1996, most recently as Associate Professor of Anesthesia and 
Chief of Cardiovascular Anesthesiology. Dr. Siegel earned a B.S. in 
Electrical Engineering from Massachusetts Institute of Technology and a M.D. 
from Harvard Medical School. Dr. Siegel is a board certified 
anesthesiologist. 

      CASEY M. TANSEY has been Vice President of Sales and Marketing of the 
Company since December, 1995. From 1988 until joining the Company in 1995, 
Mr. Tansey served in various capacities with the Edwards C.V.S. Division of 
Baxter. Mr. Tansey's most recent position at Baxter/Edwards was Vice 
President, North American Sales. Mr. Tansey earned a B.S. in Business 
Administration and an M.B.A. from the College of Notre Dame. 

      FRANK M. FISCHER has been a Director of the Company since October, 
1992. Mr. Fischer has been the President and Chief Executive Officer and a 
Director of Ventritex, Inc., a manufacturer of implantable cardiac 
defibrillators, since July, 1987. From May, 1977 until joining Ventritex, Mr. 
Fischer held various positions with 


                                    III-2 
<PAGE>

Cordis Corporation, a manufacturer of medical products, serving most recently 
as President of the Implantable Products Division. Mr. Fischer serves on the 
Board of Directors of Heartstream, Inc., a medical device company. Mr. 
Fischer holds an M.S. in Management from Rensselaer Polytechnic Institute. 

      ROBERT V. GUNDERSON, JR. has been a Director of the Company since May, 
1995. Mr. Gunderson has been a partner of the law firm of Gunderson Dettmer 
Stough Villeneuve Franklin & Hachigian, LLP, since its formation in 
September, 1995. From May, 1988, until September, 1995, Mr. Gunderson was a 
partner of the law firm of Brobeck, Phleger & Harrison, LLP. Mr. Gunderson 
holds an M.A. from Stanford University, an M.B.A. in finance from the Wharton 
School, University of Pennsylvania and a J.D. from the University of Chicago. 

      JOSEPH S. LACOB has been a Director of the Company since April, 1992. 
Mr. Lacob is a general partner of Kleiner Perkins Caufield & Byers ("Kleiner 
Perkins"), a venture capital firm he joined in 1987. Prior to joining Kleiner 
Perkins, he was Marketing Manager for Cetus Corporation, a biotechnology 
company. Mr. Lacob serves as Chairman of the Board of Directors of CellPro, 
Incorporated, and is a Director of Pharmacyclics, Inc. and eight privately 
held companies. Mr. Lacob holds a B.S. in Biochemistry from the University of 
California at Irvine, a Masters in Public Health from the University of 
California at Los Angeles, and an M.B.A. from the Graduate School of Business 
at Stanford University. 

      JOHN H. STEVENS, M.D. founded the Company with Dr. Sterman in May, 
1991, and has been a Director of the Company since that time. Dr. Stevens is 
a member of the Stanford University Medical Center team that performed the 
ten Port-Access CABG Phase I clinical trial procedures and which has been 
performing Port-Access CABG and MVR procedures on a regular basis since FDA 
clearance was received in October, 1996. Formerly Chief Resident of the 
Department of Cardiothoracic Surgery at the Stanford University School of 
Medicine, and Senior Registrar in Cardiothoracic Surgery at the Great Ormond 
Street Hospital for Sick Children in London, England, Dr. Stevens is now an 
Associate Professor in the Department of Cardiothoracic Surgery at Stanford 
University School of Medicine. Dr. Stevens earned B.U.S. and B.S. degrees in 
Communications and Psychology from the University of Utah and an M.D. from 
Stanford University. 

      PETRI T. VAINIO, M.D. has been a Director of the Company since April, 
1992. Dr. Vainio is a general partner of Sierra Ventures, a venture capital 
firm he joined in 1988. He currently serves on the Board of Directors of 
Connective Therapeutics, Inc., a biotechnology company. Dr. Vainio holds M.D. 
and Ph.D. degrees from the University of Helsinki, Finland, and an M.B.A. 
from the Graduate School of Business at Stanford University. 

      STEVEN C. WHEELWRIGHT has been a Director of the Company since January, 
1995. Dr. Wheelwright currently serves as a senior associate dean at the 
Graduate School of Business, Harvard University, where he has been a 
professor since July, 1988. Dr. Wheelwright additionally served in the same 
position from August, 1985, to August, 1986. From August, 1986 to August, 
1988, Dr. Wheelwright served as a professor at the Graduate School of 
Business at Stanford University. Dr. Wheelwright is also a member of the 
Board of Directors of Quantum Corporation, a mass storage device company, 
T.J. International Corporation, an engineered wood products company, and 
Alleghany-Ludlum Steel Corporation, a specialty steel company. 

ITEM 11.  EXECUTIVE COMPENSATION.

      The information required by this item is incorporated by reference to 
the Proxy Statement for the Registrant's 1997 Annual Meeting of Stockholders.

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

      The information required by this item is incorporated by reference to 
the Proxy Statement for the Registrant's 1997 Annual Meeting of Stockholders.


                                     III-3
<PAGE>

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

      The information required by this item is incorporated by reference to 
the Proxy Statement for the Registrant's 1997 Annual Meeting of Stockholders.


                                    III-4
<PAGE>

PART IV

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

(a) EXHIBITS

EXHIBIT NO.                            DESCRIPTION
-----------                            -----------
 2.1+              Agreement and Plan of Merger dated April 3, 1995, for 
                   the reincorporation merger of Stanford Surgical 
                   Technology, Inc., a California corporation, into 
                   Heartport, Inc., a Delaware corporation. 

 3.1+              Restated Certificate of Incorporation.

 3.2+              Bylaws of the Registrant.

 4.1               Reference is made to Exhibits 3.1 and  3.2.

 4.2+              Specimen Common Stock certificate.

 4.3+              Third Amended and Restated Rights Agreement among 
                   Registrant and the Founders and Investors specified 
                   therein dated April 17, 1995.

 4.4               Rights Agreement between the Registrant and the First 
                   National Bank of Boston dated April 25, 1996.

10.1+              Form of Indemnification Agreement entered into by and 
                   between Registrant and its officers and directors.

10.2+              1993 Stock Option Plan and forms of agreements thereunder.

10.3               1996 Stock Option Plan as amended and restated 
                   October 21, 1996.

10.4               Employee Stock Purchase Plan, as amended and restated 
                   October 21, 1996.

10.5+              Real Property Lease between the Registrant and 
                   Metropolitan Insurance Company dated September 21, 1992, 
                   as amended.

10.6+              Equipment Financing Agreement between the Registrant and 
                   Lease Management Services, Inc. dated February 23, 1995.

10.7+*             Agreement between the Company and St. Jude Medical, Inc. 
                   dated September 11, 1995.

10.8               Third Amendment to Lease Agreement between Heartport 
                   Research and Training Center, Inc. and University of 
                   Utah Research Foundation dated as of October 25, 1996.

10.9*              Amendment to agreement between Registrant and St. Jude 
                   Medical, Inc. dated January 31, 1997.

10.10              Loan and Security Agreement dated December 31, 1996 
                   between the Registrant and Silicon Valley Bank.

11.1               Computation of Net Loss Per Share.

23.1               Consent of Ernst & Young LLP, Independent Auditors.

27.1               Financial Data Schedule

___________

*  Confidential treatment has been requested for certain portions of this 
   exhibit. Omitted portions have been filed separately with the Securities 
   and Exchange Commission.

+  Incorporated by reference to the Registrant's Registration Statement on 
   Form S-1 (File No. 333-1906)


                                      IV-1
<PAGE>

(b) REPORTS ON FORM 8-K

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

(c) EXHIBITS

      See paragraph (a).

(d) The following financial statement schedules required by Regulation S-X 
are filed herewith:

                    SCHEDULE NO.                DESCRIPTION
                    ------------                -----------
                        II           Valuation and Qualifying Accounts

              All other schedules are not applicable.


                                     IV-2
<PAGE>

                                    SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities 
Exchange Act of 1934, as amended, the registrant has duly caused this Annual 
Report on Form 10-K to be signed on its behalf by the undersigned, thereunto 
duly authorized, in Redwood City, California, on this 26th day of March, 1997.

                                    HEARTPORT, INC.

                                    By:   /s/ Wesley D. Sterman, M.D.
                                        ---------------------------------
                                        Wesley D. Sterman, M.D.
                                        PRESIDENT AND CHIEF EXECUTIVE OFFICER

                                POWER OF ATTORNEY

      Know all persons by these presents, that each person whose signature 
appears below constitutes and appoints jointly and severally, Wesley D. 
Sterman and David B. Singer, and each one of them, his attorneys-in-fact, 
each with the power of substitution, for him in any and all capacities, to 
sign any and all amendments to this Annual Report on Form 10-K and to file 
the same, with exhibits thereto and other documents in connection therewith, 
with the Securities and Exchange Commission, hereby ratifying and confirming 
all that each of said attorneys-in-fact, or his substitutes, may do or cause 
to be done by virtue hereof.

      Pursuant to the requirements of the Securities Exchange Act of 1934, as 
amended, this Annual Report on Form 10-K has been signed below by the 
following persons on behalf of the registrant and in the capacities and on 
the dates indicated: 

        SIGNATURE                       TITLE                        DATE
        ---------                       -----                        ----

 /s/ Wesley D. Sterman, M.D.     President, Chief Executive      March 26, 1997
-----------------------------    Officer and Director 
Wesley D. Sterman, M.D.          (Principal Executive 
                                 Officer)

 /s/ David B. Singer             Senior Vice President,          March 26, 1997
-----------------------------    Finance and Chief Financial 
David B. Singer                  Officer (Principal Financial 
                                 and Accounting Officer)

 /s/ Frank M. Fischer            Director                         March 26, 1997
-----------------------------
Frank M. Fischer

 /s/ Robert V. Gunderson, Jr.    Director                         March 26, 1997
-----------------------------
Robert V. Gunderson, Jr.

 /s/ Joseph S. Lacob             Director                         March 26, 1997
-----------------------------
Joseph S. Lacob

 /s/ John H. Stevens, M.D.       Director                         March 26, 1997
-----------------------------
John H. Stevens, M.D.

 /s/ Petri T. Vainio, M.D.       Director                         March 26, 1997
-----------------------------
Petri T. Vainio, M.D.

 /s/ Steven C. Wheelwright       Director                         March 26, 1997
-----------------------------
Steven C. Wheelwright

<PAGE>

                                                                 SCHEDULE II


                             HEARTPORT, INC.
                   VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                                    Additions
                                        Balance     Charged to                   Balance
                                       Beginning     Costs and                     End
                                       of Period     Expenses     Deductions     of Period
                                       ---------    ----------    ----------     ---------
                                                         (in thousands)
<S>                                        <C>          <C>           <C>           <C>
Year Ended December 31, 1996
  Allowance for doubtful accounts          $-           $33           $-            $33

Year Ended December 31, 1995
  Allowance for doubtful accounts          $-           $-            $-            $-

Year Ended December 31, 1994
  Allowance for doubtful accounts          $-           $-            $-            $-
</TABLE>