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


                                      FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934 [NO FEE REQUIRED]

                     For the Fiscal Year Ended June 30, 1998, or

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

                      For the Transition period from ___ to ___.

                           Commission file number: 0-28448
                          GENERAL SURGICAL INNOVATIONS, INC.
                (Exact name of Registrant as specified in its charter)

            California                                   94-3160456
 (State or other jurisdiction of                      (I.R.S. Employer
 incorporation or organization)                       Identification No.)

                  10460 Bubb Road, Cupertino, California 95014
                    (Address of principal executive offices)

          Registrant's telephone number, including area code: (408) 863-2500

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

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

                                -----------------
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 was approximately $27,244,672 as of August 31, 1998, based upon 
the closing sale price on the NASDAQ National Market System reported for such 
date. Shares of Common Stock held by each officer and director and by each 
person who owns 5% of more of the outstanding Common Stock have been excluded 
in that such persons may be deemed to be affiliates. This determination of 
affiliate status is not necessarily a conclusive determination for other 
purposes.

There were 13,441,974 shares of Registrant's Common Stock issued and 
outstanding as of August 31, 1998.

                         DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement of the Registrant for the 1999 Annual Meeting 
of Shareholders are incorporated by reference in Part III of this Form 10-K.

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                                INTRODUCTORY STATEMENT

     Except for the historical information contained in this Annual Report 
on Form 10-K, the matters discussed herein are forward-looking statements 
that are subject to certain risks and uncertainties that could cause the 
actual results to differ materially from those projected.  Factors that could 
cause actual results to differ materially include, but are not limited to, 
market demand for the Company's products, the Company's ability to shift 
market focus successfully, the timing of orders and shipments, the timely 
development and market acceptance of new products and surgical procedures, 
the impact of performance of the Company's distributors, the Company's 
ability to further expand into international markets, public policy relating 
to health care reform in the United States and other countries, approval of 
its products by government agencies such as the United States Food and Drug 
Administration, and other risks detailed below and included from time to time 
in the Company's other SEC reports and press releases, copies of which are 
available from the Company upon request.  The Company assumes no obligation 
to update any forward-looking statements contained herein.

     References made in this Annual Report on Form 10-K to "General Surgical 
Innovations, Inc.," the "Company" or the "Registrant" refer to General 
Surgical Innovations, Inc.  The following General Surgical Innovations, Inc. 
trademarks are mentioned in this Annual Report: SPACEMAKER-Registered 
Trademark-, SAPHtrak-Registered Trademark- registered trademark of the 
Company; ENDOSAPH-TM-, and SPACEKEEPER-TM-, trademarks of the Company.

                                        PART I

ITEM 1.   BUSINESS

OVERVIEW

     Since its inception in April 1992, General Surgical Innovations ("GSI") 
has been engaged in the development, manufacturing and marketing of surgical 
balloon dissectors and related minimally invasive surgical instruments. The 
Company began commercial sales of its surgical balloon dissectors for hernia 
repair in September 1993. To date, the Company has received from the FDA 
seven 510(k) clearances for use of the Company's technology to perform 
dissection of tissue planes anywhere in the body using a broad range of 
balloon sizes and shapes. The Company currently sells products in the United 
States, Europe, Asia and South America for selected applications, such as 
hernia repair, subfascial endoscopic perforator surgery, saphenous vein 
harvesting, breast reconstruction and augmentation surgery, and tissue 
expansion.

     In December 1996, the Company entered into a five year OEM supply 
agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery ("EES"), 
pursuant to which GSI granted EES worldwide sales and marketing rights to 
sell the SPACEMAKER-Registered Trademark- surgical balloon dissectors in the 
laparoscopic hernia repair and stress urinary incontinence ("SUI") markets. 
In February 1998, the Company and EES signed a non-exclusive distribution 
agreement for the laparoscopic hernia repair and SUI markets. This agreement 
supersedes the December 1996 Expanded EES Agreement.

     Additional sales in the United States are currently made through other 
distributors and a small direct sales force. The Company currently sells its 
products in international markets through other distributors, which resell to 
surgeons and hospitals. During fiscal year 1999, the Company plans to 
increase its direct sales force in the United States. Any increase in the 
Company's direct sales force will require significant expenditures and 
additional management resources.

     At present, the Company has exclusive distribution agreements with eight 
international distributors, including Baxter International, to distribute its 
cardiovascular products in 18 European countries.

     To date, the majority of the sales to distributors and by the Company's 
direct sales force have been for use in hernia repair procedures. While the 
Company has developed or is developing 

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surgical balloon dissectors for stress urinary incontinence, vascular and 
plastic surgery, sales of products for hernia repair are expected to provide 
a majority of the Company's revenues at least through fiscal 1999.

     The Company has acquired rights to a significant number of patents from 
third parties, including rights that apply to the Company's current surgical 
balloon dissectors. The Company has historically paid and is obligated to pay 
in the future to such third parties royalties equal to 1-4% of sales of such 
products, which payments are expected to exceed certain minimum royalty 
payments due under the agreements with such parties. Total amounts charged to 
operations for royalties for the years ended June 30, 1998, 1997 and 1996 
were $289,255, $356,831 and $241,065, respectively. The payment of such 
royalty amounts will have an adverse impact on the Company's gross profit and 
results of operations.

     The Company has a limited history of operations and has experienced 
significant operating losses since inception. The Company expects such 
operating losses to continue at least through fiscal 1999. The Company's 
sales to date have consisted primarily of surgical balloon dissectors for 
hernia repair. In order to support increased levels of sales in the future 
and to augment its long-term competitive position, including the development 
of surgical balloon dissectors for other applications, the Company 
anticipates that it will be required to make significant additional 
expenditures in sales and marketing and in research and development 
(including marketing-related clinical evaluations). 

     The Company currently manufactures and ships product shortly after the 
receipt of orders, and anticipates that it will do so in the future. 
Accordingly, the Company has not developed a significant backlog and does not 
anticipate that it will develop a material backlog in the future. 

     The Company anticipates that its results of operations may fluctuate 
from quarter to quarter due to several factors, including (i) fluctuations in 
purchases of the Company's products by its distributors, (ii) the ability of 
the Company's distributors to effectively promote and sell the Company's 
products, (iii) the rate of adoption by surgeons of balloon dissection 
technology in markets targeted by the Company, (iv) the mix of sales among 
distributors and the Company's direct sales force, (v) the timing and cost of 
increasing the Company's direct domestic sales force, (vi) the expansion of 
the Company's distribution network (vii) new product introductions by the 
Company and its competitors, (viii) fluctuations in revenues among different 
product lines and markets, (ix) timing of patent and regulatory approvals, if 
any, (x) intellectual property litigation, (xi) timing and growth of 
operating expenses and (xii) general market conditions.  The Company's 
limited operating history makes accurate prediction of future operating 
results difficult or impossible.

INDUSTRY BACKGROUND

     Open surgery is an invasive procedure that generally requires large 
incisions and significant tissue manipulation in order to provide the surgeon 
with direct access to the intended surgical site. Much of the trauma suffered 
in connection with open surgery is a result of gaining access to the surgical 
site and is not caused by the surgical repair itself. For example, the 
surgeon often must make large incisions through layers of muscle and tissue, 
which may cause muscle or nerve damage, bleeding, scarring and other 
complications such as infection, temporary or permanent debilitation and 
pain. As a result, many open surgical procedures require extended operating 
times, expose the patient to the risks of general anesthesia and involve 
lengthy hospitalization and patient recovery times. In addition, because of 
the severe trauma often associated with open surgical procedures, a 
significant population of patients, including the elderly and weak, are not 
considered good candidates for these surgical procedures and are thus 
deprived of treatment. 

     In order to reduce the complications associated with open surgery, 
surgical techniques referred to as minimally invasive surgery ("MIS") have 
been developed. These techniques allow surgeons to access the surgical site 
through the body's natural openings (e.g. mouth, urethra or rectum) or by 
making small incisions to access body cavities such as the abdominal cavity 
(the peritoneal cavity). The performance of MIS generally involves five basic 
steps. First, a small incision (approximately 1 cm) is made for insertion of 
a trocar, a valved tube with a blunt or sharp insertion device. Next, 
additional trocars are introduced to gain increased access to the surgical 
site and permit the introduction of 

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surgical instruments. Third, the surgeon creates a working space through the 
use of dissection tools or by insufflating a natural body cavity (such as the 
abdominal cavity). Fourth, the surgeon utilizes a device such as an endoscope 
or laparoscope to visualize the surgical field. Finally, the surgeon utilizes 
specialized MIS instruments to perform the surgical procedure.

     Studies published in the NEW ENGLAND JOURNAL OF MEDICINE and THE JOURNAL 
OF VASCULAR SURGERY support the benefits of MIS as compared to open surgery, 
which generally include reduced patient trauma (including less muscle, nerve 
and other tissue damage), reduced blood loss, reduced post-operative 
infection, reduced scarring at the site of the incision (which in turn 
reduces reintervention requirements), shorter patient recovery time and 
ultimately lower medical costs.

     Despite the documented benefits of MIS, its adoption to date has been 
limited to a select number of surgical procedures, and, in the aggregate, 
represented only an estimated 15% of all surgical procedures performed in the 
United States in 1997. The most widely adopted MIS procedure, laparoscopic 
cholecystectomy (removal of the gall bladder), has been successfully adopted 
and is used in an estimated 93% of such cases largely because the target 
surgical site lies within the abdominal cavity, the only natural body cavity 
that provides a working space when insufflated. Application of MIS techniques 
to other surgical procedures and the ability to exploit the clinical benefits 
of MIS have been limited by the lack of a natural body cavity proximate to 
the surgical site and the inability of the surgeon to easily and 
atraumatically access the surgical site or establish a surgical working space 
where no natural body cavity exists. MIS conducted outside of a natural body 
cavity requires the surgeon to tunnel through tissue to reach the target 
surgical site and to dissect a working space. If conventional dissection 
techniques are utilized, the resulting working space is often relatively 
bloody and affords only poor visualization. 

     As a result of these limitations, many common types of surgical repairs 
cannot be effectively performed using traditional blunt dissection MIS 
techniques, including hernia repairs, and procedures performed on organs such 
as the bladder, kidney, spine, aorta or other sites that lie outside the 
abdominal cavity.  For other procedures, although MIS techniques may exist 
for the performance of the repair itself, gaining access to the target 
surgical site is invasive, thereby reducing many of the clinical benefits of 
MIS. For example, currently utilized MIS for spinal fusion requires making 
small incisions at the midline of the patient's abdomen, entering the 
peritoneum, retracting bowel and other organs to one side, exiting the back 
of the peritoneum and continuing down to the front of the spine. 

     The Company believes that a significant opportunity exists for 
technologies and surgical instruments that can effectively address the 
limitations of MIS and facilitate the adoption of MIS for a wider range of 
surgical procedures. 

GSI SOLUTION

     GSI's proprietary surgical balloon dissectors allow a surgeon to rapidly 
access and relatively atraumatically create a working space at a target 
surgical site where none previously existed. The body is largely made up of 
tissue layers (skin, fat, and muscle, for example) with distinct planes 
between layers.  The Company's surgical balloon dissectors allow the surgeon 
to exploit this anatomy using minimally invasive techniques.  By following 
such a plane with a deflated and rolled balloon, and then inflating the 
balloon to dissect and separate the two adjacent layers, a new working space 
is created. Because MIS techniques are employed, there is little damage 
compared to that likely encountered with open surgery and its related long 
incisions and collateral trauma to tissues and nerves. 

     GSI provides a wide range of surgical balloon dissectors, each having 
different attributes or combinations of attributes.  Generally, by selecting 
one of these dissectors for the purpose at hand, the surgeon may quickly and 
easily create an accurate and predictable working space, giving consideration 
to both size and shape and with the desired proximity to the chosen surgical 
site.  

     The Company believes that its SPACEMAKER-Registered Trademark- products 
can be deployed anywhere in the body where a natural tissue plane exists. For 
example, by creating a working space in the pre-peritoneal area (the space in 
front of the peritoneum) the Company's technology enables the use of MIS for 
hernia repair or treatment of urinary stress incontinence. Similarly, by 
creating a working space in the retroperitoneal area (the space behind the 
peritoneum) the Company's technology enables the use of MIS for anterior 
spinal fusion and other pathologies accessible in this area. In 

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addition, the ability of the Company's line of SPACEMAKER-Registered 
Trademark-products to create working spaces at different tissue levels 
(including subcutaneous, subfascial, submuscular and subglandular) enables 
the use of MIS for saphenous vein harvesting, subfascial endoscopic 
perforator surgery, breast augmentation and reconstruction, tissue flap 
harvesting for reconstruction, long-bone plating and a variety of other 
medical procedures.

COMPANY STRATEGY

     The Company's objective is to become the leading provider of surgical 
balloon dissectors and specialty surgical instruments for MIS. The key 
elements of the Company's strategy are as follows: 

     INCREASE MARKET ACCEPTANCE OF BALLOON DISSECTION TECHNIQUES.  The 
Company intends to increase market acceptance for its SPACEMAKER-Registered 
Trademark-products primarily by developing and maintaining relationships 
worldwide with leading general surgeons and specialists in the surgical 
fields of cardiovascular surgery, obstetrics, gynecology, urology, general, 
cosmetic and reconstructive surgery and orthopedic surgery. The Company 
intends to support these efforts through surgeon training programs designed 
to increase surgeon familiarity with the advantages and applications of the 
Company's products. In addition, the Company is conducting marketing-related 
clinical evaluations to increase exposure of surgeons to the Company's 
products and to demonstrate the effectiveness of MIS in a broad range of 
procedures when used with the Company's SPACEMAKER-Registered Trademark- 
surgical balloon dissectors. The Company intends to use data collected from 
marketing-related clinical evaluations to demonstrate the anticipated 
clinical and cost advantages of the Company's products to patients, surgeons, 
hospital administrators and third-party health care payers. 

     CAPITALIZE ON EXISTING PROPRIETARY POSITION.  GSI has established an 
extensive patent portfolio, and plans to capitalize on its proprietary 
position to establish and maintain a leadership position in the balloon 
dissection market. As of June 30, 1998, GSI had 38 United States patents 
issued, and had applied for an additional 52 United States patents, 10 of 
which had been allowed.  In addition, as of June 30, 1998, GSI had three 
foreign patents issued, and 29 in prosecution covering GSI's  technology, 
including tissue dissection with balloons. In May 1996, the Company was 
issued a United States patent that contains broad claims regarding use of 
balloons to dissect tissue planes. The Company believes that the scope of 
these claims could provide a long-term competitive advantage for many of the 
Company's balloon dissection products. 

     DEVELOP AND RAPIDLY INTRODUCE NEW BALLOON DISSECTOR PRODUCTS. The 
Company intends to develop and rapidly introduce additional surgical balloon 
dissection products and enhancements to its products that are within the 
scope of the Company's existing 510(k) clearances. GSI's 
SPACEMAKER-Registered Trademark- surgical balloon dissectors have received 
FDA 510(k) clearance for tissue plane dissection during general, endoscopic, 
laparoscopic or cosmetic and reconstructive surgery and certain vascular 
surgeries, using a broad range of balloon sizes and shapes. Accordingly, the 
Company believes it is well positioned to offer a portfolio of products for 
additional surgical procedures without significant additional United States 
regulatory pre-market clearance compliance requirements. The Company has 
developed or is planning to develop surgical balloon dissectors for a number 
of procedures for which MIS, without these products, is currently suboptimal 
or unavailable, including treatment of chronic venous insufficiency, stress 
urinary incontinence, and anterior spinal fusion and long-bone plating for 
certain fractures.

     DEVELOP NEW SURGICAL INSTRUMENTS FOR MIS.  As part of its MIS product 
strategy, the Company will continue to develop and/or seek to acquire or 
license surgical instruments tailored for use in the working spaces created 
by the Company's surgical balloon dissectors. To date, the Company has 
developed several instruments including its GSI Hook & Fork Dissectors and 
SPACEKEEPER-TM-retractor products and reusable clip applier with 5mm shaft 
for saphenous vein harvesting. The Company will continue to develop and/or 
seek to acquire or license specialized surgical instruments that facilitate 
the broader adoption of MIS and balloon dissection products for surgical 
procedures. 

     MARKET  PRODUCTS THROUGH A DIRECT SALES FORCE AND DISTRIBUTORS. 
Domestically GSI sells products through both a direct sales force which it 
has established and continues to build, as well as various distributors. For 
international sales of its products  the Company has, and intends to continue 
to build, relationships with medical device companies both in the United 
States and internationally that can provide the Company access to an 

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established distribution network in GSI's targeted markets. As of the end of 
the fiscal year 1998, the Company had in effect agreements with 24 
distributors domestically and internationally. By pursuing a strategy of 
corporate partnering to leverage established medical device distribution 
networks, the Company believes that it will be able to capitalize on the 
existing surgeon training programs, complementary products and established 
surgeon relationships of its corporate partners. For example, the Company 
currently has a distribution arrangement with Ethicon Endo-Surgery, Inc. 
("EES") under which GSI has granted EES non-exclusive worldwide sales and 
marketing rights to sell the SPACEMAKER-Registered Trademark- surgical 
balloon dissectors in the laparoscopic hernia repair and USI markets. The 
Company also has an exclusive agreement with Baxter International to 
market and distribute GSI's surgical balloon dissectors for use in vascular 
procedures. Additionally, the Company has an exclusive four-year agreement 
with Genzyme Surgical Products Corporation to market and distribute GSI's 
balloon dissection systems for use in plastic surgery (reconstructive and 
aesthetic) procedures.

SURGICAL BALLOON DISSECTORS

     GSI's SPACEMAKER-Registered Trademark- tissue dissection systems, based 
on the company's patented balloon technology, rapidly and gently create 
surgical working spaces in the body by separating natural tissue planes 
without resorting to blunt dissection used in conventional open surgery or 
minimally invasive surgery conducted outside of a natural body cavity.  In 
procedures using SPACEMAKER-Registered Trademark- dissectors, a surgeon 
creates a small incision through which the balloon is inserted and placed 
between naturally occurring tissue layers such as muscle, fat, and skin.  
Subsequently, the balloon is filled to a specific volume with air or saline, 
causing the desired dissection of the tissue planes.  The system is then 
deflated and removed and the dissected space can be insufflated with gas to 
create a surgical operating space.

     The Company's surgical balloon dissectors incorporate several 
proprietary technologies to increase the reliability, effectiveness and ease 
of use in creating working spaces during MIS. Each balloon is composed of 
strong and reliable nonelastomeric polyurethane material and is welded using 
a proprietary technique that allows the balloon to be inflated to a 
predetermined size and predictable shape with minimal risk of rupture. Each 
of the Company's balloons is designed to be deployed in a predictable manner 
that maximizes effectiveness and accuracy in creating the surgical working 
space and is designed to minimize unnecessary tissue trauma because of the 
specific and predictable manner in which the balloon unfurls. The Company has 
designed its dissection balloons in a variety of shapes and sizes that are 
tailored for specific procedures. For example, the Company's "Manta Ray" 
shaped balloon is designed for use in hernia repair to maximize working space 
and visibility of the surgical site while minimizing the disruption of other 
anatomy at the surgical site. 

     The Company currently offers its surgical balloon dissectors in five 
distinct access and deployment platforms, the SPACEMAKER-Registered 
Trademark- I with integral trocar platform, the SPACEMAKER-Registered 
Trademark- II with visualization platform, the SPACEMAKER-Registered 
Trademark- Plastics platform, SAPHtrak-Registered Trademark- platform, and 
the ENDOSAPH-TM- platform, along with 15 different balloon shapes and sizes, 
designed for various surgical techniques, procedures types and market 
segments. Each balloon dissection system, except ENDOSAPH-TM-, contains three 
primary components: a guide rod and blunt tip to access the surgical site; a 
single use, disposable balloon dissector (which includes a tubing mechanism 
and valve apparatus to fill the balloon) to create a working space at the 
surgical site; and a balloon cover to protect the balloon dissector and 
maintain the balloon in its furled state prior to inflation. ENDOSAPH-TM- 
contains the first two components.  End-user prices for the Company's 
surgical balloon dissectors and kits range from approximately $140 to 
$650 per unit, depending upon the type of product platform purchased and the 
nature of the product packaging. 

     The key attributes of the Company's five major product platforms are 
described below:

     SPACEMAKER-Registered Trademark- I (WITH INTEGRAL TROCAR) PLATFORM.  The 
SPACEMAKER-Registered Trademark- I platform is composed of a stainless steel 
rod with a blunt tip which is used both as the guide rod for the balloon and 
as the insertion rod for a pre-loaded integral trocar. This enables the 
surgeon to quickly and accurately insert the trocar into the dissected space 
once the balloon is removed. In addition, the balloon cover used with the 
SPACEMAKER-Registered Trademark- I platform is a strong sheath that maximizes 
its tunneling capability. 

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     SPACEMAKER-Registered Trademark- II PLATFORM.  The SPACEMAKER-Registered 
Trademark- II platform is a blunt-tipped, polymeric, hollow tube that is used 
both as a guide rod for insertion of the balloon and as a scope cover for 
protection of a laparoscope lens. This platform is designed to allow 
endoscopic visualization both during insertion and inflation of the balloon. 
Visualization enables the surgeon to identify the appropriate tissue plane 
for dissection, as well as identify anatomical features while accessing the 
surgical site. The SPACEMAKER-Registered Trademark- II platform includes an 
integral polyurethane balloon cover, which releases automatically upon 
inflation of the balloon thus simplifying the procedure for the surgeon. 

     SPACEMAKER-Registered Trademark- PLASTICS PLATFORM.  The 
SPACEMAKER-Registered Trademark- Plastics platform consists of a combined 
blunt-tipped guide rod and handle, used for insertion, and a balloon 
cartridge, composed of a hollow tube upon which the balloon is loaded and an 
integral cover over the balloon and tubing to protect them during insertion. 
This platform is used primarily for plastic and reconstructive surgery. 

     SPACEMAKER-Registered Trademark- SAPHTRAK-Registered Trademark- 
PLATFORM.  The SPACEMAKER-Registered Trademark- SAPHtrak platform consists of 
a stainless steel rod with a blunt tip, an eight inch balloon and a handle.  
The malleable feature of the guide rod allows the surgeon to adjust the 
curvature of the device to maneuver around challenging patient anatomy. The 
150cc capacity balloon is not removable from the guide so that it is 
redeployable at multiple sites along the course of the vein.  This platform 
is used primarily for saphenous vein harvesting.

     ENDOSAPH-TM- PLATFORM. The SPACEMAKER-Registered Trademark- 
ENDOSAPH-TM-platform consists of two disposable devices - The SAPHfinder-TM- 
balloon dissector and the SPACEKEEPER-TM- retractor.  The SAPHfinder-TM- 
balloon dissector consists of an open-ended tip on a hollow guide rod, an 
eight inch balloon, and a handle.  The device is designed to accommodate a 
standard-length 5mm endoscope for viewing from the tip.  The 150cc capacity 
balloon is not removable from the guide rod so that it is re-deployable at 
multiple sites along the course of the vein.  The SPACEKEEPER-TM- retractor 
is a single-piece, polycarbonate construction consisting of a distal 
retractor, 5mm endoscope channel and handle.  The retractor is also designed 
to accommodate a standard-length 5mm endoscope. This platform is used 
primarily for saphenous vein harvesting.  

APPLICATIONS OF BALLOON DISSECTION TECHNOLOGIES

     The Company's initial market focus was the application of its 
SPACEMAKER-Registered Trademark- balloon dissection technology for hernia 
repair. More recently, the Company has  begun to increase its emphasis on 
cardiovascular applications. The Company has completed marketing-related 
clinical evaluations of, and has introduced products  for, saphenous vein 
harvesting, subfascial endoscopic perforator surgery ("SEPS"), breast 
augmentation and reconstruction procedures, SUI and urological and 
gynecological applications. The Company is currently conducting additional 
marketing-related clinical evaluations for tissue dissection/expansion. The 
Company believes that its current FDA clearances provide coverage for many 
surgical applications that the Company may pursue. The Company has commenced 
commercial sales of its products in the United States, Europe, Asia and South 
America for selected applications including hernia repair, saphenous vein 
harvesting, SEPS and breast augmentation and reconstruction surgery. To date, 
the Company has received 510(k) clearances from the FDA for the use of its 
SPACEMAKER-Registered Trademark-balloon dissection technology to perform 
dissection of tissue planes using a broad range of balloon sizes and shapes. 

     HERNIA REPAIR

     A hernia, a condition that commonly occurs in the groin, is a protrusion 
of normal abdominal contents through a muscle defect, usually in the tissue 
layers overlying the abdomen. The peritoneum and/or bowel often project into 
this defect, causing pain and potential major complications. Hernias affect 
over 650,000 people in the United States and approximately 1.3 million people 
worldwide each year. 

     The open surgical procedure for hernia repair is a herniorrhaphy, which 
involves making a 10 to 15 cm open incision in the groin over the muscle 
defect to be repaired. As in most invasive surgical procedures, recovery 
periods tend to be long, typically extending between three and six weeks. 
Over the last few years, in an effort to reduce 

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post-operative pain and recovery times, several laparoscopic techniques have 
been developed to repair hernias. Despite these advances, MIS has not been 
optimized for hernia repair. For example, in certain MIS hernia repair 
procedures, a surgeon must first make an incision in the abdominal wall to 
gain access to the abdominal cavity. The surgeon then must make an additional 
incision in the peritoneum enabling the surgeon to reach the surgical site 
and create the working space required to conduct the surgical repair.

     The Company believes that its balloon dissection technology can 
significantly improve the outcomes of laparoscopic hernia repair procedures. 
Utilizing the Company's SPACEMAKER-Registered Trademark- products, the 
surgeon tunnels the device through a small incision at the umbilicus  and 
then inflates the balloon to create a large and relatively bloodless space at 
the site of the hernia. As a result, the surgeon is able to more rapidly and 
easily access the target surgical site and complete the hernia repair. In 
addition, because the surgeon never enters the peritoneum, this procedure 
reduces the risk of organ damage, adhesion formation and morbidity, and 
eliminates the requirement for general anesthesia. In a study presented in 
March 1996, MIS hernia repair procedures utilizing the Company's balloon 
dissection systems resulted in lower cost, fewer complications and faster 
recovery time as compared to open surgical hernia repair procedures.    

     The Company believes that its SPACEMAKER-Registered Trademark-  products 
provide a platform for increasing the conversion of open hernia repair 
procedures to laparoscopic procedures. According to Medical Data 
International, Inc., laparoscopic hernia repair procedures represented 
approximately 160,000 or 25% of total hernia repair procedures in 1995. The 
Company estimates that approximately half of these laparoscopic hernia repair 
procedures are now performed using balloon dissection technology. 

     The Company commenced commercial sales of its hernia repair balloon 
dissection products in the United States in late 1993 and in Europe in 1994 
and currently sells three versions: the SPACEMAKER-Registered Trademark- I 
platform in both 900cc and 1500cc volume, which were introduced in September 
1993, and the SPACEMAKER-Registered Trademark- II platform, which was 
introduced in October 1995. The Company sells these products both in the 
United States and certain foreign markets, including Europe, Asia and South 
America, through its direct sales force and distributors. 

     SUBFASCIAL ENDOSCOPIC PERFORATOR SURGERY (SEPS)

     Chronic venous insufficiency, which results in insufficient blood flow 
from the extremities, is a common and debilitating disease. A frequent 
manifestation of venous insufficiency is venous stasis ulceration (chronic 
skin ulcers), which currently affects approximately 1.25 million people in 
the United States. 

     The Company believes that current treatment options for venous stasis 
ulceration and venous insufficiency  are suboptimal. Compression stockings 
(elastic stockings that put pressure on the leg to force blood flow), the 
most common treatment, often temporarily heal the ulcers but do not treat the 
underlying venous incompetence. Compression stockings as treatments are also 
ineffective because patients often do not wear the stockings, the associated 
healing process is slow and the recurrence rate for the ulcers is high. 
Treating the incompetent vein through an open surgical procedure allows 
treatment of the underlying condition, but requires an incision through the 
ulcer wound, which is composed of diseased tissue and is often incapable of 
healing. Alternatively, a minimally invasive ligation procedure known as 
subfascial endoscopic perforator surgery ("SEPS") allows the surgeon to 
access the incompetent vein from an incision remote from the ulcer wound 
using traditional dissection instruments. However, because this access to the 
surgical site causes bleeding and significant tissue trauma, the procedure is 
difficult and time consuming for the surgeon to perform because of poor 
visualization. 

     The Company's SPACEMAKER-Registered Trademark- surgical balloon 
dissectors allow the surgeon to perform SEPS to ligate incompetent veins 
endoscopically in a relatively atraumatic, bloodless manner. By utilizing the 
Company's SPACEMAKER-Registered Trademark- technology, the surgeon is able to 
deploy an elongated balloon down the length of the patient's leg to create an 
operating space for access to one or more incompetent veins. Because the 
incisions needed for this procedure are very small (approximately one cm) and 
are remote from the area of ulcerated skin, the Company believes that wounds 
will heal more rapidly and that there will be fewer complications compared to 
open surgery. In addition, the relatively bloodless working space created by 
the Company's balloon provides the surgeon with improved visualization of the 
veins requiring ligation, making the procedure easier and faster for the 
surgeon. 

                                      -8-
<PAGE>

     The Company launched its initial product to treat venous stasis 
ulceration and venous insufficiency in January 1996. To date, the Company's 
SPACEMAKER-Registered Trademark- I balloon dissection products have been used 
to treat over 1,100 patients suffering from venous stasis ulcers or venous 
insufficiency in over 250 centers across the United States, with results 
indicating generally successful outcomes. Additional outcome studies have 
been completed or are underway such as the study recently reported in the 
June 1997 JOURNAL OF VASCULAR SURGERY that supported the Company's belief 
that balloon assisted SEPS tends to produce faster healing rates, fewer 
complications and lower recurrence rates as compared to compression stockings 
or open surgical ligation. 

     SAPHENOUS VEIN HARVESTING

     In recent years, advanced coronary artery disease has been increasingly 
treated by coronary artery bypass graft (CABG) procedures, which involve 
grafting a portion of a patient's vein, taken from a different part of the 
body, around the blocked artery. More than 600,000 CABG procedures were 
performed worldwide in 1997. Nearly 90% of these procedures in the United 
States and 60% outside the United States utilized the patient's saphenous 
vein as a bypass graft. 

     Traditional saphenous vein harvesting procedures often require a 
continuous incision from the ankle to the upper thigh of a patient's leg. The 
saphenous vein is then dissected and removed, and the wound is sutured 
closed. A study involving 112 patients indicates that the open surgical 
procedure for saphenous vein harvesting results in wound healing impairment 
in approximately 24% of patients. The length and invasiveness of the leg 
incision also causes significant postoperative patient pain and discomfort. 
Surgeons indicate that after the CABG procedure patients more frequently 
complain about the pain caused by leg incisions than other aspects of the 
procedure.

     By utilizing the Company's SAPHtrak-Registered Trademark- balloon 
dissector and Hook and Fork dissection tools in the saphenous vein harvest 
procedure, the surgeon can reduce the leg incisions to three or four 
centimeter long incisions, and can minimize damage to the muscles and nerve 
endings surrounding the saphenous vein. Results from clinical usage of the 
ENDOSAPH-TM- vein harvest system indicate generally successful outcomes from 
the procedure including less postoperative pain, faster healing and less 
scarring than with traditional open procedures. 

     STRESS URINARY INCONTINENCE SURGERY

     Stress urinary incontinence ("SUI") is the uncontrollable loss of urine 
due to a displacement of the bladder neck. According to Frost & Sullivan, 
approximately 1.7 million women 30 years or older suffer from SUI on a daily 
basis and are thus candidates for interventional treatment. 

     Depending on the severity of incontinence, there are a number of 
treatment options for SUI, including collagen injections, drugs, biofeedback 
exercises and absorbent pads.  The standard treatment for severe SUI is a 
highly invasive, open surgical procedure involving suture suspension of the 
bladder neck.  This method can create significant complications for the 
patient, including enterocele (a hernia within the vaginal wall) and genital 
prolapse (a descending of the uterus due to a weakness of the pelvic floor). 
Furthermore, after surgery patients may require up to six weeks or more to 
resume their preoperative lifestyle. Because of the risk, expense and 
complexity of open suture suspension, this surgical procedure is often 
performed only in conjunction with other open abdominal procedures such as 
hysterectomy. 

     Several MIS alternatives to open surgical procedures for the treatment 
of SUI have recently been developed to suspend the bladderneck. These MIS 
procedures have been increasingly accepted as stand-alone procedures and are 
typically less expensive and less likely to cause adverse side effects. 
Outcome studies are now becoming available which  indicate satisfactory 
outcomes  for MIS procedures when compared to open bladder neck suspension 
procedures in successfully treating incontinence. Unfortunately, as in hernia 
repair, some MIS procedures involve accessing the surgical site by entering, 
traversing and then exiting the peritoneal cavity. While these procedures 
offer improvements over open surgery and afford the benefits of MIS, they 
still involve the morbidity risks and difficulties associated with violating 
the peritoneum. 

     Utilizing the Company's surgical balloon dissectors, the surgeon can 
suspend the bladderneck laparoscopically without entering the peritoneum, and 
can do so under visualization. As in the hernia repair procedure, GSI's

                                      -9-

<PAGE>

SPACEMAKER-Registered Trademark- dissection products can be deployed through 
the umbilicus to provide direct access to the bladder and bladderneck. The 
surgeon can then use conventional laparoscopic instruments to complete the 
procedure. The Company believes that the entire SUI repair procedure can be 
performed in less than one hour on an outpatient basis. 

     GSI offers a SPACEMAKER-Registered Trademark- II dissector specifically 
to address the extra-peritoneal treatment of SUI, which the Company believes 
will allow a surgeon to optimize the working space for the procedure. 

     BREAST AUGMENTATION AND RECONSTRUCTIVE SURGERY

     In 1995, approximately 90,000 women worldwide had breast reconstructive 
surgery due to partial or full mastectomies relating to breast cancer, and an 
additional 110,000 had elective (aesthetic) breast augmentation surgery. 
Traditional surgical methods for such procedures require making a three to 
five cm incision in the skin, finding the required tissue plane, and then 
using a combination of blunt and sharp dissection tools to create a pocket 
for the implant. The procedure can cause substantial bleeding, can sever both 
sensory nerves and perforating vessels and can leave the patient with 
substantial, noticeable scars. 

     In contrast to traditional breast augmentation and reconstruction 
procedures, the Company's SPACEMAKER-Registered Trademark- products require 
only small incisions, create a relatively bloodless pocket, minimize 
disruption of sensory nerves or perforating vessels and minimize scarring and 
loss of movement or sensation. In addition, because the SPACEMAKER-Registered 
Trademark- product allows the surgeon to introduce the balloon dissector from 
a crease in the axilla (armpit), from the inframammary fold (below the breast 
inside the mammary fold), or in the periareolar (nipple) area, the surgeon 
can minimize the appearance of any marks or scars. The Company believes that 
its SPACEMAKER-Registered Trademark- dissection products for breast 
augmentation and reconstruction procedures enable the surgeon to create 
uniform, symmetrical pockets in less time and with much less bleeding than is 
possible with traditional blunt or sharp dissection tools. 

     The Company's balloon dissection products for breast augmentation and 
reconstruction were first introduced commercially in the United States in 
January 1995. The Company currently sells the SPACEMAKER-Registered 
Trademark-Plastic platform for use in this indication. 

     OTHER COSMETIC AND RECONSTRUCTIVE SURGERY

     In addition to the market opportunities for breast augmentation and 
reconstruction, the Company has designed, developed and is performing 
marketing related clinical evaluations of its balloon dissection technology 
for combined tissue dissection and expansion for cosmetic and reconstructive 
surgery procedures. The Company believes that its balloon dissection 
technology is well-suited for such procedures. 

      ORTHOPEDIC SPINE SURGERY

     The Company believes that its products can be used in several orthopedic 
spinal procedures to both reduce the costs of the procedure and enhance 
patient benefits. Foremost among these procedures is spinal fusion, which was 
performed approximately 200,000 times in the United States in 1994. Spinal 
fusion is usually performed to remove a ruptured vertebral disc that is 
causing significant patient discomfort, and subsequently to promote fusion 
between the then exposed and adjacent vertebrae. This fusion procedure can be 
performed by using any of several prosthetic systems, by traditional bone 
prostheses, or by a combination of the two. 

     Most traditional open spinal fusion procedures have approached the spine 
from the back. Several newer procedures, some currently under clinical 
investigation, approach the spine through the abdomen, which appears to yield 
better results. The open abdominal approach is highly invasive, however, and 
has led researchers to try to develop a minimally invasive, transperitoneal 
laparoscopic approach. This approach still subjects the patient to the same 
risks associated with the open abdominal approach. 

     The Company's surgical balloon dissectors have been used in several 
cadaver studies in which an extraperitoneal laparoscopic approach to the 
spine has been successfully performed. In this procedure, the balloon is 
deployed in the retroperitoneal area under the rib cage and is inflated in 
order to dissect the peritoneum away from 

                                      -10-

<PAGE>

muscle layers in the back and side of the patient. By doing so, the surgeon 
can create a large working space to access the spine without entering the 
peritoneum. The Company believes the spinal fusion procedure is a natural 
extension of the aortic reconstruction application for balloon dissection 
technology because the required dissected space is essentially the same. The 
Company intends to conduct additional marketing-related clinical evaluations 
to evaluate physician preference and utility of the Company's 
SPACEMAKER-Registered Trademark- surgical balloon dissectors for the 
orthopedic spine surgery market.

ADDITIONAL PRODUCTS UNDER DEVELOPMENT

     As part of its competitive strategy, GSI continually seeks to leverage 
its core technology to develop surgical balloon dissectors for new surgical 
procedures, as well as to develop new surgical instruments for MIS. The 
Company has made a significant investment in developing its proprietary 
balloon dissection technology and believes its research and development 
commitment in this area is critical to its competitive position. Research and 
development expenses for fiscal 1998, 1997 and 1996 were approximately $2.8 
million,  $2.2 million, and $1.3 million, respectively.  As of June 30, 1998, 
the Company employed 19 persons engaged in research and development 
activities. 

     The Company is also exploiting its expertise in MIS to develop a range 
of instruments to maximize the surgeon's ability to perform MIS once an 
operative working space is created by the Company's surgical balloon 
dissectors. Product research and development will require substantial 
expenditures, and there can be no assurance that the Company will be 
successful in identifying products for which demand exists, in developing 
products that have the characteristics necessary to treat target indications, 
or that any new product introduced will receive regulatory approval or be 
commercially successful. 

MARKETING, SALES AND DISTRIBUTION

     The Company markets its products, both domestically and internationally, 
to general surgeons, urologists, gynecologists, vascular surgeons, orthopedic 
surgeons and cosmetic and reconstructive surgeons. Sales in the United States 
and internationally in the hernia and SUI markets are currently made through 
non-exclusive relationships with EES, United States Surgical Corporation, 
other distributors and a direct sales force. Additionally, the Company has an 
exclusive four-year agreement with Genzyme Surgical Products Corporation to 
market and distribute GSI's surgical balloon dissection systems for use in 
plastic surgery (reconstructive and aesthetic) procedures. Sales of devices 
for cardiovascular applications are made through a non-exclusive agreement 
with Baxter International and through the Company's direct sales force and 
other distributors.  

     MARKETING PROGRAMS. The Company's marketing strategy for its surgical 
balloon dissector products is designed to target surgeons who are leaders in 
their respective surgical specialties, and to promote visibility of the 
Company's products and awareness of the clinical efficacy and cost 
effectiveness of surgical techniques that employ the Company's products. For 
product sales in the cardiovascular, hernia, and SUI markets, the Company is 
using a combination of a direct sales force and distributors. The Company has 
entered into or is seeking to enter into agreements with independent 
distributors that have well-established distribution networks across wide 
geographic areas as well as well-developed training programs. 

     The Company has a program to disseminate clinical and technical 
information worldwide to educate surgeons about the benefits of the Company's 
products and to encourage surgeons to perform procedures utilizing the 
Company's products. In support of this program, the Company has produced and 
distributed to surgeons SPACEMAKER-Registered Trademark- dissector procedure 
demonstration videos and educational videos for hernia repair, bladder neck 
suspension, vascular surgery and cosmetic and reconstructive surgery. In 
addition, the Company has developed relationships with several leading 
surgeons in each of the Company's targeted major surgical specialty areas who 
provide input on clinical and product development, as well as surgical 
procedures that are candidates for GSI's products. In 

                                      -11-

<PAGE>

addition, the Company is actively sponsoring a number of marketing-related 
clinical evaluations designed to demonstrate the utility and ease of use of 
the Company's products.

     SALES IN THE UNITED STATES.  GSI maintains a small direct sales 
organization in the United States to market its products to general surgeons 
and specialists, and to support its distributors' sales efforts. As of June 
30, 1998, the Company's direct sales force in the United States consisted of 
14 persons. The Company plans to increase its direct sales force during the 
next fiscal year. As of the end of the fiscal year 1998, the Company had 
agreements with 16 U.S. distributors and intends to establish additional 
distributorships in the United States. There can be no assurance that such 
efforts will be successful.  

     INTERNATIONAL SALES.  The Company's products are currently sold 
internationally to general surgeons and specialists through EES, Baxter 
International, Genzyme, Inc., United States Surgical Corporation and 
independent distributors in Europe, Asia, Latin America and the Middle East.  
 The Company generally operates under written agreements with its 
international distributors, which typically grant distributors the right to 
sell the Company's products within a defined territory and permit the 
distributors to sell other non-competing medical products. In addition, the 
agreements often include requirements regarding minimum purchases, 
participation in trade shows and marketing efforts on behalf of GSI, and 
training programs for end-users. The Company's distributors typically 
purchase the Company's products at discounts that vary by product and market. 

     Substantially all of the Company's revenues to date have been derived 
from hernia repair products sold to distributors and from guaranteed payments 
from EES. Guaranteed payments from EES accounted for 24% of total revenues in 
fiscal year 1998, and  54% of GSI's total revenues in fiscal year 1997.  
Product sales to distributors accounted for approximately 89% of the 
Company's total product sales for  the year ended June 30, 1998 and 92% for 
the year ended June 30, 1997.  Product sales outside of the United States 
accounted for approximately .4% and .5% of the Company's sales in fiscal year 
1998 and the fiscal year 1997, respectively. The Company expects that 
international sales will represent an increasing portion of revenue in the 
future. The Company records all sales to EES as domestic sales.

MANUFACTURING

     The Company manufactures its products in a controlled environment in a 
facility in Cupertino, California. The Company has implemented quality 
control systems as part of its manufacturing process and achieved ISO 9001 
certification status in August 1997. The Company has also been inspected by 
the California Department of Health Services ("CDHS"), on behalf of the CDHS 
and the FDA, and is registered with the State of California to manufacture 
its medical devices. The Company believes that it is in compliance with all 
FDA requirements including FDA Good Manufacturing Practices ("GMP") for 
medical devices. There can be no assurance, however,  that the Company will 
remain in compliance with GMP, and failure to do so could have a material 
adverse effect on the Company's business, operating results or financial 
condition.

     Raw materials used in the production of the Company's surgical balloon 
dissectors are purchased from various qualified suppliers, subjected to 
stringent quality specifications and assembled by the Company. Quality audits 
of suppliers are conducted, and the Company has adopted a supplier 
qualification program. The Company currently obtains certain products from 
single source suppliers, including its supplier of product molds. The Company 
believes that alternative suppliers are available for its raw materials and 
other product components and plans to qualify additional suppliers when sales 
volumes warrant.  There can be no assurance that the single source suppliers 
will meet the Company's future requirements for timely delivery of products 
of sufficient quality and quantity. The failure of GSI's single source 
suppliers to provide it with adequate supplies of high quality products, or 
the loss of any of the Company's single source suppliers, could cause a delay 
in GSI's ability to fulfill orders while the Company attempts to identify and 
certify a replacement supplier, if any, and could have a material adverse 
effect upon the Company's business, financial condition and results of 
operations. See "Factors Affecting Future Results --Limited Manufacturing 
Experience." 

                                      -12-
<PAGE>

COMPETITION

     Competition in the market for medical devices and tissue dissection 
products is intense and is expected to increase. The Company competes 
primarily with other producers of  MIS tissue dissection products. Origin, a 
subsidiary of Guidant Corporation, currently competes with the Company in the 
development, production and marketing of balloon based tissue dissection 
instruments and tissue dissection technology. To the extent that surgeons 
elect to use open surgical procedures rather than MIS, the Company also 
competes with producers of tissue dissection products used in open surgical 
procedures, such as blunt dissectors or graspers. A number of companies 
currently compete against the Company in the development, production and 
marketing of tissue dissection products and technology for open surgical 
procedures. In addition, the Company competes indirectly with producers of 
therapeutic drugs, when such drugs are used as an alternative to surgery. 
Many of the Company's competitors and potential competitors have 
substantially greater name recognition and capital resources than the Company 
and also have greater resources and expertise in the areas of research and 
development, obtaining regulatory approvals, manufacturing and marketing. 

     The Company believes that the primary competitive factors in the market 
for tissue dissection products include safety, efficacy, ease of use, 
quality, reliability and cost effectiveness. In addition, the length of time 
required for products to be developed and to receive regulatory approval is 
an important competitive factor. The Company believes that it competes 
favorably with respect to these factors, although there can be no assurance 
that it will continue to do so. 

     The market for tissue dissection products is characterized by rapid 
technical innovation. Product development involves a high degree of risk, and 
there can be no assurance that the Company's competitors and potential 
competitors will not succeed in developing and marketing technologies and 
products that are more effective than those developed and marketed by the 
Company or that would render the Company's technology and products obsolete 
or noncompetitive. The medical applications for which the Company's MIS 
tissue dissection products are used can also be addressed by other medical 
devices in either MIS or open surgical procedures, many of which are widely 
accepted in the medical community. There can be no assurance that a procedure 
using MIS balloon dissection technology will be able to replace such 
established products and procedures. Additionally, new surgical products or 
procedures could be developed that replace or reduce the importance of 
current procedures that use the Company's products. 

PATENTS AND PROPRIETARY RIGHTS

       The Company's success will depend on its ability to obtain patent 
protection for its products and processes, to preserve its trade secrets and 
proprietary technology and to operate without infringing upon the patents or 
proprietary rights of third parties.  As of  June 30, 1998, GSI had 38 United 
States patents issued, and had applied for an additional 52 United States 
patents, 10 of which had been allowed.  In addition, as of June 30, 1998, GSI 
had three foreign patents issued, and 29 in prosecution covering GSI's 
technology, including tissue dissection with balloons. In May 1996, the 
Company was issued a United States patent that contains broad claims 
regarding use of balloons to dissect tissue planes.

     In May 1996, Origin MedSystems, Inc. ("Origin") a unit of Guidant 
Corporation filed suit against GSI for infringement of U.S. Patent No. 
5,520,609 in the United States District Court for the Northern District of 
California. That suit was resolved in  GSI's favor by judgment entered on May 
15, 1998, finding Origin's patent unenforceable. Origin's appeal of that 
judgment is pending and is expected to be decided in 1999.

     In June 1996, GSI filed an action against Origin in the U.S. District 
Court for the Northern District of California alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,514,153.  In September 
1997, the Company filed an action against Origin alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,667,520.  Both actions 
are still pending. Discovery has been completed in the first case, and is 
near completion in the second case.  At present, the first of these actions 
is scheduled for trial in early 1999, and the second is expected to go to 
trial later in 1999. While the Company believes it will be successful in 
these proceedings, there can be no assurance of such success. 

     GSI is also involved in an interference proceeding in the U.S. Patent 
Office to determine whether certain subject matter was first invented by GSI 
and whether Origin improperly filed a patent application based on information 
received from GSI's inventor. Failure of the Company to prevail in such 
interference proceeding would have a material adverse effect on the Company's 
business, financial condition and results of operations.

                                      -13-
<PAGE>

        Patent interference or infringement involves complex legal and 
factual issues and is highly uncertain, and there can be no assurance that 
any conclusion reached by the Company regarding patent interference or 
infringement will be consistent with the resolution of such issue by a court. 
In the event the Company's products are found to infringe patents held by 
competitors, there can be no assurance that the Company will be able to 
modify successfully its products to avoid infringement, or that any modified 
products will be commercially successful. Failure in such event to either 
develop a commercially successful alternative or obtain a license to such 
patent on commercially reasonable terms would have a material adverse effect 
on the Company's business, financial condition and results of operations. As 
discussed above, the Company is defending itself, and may in the future have 
to defend itself, in court against allegations of infringement of third-party 
patents. Patent litigation is expensive, requires extensive management time, 
and could subject the Company to significant liabilities, require disputed 
rights to be licensed from third parties or require the Company to cease 
selling its products.

     The validity and breadth of claims in medical technology patents involve 
complex legal and factual questions and, therefore, may be highly uncertain. 
No assurance can be given that any patents based on pending patent 
applications or any future patent applications will be issued, that the scope 
of any patent protection will exclude competitors or provide competitive 
advantages to the Company, that any of the Company's patents or patents to 
which it has licensed rights will be held valid under current challenges or 
if subsequently challenged or that persons or entities in addition to Origin 
will not claim rights in or ownership of the patents and other proprietary 
rights held or licensed by the Company or that the Company's existing patents 
will cover the Company's future products. Furthermore, there can be no 
assurance that others have not developed or will not develop similar 
products, duplicate any of the Company's products or design around any 
patents issued to or licensed by the Company or that may be issued in the 
future to the Company. Since patent applications in the United States are 
maintained in secrecy until patents issue, the Company also cannot be certain 
that others did not first file applications for inventions covered by the 
Company's pending patent applications, nor can the Company be certain that it 
will not infringe any patents that may issue to others on such applications.

        The patent laws of European and certain other foreign countries 
generally do not allow for the issuance of patents for methods of surgery on 
the human body. Accordingly, the ability of the Company to gain patent 
protection for its methods of tissue dissection will be significantly 
limited. As a result, there can be no assurance that the Company will be able 
to develop a patent portfolio in Europe or that the scope of any patent 
protection will provide competitive advantages to the Company.

GOVERNMENT REGULATION

       The Company's SPACEMAKER-Registered Trademark- surgical balloon 
dissectors and other products are subject to extensive and rigorous 
regulation by the FDA and, to varying degrees, by state and foreign 
regulatory agencies. Under the federal Food, Drug, and Cosmetic Act, the FDA 
regulates the clinical testing, manufacture, labeling, packaging, marketing, 
distribution and record keeping for medical devices, in order to ensure that 
medical devices distributed in the United States are safe and effective for 
their intended use. Prior to commercialization, a medical device generally 
must receive FDA and foreign regulatory clearance or approval, which can be 
an expensive, lengthy and uncertain process. The Company is also subject to 
routine inspection by the FDA and state agencies, such as the California 
Department of Health Services ("CDHS"), for compliance with Good 
Manufacturing Practice requirements, Medical Device Reporting requirements 
and other applicable regulations. Noncompliance with applicable requirements 
can result in warning letters, import detentions, fines, civil penalties, 
injunctions, suspensions or losses of regulatory approvals, recall or seizure 
of products, operating restrictions, refusal of the government to approve 
product export applications or allow the Company to enter into supply 
contracts, and criminal prosecution. Delays in receipt of, or failure to 
obtain, regulatory clearances and approvals, or any failure to comply with 
regulatory requirements could have a material adverse effect on the Company's 
business, financial condition and results of operations.

       Labeling and promotional activities are subject to scrutiny by the FDA 
and, in certain circumstances, by the Federal Trade Commission. Current FDA 
enforcement policy prohibits the marketing of cleared medical devices for 
unapproved uses. The SPACEMAKER-Registered Trademark- I platform, 
SPACEMAKER-Registered Trademark- II platform, SPACEMAKER-Registered 
Trademark-Plastics platform, and KnotMaker-TM- product each have received 
510(k) clearance for use during general, endoscopic, 

                                      -14-
<PAGE>

laparoscopic or cosmetic and reconstructive surgery, either when tissue 
dissection is required or, with respect to the KnotMaker product, when a 
surgical knot for suturing is required. The Company has promoted these 
products for surgical applications (e.g., hernia repair, subfascial 
endoscopic perforator surgery and breast augmentation and reconstruction), 
and may in the future promote these products for the dissection or knotmaking 
required for additional selected applications (e.g., a variety of orthopedic 
procedures such as anterior spinal fusion). For any medical device cleared 
through the 510(k) process, modifications or enhancements that could 
significantly affect the safety or effectiveness of the device or that 
constitute a change to the intended use of the device will require a new 
510(k) submission. The Company has made modifications to its products which 
the Company believes do not affect the safety or effectiveness of the device 
or constitute a change to the intended use and therefore do not require the 
submission of new 510(k) notices. There can be no assurance, however, that 
the FDA will agree with any of the Company's determinations not to submit a 
new 510(k) notice for any of these changes or will not require the Company to 
submit a new 510(k) notice for any of the changes made to the product. If 
such additional 510(k) clearances are required, there can be no assurance 
that the Company will obtain them on a timely basis, if at all, and delays in 
receipt of or failure to receive such approvals could have a material adverse 
effect on the Company's business, financial condition and results of 
operations. If the FDA requires the Company to submit a new 510(k) notice for 
any product modification, the Company may be prohibited from marketing the 
modified product until the 510(k) notice is cleared by the FDA.
       
     Sales of medical devices outside of the United States are subject to 
foreign regulatory requirements that vary widely from country to country. The 
Company currently relies on its international distributors for the receipt of 
premarket approvals and compliance with clinical trial requirements in those 
countries that require them, and it expects to continue to rely on 
distributors in those countries where the Company continues to use 
distributors. In the event that the Company's international distributors fail 
to obtain or maintain premarket approvals or compliance in foreign countries 
where such approvals or compliance are required, the Company may be required 
to cause the applicable distributor to file revised governmental 
notifications, cease commercial sales of its products in the applicable 
countries or otherwise act so as to stop any ongoing noncompliance in such 
countries. Any enforcement action by regulatory authorities with respect to 
past or any future regulatory noncompliance could have a material adverse 
effect on the Company's business, financial condition and results of 
operations.

     In order to continue selling its products within the European Economic 
Area, the Company achieved compliance with the requirements of the Medical 
Devices Directive and affixes CE marking on its products to attest to such 
compliance. The Company received this marking in August, 1997. 

THIRD-PARTY REIMBURSEMENT

     In the United States, hospitals, physicians and other healthcare 
providers that purchase medical devices generally rely on third-party payors, 
such as private health insurance plans, to reimburse all or part of the costs 
associated with the treatment of patients. 

     The Company's success will depend upon the ability of surgeons to obtain 
satisfactory reimbursement from healthcare payors for the Company's products. 
Reimbursement in the United States for the Company's balloon dissection 
products is currently available from most third-party payors, including most 
major private health care insurance plans and Medicaid, under existing 
surgical procedure codes. The Company does not expect that third-party 
reimbursement in the United States will be available for use of its other 
products unless and until FDA clearance or approval is received. If FDA 
clearance or approval is received, third-party reimbursement for these 
products will be dependent upon decisions by individual health maintenance 
organizations, private insurers and other payors. Many payors, including the 
federal Medicare program, pay a preset amount for the surgical facility 
component of a surgical procedure. This amount typically includes medical 
devices such as the Company's. Thus, the surgical facility or surgeon may not 
recover the added cost of the Company's products. In addition, managed care 
payors often limit coverage to surgical devices on a pre-approved list or 
obtained from an exclusive source. If the Company's products are not on the 
list or are not available from the exclusive source, the facility or surgeon 
will need to obtain an exception from the payor or the patient will be 
required to pay for some or all of the cost of the Company's product. The 

                                      -15-
<PAGE>

Company believes that procedures using its balloon dissection products may be 
reimbursed in the United States under certain existing procedure codes. 
However, there can be no assurance that such procedure codes will remain 
available or that the reimbursement under these codes will be adequate. Given 
the efforts to control and decrease health care costs in recent years, there 
can be no assurance that any reimbursement will be sufficient to permit the 
Company to achieve or maintain profitability.

     Reimbursement systems in international markets vary significantly by 
country, and by region within some countries, and reimbursement approvals 
must be obtained on a country-by-country basis. Many international markets 
have government managed health care systems that govern reimbursement for new 
devices and procedures. In most markets, there are private insurance systems 
as well as government-managed systems. Large-scale market acceptance of the 
Company's surgical balloon dissectors and other products will depend on the 
availability and level of reimbursement in international markets targeted by 
the Company. Currently, the Company has been informed by its international 
distributors that surgical balloon dissectors have been approved for 
reimbursement in many of the countries in which the Company markets its 
products. Obtaining reimbursement approvals can require 6 to 18 months or 
longer. There can be no assurance that the Company will obtain reimbursement 
in any country within a particular time frame, for a particular amount, or at 
all. Failure to obtain such approvals could have a material adverse effect on 
the Company's sales, business, financial condition and results of operations. 

     Regardless of the type of reimbursement system, the Company believes 
that surgeon advocacy of its products will be required to obtain 
reimbursement. Availability of reimbursement will depend on the clinical 
efficacy and cost of the Company's surgical balloon dissectors. There can be 
no assurance that surgeons will support and advocate reimbursement for use of 
the Company's products for all applications intended by the Company. Failure 
by surgeons, hospitals and other users of the Company's products to obtain 
sufficient reimbursement from health care payors or adverse changes in 
government and private third-party payors' policies toward reimbursement for 
procedures employing the Company's products would have a material adverse 
effect on the Company's business, financial condition and results of 
operations. 

PRODUCT LIABILITY AND INSURANCE

     The Company's business involves an inherent risk of exposure to product 
liability claims. Although the Company has not experienced any product 
liability claims to date, there can be no assurance that the Company will be 
able to avoid significant product liability claims and potential related 
adverse publicity. The Company maintains product liability insurance with 
coverage limits of $5,000,000 per occurrence and an annual aggregate maximum 
of $5,000,000, which the Company believes is comparable to that maintained by 
other companies of similar size serving similar markets. However, there can 
be no assurance that product liability claims will not exceed such insurance 
coverage limits, which could have a material adverse effect on the Company, 
or that such insurance will continue to be available on commercially 
reasonable terms, or at all. 

ENVIRONMENTAL MATTERS

     The Company is subject to federal, state and local laws, rules, 
regulations and policies governing the use, generation, manufacture, storage, 
air emission, effluent discharge, handling and disposal of certain hazardous 
and potentially hazardous substances used in connection with the Company's 
operations. Although the Company believes that it has complied with these 
laws and regulations in all material respects and to date has not been 
required to take any action to correct any noncompliance, there can be no 
assurance that the Company will not be required to incur significant costs to 
comply with environmental regulations in the future. 

EMPLOYEES

     As of June 30, 1998, GSI employed 75 individuals, 24 of whom were 
engaged directly in research, development, operations, regulatory affairs and 
quality assurance, 17 in manufacturing, 20 in marketing and sales and 14 in 
finance, customer service and administration. The Company also contracts with 
outside consultants. None of the 

                                      -16-

<PAGE>

Company's employees is covered by a collective bargaining agreement. GSI 
believes that it maintains good relations with its employees.

EXECUTIVE OFFICERS OF THE COMPANY

     The executive officers of the Company and their ages as of August 5, 
1998 are as follows: 

<TABLE>
<CAPTION>

 NAME                         AGE            POSITION
 ----                         ---            --------
<S>                       <C>       <C>
      Gregory D. Casciaro      41  President, Chief Executive Officer and Director
      James E. Jervis          62  Vice President of Research and Development 
      Stephen J. Bonelli       36  Chief Financial Officer, Vice President of Finance & Administration & Treasurer
      Ferolyn T. Powell        36  Vice President of Operations

</TABLE>

     The officers of the Company are appointed by the Board of Directors and 
serve at the discretion of the Board. There are no family relationships among 
the directors or officers of GSI.

     GREGORY D. CASCIARO joined GSI in February 1995 as Vice President of 
Sales and Marketing, was promoted to Senior Vice President in November 1996, 
President, Chief Operating Officer and Director of the Company in August 1997 
and has served as President, Chief Executive Officer and Director of the 
Company since April 1998. Prior to joining GSI, Mr. Casciaro held various 
positions at Devices for Vascular Intervention, Inc., a medical device 
manufacturer, including Vice President of Sales from June 1991 to February 
1995. Previously, Mr. Casciaro held various sales positions at North American 
Instrument Corporation, a medical device company, from March 1983 to May 
1991. Mr. Casciaro received a B.S. degree in Business Administration at 
Marquette University. 

     JAMES E. JERVIS joined GSI in March 1994, and serves as Vice President 
of Research and  Development. Prior to joining GSI, Mr. Jervis had 30 years 
of engineering design, development and operations experience at Raychem 
Corporation ("Raychem"). At Raychem, Mr. Jervis held various executive 
positions, including Director of New Business Development, General Manager - 
Medical Products Group and Operations Manager. Mr. Jervis holds 19 patents 
and is named as inventor in over 50 other patents. Mr. Jervis holds a B.S. in 
Mechanical Engineering and an MBA from Stanford University.

     STEPHEN J. BONELLI joined GSI in September 1994, and serves as Chief 
Financial Officer, Vice President of Finance and Administration and 
Treasurer. Prior to joining GSI, Mr. Bonelli held financial management 
positions at Coactive Computing Corporation, a computer networking company, 
from November 1993 to August 1994, and Ready Systems Corporation, a software 
company, from May 1990 to October 1993. Previous to those positions, Mr. 
Bonelli held a management position with Ernst & Young. Mr. Bonelli received a 
B.S. degree in Business Administration from California Polytechnic State 
University, San Luis Obispo. Mr. Bonelli is a Certified Public Accountant. 

     FEROLYN T. POWELL joined GSI in October 1995, and has served as Vice 
President of Operations since November 1996.  Prior to joining GSI, Ms. 
Powell served as Director of Research and Development at Adjacent Surgical, 
Inc. from June 1995 to October 1995, and as Senior Engineer, Project Manager 
and Director at Devices for Vascular Interventions, Inc. from September 1992 
to June 1995. Previous to those positions, Ms. Powell held technical 
management positions at Frantz Medical Development Ltd. and Life Systems, 
Inc.  Ms. Powell received her M.S. degree in Engineering from the University 
of Akron and her B.S. degree in Chemical Engineering from Cleveland State 
University.

ITEM 2.   PROPERTIES

     The Company occupies a facility of approximately 30,400 square feet in 
Cupertino, California, which houses the Company's headquarters, 
administrative offices, research laboratories and manufacturing facilities. 

                                      -17-

<PAGE>

ITEM 3.   LEGAL PROCEEDINGS

     In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant 
Corporation, filed suit against GSI for infringement of U.S. Patent No. 
5,520,609 in the United States District Court for the Northern District of 
California. That suit was resolved in  GSI's favor by judgment entered on May 
15, 1998, finding Origin's patent unenforceable.  Origin's appeal of that 
judgment is pending and is expected to be decided in 1999.

     In June 1996, GSI filed an action against Origin in the U.S. District 
Court for the Northern District of California alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,514,153. In September 
1997, the Company filed an action against Origin alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,667,520.  Both actions 
are still pending. Discovery has been completed in the first case, and is 
near completion in the second case.  At present, the first of these actions 
is scheduled for trial in early 1999, and the second is expected to go to 
trial later in 1999. While the Company believes it will be successful in 
these proceedings, there can be no assurance of such success. 

     GSI is also involved in an interference proceeding in the U.S. Patent 
Office to determine whether certain subject matter was first invented by GSI 
and whether Origin improperly filed a patent application based on information 
received from GSI's inventor. Failure of the Company to prevail in such 
interference proceeding would have a material adverse effect on the Company's 
business, financial condition and results of operations.
     
     From time to time the Company may be exposed to litigation arising out 
of its products or operations.  The Company is not engaged in any legal 
proceedings that are expected, individually or in the aggregate, to have a 
material adverse effect on the Company, except for the patent interference 
and infringement proceedings discussed herein.

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

     Not Applicable.

                                      -18-

<PAGE>

                                       PART II

ITEM 5.   MARKET FOR THE REGISTRANT'S COMMON STOCK AND  RELATED SHAREHOLDER
MATTERS

MARKET INFORMATION

     The Company completed its initial public offering on May 15, 1996, and 
the Company's common stock is traded on the Nasdaq National Market under the 
symbol GSII.  As of August 31, 1998 the Company had approximately 128 
shareholders of record.

     The following table shows the Company's high and low selling prices for 
the periods indicated as reported by NASDAQ:

<TABLE>
<CAPTION>
                                                  1998
                                       --------------------------
     QUARTERS ENDED                      HIGH               LOW 
     --------------                      ----               ---
<S>                                   <C>                <C>
     June 30, 1998                      $   4.62            $   3.50
     March 31, 1998                     $   6.00            $   3.87
     December 31, 1997                  $   6.00            $   3.37
     September 30, 1997                 $   5.81            $   3.31
     June 30, 1997                      $   7.25            $   3.38
     March 31, 1997                     $  10.00            $   6.50
     December 31, 1996                  $  12.00            $   6.25
     September 30, 1996                 $  16.00            $   8.00
</TABLE>

DIVIDEND POLICY

The Company has not paid dividends on its common stock and has no present 
plans to do so. Provisions of the Company's bank line of credit prohibit the 
payment of dividends without the bank's permission.

ITEM 6.   SELECTED FINANCIAL DATA

STATEMENT OF OPERATIONS DATA:

<TABLE>
<CAPTION>

                                                                                  YEARS ENDED JUNE 30,
                                                        1998              1997             1996             1995            1994
                                                       ------            ------           ------           ------          ------
                                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                             <C>                <C>                <C>              <C>             <C>
 Sales                                              $     5,193       $     4,090      $    6,165       $    2,437      $      789 
 Guaranteed payments                                      1,635             4,896               -                -               - 
                                                    -----------       -----------      ----------       ----------      ----------
 Total revenue                                            6,828             8,986           6,165            2,437             789 
 Cost of Sales                                            3,565             2,385           2,772            1,262             600 
                                                    -----------       -----------      ----------       ----------      ----------
          Gross profit                                    3,263             6,601           3,393            1,175             189 
                                                    -----------       -----------      ----------       ----------      ----------
 Operating expenses:
     Research and development                             2,825             2,231           1,306              975             496 
     Selling, general and administrative                 11,843             8,784           5,204            4,258           2,870 
     Write-off of acquired in-process
        research and development                              -                 -           2,791                -               - 
                                                    -----------       -----------      ----------       ----------      ----------
          Total operating expense                        14,668            11,015           9,301            5,233           3,366 
                                                    -----------       -----------      ----------       ----------      ----------
          Operating loss                                (11,405)           (4,414)         (5,908)          (4,058)         (3,177)
 Interest and other income, net                           2,263             2,538             443                7              58 
                                                    -----------       -----------      ----------       ----------      ----------
          Net loss                                  $    (9,142)      $    (1,876)     $   (5,465)      $   (4,051)     $   (3,119)
                                                    -----------       -----------      ----------       ----------      ----------
                                                    -----------       -----------      ----------       ----------      ----------
 Net loss per common share and per common 
    share-assuming dilution                         $     (0.68)      $     (0.14)     $    (0.74)      $    (0.62)     $    (0.49)
                                                    -----------       -----------      ----------       ----------      ----------
                                                    -----------       -----------      ----------       ----------      ----------
 Shares used in computing net loss per 
    common share and per common share-
    assuming dilution                                    13,373            13,197           7,411            6,496           6,313
                                                    -----------       -----------      ----------       ----------      ----------
                                                    -----------       -----------      ----------       ----------      ----------

</TABLE>

                                      -19-

<PAGE>

BALANCE SHEET DATA:

<TABLE>
<CAPTION>

                                                                                   JUNE 30,
                                                      ------------------------------------------------------------------
                                                       1998           1997           1996           1995           1994
                                                      ------         ------         ------         ------         ------
                                                                               (IN THOUSANDS)
<S>                                               <C>             <C>           <C>             <C>            <C>
Cash, cash equivalents and
     available-for-sale securities                $   37,469     $   43,731     $   49,790      $   4,541      $   2,301
Working capital                                       29,414         46,835         50,068          4,457          2,516
Total assets                                          42,824         51,062         52,767          6,245          3,525
Convertible redeemable preferred stock                     -              -             -          13,225          6,841
Accumulated deficit                                  (24,835)       (15,693)       (13,817)        (8,352)        (4,301)
Shareholders' equity (deficit)                    $   40,238     $   48,987     $   50,474      $  (8,316)     $  (4,279)

</TABLE>

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

OVERVIEW

     Since its inception in April 1992, General Surgical Innovations ("GSI" 
or the "Company") has been engaged in the development, manufacturing and 
marketing of surgical balloon dissectors and related minimally invasive 
surgical instruments.  GSI began commercial sales of its surgical balloon 
dissectors for hernia repair in September 1993. To date, the Company has 
received from the FDA seven 510(k) clearances for use of the Company's 
technology to perform dissection of tissue planes anywhere in the body using 
a broad range of balloon sizes and shapes. The Company currently sells 
products in the United States, Europe, Asia and South America for selected 
applications, such as hernia repair, saphenous vein harvesting, subfascial 
endoscopic perforator surgery, breast augmentation and reconstruction 
surgery, and tissue expansion.

     In December 1996, the Company entered into a five-year OEM supply 
agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery ("EES"), 
pursuant to which GSI granted EES worldwide sales and marketing rights to 
sell the SPACEMAKER-Registered Trademark- surgical balloon dissectors in the 
laparoscopic hernia repair and stress urinary incontinence ("SUI") markets. 
In February 1998, the Company and EES signed a non-exclusive distribution 
agreement for the laparoscopic hernia repair and stress urinary incontinence 
markets.  This agreement supersedes the December 1996 Expanded EES Agreement.

     Additional sales in the United States are currently made through other 
distributors and a small direct sales force. The Company currently sells its 
products (other than for hernia and SUI applications) in international 
markets through other distributors, which resell to surgeons and hospitals. 
During fiscal year 1999, the Company plans to increase its direct sales force 
in the United States. Any increase in the Company's direct sales force will 
require significant expenditures and additional management resources.

     At present, the Company has exclusive distribution agreements with eight 
international distributors, including Baxter International, to distribute its 
cardiovascular products in 18 European countries.

                                      -20-

<PAGE>

     To date, the majority of the sales to distributors and by the Company's 
direct sales force have been for use in hernia repair procedures. While the 
Company has developed or is developing surgical balloon dissectors for stress 
urinary incontinence, vascular and plastic surgery, sales of products for 
hernia repair are expected to provide a majority of the Company's revenues at 
least through fiscal 1999.  

     The Company has acquired rights to a significant number of patents from 
third parties, including rights that apply to the Company's current surgical 
balloon dissectors. The Company has historically paid and is obligated to pay 
in the future to such third parties royalties equal to 1-4% of sales of such 
products, which payments are expected to exceed certain minimum royalty 
payments due under the agreements with such parties. Total amounts charged to 
operations for royalties for the years ended June 30, 1998, 1997 and 1996 
were $289,255, $356,831 and $241,065, respectively. The payment of such 
royalty amounts will have an adverse impact on the Company's gross profit and 
results of operations.

     The Company has a limited history of operations and has experienced 
significant operating losses since inception. The Company expects such 
operating losses to continue at least through fiscal 1999. The Company's 
sales to date have consisted primarily of surgical balloon dissectors for 
hernia repair. In order to support increased levels of sales in the future 
and to augment its long-term competitive position, including the development 
of surgical balloon dissectors for other applications, the Company 
anticipates that it will be required to make significant additional 
expenditures in sales and marketing, and in research and development 
(including marketing-related clinical evaluations).

     The Company currently manufactures and ships product shortly after the 
receipt of orders, and anticipates that it will do so in the future. 
Accordingly, the Company has not developed a significant backlog and does not 
anticipate that it will develop a material backlog in the future. 

                                      -21-

<PAGE>

RESULTS OF OPERATIONS

     The following table sets forth certain data from the Company's 
consolidated statement of operations, expressed as a percentage of sales and 
guaranteed payments:

AS A PERCENTAGE OF SALES AND GUARANTEED PAYMENTS: 

<TABLE>
<CAPTION>

                                                                             YEARS ENDED JUNE 30,
                                                                      1998           1997           1996
<S>                                                             <C>              <C>             <C>
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       76.1%           45.5%           97.8%
Guaranteed payments . . . . . . . . . . . . . . . . . . . . . .       23.9            54.5             2.2
                                                                  --------         -------         -------
Total revenue . . . . . . . . . . . . . . . . . . . . . . . . .      100.0%          100.0%          100.0%
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . .       52.2            26.5            45.0
                                                                  --------         -------         -------
         Gross profit . . . . . . . . . . . . . . . . . . . . .       47.8            73.5            55.0
Operating expenses:
    Research and development. . . . . . . . . . . . . . . . . .       41.4            24.8            21.2
    Selling, general and administrative . . . . . . . . . . . .      173.4            97.8            84.4
    Write-off of acquired in-process research and development .          -               -            45.3
                                                                  --------         -------         -------
         Total operating expenses . . . . . . . . . . . . . . .      214.8           122.6           150.9
                                                                  --------         -------         -------
         Operating loss . . . . . . . . . . . . . . . . . . . .     (167.0)          (49.1)          (95.9)
Interest and other income, net. . . . . . . . . . . . . . . . .       33.1            28.2             7.3
                                                                  --------         -------         -------
         Net loss . . . . . . . . . . . . . . . . . . . . . . .     (133.9)%         (20.9)%         (88.6)%
                                                                  --------         -------         -------
                                                                  --------         -------         -------
</TABLE>

     YEARS ENDED JUNE 30, 1998 AND 1997

     SALES AND GUARANTEED PAYMENTS.    Sales and guaranteed payments totaled 
$6.8 million in fiscal 1998, a decrease of $2.2 million or 24% below sales 
and guaranteed payments of $9.0 million in fiscal 1997.  This decrease in 
revenue is in connection with the conversion of EES to a non-exclusive 
distributor, which eliminated future guaranteed payments. During fiscal 1998, 
$1.6 million in guaranteed payments was received from EES versus $4.9 million 
during fiscal 1997.  Product sales accounted for  $5.2 million of total 
revenues in fiscal 1998, which represents a 27% increase over fiscal 1997.  
This increase was a result of rapid growth in sales of the Company's vascular 
surgery products and plastic surgery products.

     COST OF SALES.    Cost of sales at $3.6 million in fiscal 1998 was 52% 
of total revenues versus $2.4 million or 27% of total revenues in fiscal 
1997. This increase was related to decreases in guaranteed payments by EES 
during fiscal 1998.  Direct product costs were 69% of total product sales in 
fiscal 1998, an increase of 11% from fiscal 1997, as a result of 
underutilized manufacturing capacity in fiscal 1998.   

     RESEARCH AND DEVELOPMENT EXPENSES.   Research and Development ("R&D") 
expenses for fiscal 1998 increased 27% to $2.8 million versus $2.2 million 
for the year end June 30, 1997, as the Company continued to develop products 
for its vascular and hernia markets.  The Company expects to continue to 
increase R&D expenses as it pursues additional market opportunities. 

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.   Selling, General and 
Administrative ("SG&A") expenses were $11.8 million in fiscal year 1998, an 
increase of 35% as compared to $8.8 million in fiscal 1997.  This increase is 
primarily related to continued litigation expenses related to the Origin 
Medsystems, Inc. ("Origin") infringement case.  GSI expects some increases in 
SG&A expenses as the Company hires additional salespeople, the Company's 
level of sales increases and the Company continues to administratively 
support growth.

     NET LOSS.   The Company had a net loss of approximately $9.1 million in 
fiscal 1998 compared to a $1.9 million net loss in fiscal 1997, primarily due 
to the loss of the guaranteed payments from EES and increased operating 
expenses as the Company prepared for anticipated sales growth and 
aggressively defended its patent positions.

                                      -22-
<PAGE>

     YEARS ENDED JUNE 30, 1997 AND 1996

     SALES AND GUARANTEED PAYMENTS.    Sales and guaranteed payments totaled 
$9.0 million in fiscal 1997, an increase of $2.8 million or 46% over sales 
and guaranteed payments of $6.2 million in fiscal 1996.  This increase in 
revenue was due to guaranteed payments of $4.9 million from EES during its 
first year as the Company's major hernia product distributor.  Product sales 
accounted for $4.1 million of total revenues in fiscal 1997, which represents 
a 34% decrease from fiscal 1996.  This decrease reflects lower levels of 
sales in the hernia market due to competition in this market and the 
transition to EES as the Company's major distributor.

     COST OF SALES.    Cost of sales decreased 14% to $2.4 million in fiscal 
1997 from $2.8 million in fiscal 1996. This decrease was related to the lower 
level of product sales which the Company experienced.  Direct product costs 
were 58% of total product sales in fiscal 1997, an increase of 13% from 
fiscal 1996, as a result of spreading certain fixed overhead expenses over a 
lower number of unit sales in fiscal 1997.   

     RESEARCH AND DEVELOPMENT EXPENSES.   R&D expenses for fiscal 1997 
increased 71% to $2.2 million versus $1.3 million for the year end June 30, 
1996, as the Company continued to develop products for its expanding vascular 
market and developing orthopedic market. 

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.   SG&A expenses were $8.8 
million in fiscal year 1997, an increase of 69% as compared to $5.2 million 
in fiscal 1996.  This increase was primarily related to expanding GSI's sales 
presence, both domestically and internationally, and increased litigation 
expenses related to the Origin infringement case.

     NET LOSS.   The Company had a net loss of approximately $1.9 million in 
fiscal 1997 compared to a $5.5 million net loss in fiscal 1996, primarily due 
to the effect of the guaranteed payments from EES and interest income.
     

QUARTERLY RESULTS OF OPERATIONS

     The following tables set forth certain unaudited quarterly results of 
operations for the fiscal year ended June 30, 1998, as well as such data 
expressed as a percentage of the Company's total revenue. This information 
has been derived from unaudited financial statements that, in the opinion of 
management, reflect all adjustments (consisting only of normally recurring 
adjustments) necessary to fairly present this information when read in 
conjunction with the financial statements and notes thereto included herein. 
The results of operations for any quarter are not necessarily indicative of 
the results to be expected for any future period. 

<TABLE>
<CAPTION>

                                                                      QUARTERS ENDED (IN THOUSANDS)
                                                      --------------------------------------------------------
                                                         6/30/98        3/31/98        12/31/97       9/30/97
                                                      -------------  -------------   -----------    ----------
                                                                                (UNAUDITED)
<S>                                                   <C>              <C>          <C>           <C> 
Sales . . . . . . . . . . . . . . . . . . . . . .     $     1,324      $     894    $     1,408   $     1,567
Guaranteed payments . . . . . . . . . . . . . . .               -              -            860           775
                                                      -----------      ---------    -----------   -----------
Total revenue . . . . . . . . . . . . . . . . . .           1,324            894          2,268         2,342
Cost of sales . . . . . . . . . . . . . . . . . .             821            602          1,186           956
                                                      -----------      ---------    -----------   -----------
         Gross profit . . . . . . . . . . . . . .             503            292          1,082         1,386
                                                      -----------      ---------    -----------   -----------
Operating Expenses:
    Research and development. . . . . . . . . . .             751            651            658           765
    Selling, general and administrative . . . . .           3,262          3,203          2,906         2,472
                                                      -----------      ---------    -----------   -----------
         Total operating expenses . . . . . . . .           4,013          3,854          3,564         3,237
                                                      -----------      ---------    -----------   -----------
         Operating loss . . . . . . . . . . . . .          (3,510)        (3,562)        (2,482)       (1,851)
Interest and other income, net. . . . . . . . . .             524            563            585           591
                                                      -----------      ---------    -----------   -----------
         Net loss . . . . . . . . . . . . . . . .     $    (2,986)     $  (2,999)   $    (1,897)  $    (1,260)
                                                      -----------      ---------    -----------   -----------
                                                      -----------      ---------    -----------   -----------
</TABLE>

                                      -23-
<PAGE>

<TABLE>
<CAPTION>

                                                                              QUARTERS ENDED
                                                         --------------------------------------------------------
                                                          6/30/98         3/31/98        12/31/97        9/30/97
                                                         ---------      ----------      ----------      ---------
                                                                               (UNAUDITED)
<S>                                                    <C>            <C>             <C>             <C>
Net sales . . . . . . . . . . . . . . . . . . . .          100.0%         100.0%          62.1%         66.9%
Guaranteed payments . . . . . . . . . . . . . . .              -              -           37.9          33.1 
                                                          -------        -------        -------       -------
Total revenue . . . . . . . . . . . . . . . . . .          100.0          100.0          100.0         100.0 
Cost of sales . . . . . . . . . . . . . . . . . .           62.0           67.3           52.3          40.8 
                                                          -------        -------        -------       -------
    Gross profit. . . . . . . . . . . . . . . . .           38.0           32.7           47.7          59.2 
                                                          -------        -------        -------       -------
Operating Expenses: . . . . . . . . . . . . . . . 
  Research and development. . . . . . . . . . . .           56.7           72.8           29.0          32.7 
  Selling, general and administrative . . . . . .          246.4          358.3          128.1         105.5 
                                                          -------        -------        -------       -------
  Total operating expenses. . . . . . . . . . . .          303.1           431.1         157.1         138.2 
                                                          -------        -------        -------       -------
    Operating loss. . . . . . . . . . . . . . . .          (265.1)        (398.4)        (109.4)        (79.0)
Interest and other income (expense), net. . . . .            39.6          63.0           25.8          25.2 
                                                          -------        -------        -------       -------
    Net loss. . . . . . . . . . . . . . . . . . .          (225.5)%       (335.4)%        (83.6)%       (53.8)%
                                                          -------        -------        -------       -------
                                                          -------        -------        -------       -------

</TABLE>

     The Company anticipates that its results of operations may fluctuate 
from quarter to quarter due to several factors, including (i) fluctuations in 
purchases of the Company's products by its distributors, (ii) the ability of 
the Company's distributors to effectively promote and sell the Company's 
products, (iii) the rate of adoption by surgeons of balloon dissection 
technology in markets targeted by the Company, (iv) the mix of sales among 
distributors and the Company's direct sales force, (v) the timing and cost of 
increasing the Company's direct domestic sales force, (vi) the expansion of 
the Company's distribution network, (vii) new product introductions by the 
Company and its competitors, (viii) fluctuations in revenues among different 
product lines and markets, (ix) timing of patent and regulatory approvals, if 
any, (x) intellectual property litigation, (xi) timing and growth of 
operating expenses and (xii) general market conditions.  In addition, 
announcements or expected announcements by the Company, its competitors or 
its distributors of new products, new technologies or pricing changes could 
cause existing or potential customers of the Company to defer purchases of 
the Company's existing products and could alter the mix of products sold by 
the Company, which could have a material adverse effect on the Company's 
business, financial condition and results of operations. There can be no 
assurance that future products or product enhancements will be successfully 
introduced or that such introductions will not adversely affect the demand 
for existing products. As a result of these and other factors, the Company's 
quarterly operating results have fluctuated in the past, and the Company 
expects that such results may fluctuate in the future. Due to such quarterly 
fluctuations in operating results, quarter-to-quarter comparisons of the 
Company's operating results are not necessarily meaningful and should not be 
relied upon as indicators of likely future performance or annual operating 
results. In addition, the Company's limited operating history makes accurate 
prediction of future operating results difficult or impossible to make. There 
can be no assurance that in the future the Company will achieve sales growth 
or become profitable on a quarterly or annual basis, if at all, or that its 
growth, if any, will be consistent with predictions by securities analysts 
and investors. In such event, the price of the Company's common stock would 
likely be materially and adversely affected.

LIQUIDITY AND CAPITAL RESOURCES

     Since inception, the Company's cash expenditures have significantly 
exceeded its sales, resulting in an accumulated deficit of $24.8 million at 
June 30, 1998.  The Company has funded its operations primarily through the 
sale of equity securities.  From its inception through June 30, 1998, the 
Company raised approximately $15.5 million through the private placement of 
equity securities, and approximately $46.9 million (net of underwriting 
discounts and commissions) in an initial public offering.

     Net cash used in operating activities in 1998 was approximately 
$5,541,000, which consisted mainly of the Company's net loss for the year of 
$9,142,000, offset by depreciation and amortization charges of $1,049,000 and 
decreases in accounts receivable of $1,064,000. Net cash provided by 
investing activities totaled approximately $15,576,000. Proceeds from sales 
and maturities of available-for-sale securities of $38,792,000 was somewhat 
offset by purchases of available-for-sale securities of $22,766,000. Net cash 
provided by financing activities was approximately $19,000, which consisted 
of $201,000 in proceeds from the issuance of common stock, offset by $182,000 
in payments on capital lease obligations and bank borrowings.

     As of June 30, 1998, the Company's principal source of liquidity 
consists of cash, cash equivalents and investments of $37.5 million. In 
addition, the Company has a bank line of credit available for $5.0 million.  


                                      -24-

<PAGE>

As of June 30, 1998, the Company has no amounts outstanding under this line. 
The Company also has equipment loans with a balance of approximately $185,000 
under a previous bank line of credit.

     The Company expects to incur additional costs, including costs related 
to increased sales and marketing activities, increased research and 
development, additional marketing-related clinical evaluations, and costs to 
defend its patent positions.  The Company believes that its current cash 
balances and short-term investments along with cash generated from the future 
sales of products will be sufficient to meet the Company's operating and 
capital requirements through calendar year 2000.  The Company may seek 
additional equity or debt financing to address its working capital needs or 
to provide funding for capital expenditures.  There can be no assurance that 
additional financing, if sought, will be available on satisfactory terms or 
at all.

YEAR 2000 COMPLIANCE

     The Year 2000 ("Y2K") issue arises from computer programs using two 
digits rather than four to define the applicable year. Such software may 
recognize a date using "00" as the year 1900 rather than the year 2000. This 
could result in system failures or miscalculations leading to disruptions or 
delays in the Company's activities and operations. If the Company, its key 
customers or suppliers fail to make necessary modifications to their 
information technology or non-information technology systems on a timely 
basis, the Y2K issue could have a material adverse effect on Company 
operations. However, the impact cannot be quantified at this time.

     In January 1998 the Company began to evaluate and assess the Company's 
information technology and non-information technology systems for compliance 
with the Y2K issue. The Company intends to fix or replace noncompliant 
software and systems by March 31, 1999, but there can be no assurance that 
such fixes or replacements will occur by such date. The Company is currently 
conducting testing and remediation activities on its systems, and intends to 
survey major customers and suppliers to assess their systems' compliance as 
well as their systems' compatability with the Company's existing or projected 
compliant systems. There can be no assurance that there will not be an 
adverse material effect on the Company's business, financial condition or 
results of operations if the Company or its suppliers or customers do not 
convert or replace their systems in a timely manner to comply with the Y2K 
issue.

     The Company's costs related to the Y2K issue are funded through 
operating cash flows. Through fiscal 1998, the Company expended approximately 
$5,000 in evaluating and planning. The Company estimates total costs to be 
between $50,000 and $100,000 for fixing and replacing noncompliant systems, 
including the cost of new software and modifying the applicable code of 
existing software. The Company currently believes that the total cost of 
achieving Y2K compliant systems will not be material to its business, 
financial condition or results of operations. In the event that the Company 
will be unable to achieve Y2K compliance in a timely manner with existing 
personnel, as a contingency the Company expects to hire outside Y2K solution 
providers to assist in achieving such compliance.

     Time and cost estimates are based on currently available information. 
Factors that could affect these estimates include, but are not limited to, 
the availability and cost of trained personnel to evaluate and implement the 
changes, the ability to locate and correct all noncompliant systems, and the 
ability of the Company's customers and suppliers to successfully implement 
Y2K compliant systems or fixes.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company had no holdings of derivative financial or commodity 
instruments at June 30, 1998.  A review of the Company's other financial 
instruments and risk exposures at that date revealed that the Company had 
exposure to interest rate risk.  At June 30, 1998 the Company performed 
sensitivity analyses to assess the potential effect of this risk and 
concluded that near-term changes in interest rates should not materially 
adversely affect the Company's financial position, results of operations or 
cash flows.

FACTORS AFFECTING FUTURE RESULTS

     The following discussion should be read in conjunction with the 
consolidated financial statements and notes thereto included herein. 

     The Company desires to take advantage of the "safe harbor" provisions of 
the Private Securities Litigation Reform Act of 1995. Specifically the 
Company wishes to alert readers that, except for the historical information 
contained in this Annual Report on Form 10-K, the matters discussed herein 
are forward-looking statements that are subject to certain risks and 
uncertainties that could cause the actual results to differ materially from 
those projected. Factors that could cause actual results to differ materially 
include, but are not limited to, market demand for the Company's products, 
the Company's ability to shift market focus successfully, the timing of 
orders and shipments, the timely development and market acceptance of new 
products and surgical procedures, the impact of performance of the Company's 
distributors, the Company's ability to further expand into international 
markets, public policy relating to health care reform in the United States 
and other countries, approval of its products by government agencies such as 
the United States Food and Drug Administration, and other risks detailed 
below and included from time to time in the Company's other SEC reports and 
press releases, copies of which are available from the Company upon request.  
The Company assumes no obligation to update any forward-looking statements 
contained herein. The factors listed below under "Factors Affecting Future 
Results," as well as other factors, have in the past affected, and could in 
the future affect, the Company's actual results and could cause the Companys 
results for future periods to differ materially from those expressed in any 
forward-looking statements contained in the following discussion.

     LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES.  The Company has a 
limited operating history upon which an evaluation of the Company and its 
prospects can be based. As of June 30, 1998, the Company had an accumulated 
deficit of $24.8 million. The Company's net operating losses for the fiscal 
years ending June 30, 1998, 1997 and 1996 were $9.1 million, $1.9 million and 
$5.5 million, respectively.  The Company expects to continue to incur 
operating losses on a quarterly and annual basis through at least fiscal 
1999.  Due to the Company's limited operating history  there can be no 
assurance of sales growth or profitability  in the future. The Company 
intends to increase its investments in research and development, sales and 
marketing, marketing-related clinical evaluations and related infrastructure. 
Due to the anticipated increases in the Company's operating expenses, the 
Company's operating results will be adversely affected if sales do not 
increase. The Company's prospects must be considered in light of the risks, 
expenses and difficulties frequently encountered by companies in their early 
stage of development, particularly companies in rapidly evolving markets. To 
address these risks, the Company must respond to competitive developments, 
continue to attract, retain and motivate qualified persons and successfully 
commercialize products incorporating advanced technologies. There can be no 
assurance that the Company will be successful in addressing such risks. See 
"Management's Discussion and Analysis of Financial Condition and Results of 
Operations" and "Business -- Company Strategy."

     DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL 
OBSOLESCENCE.  Nearly all of the Company's sales since inception have been 
derived from sales of its balloon dissection products, with a substantial 
portion derived from sales for hernia repair procedures. Failure of the 
Company to develop successfully and commercialize balloon dissection products 
for applications other than hernia repair could have a material adverse 
effect on the Company's business, financial condition and results of 
operations. The success of the Company's products 

                                      -25-

<PAGE>

depends on the market acceptance of and demand for the Company's products and 
related procedures, the nature of the technological advances inherent in the 
product designs, reduction in patient trauma or other benefits provided by 
such products, continued adoption of minimally invasive surgery ("MIS") 
procedures by surgeons, reimbursement for the Company's products by health 
care payors and the Company's receipt of regulatory approvals. There can be 
no assurance that the Company's products will have the required technical 
characteristics, that the Company's products will provide adequate patient 
benefits, that marketing-related clinical evaluations results will be 
favorable, that surgeons will continue to adopt MIS procedures, that 
recently-introduced products or future products of the Company or related 
procedures will gain market acceptance, or that required regulatory approvals 
will be obtained. The failure to achieve any of the foregoing could have a 
material adverse effect on the Company's business, financial condition and 
results of operations. To the extent demand for the Company's surgical 
balloon dissectors for hernia repair declines and the Company's 
newly-introduced products are not commercially accepted or its existing 
products are not developed for new procedures, there could be 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" and "Business -- Applications of Balloon 
Dissection Technology," and "- Additional Products Under Development."

     DEPENDENCE ON KEY DISTRIBUTORS. In February 1998, the Company replaced 
its five-year OEM supply agreement with EES with a non-exclusive distribution 
agreement which granted EES worldwide sales and marketing rights to sell the 
SPACEMAKER-Registered Trademark- surgical balloon dissectors in the 
laparoscopic hernia repair and urinary stress incontinence ("USI") markets.  
This new EES agreement does not provide for any minimum payments from EES to 
the Company.  In December 1997, the Company entered into a four year 
distribution agreement with Genzyme Surgical Products Corporation 
("Genzyme").  Under the agreement, Genzyme has exclusive rights to market and 
distribute GSI's surgical balloon dissection systems worldwide for use in 
plastic surgery (reconstructive and aesthetic) procedures.

     The Company's products are sold internationally to hospitals, surgeons 
and specialists through EES and independent distributors in Europe, Asia, 
Latin America and the Middle East.  In June 1997, GSI entered into an 
exclusive agreement with Japan Lifeline to market and distribute in Japan 
GSI's balloon dissection systems for use in vascular procedures.  Japan 
Lifeline is expected to begin distribution of the GSI balloon dissection 
systems following receipt of the Japanese Ministry of Health and Welfare 
approval, which the Company expects to occur in fiscal 1999.

     During the third quarter of fiscal year 1998, the Company expanded its 
international distribution network by adding eight international 
distributors, including Baxter International, to distribute its 
cardiovascular products. Although the Company intends to continue to 
establish additional distributorships in the United States and 
internationally for products in areas other than certain plastic surgery 
procedures, there can be no assurance that recently appointed distributors 
will be successful, or that efforts to establish additional distributors will 
be successful.  Failure of current distributors to succeed, or failure to add 
additional distributors to its distribution network, could have a material 
adverse effect on the Company's business, financial condition and results of 
operations.

     LIMITED MARKETING AND DIRECT SALES EXPERIENCE.  The Company has only 
limited experience marketing and selling its products through its direct 
sales force, and has sold its products in commercial quantities through its 
direct sales force to the hernia market and, to a lesser degree, to the 
cardiovascular and cosmetic and reconstructive surgery markets. The Company 
intends to establish relationships with additional distribution partners, and 
there can be no assurance that the Company will be successful in establishing 
such relationships on commercially reasonable terms, if at all. The failure 
to establish and maintain an effective distribution channel for the Company's 
products, or establish and retain qualified and effective sales personnel to 
support commercial sales of the Company's products, 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," and "Business -- Marketing, Sales and 
Distribution." 

     UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE.  
The Company's success is substantially dependent upon the success of its 
SPACEMAKER-Registered Trademark-  balloon dissection products. The Company 
believes that market acceptance of the Company's products will depend on the 
Company's ability to provide evidence to the medical community of the safety, 
efficacy, clinical advantage and cost-effectiveness of its products and the 
procedures in which these products are intended to be used. Market acceptance 
is also dependent on the adoption of laparoscopic 

                                      -26-

<PAGE>

techniques generally and the conversion of non-balloon dissection techniques to
balloon dissection techniques specifically. To date, the Company's products have
only been used to treat a limited number of patients and the Company has limited
long-term outcomes data. If the Company is not able to demonstrate consistent
clinical benefits resulting from the use of its products (including reduced
procedure time, reduced patient trauma and lower costs), the Company's business,
financial condition and results of operations could be materially and adversely
affected.

     The Company further believes that the ability of health care providers to
obtain adequate reimbursement for procedures using the Company's
SPACEMAKER-Registered Trademark- balloon dissection products and related
instruments will be critical to market acceptance of the Company's products.
Although the Company believes that procedures using its balloon dissection
products currently may be reimbursed in the United States under certain existing
procedure codes, there can be no assurance that such procedure codes will remain
available or that reimbursement under these codes will be adequate. The Company
has limited experience in obtaining third-party reimbursement, and the failure
to obtain reimbursement for some or all of its products could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business -- Third-Party Reimbursement."

     The Company introduced its surgical balloon dissectors in late 1993 and 
to date there has been relatively little education among surgeons about the 
benefits of balloon dissection technology. Furthermore, because of the 
novelty of balloon dissection procedures, many surgeons and surgeons' 
assistants have not developed the requisite skills to perform balloon 
dissection procedures. To the extent that laparoscopic techniques are adopted 
slowly, that surgical balloon dissectors are incorporated into laparoscopic 
techniques less often or that surgeons are unwilling or unable to develop the 
skills necessary to utilize surgical balloon dissectors, the Company's 
business, financial condition and results of operations could be materially 
adversely affected. See "Business --Marketing, Sales and Distribution."

     FLUCTUATIONS IN QUARTERLY RESULTS. Results of the Company's operations 
may fluctuate significantly from quarter to quarter and will depend on 
numerous factors, including (i) fluctuations in purchases of the Company's 
products by its distributors, (ii) the ability of the Company's distributors 
to effectively promote and sell the Company's products, (iii) the rate of 
adoption by surgeons of balloon dissection technology in markets targeted by 
the Company, (iv) the mix of sales among distributors and the Company's 
direct sales force, (v) the timing and cost of increasing the Company's 
direct domestic sales force, (vi) the expansion of the Company's distribution 
network, (vii) new product introductions by the Company and its competitors, 
(viii) fluctuations in revenues among different product lines and markets, 
(ix) timing of patent and regulatory approvals, if any, (x) intellectual 
property litigation, (xi) timing and growth of operating expenses and (xii) 
general market conditions. In December 1996, the Company entered into the 
Expanded Ethicon Agreement, pursuant to which EES made approximately $4.9 
million in guaranteed payments to the Company in fiscal year 1997, which 
constituted 54% of revenues for fiscal year 1997 and payments by mutual 
consent of  $775,000 in the first quarter of fiscal year 1998 and $860,000 in 
the second quarter of fiscal 1998.  The company and EES entered into a 
nonexclusive distribution agreement for the laparoscopic hernia repair and 
urinary stress incontinence markets in February 1998, which supersedes the 
Expanded Ethicon Agreement.  The Company anticipates that sales to EES may 
decrease in the future.  Failure by EES to achieve certain levels of sales 
growth or purchases could adversely affect the Company's operating results.  
In addition, announcements or expected announcements by the Company, its 
competitors or its distributor of new products, new technologies or pricing 
changes could cause existing or potential customers of the Company to defer 
purchases of the Company's existing products and could alter the mix of 
products sold by the Company, which could have a material adverse effect on 
the Company's business, financial condition and results of operations. There 
can be no assurance that future products or product enhancements will be 
successfully introduced or that such introductions will not adversely affect 
the demand for existing products. As a result of these and other factors, the 
Company's quarterly operating results have fluctuated in the past, and the 
Company expects that such results may fluctuate in the future. Due to such 
quarterly fluctuations in operating results, quarter-to-quarter comparisons 
of the Company's operating results are not necessarily meaningful and should 
not be relied upon as indicators of likely future performance or annual 
operating results. In addition, the Company's limited operating history makes 
accurate prediction of future operating results difficult or impossible. 
There can be no assurance that in the future the Company will achieve sales 
growth or become profitable on a quarterly or annual basis, if at all, or 
that its growth, if any, will be consistent with predictions by securities 
analysts and investors. In such event, the price of the Company's Common 
Stock would likely be materially and adversely affected. See "Management's 
Discussion and Analysis of Financial Condition and Results of Operations."

                                      -27-
<PAGE>

     RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company's success will
depend on its ability to obtain patent protection for its products and
processes, to preserve its trade secrets and proprietary technology and to
operate without infringing upon the patents or proprietary rights of third
parties.

      In May 1996, Origin MedSystems, Inc. ("Origin"), a unit of Guidant 
Corporation filed suit against GSI for infringement of U.S. Patent No. 
5,520,609 in the United States District Court for the Northern District of 
California. That suit was resolved in  GSI's favor by judgment entered on May 
15, 1998, finding Origin's patent unenforceable.  Origin's appeal of that 
judgment is pending and is expected to be decided in 1999.

      In June 1996, GSI filed an action against Origin in the U.S. District 
Court for the Northern District of California alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,514,153. In September 
1997, the Company filed an action against Origin alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,667,520.  Both actions 
are still pending. Discovery has been completed in the first case, and is 
near completion in the second case.  At present, the first of these actions 
is scheduled for trial in early 1999, and the second is expected to go to 
trial later in 1999. While the Company believes it will be successful in 
these proceedings, there can be no assurance of such success. 

      GSI is also involved in an interference proceeding in the U.S. Patent 
Office to determine whether certain subject matter was first invented by GSI 
and whether Origin improperly filed a patent application based on information 
received from GSI's inventor. Failure of the Company to prevail in such 
interference proceeding would have a material adverse effect on the Company's 
business, financial condition and results of operations.

     Patent interference or infringement involves complex legal and factual
issues and is highly uncertain, and there can be no assurance that any
conclusion reached by the Company regarding patent interference or infringement
will be consistent with the resolution of such issue by a court. In the event
the Company's products are found to infringe patents held by competitors, there
can be no assurance that the Company will be able to modify successfully its
products to avoid infringement, or that any modified products will be
commercially successful. Failure in such event to either develop a commercially
successful alternative or obtain a license to such patent on commercially
reasonable terms would have a material adverse effect on the Company's business,
financial condition and results of operations. As discussed above, the Company
is defending itself, and may in the future have to defend itself, in court
against allegations of infringement of third-party patents. Patent litigation is
expensive, requires extensive management time, and could subject the Company to
significant liabilities, require disputed rights to be licensed from third
parties or require the Company to cease selling its products.

     The validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain. No
assurance can be given that any patents based on pending patent applications or
any future patent applications will be issued, that the scope of any patent
protection will exclude competitors or provide competitive advantages to the
Company, that any of the Company's patents or patents to which it has licensed
rights will be held valid under current challenges or if subsequently challenged
or that persons or entities in addition to Origin will not claim rights in or
ownership of the patents and other proprietary rights held or licensed by the
Company or that the Company's existing patents will cover the Company's future
products. Furthermore, there can be no assurance that others have not developed
or will not develop similar products, duplicate any of the Company's products or
design around any patents issued to or licensed by the Company or that may be
issued in the future to the Company. Since patent applications in the United
States are maintained in secrecy until patents issue, the Company also cannot be
certain that others did not first file applications for inventions covered by
the Company's pending patent applications, nor can the Company be certain that
it will not infringe any patents that may issue to others on such applications.

     The patent laws of European and certain other foreign countries generally
do not allow for the issuance of patents for methods of surgery on the human
body. Accordingly, the ability of the Company to gain patent protection for its
methods of tissue dissection will be significantly limited. As a result, there
can be no assurance that the Company will be able to develop a patent portfolio
in Europe or that the scope of any patent protection will provide competitive
advantages to the Company. See "Business -- Patents and Proprietary Rights."

     ROYALTY PAYMENT OBLIGATIONS.  The Company has acquired rights to patents
from third parties, including rights that apply to the Company's current balloon
dissection systems. The Company has historically paid and is obligated to pay in
the future to such third parties royalties equal to 4% of sales of such
products, which payments are expected to



                                      -28-
<PAGE>

exceed minimum royalty payments due under agreements with such parties. The
payment of such royalty amounts will have an adverse impact on the Company's
gross profit and other results of operations. There can be no assurance that the
Company will be able to continue to satisfy such royalty payment obligations in
the future, and a failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations.

     EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF ABILITY
TO MANAGE GROWTH.  The Company has limited experience in manufacturing,
marketing and selling its products commercially.  In addition, the Company has
experienced rapid growth in the number of its employees, the number of products
under development, the number and amount of products manufactured, and the
geographic scope of its sales. In order to augment its long-term competitive
position, the Company anticipates that it will be required to make significant
additional expenditures in research and development and sales and marketing.
The Company's inability to manage its growth effectively could have a material
adverse effect on the Company's business, financial condition and results of
operations.

     COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE.  Competition in the
market for medical devices used in tissue dissection surgical procedures is
intense and is expected to increase. The Company competes primarily with other
producers of MIS tissue dissection instruments. Origin, a subsidiary of Guidant
Corporation, and others currently compete against the Company in the
development, production and marketing of MIS tissue dissection instruments and
tissue dissection technology. To the extent that surgeons elect to use open
surgical procedures rather than MIS, the Company also competes with producers of
tissue dissection instruments used in open surgical procedures, such as blunt
dissectors or graspers. A number of companies currently compete against the
Company in the development, production and marketing of tissue dissection
instruments and technology for open surgical procedures. In addition, the
Company indirectly competes with producers of therapeutic drugs, when such drugs
are used as an alternative to surgery. Many of the Company's competitors have
substantially greater capital resources, name recognition, expertise in research
and development, manufacturing and marketing and obtaining regulatory approvals.
There can be no assurance that the Company's competitors will not succeed in
developing balloon dissection systems or competing technologies that are more
effective than products marketed by the Company or that render the Company's
technology obsolete. Additionally, even if the Company's products provide
performance comparable to competing products or procedures, there can be no
assurance that the Company will be able to obtain necessary regulatory approvals
or compete against competitors in terms of price, manufacturing, marketing and
sales.

     Many of the alternative treatments for medical indications that can be 
treated by surgical balloon dissectors and laparoscopic surgery are widely 
accepted in the medical community and have a long history of use. In 
addition, technological advances with other therapies could make such other 
therapies more effective or cost-effective than surgical balloon dissectors 
and minimally invasive surgery, and could render the Company's technology 
non-competitive or obsolete. There can be no assurance that surgeons will use 
MIS to replace or supplement established treatments or that MIS will remain 
competitive with current or future treatments. The failure of surgeons to 
adopt MIS could have a material adverse effect on the Company's business, 
financial condition and results of operations.

     In addition to the Company's development of its surgical balloon 
dissectors, the Company has also developed surgical instruments for use in 
MIS. There can be no assurance that the Company's surgical instruments will 
successfully compete with those manufactured by other producers of such 
surgical instruments. The failure to achieve commercial market acceptance of 
such surgical instruments could have a material adverse effect on the 
Company's business, financial condition and results of operations. See 
"Business -- Competition."

     UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT.  The Company's success
will depend upon the ability of surgeons to obtain satisfactory reimbursement
from healthcare payors for the Company's products. In the United States,
hospitals, physicians and other healthcare providers that purchase medical
devices generally rely on third-party payors, such as private health insurance
plans, to reimburse all or part of the costs associated with the treatment of
patients. Reimbursement in the United States for the Company's balloon
dissection products is currently available from most third-party payors,
including most major private health care insurance plans and Medicaid, under
existing surgical procedure codes. The Company does not expect that third-party
reimbursement in the United States will be available for use of its other
products unless and until clearance or approval is received from the federal
Food and Drug Administration (the "FDA"). If FDA clearance or approval is
received, third-party reimbursement for these products will depend upon
decisions by individual health maintenance organizations, private insurers and
other payors.



                                      -29-
<PAGE>

Many payors, including the federal Medicare program, pay a preset amount for the
surgical facility component of a surgical procedure. This amount typically
includes medical devices such as the Company's. Thus, the surgical facility or
surgeon may not recover the added cost of the Company's products. In addition,
managed care payors often limit coverage to surgical devices on a preapproved
list or obtained from an exclusive source. If the Company's products are not on
the list or are not available from the exclusive source, the facility or surgeon
will need to obtain an exception from the payor or the patient will be required
to pay for some or all of the cost of the Company's product. The Company
believes that procedures using its balloon dissection products currently may be
reimbursed in the United States under certain existing procedure codes. However,
there can be no assurance that such procedure codes will remain available or
that the reimbursement under these codes will be adequate. Given the efforts to
control and decrease health care costs in recent years, there can be no
assurance that any reimbursement will be sufficient to permit the Company to
increase revenues or achieve or maintain profitability. The unavailability of
third-party or other adequate reimbursement could have a material adverse effect
on the Company's business, financial condition and results of operations.

     Reimbursement systems in international markets vary significantly by 
country, and by region within some countries, and reimbursement approvals 
must be obtained on a country-by-country basis. Many international markets 
have government-managed health care systems that govern reimbursement for new 
devices and procedures. In most markets, there are private insurance systems 
as well as government-managed systems. Large-scale market acceptance of the 
Company's surgical balloon dissectors and other products will depend on the 
availability and level of reimbursement in international markets targeted by 
the Company. Currently, the Company has been informed by its international 
distributors that the surgical balloon dissectors have been approved for 
reimbursement in many of the countries in which the Company markets its 
products. Obtaining reimbursement approvals can require 12 to 18 months or 
longer. There can be no assurance that the Company will obtain reimbursement 
in any country within a particular time, for a particular amount, or at all. 
Failure to obtain such approvals could have a material adverse effect on the 
Company's business, financial condition and results of operations.

     Regardless of the type of reimbursement system, the Company believes that
surgeon advocacy of its products will be required to obtain reimbursement.
Availability of reimbursement will depend on the clinical efficacy of the
procedure and the utility and cost of the Company's products. There can be no
assurance that surgeons will support and advocate reimbursement for use of the
Company's systems for all applications intended by the Company. Failure by
surgeons, hospitals and other users of the Company's products to obtain
sufficient reimbursement from health care payors or adverse changes in
government and private third-party payors' policies toward reimbursement for
procedures employing the Company's products could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Business -- Third-Party Reimbursement."

     GOVERNMENT REGULATION.  The Company's SPACEMAKER-Registered Trademark-
balloon dissection systems and other products are subject to extensive and
rigorous regulation by the FDA and, to varying degrees, by state and foreign
regulatory agencies. Under the federal Food, Drug, and Cosmetic Act, the FDA
regulates the clinical testing, manufacture, labeling, packaging, marketing,
distribution and record keeping for medical devices, in order to ensure that
medical devices distributed in the United States are safe and effective for
their intended use. Prior to commercialization, a medical device generally must
receive FDA and foreign regulatory clearance or approval, which can be an
expensive, lengthy and uncertain process. The Company is also subject to routine
inspection by the FDA and state agencies, such as the California Department of
Health Services ("CDHS"), for compliance with Good Manufacturing Practice
requirements, Medical Device Reporting requirements and other applicable
regulations. Noncompliance with applicable requirements can result in warning
letters, import detentions, fines, civil penalties, injunctions, suspensions or
losses of regulatory approvals, recall or seizure of products, operating
restrictions, refusal of the government to approve product export applications
or allow the Company to enter into supply contracts, and criminal prosecution.
Delays in receipt of, or failure to obtain, regulatory clearances and approvals,
if obtained, or any failure to comply with regulatory requirements could have a
material adverse effect on the Company's business, financial condition and
results of operations.

     Labeling and promotional activities are subject to scrutiny by the FDA 
and, in certain circumstances, by the Federal Trade Commission. Current FDA 
enforcement policy prohibits the marketing of approved medical devices for 
unapproved uses. The SPACEMAKER-Registered Trademark- I platform, 
SPACEMAKER-Registered Trademark- II platform, SPACEMAKER-Registered 
Trademark-Plastics platform, SPACEMAKER-Registered Trademark- SAPHtrak 
-Registered Trademark- platform and KnotMaker-TM- product each have received 
510(k) clearance for use

                                      -30-
<PAGE>

during general, endoscopic, laparoscopic or cosmetic and reconstructive 
surgery, when tissue dissection is required. The Company has promoted these 
products for surgical applications (e.g., hernia repair, subfascial 
endoscopic perforator surgery, breast augmentation and reconstruction, 
treatment of stress urinary incontinence, and saphenous vein harvesting), and 
may in the future promote these products for the dissection required for 
additional selected applications (e.g., tissue dissection/expansion and a 
variety of orthopedic procedures such as anterior spinal fusion and long-bone 
plating). For any medical device cleared through the 510(k) process, 
modifications or enhancements that could significantly affect the safety or 
effectiveness of the device or that constitute a major change to the intended 
use of the device will require a new 510(k) submission. The Company has made 
modifications to its products which the Company believes do not affect the 
safety or effectiveness of the device or constitute a major change to the 
intended use and therefore do not require the submission of new 510(k) 
notices. There can be no assurance, however, that the FDA will agree with any 
of the Company's determinations not to submit a new 510(k) notice for any of 
these changes or will not require the Company to submit a new 510(k) notice 
for any of the changes made to the product. If such additional 510(k) 
clearances are required, there can be no assurance that the Company will 
obtain them on a timely basis, if at all, and delays in receipt of or failure 
to receive such approvals could have a material adverse effect on the 
Company's business, financial condition and results of operations. If the FDA 
requires the Company to submit a new 510(k) notice for any product 
modification, the Company may be prohibited from marketing the modified 
product until the 510(k) notice is cleared by the FDA.

     Sales of medical devices outside of the United States are subject to
foreign regulatory requirements that vary widely from country to country. The
Company currently relies on its international distributors for the receipt of
premarket approvals and compliance with clinical trial requirements in those
countries that require them, and it expects to continue to rely on distributors
in those countries where the Company continues to use distributors. In the event
that the Company's international distributors fail to obtain or maintain
premarket approvals or compliance in foreign countries where such approvals or
compliance are required, the Company may be required to cause the applicable
distributor to file revised governmental notifications, cease commercial sales
of its products in the applicable countries or otherwise act so as to stop any
ongoing noncompliance in such countries. Any enforcement action by regulatory
authorities with respect to past or any future regulatory noncompliance could
have a material adverse effect on the Company's business, financial condition
and results of operations.

     In order to continue selling its products within the European Economic Area
following June 14, 1998, the Company has achieved compliance with the
requirements of the Medical Devices Directive and  affixes CE markings on its
products to attest to such compliance.  The Company received this marking in
August, 1997.

     LIMITED MANUFACTURING EXPERIENCE.  The Company has only limited experience
in manufacturing its products in commercial quantities. The Company intends to
scale up its production of new products . However, manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields, quality control and assurance, component supply and
shortages of qualified personnel. Difficulties experienced by the Company in
manufacturing scale-up and manufacturing difficulties could have a material
adverse effect on its business, financial condition and results of operations.
There can be no assurance that the Company will be successful in scaling up or
that it will not experience manufacturing difficulties or  product recalls in
the future.

     DEPENDENCE ON SINGLE SOURCE SUPPLIERS; LACK OF CONTRACTUAL ARRANGEMENTS.
The Company currently relies upon single source suppliers for several components
of its balloon dissection products, and in most cases there are no formal supply
contracts. There can be no assurance that the component materials obtained from
single source suppliers will continue to be available in adequate quantities or,
if required, that the Company will be able to locate alternative sources of such
component materials on a timely basis to market its products, if at all.  In
addition, there can be no assurance that the single source suppliers will meet
the Company's future requirements for timely delivery of products of sufficient
quality and quantity. The failure to obtain sufficient quantities and qualities
of such component materials, or the loss of any of the Company's single source
suppliers, could cause a delay in GSI's ability to fulfill orders while it
attempts to identify and certify a replacement supplier, if any, and could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Manufacturing."


                                      -31-
<PAGE>

     PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE COVERAGE.  The
Company's business exposes it to potential product liability risks or product
recalls that are inherent in the design, development, manufacture and marketing
of medical devices, in the event the use of the Company's products cause or are
alleged to have caused adverse effects on a patient or such products are
believed to be defective. The Company's products are designed to be used in
certain procedures where there is a high risk of serious injury or death. Such
risks will exist even with respect to those products that have received, or may
in the future receive, regulatory clearance for commercial sale. As a result,
there can be no assurance that the Company's product liability insurance is
adequate or that such insurance coverage will continue to be available on
commercially reasonable terms or at all. Particularly given the lack of data
regarding the long-term results of the use of balloon dissection products, there
can be no assurance the Company will avoid significant product liability claims.
Consequently, a product liability claim or other claim with respect to uninsured
or underinsured liabilities could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Product Liability and Insurance."

     RISKS ASSOCIATED WITH INTERNATIONAL SALES.  Sales outside of the United
States accounted for approximately .4% and .5% of the Company's sales in fiscal
1998 and 1997, respectively. The Company expects that international sales will
represent an increasing portion of revenue in the future. The Company intends to
continue to expand its sales outside of the United States and to enter
additional international markets, which will require significant management
attention and financial resources and subject the Company further to the risks
of selling internationally. These risks include unexpected changes in regulatory
requirements, tariffs and other barriers and restrictions, reduced protection
for intellectual property rights, and the burdens of complying with a variety of
foreign laws. In addition, because all of the Company's sales are denominated in
U.S. dollars, fluctuations in the U.S. dollar could increase the price in local
currencies of the Company's products in foreign markets and make the Company's
products relatively more expensive than competitors' products that are
denominated in local currencies. There can be no assurance that regulatory,
currency and other factors will not adversely impact the Company's operations in
the future or require the Company to modify its current business practices. See
"Business -- Marketing, Sales and Distribution."

     DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL.  The Company is dependent
upon a limited number of key management and technical personnel. The loss of the
services of one or more of such key employees could have a material adverse
effect on the Company's business, financial condition, and results of
operations. In addition, the Company's success will be dependent upon its
ability to attract and retain additional highly qualified sales, management,
manufacturing and research and development personnel. The Company faces intense
competition in its recruiting activities and there can be no assurance that the
Company will be able to attract and/or retain qualified personnel.

     POTENTIAL VOLATILITY OF STOCK PRICE.  The market prices of the Company's
common stock and the stock of many other publicly held medical device companies
have in the past been, and can in the future be expected to be, especially
volatile.  Announcements regarding competitive developments, product sales,
clinical marketing trial results, release of reports by securities analysts,
developments or disputes concerning patents or proprietary rights, regulatory
developments, changes in regulatory or medical reimbursement policies, economic
and other external factors, as well as period-to-period fluctuations in the
Company's financial results, may have a significant impact on the market price
of the Common Stock.  In addition, the securities markets have from time to time
experienced significant price and volume fluctuations that are unrelated to the
operating performance of particular companies.

     YEAR 2000 COMPLIANCE.  The Year 2000 ("Y2K") issue arises from computer 
programs using two digits rather than four to define the applicable year. 
Such software may recognize a date using "00" as the year 1900 rather than 
the year 2000. This could result in system failures or miscalculations 
leading to disruptions or delays in the Company's activities and operations. 
If the Company, its key customers or suppliers fail to make necessary 
modifications to their information technology or non-information technology 
systems on a timely basis, the Y2K issue could have a material adverse effect 
on Company operations. However, the impact cannot be quantified at this time.

     In January 1998 the Company began to evaluate and assess the Company's 
information technology and non-information technology systems for compliance 
with the Y2K issue. The Company intends to fix or replace noncompliant software 
and systems by March 31, 1999, but there can be no assurance that such fixes 
or replacements will occur by such date. The Company is currently conducting 
testing and remediation activities on its systems, and intends to survey 
major customers and suppliers to assess their systems' compliance as well as 
their systems' compatability with the Company's existing or projected 
compliant systems. There can be no assurance that there will not be an 
adverse material effect on the Company's business, financial condition or 
results of operations if the Company or its suppliers or customers do not 
convert or replace their systems in a timely manner to comply with the Y2K 
issue. See "Management's Discussion and Analysis of Financial Condition and 
Results of Operations--Year 2000 Compliance".

                                      -32-
<PAGE>

RECENT PRONOUNCEMENTS

     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), DISCLOSURES ABOUT SEGMENTS OF
AN ENTERPRISE AND RELATED INFORMATION.  This statement establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports.  It also establishes standards for
related disclosures about products and services, geographic areas and major
customers.  This statement supersedes Statement of Financial Accounting
Standards No. 14, FINANCIAL REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE.
The new standard becomes effective for fiscal years beginning after December 15,
1997, and requires that comparative information from earlier years be restated
to conform to the requirements of this standard.  The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's current
reporting and disclosures.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The Company's financial statements as of June 30, 1998 and 1997 and for 
each of the three years ending June 30, 1998, June 30, 1997 and June 30, 
1996 are included in this Form 10-K starting at page 40.

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

     Not applicable.




                                      -33-
<PAGE>


                                       PART III


     Certain information required by Part III is omitted from this report
because the Company will file a definitive Proxy Statement within 120 days after
the end of its fiscal year pursuant to Regulation 14A (the "Proxy Statement")
for its Annual Meeting of Shareholders to be held November 19, 1998, and the
information included therein is incorporated herein by reference to the extent
detailed below.

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

     The information regarding the Company's directors will be set forth under
the caption "Election of Directors -- Nominees" in the Company's proxy statement
and is incorporated herein by reference.  The Proxy Statement will be filed with
the Securities and Exchange Commission within 120 days after the end of the
Company's fiscal year.

ITEM 11.  EXECUTIVE COMPENSATION

     The information required by this item is incorporated by reference into
this Form 10-K from the information set forth under the caption "Compensation
of Executive Officers" in the Company's Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this item is incorporated by reference into
this Form 10-K from the information set forth  under the caption "Common Stock
Ownership of Certain Beneficial Owners and Management" in the Company's Proxy
Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information required by this item is incorporated by reference into
this Form 10-K from the information set forth under the caption "Certain
Relationships and Related Transactions" in the Company's Proxy Statement.




                                      -34-
<PAGE>

                                       PART IV

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

<TABLE>
<CAPTION>
                                                                       PAGE
<S>            <C>                                                     <C>
(a)  (1)       Financial Statements:
               Report of Independent Accountants . . . . . . . . . . . .38
               Balance Sheets. . . . . . . . . . . . . . . . . . . . . .39
               Statements of Operations and Comprehensive Loss . . . . .40
               Statements of Shareholders' Equity (Deficit). . . . . . .41
               Statements of Cash Flows. . . . . . . . . . . . . . . . .42
               Notes to Financial Statements . . . . . . . . . . . . . .43
     (2)       Financial Statement Schedules:
               Independent Accountants' Report on Schedule . . . . . . .S1
               II-Valuation and Qualifying Accounts. . . . . . . . . . .S2
</TABLE>

     All other schedules are omitted because they are not applicable or the
     required information is shown in the consolidated financial statements or
     notes thereto.

     (3)       Exhibits included herein (numbered in accordance
               with Item 601 of Regulation S-K)

Exhibit
Number         Description

3.2(1)         Amended and Restated Articles of Incorporation of Company.

3.4(1)         By-laws of  Company, as amended.

4.2(2)         Shareholder Rights Plan.

10.1(1)        Form of Indemnification Agreement.

10.2(1)        1992 Stock Option Plan and form of Agreement.

10.3(1)        1996 Employee Stock Purchase Plan and form of Subscription
               Agreement.

10.4(1)        1995 Directors' Stock Option Plan and form of Option Agreement.

10.5(1)        Third Amended and Restated Registration Rights Agreement among
               the Company and certain security holders of the Company dated as
               of March 21, 1996.

10.6(1)        Commercial Security Agreement and Promissory Note dated as of
               December 15, 1994 between Silicon Valley Bank and the Company.

10.7(1)        Sublease dated July 13, 1994, Sublease Amendment dated November
               4, 1995 and Sublease Second Amendment dated March 15, 1996
               between the Company and CV Therapeutics, Inc.

10.8(1)(3)     Agreement and Plan of Reorganization dated as of October 1, 1995,
               by and among the Company, General Surgical Acquisition
               Corporation and Adjacent Surgical, Inc.

10.9(1)        Merger Agreement dated February 12, 1996 by and among Adjacent
               Surgical, Inc. , Thomas J. Fogarty, Fogarty Engineering and the
               Company.

10.10(1)(3)    Exclusive License Agreement dated as of February 12, 1996 by and
               among Adjacent Surgical, Inc., Thomas J. Fogarty, Fogarty
               Engineering and the Company.



                                      -35-
<PAGE>

Exhibit
Number         Description

10.11(1)(3)    Assignment Agreement dated as of March 9, 1995 between Apogee
               Medical Products, Inc., and the Company.

10.12(1)(3)    Hernia Repair Device Agreement dated as of April 29, 1992 by and
               among Maciej Kieturakis, Thomas J. Fogarty and the Registrant, as
               amended on April 18, 1995.

10.14(1)       Professional Services Agreement dated June 16, 1992 between the
               Company and Thomas J. Fogarty.

10.15(1)       Professional Services Agreement dated June 16, 1992 between the
               Company and Mark A. Wan.

10.16(1)       Bill of Sale and Instrument of Assignment and Grantback License
               Agreement dated June 16, 1992 between the Company and Thomas J.
               Fogarty.

10.17(1)       Bill of Sale and Instrument of Assignment dated June 16, 1992,
               between the Company and Mark Wan.

10.18(1)       Loan Modification Agreement dated as of March 25, 1996, by and
               between the Company and Silicon Valley Bank.

10.20(4)       OEM Supply Agreement (Expanded Field) dated December 20, 1996
               between Ethicon Endo-Surgery, Inc. and the Company.

10.21(4)       Modification and Termination Agreement and Mutual Release dated
               November 12, 1996, between United States Surgical Corporation and
               the Company.

10.22(4)       Real Estate Lease between Berg & Berg Developers and the Company.

10.23(5)       Form of change of Control Agreement between the Company and
               Executive Officers dated January 20, 1998.

10.24(5)       Termination, Release and Distribution Agreement between the
               Company and Ethicon Endo-Surgery, Inc. dated February 23, 1998.

23.1           Consent of PricewaterhouseCoopers LLP Independent Accountants.

25.1           Power of Attorney (see p. 54).

27.1           Financial Data Schedule.

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

(1)       Incorporated by reference to identically numbered exhibits filed in
          response  to Item 16(a), "Exhibits," of the Company's Registration
          Statement on Form S-1 and Amendments thereto (File No. 333-2774),
          which became effective on May 10, 1996.
(2)       Incorporated by reference to identically numbered exhibits filed in
          response to item 2, "Exhibits," of  the Company's Registration
          Statement on Form 8-A (File No. 000-28448), filed with the Commission
          on May 13, 1997.
(3)       Confidential treatment has been granted with regard to certain
          portions of this exhibit.
(4)       Incorporated by reference to identically numbered exhibits filed in
          response to Item 6(a), "Exhibits," of the



                                      -36-
<PAGE>

          Company's Quarterly Report on Form 10-Q, filed with the Commission on
          February 14, 1997 (File no. 000-28448).

(5)       Incorporated by reference to identically numbered exhibits filed in
          response to Item 6(a), "Exhibits," of the Company's Quarterly Report
          on Form 10-Q, filed with the Commission on May 14, 1998 (File no.
          000-28448).

(b)       REPORTS ON FORM 8-K: The Company filed no reports on form 8-K during
          the quarter ended June 30, 1998.



                                      -37-
<PAGE>



                       REPORT OF INDEPENDENT ACCOUNTANTS



The Board of Directors and Shareholders
General Surgical Innovations, Inc.:


     In our opinion, the accompanying balance sheets and the related 
statements of operations and comprehensive loss, shareholders' equity 
(deficit) and cash flows present fairly, in all material respects, the 
financial position of General Surgical Innovations, Inc. at June 30, 1998 and 
1997, and the results of their operations and their cash flows for each of the 
three years in the period ended June 30, 1998, in conformity with generally 
accepted accounting principles.  These financial statements are the 
responsibility of the Company's management; our responsibility is to express 
an opinion on these financial statements based on our audits.  We conducted 
our audits of these statements in accordance with generally accepted auditing 
standards which 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, 
assessing the accounting principles used and significant estimates made by 
management, and evaluating the overall financial statement presentation.  We 
believe that our audits provide a reasonable basis for the opinion expressed 
above.

                          PricewaterhouseCoopers LLP


San Jose, California
July 29, 1998






                                      -38-
<PAGE>

                          GENERAL SURGICAL INNOVATIONS, INC.
                                   BALANCE SHEETS
                        (in thousands, except per share data)


<TABLE>
<CAPTION>
                                                                          June 30,
                                                                    ---------------------
                                                                      1998        1997
                                                                    --------     --------
<S>                                                                 <C>          <C>     
                                     ASSETS

Current assets:
     Cash and cash equivalents .................................    $ 17,954     $  7,900
     Available-for-sale securities .............................      10,743       35,831
     Accounts receivable, net of allowance for doubtful
       accounts of $72 in 1998 and $47 in 1997 .................       1,043        2,131
     Inventories ...............................................       1,284        1,717
     Prepaid expenses and other current assets .................         733          971
                                                                    --------     --------
       Total current assets ....................................      31,757       48,550

Available-for-sale  securities, non-current ....................       8,772         --
Property and equipment, net ....................................       2,101        2,251
Intangible and other assets, net ...............................         194          261
                                                                    --------     --------
          Total assets .........................................    $ 42,824     $ 51,062
                                                                    --------     --------
                                                                    --------     --------
                                 LIABILITIES


Current liabilities:
     Accounts payable ..........................................    $    910     $    504
     Accrued liabilities .......................................       1,316        1,044
     Capital leases ............................................          14         --
     Bank borrowings ...........................................         103          167
                                                                    --------     --------
       Total current liabilities ...............................       2,343        1,715
Other long-term liabilities ....................................         149          175
Capital leases, less current portion ...........................          12         --
Bank borrowings, less current portion ..........................          82          185
                                                                    --------     --------
          Total liabilities ....................................       2,586        2,075
Commitments and Contingencies (Note 5)



                           SHAREHOLDERS' EQUITY


Preferred stock, $.001 par value:
     Authorized: 2,000 shares; issued and outstanding: none ....        --           --
Common stock, $.001 par value:
     Authorized: 50,000 shares; issued and outstanding:
       13,435 on June 30, 1998, and 13,291 on June 30, 1997  ...          13           13
Additional paid-in capital .....................................      65,290       65,089
Notes receivable from shareholders .............................         (87)         (87)
Deferred compensation, net .....................................        (159)        (297)
Accumulated other comprehensive income (loss)  .................          16          (38)
Accumulated deficit ............................................     (24,835)     (15,693)
                                                                    --------     --------
     Total shareholders' equity ................................      40,238       48,987
                                                                    --------     --------
       Total liabilities and shareholders' equity ..............    $ 42,824     $ 51,062
                                                                    --------     --------
                                                                    --------     --------
</TABLE>



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



                                      -39-
<PAGE>

                          GENERAL SURGICAL INNOVATIONS, INC.

                   STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                        (IN THOUSANDS EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                                                      YEARS ENDED JUNE 30,
                                                                               ----------------------------------
                                                                                 1998         1997        1996
                                                                               --------     --------     -------- 
<S>                                                                            <C>          <C>          <C>     
Sales .....................................................................    $  5,193     $  4,090     $  6,165
Guaranteed payments .......................................................       1,635        4,896         --
                                                                               --------     --------     -------- 
Total revenue .............................................................       6,828        8,986        6,165
Cost of sales .............................................................       3,565        2,385        2,772
                                                                               --------     --------     -------- 
         Gross profit .....................................................       3,263        6,601        3,393
                                                                               --------     --------     -------- 
Operating expenses:
    Research and development ..............................................       2,825        2,231        1,306
    Sales and marketing ...................................................       4,911        4,906        3,609
    General and administrative ............................................       6,932        3,878        1,595
    Write-off of acquired in-process research and development .............        --           --          2,791
                                                                               --------     --------     -------- 
         Total operating expenses .........................................      14,668       11,015        9,301
                                                                               --------     --------     -------- 
         Operating loss ...................................................     (11,405)      (4,414)      (5,908)
                                                                               --------     --------     -------- 
Interest income ...........................................................       2,308        2,572          443
Interest expense ..........................................................         (38)         (47)         (48)
Other income (expense), net ...............................................          (7)          13           48
                                                                               --------     --------     -------- 
         Net loss .........................................................      (9,142)      (1,876)      (5,465)

Other comprehensive income (loss):
    Change in unrealized gain or loss on available-for-sale securities ....          54          (39)           1
                                                                               --------     --------     -------- 
    Comprehensive loss ....................................................    $ (9,088)    $ (1,915)    $ (5,464)
                                                                               --------     --------     -------- 
                                                                               --------     --------     -------- 
Net loss per common share and per common share-assuming
    dilution ..............................................................    $  (0.68)    $  (0.14)    $  (0.74)
                                                                               --------     --------     -------- 
                                                                               --------     --------     -------- 
Shares used in computing net loss per common share and per
    common share-assuming dilution ........................................      13,373       13,197        7,411
                                                                               --------     --------     -------- 
                                                                               --------     --------     -------- 
</TABLE>

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




                                      -40-
<PAGE>

                       GENERAL SURGICAL INNOVATIONS, INC.
                  STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
                    FOR THE THREE YEARS ENDED JUNE 30, 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                              Notes       
                                                                                           Additional       Receivable    
                                                                  Common Stock              Paid-in            From       
                                                             Shares          Amount         Capital         Shareholders  
                                                             ------         --------        --------        ------------ 
<S>                                                          <C>            <C>            <C>              <C>      
Balances, June 30, 1995 ...........................           3,490         $      3        $    153         $   (120)
     Exercise of stock options ....................              33             --                14             --   
     Issuance of common stock .....................             254             --             1,388             --   
     Issuance of common stock in connection
       with public offering at $15.00 per share,
       net of issuance costs of $4,810 ............           3,450                4          46,920             --   
     Conversion of convertible redeemable
       preferred into common stock ................           5,834                6          15,541             --   
     Conversion of note payable into common
       stock ......................................              72             --               269             --   
     Deferred compensation related to stock options            --               --               600             --   
     Amortization of deferred compensation ........            --               --              --               --   
     Change in unrealized gain on available-for-
       sale securities ............................            --               --              --               --   
     Payment of shareholders' notes receivable ....            --               --              --                  8
     Net loss .....................................            --               --              --               --   
                                                             ------         --------        --------         -------- 
Balances, June 30, 1996 ...........................          13,133               13          64,885             (112)
     Exercise of stock options ....................             148             --                67             --   
     Exercise of stock options with notes
       receivable .................................              23             --                11              (11)
     Issuance of common stock in connection
       with employee stock purchase plan ..........              18             --               135             --   
     Repurchase of common stock ...................             (31)            --                (9)               9
     Amortization of deferred compensation ........            --               --              --               --   
     Change in unrealized loss on available-for-
       sale securities ............................            --               --              --               --   
     Payment of shareholders' notes receivable ....            --               --              --                 27
     Net loss .....................................            --               --              --               --   
                                                             ------         --------        --------         -------- 
Balances, June 30, 1997 ...........................          13,291               13          65,089              (87)
     Exercise of stock options ....................             128             --               129             --   
     Issuance of common stock in connection
       with employee stock purchase plan ..........              16             --                72             --   
     Amortization of deferred compensation ........            --               --              --               --   
     Change in unrealized gain on available-for-
       sale securities ............................            --               --              --               --   
     Net loss .....................................            --               --              --               --   
                                                             ------         --------        --------         -------- 
Balances, June 30, 1998 ...........................          13,435         $     13        $ 65,290         $    (87)
                                                             ------         --------        --------         -------- 
                                                             ------         --------        --------         -------- 

<CAPTION>
                                                                          Accumulated
                                                                             Other
                                                          Deferred        Comprehensive      Accumulated             
                                                         Compensation     Income (Loss)       Deficit           Total
                                                         ------------     -------------      -----------        -----
<S>                                                      <C>              <C>                <C>              <C> 
Balances, June 30, 1995 ...........................        $   --           $   --           $ (8,352)        $ (8,316)
     Exercise of stock options ....................            --               --               --                 14
     Issuance of common stock .....................            --               --               --              1,388
     Issuance of common stock in connection        
       with public offering at $15.00 per share,   
       net of issuance costs of $4,810 ............            --               --               --             46,924
     Conversion of convertible redeemable          
       preferred into common stock ................            --               --               --             15,547
     Conversion of note payable into common        
       stock ......................................            --               --               --                269
     Deferred compensation related to stock options            (600)            --               --               --
     Amortization of deferred compensation ........             104             --               --                104
     Change in unrealized gain on available-for-   
       sale securities ............................            --                  1             --                  1
     Payment of shareholders' notes receivable ....            --               --               --                  8
     Net loss .....................................            --               --             (5,465)          (5,465)
                                                             ------         --------         --------         --------
Balances, June 30, 1996 ...........................            (496)               1          (13,817)          50,474
     Exercise of stock options ....................            --               --               --                 67
     Exercise of stock options with notes          
       receivable .................................            --               --               --               --
     Issuance of common stock in connection        
       with employee stock purchase plan ..........            --               --               --                135
     Repurchase of common stock ...................            --               --               --               --
     Amortization of deferred compensation ........             199             --               --                199
     Change in unrealized loss on available-for-   
       sale securities ............................            --                (39)            --                (39)
     Payment of shareholders' notes receivable ....            --               --               --                 27
     Net loss .....................................            --               --             (1,876)          (1,876)
                                                             ------         --------         --------         --------
Balances, June 30, 1997 ...........................            (297)             (38)         (15,693)          48,987
     Exercise of stock options ....................            --               --               --                129
     Issuance of common stock in connection        
       with employee stock purchase plan ..........            --               --               --                 72
     Amortization of deferred compensation ........             138             --               --                138
     Change in unrealized gain on available-for-   
       sale securities ............................            --                 54             --                 54
     Net loss .....................................            --               --             (9,142)          (9,142)
                                                             ------         --------         --------         --------
Balances, June 30, 1998 ...........................        $   (159)        $     16         $(24,835)        $ 40,238
                                                             ------         --------         --------         --------
                                                             ------         --------         --------         --------
</TABLE>


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




                                      -41-
<PAGE>

                       GENERAL SURGICAL INNOVATIONS, INC.
                            Statements of Cash Flows
                                 (in thousands)


<TABLE>
<CAPTION>
                                                                                       YEARS ENDED JUNE 30,
                                                                             ------------------------------------------
                                                                               1998             1997             1996
                                                                             --------         --------         --------
<S>                                                                          <C>              <C>              <C>      
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................................        $ (9,142)        $ (1,876)        $ (5,465)
Adjustments to reconcile net loss to net cash used in operating
   activities:
     Amortization of deferred compensation ..........................             138              199              104
     Depreciation and amortization ..................................           1,049              889              346
     Provision for uncollectible accounts ...........................              25              (31)              68
     Loss on write-off of fixed assets ..............................               7               38                3
     Provision for excess and obsolete inventory ....................              43               57             --
     Write-off of acquired in-process research and development ......            --               --              2,791

     Changes in operating assets and liabilities:
        Accounts receivable .........................................           1,064           (1,227)            (685)
        Inventory ...................................................             390           (1,074)            (281)
        Prepaid expenses and other current assets ...................             238             (533)            (351)
        Intangible and other assets .................................              (5)             (69)              (3)
        Accounts payable ............................................             406             (110)            (202)
        Accrued and other liabilities ...............................             246              127              565
        Deferred revenue ............................................            --               (100)            (133)
                                                                             --------         --------         --------
          Net cash used in operating activities .....................          (5,541)          (3,710)          (3,243)
                                                                             --------         --------         --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities ..........................         (22,766)         (54,335)         (21,450)
Proceeds from sales and maturities of available-for-sale securities .          38,792           39,467             --
Acquisition of property and equipment ...............................            (450)          (2,018)            (337)
Disposal of fixed assets ............................................            --                 63               39
Cash received on acquisition of Adjacent Surgical, Inc. .............            --               --                 21
                                                                             --------         --------         --------
          Net cash provided by (used in) investing activities .......          15,576          (16,823)         (21,727)
                                                                             --------         --------         --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Series D convertible redeemable
   preferred stock ..................................................            --               --              1,754
Proceeds from issuance of common stock, net of issuance costs .......             201              202           46,938
Proceeds from payment on shareholders' notes receivable .............            --                 27                8
Principal payments on note payable ..................................            --               --               (140)
Proceeds from bank borrowings .......................................            --               --                787
Payments on capital lease obligations ...............................             (15)            --               --
Principal payments on bank borrowings ...............................            (167)            (135)            (579)
                                                                             --------         --------         --------
          Net cash provided by financing activities .................              19               94           48,768
                                                                             --------         --------         --------
Net increase (decrease) in cash and cash equivalents ................          10,054          (20,439)          23,798
Cash and cash equivalents, beginning of year ........................           7,900           28,339            4,541
                                                                             --------         --------         --------
Cash and cash equivalents, end of year ..............................        $ 17,954         $  7,900         $ 28,339
                                                                             --------         --------         --------
                                                                             --------         --------         --------
Cash paid during the period for:

     Interest .......................................................        $     38         $     51         $     37
     Taxes ..........................................................        $   --           $      1         $      1

NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for notes receivable .......................        $   --           $     11         $   --
Repurchase of common stock for notes receivable .....................        $   --           $      9         $   --
Change in unrealized gain or loss on available-for-sale securities ..        $     54         $     39         $      1
Property acquired under capital leases ..............................        $     41         $   --           $   --
</TABLE>


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



                                      -42-
<PAGE>

                       GENERAL SURGICAL INNOVATIONS, INC.

                          NOTES TO FINANCIAL STATEMENTS

1.  FORMATION AND BUSINESS OF THE COMPANY:

     General Surgical Innovations, Inc. ("the Company") was incorporated on 
April 13, 1992, to engage in the development, manufacturing and marketing of 
medical device surgical balloon dissectors which create new working spaces 
between natural tissue planes in the human body.  The company sells products 
in the United States, Europe, Asia and South America, through its direct 
sales force and key distributors. While the Company has developed or is 
developing surgical balloon dissectors for stress urinary incontinence, 
vascular, and plastic surgery, sales of products for hernia repair are 
expected to provide a majority  of the Company's revenues at least through 
fiscal 1999.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     RECLASSIFICATION:
     Certain amounts in the financial statements have been reclassified to 
conform with the current year's presentation.  These reclassifications had no 
impact on previously reported working capital, operating income, or net 
income.

     USE OF ESTIMATES:

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

     CASH AND CASH EQUIVALENTS:

     The Company considers investments with an original maturity of 90 days or
less as of the date of purchase to be cash equivalents.

     AVAILABLE-FOR-SALE SECURITIES:

     The Company has classified its investments as "available-for-sale."  Such
investments are recorded at fair value, and unrealized holding gains and losses
are recorded net of related taxes as a separate component of shareholders'
equity.  Interest income is recorded using an effective interest rate, with
associated premium or discount amortized to "investment income."  Realized gains
and losses on sales of all such securities are reported in earnings and computed
using the specific identification cost method.  All investments with maturity
dates greater than 365 days are classified as non-current.

     INVENTORIES:

     Inventories are stated at the lower of cost or market.  Cost is based on
actual costs computed on a first-in, first-out basis.

     PROPERTY AND EQUIPMENT:

     Property and equipment are stated at cost, net of accumulated depreciation
and amortization.  Furniture, fixtures, equipment and tooling are depreciated on
a straight-line basis over their estimated useful lives of three to five years.
Leasehold improvements are amortized over the lesser of their estimated useful
lives or the term of the lease.

     INTANGIBLE ASSETS:



                                      -43-
<PAGE>

     Intangible assets include patents which are being amortized on a
straight-line basis over five years. The Company periodically assesses the
recoverability of intangible assets by determining whether amortization of the
asset balance over the remaining life can be recovered through undiscounted
future operating cash flows of the acquired operation. The amount of impairment,
if any, is measured based on projected discounted future operating cash flows
and is recognized as a write down of the asset to net realizable value.

     EMPLOYEE STOCK PLANS:

     The Company accounts for its stock option plans and its employee stock 
purchase plan in accordance with the provisions of the Accounting Principles 
Board's Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to 
Employees." In 1995, the Financial Accounting Standards Board issued 
Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting 
for Stock-Based Compensation."  SFAS 123 establishes a fair value based 
method of accounting for stock-based plans and is effective for fiscal years 
beginning after December 15, 1995.  The Company is continuing to account for 
its employee stock plans in accordance with the provisions of APB 25, and has 
provided pro forma disclosure in Note 6 as if the measurement provisions of 
SFAS 123 had been adopted.

     REVENUE RECOGNITION:

     The Company recognizes revenue from product sales upon shipment of product
and when title passes to its customer.  Allowances are provided for estimated
returns.   Revenue from guaranteed payments is recognized in the period received
according to the terms and conditions of a distributor agreement.

     RESEARCH AND DEVELOPMENT:

     Research and development expenses are charged to operations as incurred.

     BUSINESS RISKS AND CREDIT CONCENTRATION:

     A substantial portion of the Company's sales have been derived from 
sales of its surgical balloon dissectors for hernia repair procedures.  
Failure of the Company to successfully develop and commercialize surgical 
balloon dissector products for applications other than hernia repair could 
have a material adverse effect on the Company's business, financial condition 
and results of operations.

     In March 1994, the Company entered into a distribution agreement with 
United States Surgical Corporation ("USSC") providing USSC with limited 
exclusive rights to distribute the Company's surgical balloon dissectors in 
the hernia repair market in both the United States and certain other 
countries.  In fiscal 1997 and 1996, sales to USSC, which include sales to 
Autosuture, Inc., a subsidiary of USSC, represented approximately 27% and 
92%, respectively, of the Company's sales. In November 1996, the Company 
terminated its distribution agreement with USSC; there were no sales to USSC 
in 1998.

In December 1996, the Company entered into a five-year OEM supply agreement 
(the "EES Agreement") with Ethicon Endo-Surgery ("EES"), pursuant to which 
GSI granted EES exclusive worldwide sales and marketing rights to sell the 
SPACEMAKER-C- surgical balloon dissectors in the laparoscopic hernia repair 
and stress urinary incontinence ("SUI") markets. EES made guaranteed payments 
pursuant to the EES Agreement of $4.9 million in fiscal year 1997, and 
additional payments in lieu of product purchases pursuant to a mutual 
agreement in the amount of $775,000 in the first quarter of fiscal year 1998 
and $860,000 in the second quarter of fiscal year 1998. In February 1998, the 
Company and EES replaced the exclusive EES Agreement with a non-exclusive 
distribution agreement for the laparoscopic hernia repair and SUI markets.  
Sales and guaranteed payments from EES represented approximately 74% and 65% 
of the Company's 1998 and 1997 revenues, respectively.

     The Company maintains its cash balances in demand accounts primarily with
one financial institution.  For its accounts receivable, management of the
Company performs ongoing credit evaluations of its customers and maintains
allowances for doubtful accounts.  Historically the Company has not experienced
significant losses related to individual customers or groups of customers in any
particular geographic area. At June 30, 1998, 1997 and 1996, one distributor
accounted for approximately 46%, 93% and 91%, respectively, of accounts
receivable.



                                      -44-
<PAGE>

     FAIR VALUE OF FINANCIAL INSTRUMENTS:

     Carrying amounts of the Company's financial instruments including cash and
cash equivalents, accounts receivable, accounts payable and accrued liabilities
approximate fair values due to their short maturities.  Based on the borrowing
rates currently available to the Company for loans with similar terms, the
carrying values of the equipment loan and line of credit approximate fair
values.  Estimated fair values for available-for-sale securities, which are
separately disclosed elsewhere, are based on quoted market prices for the same
or similar instruments.

     INCOME TAXES:

     The Company accounts for income taxes under the liability method.  Under
the liability method, deferred tax assets and liabilities are determined based
on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.  The Company is required
to adjust deferred tax liabilities in the period when tax rates or the
provisions of the income tax laws change.  Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be
realized.

     COMPUTATION OF NET LOSS PER COMMON SHARE AND PER COMMON SHARE-ASSUMING 
     DILUTION:

     Effective December 15, 1997, the Company adopted Financial Accounting 
Standards Board No. 128 "Earnings Per Share", and the provisions of the 
Securities and Exchange Commission Staff Accounting Bulletin ("SAB 98"), and 
accordingly all prior periods have been restated.  Net loss per common share 
and per common share-assuming dilution are computed using the weighted 
average number of shares of common stock outstanding.  Common equivalent 
shares from stock options are excluded from the computation of net loss per 
common share-assuming dilution as their effect is antidilutive.  The Company 
has determined that no incremental shares should be included in the 
computation of earnings per share in accordance with SAB 98.

     Stock options to purchase 1,816,906, 1,363,447 and 1,096,067 shares of 
common stock at prices ranging from $0.09 to $9.75 per share were outstanding 
at June 30, 1998, 1997 and 1996, respectively, but were not included in the 
computation of net loss per common share-assuming dilution because they were 
antidilutive.  The aforementioned stock options could potentially dilute 
earnings per share in the future.

     RECENT PRONOUNCEMENTS:

     In June 1997, the Financial Accounting Standards Board issued Statement 
of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures About 
Segments of an Enterprise and Related Information."  This statement 
establishes standards for disclosure about operating segments in annual 
financial statements and selected information in interim financial reports.  
It also establishes standards for related disclosures about products and 
services, geographic areas and major customers.  This statement supersedes 
Statement of Financial Accounting Standards No. 14, "Financial Reporting for 
Segments of a Business Enterprise." The new standard becomes effective for the 
Company's 1999 fiscal year, and requires that comparative information from 
earlier years be restated to conform to the requirements of this standard.  
The Company is evaluating the requirements of SFAS 131 and the effects, if 
any, on the Company's current reporting and disclosures.

     COMMON STOCK SPLIT:

          In March 1996, the Board of Directors approved a 1.37 to 1 stock split
of its common stock and preferred stock.  All share and per share information in
the accompanying financial statements have been restated to give retroactive
recognition to the stock split for all periods presented.


                                      -45-
<PAGE>

3.  BALANCE SHEET DETAIL:

     AVAILABLE-FOR-SALE SECURITIES:

     As of June 30, 1998, available-for-sale securities consisted of the 
following (IN THOUSANDS):

<TABLE>
<CAPTION>
                                                             AMORTIZED      UNREALIZED     ESTIMATED      MATURITY
                                                                COST          GAINS       FAIR VALUE      DATES
                                                             ---------      ----------    ---------       --------
<S>                                                          <C>            <C>           <C>             <C>
Corporate obligations, principally commercial
     paper and corporate notes, short-term ...........        $10,729        $    14        $10,743        7/98-6/99
Corporate obligations, principally commercial
     paper and corporate notes, long-term ............          8,770              2          8,772        7/99-4/00
                                                              -------        -------      ---------
                                                              $19,499        $    16      $  19,515
                                                              -------        -------      ---------
                                                              -------        -------      ---------
</TABLE>

As of June 30, 1997, available-for-sale securities consisted of the following
(IN THOUSANDS):


<TABLE>
<CAPTION>
                                                              AMORTIZED       UNREALIZED       ESTIMATED
                                                                COST            LOSSES         FAIR VALUE
                                                              --------         --------        ----------
<S>                                                           <C>             <C>              <C>     
Obligations of federal government agencies,
     short-term ......................................        $  2,000         $     (2)        $  1,998
Corporate obligations, principally commercial
     paper and corporate notes, short-term ...........          33,869              (36)          33,833
                                                              --------         --------         --------
                                                              $ 35,869         $    (38)        $ 35,831
                                                              --------         --------         --------
                                                              --------         --------         --------
</TABLE>

During 1998 and 1997, there were no realized gains or losses on the disposal of
available-for-sale securities.

     PROPERTY AND EQUIPMENT:

     Property and equipment comprise (IN THOUSANDS):


<TABLE>
<CAPTION>
                                                                   JUNE 30,
                                                             ---------------------
                                                              1998          1997
                                                             -------       -------
<S>                                                          <C>           <C>    
Equipment .............................................      $ 1,238       $ 1,074
Furniture and fixtures ................................          437           436
Tooling ...............................................          457           277
Leasehold improvements ................................        1,192         1,152
                                                             -------       -------
                                                               3,324         2,939
Less accumulated depreciation and amortization ........       (1,223)         (688)
                                                             -------       -------
                                                             $ 2,101       $ 2,251
                                                             -------       -------
                                                             -------       -------
</TABLE>

     INVENTORIES:

     Inventories comprise (IN THOUSANDS):


<TABLE>
<CAPTION>
                                                                 JUNE 30,
                                                            ------------------
                                                             1998        1997
                                                            ------      ------
<S>                                                         <C>         <C>   
Raw materials ........................................      $  910      $  706
Work in progress .....................................        --            43
Finished goods .......................................         374         968
                                                            ------      ------
                                                            $1,284      $1,717
                                                            ------      ------
                                                            ------      ------
</TABLE>



                                      -46-
<PAGE>

     INTANGIBLE AND OTHER ASSETS:

     Intangible and other assets comprise (IN THOUSANDS):

<TABLE>
<CAPTION>

                                        JUNE 30,
                                    ----------------
                                    1998        1997
                                    ----        ----
<S>                              <C>         <C>
Patents .....................      $ 360       $ 360
Other .......................         80          75
                                   ------     -------
                                     440         435
Less accumulated amortization       (246)       (174)
                                   ------     -------
                                   $ 194       $ 261
                                   ------     -------
                                   ------     -------

</TABLE>

     ACCRUED LIABILITIES:

     Accrued liabilities comprise (IN THOUSANDS):

<TABLE>
<CAPTION>

                                                JUNE 30,
                                           ------------------
                                            1998        1997
                                           ------      ------
<S>                                     <C>         <C>
Accrued payroll and related expenses      $  391      $  300
Accrued legal expenses .............         660         547
Accrued other ......................         265         197
                                           -----     -------
                                          $1,316      $1,044
                                          ------     -------
                                          ------     -------

</TABLE>

4.  BANK BORROWINGS:

     On March 25, 1996, the Company entered into a loan agreement with a
financial institution which provides for two equipment loans of $300,000 and
$700,000 with interest at the bank's prime rate plus 1.75% (10.25% at June 30,
1998) and 1.25% (9.75% at June 30, 1998), respectively. The note for $300,000
matures September 30, 1998, and the note for $700,000 matures on June 30, 2000.
Future minimum payments under the loans are as follows (IN THOUSANDS):

<TABLE>
<CAPTION>

     YEAR ENDING JUNE 30,
     --------------------
<S>                                           <C>
         1999...............................  $103
         2000...............................    82
                                             ------
                                              $185

</TABLE>

     On March 24, 1998, the Company entered into a line of credit with a bank 
permitting borrowings up to $5.0 million.  This line of credit bears interest 
at the bank's prime rate (8.5% at June 30, 1998), and is due on March 23, 
1999. There are no amounts outstanding under the line of credit at June 30, 
1998, with $5.0 million available for future use.

     The bank borrowings are collateralized by substantially all of the
Company's assets.  In addition, the Company is required to maintain certain
restrictive financial covenants including minimum tangible net worth and a
minimum quick ratio.

5.  COMMITMENTS AND CONTINGENCIES:

     OPERATING LEASE AGREEMENTS:

      The Company leases its facilities under a non-cancelable operating 
lease that expires on April 20, 2004. The lease contains two options to 
extend the lease term, with each extended term to be for a period of five 
years. The Company is responsible for certain taxes, maintenance costs and 
insurance under the lease.  Future minimum rental payments under the lease 
are as follows (IN THOUSANDS):

                                      -47-
<PAGE>

YEAR ENDING JUNE 30,


     1999. . . . . . . . . . . . . . . . . . . . . . .          $  864
     2000. . . . . . . . . . . . . . . . . . . . . . .             986
     2001. . . . . . . . . . . . . . . . . . . . . . .           1,013
     2002. . . . . . . . . . . . . . . . . . . . . . .           1,041
     2003. . . . . . . . . . . . . . . . . . . . . . .           1,069
     Thereafter. . . . . . . . . . . . . . . . . . . .             880
                                                                ------
                                                                $5,853
                                                                ------
                                                                ------


     Rent expense for the years ended June 30, 1998, 1997 and 1996 was 
$625,488, $600,645 and $486,721, respectively.

Capital Lease Agreements:

     The Company has two capital lease agreements for office equipment.  
Amounts financed under these leases total approximately $41,000, with 
associated accumulated depreciation of $16,000.  Future minimum lease 
payments under these capital leases are as follows (IN THOUSANDS):

<TABLE>
<CAPTION>

YEAR ENDING JUNE 30,
--------------------
<S>                                                            <C>
     1999 ...................................................  $    15
     2000 ...................................................       12
                                                               -------
                                                                    27
     Less amount representing interest ......................       (1)
                                                               -------
     Principle amount of minimum lease payments .............       26
     Less current portion ...................................      (14)
                                                               -------
                                                               $    12
                                                               -------
                                                               -------

</TABLE>

     OTHER COMMITMENTS:

     The Company has entered into certain royalty agreements to obtain
technology which provide for royalties ranging from 1-4% of the sales price
for products which utilize this technology.  Amounts charged to operations for
the years ended June 30, 1998, 1997 and 1996 were $289,255, $356,831 and
$241,065, respectively.

     Also, in 1994 in conjunction with obtaining technology, the Company 
entered into a royalty agreement which provides for royalties of 4% of net 
sales for products which utilize this technology through 2001.  Minimum 
royalties under the agreement are $62,500, $75,000 and $37,500 for the years 
ending June 30, 1999, 2000 and 2001, respectively.

     Contingencies:

     In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant 
Corporation, filed suit against GSI for infringement of U.S. Patent No. 
5,520,609 in the United States District Court for the Northern District of 
California. That suit was resolved in  GSI's favor by judgment entered on May 
15, 1998, finding Origin's patent unenforceable.  Origin's appeal of that 
judgment is pending, and is expected to be decided in 1999.

     In June 1996, GSI filed an action against Origin in the U.S. District 
Court for the Northern District of California alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,514,153. In September 
1997, the Company filed an action against Origin alleging that the use of 
Origin's products infringes GSI's U.S. Patent No. 5,667,520.  Both actions 
are still pending. Discovery has been completed in the first case, and is 
near completion in the second case.  At present, the first of these actions 
is scheduled for trial in early 1999, and the second is expected to go to 
trial later in 1999. While the Company believes it will be successful in 
these proceedings, there can be no assurance of such success. 

     GSI is also involved in an interference proceeding in the U.S. Patent 
Office to determine whether certain subject matter was first invented by GSI 
and whether Origin improperly filed a patent application based on information 
received from GSI's inventor. Failure of the Company to prevail in such 
interference proceeding would have a material adverse effect on the Company's 
business, financial condition and results of operations.


                                      -48-
<PAGE>

6.   SHAREHOLDERS' EQUITY:

     PREFERRED STOCK:

     Under the Company's Articles of Incorporation, the Company's preferred
stock is issuable in series and the Company's Board of Directors is authorized
to determine the rights, preferences and terms of each series.

     During 1996, the Company amended its Articles of Incorporation to authorize
2,000,000 shares of undesignated preferred stock.  Preferred stock may be issued
from time to time in one or more series.  As of June 30, 1998, the Company had
no shares issued and outstanding.

     COMMON STOCK:

     The Company has issued through June 30, 1998, shares of its common stock to
the founders and key employees of the Company under stock purchase agreements.
Certain stock purchase agreements (the "Agreements") contain provisions for the
repurchase of common stock by the Company in the event of termination of
employment during the vesting period following the date of employment.
Generally, 25% of the shares of common stock purchased under the Agreements are
released from the Company's repurchase option at the end of twelve months from a
participant's hiring date with the remaining shares being released from
repurchase ratably over the next 36 months.  At June 30, 1998, 52,490 shares are
subject to repurchase under the Agreements.  Each share of common stock has the
right to one vote.  The holders of common stock are also entitled to receive
dividends whenever funds are legally available and when declared by the Board of
Directors, subject to the prior rights of holders of any class of outstanding
stock having priority rights as to dividends.

     STOCK OPTION PLANS:

1992 Stock Option Plan

     The Company has an Incentive Stock Option Plan ("the Plan") under which 
1,715,895 shares of common stock were originally reserved for issuance. In 
November 1997, an additional 500,000 shares were reserved, bringing the 
aggregate number of shares of common stock reserved for issuance to 2,615,895 
as of June 30, 1998. Also in November 1997, the Plan was amended to permit 
non-employee directors of the Company to be eligible to receive grants under 
the Plan.

     Under the Plan, incentive options may be granted at prices not lower than
fair market value at the date of grant or 110% of the fair market value if the
optionee, immediately prior to the grant, owns stock representing 10% or more of
the voting power or value of all securities.  Nonstatutory options may be
granted at prices not lower than 85% of fair market value at the date of grant
as determined by the Board of Directors.  Options granted under the Plan are
exercisable and vest at such times and under such conditions as determined by
the Board.  The options generally expire from five years to ten years from date
of grant.


                                      -49-
<PAGE>


1995 Directors' Stock Option Plan

     In November 1995, the Company adopted the Directors' Stock Option Plan 
("the Directors' Plan"), under which 164,726 shares of Common Stock have been 
reserved for issuance.  The Directors' Plan provides for the grant of 
nonstatutory stock options to non-employee directors of the Company.  The 
Directors' Plan provides an initial option to purchase 27,454 shares of 
common stock, which vests annually over four years, and beginning with the 
1997 annual meeting, provides an additional annual option to purchase 6,864 
shares of common stock.

     The exercise price of all stock options granted under the Directors' Plan
shall be equal to the fair market value of the Company's common stock on the
date of grant of the option.  Options granted under the Directors' Plan have a
term of ten years.

     During 1998, an additional 25,000 shares were granted outside of the above
stock options plans.

     Stock option activity is set forth below (IN THOUSANDS, EXCEPT PER SHARE 
DATA):

<TABLE>
<CAPTION>

                                                                                                OUTSTANDING OPTIONS
                                                                                ------------------------------------------------
                                                                 SHARES                               WEIGHTED        AGGREGATE
                                                               AVAILABLE           NUMBER OF       AVERAGE PRICE       PRICE IN
                                                               FOR GRANT             SHARES          PER SHARE         DOLLARS
                                                               ---------           ---------       -------------      ----------
<S>                                                        <C>                  <C>              <C>                 <C>
Balances, June 30, 1995 ..............................             131                431              $   .24           $   103
     Increase in shares reserved .....................           1,263                  -                    -                 -
     Options granted .................................            (745)               745                 1.91             1,421
     Options exercised ...............................               -                (33)                 .42               (14)
     Options terminated ..............................              47                (47)                4.00              (188)
                                                               -------            -------              -------           -------
Balances, June 30, 1996 ..............................             696              1,096                 1.21             1,322
     Increase in shares reserved .....................             400                  -                    -                 -
     Options granted .................................            (497)               497                 8.65             4,299
     Options exercised ...............................               -               (172)                 .45               (78)
     Options terminated ..............................              58                (58)                2.21              (128)
                                                               -------            -------              -------           -------
Balances, June 30, 1997 ..............................             657              1,363                 3.97             5,415
     Increase in shares reserved .....................             525                  -                    -                 -
     Options granted .................................          (1,153)             1,153                 4.39             5,058
     Options exercised ...............................               -               (128)                1.00              (128)
     Options terminated ..............................             571               (571)                6.40            (3,655)
                                                               -------            -------              -------           -------
Balances, June 30, 1998 ..............................             600              1,817             $   3.68         $   6,690
                                                               -------            -------              -------           -------
                                                               -------            -------              -------           -------

</TABLE>


At June 30, 1998, stock options outstanding are as follows (IN THOUSANDS, 
EXCEPT PER SHARE DATA):

<TABLE>
<CAPTION>

                            OPTIONS OUTSTANDING                                                      OPTIONS EXERCISABLE
 ---------------------------------------------------------------------------------------       -------------------------------------
                                             WEIGHTED AVERAGE              WEIGHTED                                    WEIGHTED
     RANGE OF              NUMBER               REMAINING                  AVERAGE                 NUMBER              AVERAGE
 EXERCISE PRICES         OF SHARES           CONTRACTUAL LIFE           EXERCISE PRICE           OF SHARES          EXERCISE PRICE
 ----------------        ---------           ----------------           --------------           ---------          ---------------
<S>                    <C>                <C>                      <C>                       <C>                  <C>
 $ 0.09 - $ 2.50             622                    6.8 years              $   0.96                 453               $    0.88
 $ 2.51 - $ 5.00             760                    9.1                        4.22                 143                    4.26
 $ 5.01 - $ 7.50             276                    9.5                        5.19                  29                    5.22
 $ 7.51 - $ 9.75             159                    8.5                        9.73                  54                    9.71
                           -----                    ---                    --------                 ---               ---------
                           1,817                    8.3 years              $   3.97                 679               $    2.49
                           -----                    ---                    --------                 ---               ---------
                           -----                    ---                    --------                 ---               ---------

</TABLE>

     At June 30, 1997 and 1996, options to purchase 434,609 and 259,373 
shares were exercisable at a weighted average exercise price of $1.60 and 
$0.50 per share, respectively.

     Compensation of approximately $600,000 has been attributed to stock options
granted after May 1995 and prior to the sale of the Company's common stock in an
initial public offering.  The deferred compensation is being recognized as a
charge 


                                      -50-
<PAGE>

to income over the period for which the related stock options become
exercisable, which is generally four years. Amortization of the deferred
compensation was approximately $138,000, $199,000 and $104,000 during the years
ended June 30, 1998, 1997 and 1996, respectively.

     On August 5, 1997, the Company repriced 357,034 options, ranging in price
from $5.63-$22.25 per share, to the fair market value on that date of $4.38 per
share.

     PRO FORMA INFORMATION:

     Had compensation costs for options awarded in fiscal 1998, 1997 and 1996 
been determined based on the fair value at the grant date consistent with the 
provisions of  SFAS 123, the Company's net loss and net loss per share would 
have resulted in the pro forma amounts indicated in the following: (IN 
THOUSANDS, EXCEPT PER SHARE DATA):

<TABLE>
<CAPTION>

                                                        JUNE 30,
                                        ---------------------------------------
                                           1998           1997           1996
                                        ----------    ----------      ---------
<S>                                   <C>          <C>             <C>
 Actual net loss                        $  (9,142)    $  (1,876)      $ (5,465)
 Pro forma net loss                     $ (10,511)    $  (2,661)      $ (5,724)

 Actual net loss per share              $    (.68)    $    (.14)      $   (.74)
 Pro forma net loss per share           $    (.79)    $    (.20)      $   (.77)

</TABLE>


     The above pro forma disclosures are not necessarily representative of the
effects on reported net income (loss) in future years.

     In fiscal 1998, 1997 and 1996, the weighted-average fair value of options
granted during the year was $2.61, $5.12 and $1.99, respectively. The fair value
of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants during the years ended June 30, 1998, 1997 and 1996: dividend yield of
0%, expected volatility of 62%, risk-free interest rate of between 5.93% and
6.69 % at the date of grant, and an expected term of 5 years.

     EMPLOYEE STOCK PURCHASE PLAN:

     In March 1996, the Board of Directors adopted the 1996 Employee Stock 
Purchase Plan (the "ESPP") and reserved 274,543 shares of common stock for 
issuance. The purpose of the ESPP is to provide eligible employees of the 
Company with a means of acquiring common stock of the Company through payroll 
deductions.  The purchase price of such stock under the ESPP cannot be less 
than 85% of the lower of the fair market value on the specified purchase date 
or at the beginning of the offering period.  This purchase price was modified 
from 95% to 85% effective July 1, 1998.  At June 30, 1998, 33,998 shares had 
been issued under the ESPP.

     COMMON STOCK PURCHASE RIGHTS:

     In May 1997, the Company distributed a dividend to shareholders 
comprised of a right to purchase one share of common stock (a "Right") for 
each outstanding share of common stock of the Company they hold.  These 
Rights do not become exercisable or transferable apart from the common stock 
until the Distribution Date which is the tenth day after a person or group 
either (a) acquires beneficial ownership of 15% or more of the Company's 
common stock or (b) announces a tender or exchange offer, the consummation of 
which would result in ownership by a person or group of 15% or more of the 
Company's common stock.  After the Distribution Date, each Right will entitle 
the holder to purchase from the Company one share of common stock at a price 
of $35 per share.

     If the Company is acquired in a merger or other business combination
transaction, or if 50% or more of its assets or earnings power is sold,
each Right will entitle the holder to purchase at the exercise price that number
of shares of the acquiring company having a then current market value of two
times the exercise price of the Right. In the event that the Company is the
surviving corporation in a merger and the Company's common stock remains
outstanding, or in the event that an acquiring party engages in certain
self-dealing transactions, each Right not owned


                                      -51-
<PAGE>

by the acquiring party will entitle the holder to purchase at the exercise price
that number of shares of the Company's common stock having a then current market
value of two times the exercise price of the Right.

     The Rights are redeemable at the Company's option for $.01 per Right prior
to becoming exercisable, may be amended at the Company's option on or prior to
the Distribution Date and expire on May 8, 2007.

7.   GSI 401(k) PLAN:

     The Company has a qualified 401(k) plan available to substantially all 
employees over the age of 21. Participants may contribute up to 20% of their 
annual compensation to the plan, limited to a maximum amount set by the 
Internal Revenue Service. The Company may make contributions to the 401(k) 
plan at the discretion of the Board of Directors. No Company contributions 
have been made to the plan since inception.

8.   INCOME TAXES:

     At June 30, 1998, the Company had federal and state net operating loss 
carryforwards of $21.3 million and $6.6 million, respectively, which expire 
in the years 1999 - 2013.

     As a result of a change in ownership, as defined, federal and state net 
operating loss carryforwards are subject to an annual limitation of  
$400,000.

     Temporary differences and carryforwards that gave rise to significant
portions of deferred tax assets and liabilities are as follows (IN THOUSANDS):



<TABLE>
<CAPTION>

                                                                              JUNE 30,
                                                                      -------------------------
                                                                            1998          1997  
                                                                      -----------    ---------- 
<S>                                                                <C>             <C>          
     Deferred tax assets:
          Net operating loss carryforwards ......................     $    7,657     $    3,685 
          Capitalized research expenses .........................            370            216 
          Research and development credit carryforward ..........            421            138 
          Accrued liabilities and other .........................            240            159 
          Valuation allowance ...................................         (8,688)        (4,198)
                                                                      ----------     ---------- 
                                                                      $      ---     $      --- 
                                                                      ----------     ---------- 
                                                                      ----------     ---------- 

</TABLE>

     In accordance with generally accepted accounting principles, a valuation 
allowance must be established for a deferred tax asset if it is more likely 
than not that a tax benefit will not be realized from the asset in the 
future. The Company has established a valuation allowance to the extent of 
its deferred tax assets since it is more likely than not that a benefit will 
not be realized in the future due to the Company's recurring operating losses.

     The Company's effective tax rate differs from the statutory federal 
income tax rate as shown in the following schedule:

<TABLE>
<CAPTION>

                                                                                        JUNE 30,
                                                                         --------------------------------------
                                                                           1998           1997           1996
                                                                         --------       -------        --------
<S>                                                                   <C>             <C>            <C>       
     Income tax benefit at statutory rate ......................            (34)%          (34)%          (34)%
     Net operating loss not benefitted .........................             34             34             34
                                                                         ------        -------        -------
     Effective tax rate ........................................            --- %          --- %          --- %
                                                                         ------        -------        -------
                                                                        -------        -------        -------

</TABLE>

9.   RELATED PARTY TRANSACTIONS:

     The Company entered into certain product development arrangements and
royalty agreements with a sole proprietorship which is owned by a director of
the Company.  Under these agreements, the Company pays royalties of 1-4% of the
sales price for products which utilize the technology obtained.  The Company has
paid this sole proprietorship $111,536, $190,485 and $223,368 in fiscal years
1998, 1997 and 1996, respectively.

                                      -52-

<PAGE>

                                      SIGNATURES

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

                                        GENERAL SURGICAL INNOVATIONS, INC



Date: September 28, 1998           By: /S/ GREGORY D. CASCIARO
                                       -----------------------------------
                                       Gregory D. Casciaro
                                       President, Chief Executive Officer 
                                         and Director




                                      -53-
<PAGE>

                                POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Gregory D. Casciaro and Stephen J.
Bonelli his attorneys-in-fact, each with the power of substitution, for him in
any and all capacities, to sign any amendments to this 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 substitute or
substitutes, may do or cause to be done by virtue hereof.

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


 

<TABLE>
<CAPTION>
          SIGNATURE                            TITLE                             DATE
          ---------                            -----                             ----
<S>                           <C>                                          <C>
/S/ RODERICK A. YOUNG         Chairman of the Board of Directors           September 25, 1998
-------------------------
(Roderick A. Young)


/S/ GREGORY D. CASCIARO                      President,                    September 25, 1998
-------------------------     Chief Executive Officer and Director
(Gregory D. Casciaro)         


/S/ STEPHEN J. BONELLI               Chief Financial Officer,              September 25, 1998
-------------------------     Vice President of Finance and Treasurer
(Stephen J. Bonelli)          

 /S/ DAVID W. CHONETTE        Director                                     September 25, 1998
-------------------------
(David W. Chonette)

/S/ THOMAS A. FOGARTY         Director                                     September 25, 1998
-------------------------
(Thomas A. Fogarty)

 /S/ PAUL GOELD               Director                                     September 25, 1998
-------------------------
(Paul Goeld)

/S/ JAMES SULAT               Director                                     September 25, 1998
-------------------------
(James Sulat)

/S/ MARK A. WAN               Director                                     September 25, 1998
-------------------------
(Mark A. Wan)
</TABLE>


                                      -54-
<PAGE>



                    INDEPENDENT ACCOUNTANTS' REPORT ON SCHEDULE

To The Board of Directors of General Surgical Innovations, Inc.:

     Our audits of the financial statements referred to in our report dated 
July 29, 1998, appearing on page 40 of this  Form 10-K also included an audit 
of the financial statement schedule listed in Item 14(a)(2) of this Form 
10-K. In our opinion, this financial statement schedule presents fairly, in 
all material respects, the information set forth therein when read in 
conjunction with the related financial statements.

          PricewaterhouseCoopers LLP


San Jose, California
July 29, 1998


                                         S-1

<PAGE>





                         GENERAL SURGICAL INNOVATIONS, INC.

                   SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                    (IN THOUSANDS)

<TABLE>
<CAPTION>

                                        BALANCE AT          CHARGED IN
                                        BEGINNING OF        COSTS AND                     BALANCE AT
DESCRIPTION                                 PERIOD           EXPENSES       DEDUCTIONS     END OF PERIOD
-----------                             ------------        -----------     ----------    --------------
<S>                                  <C>                 <C>             <C>           <C>
Year ended June 30, 1998
  Allowance for doubtful accounts:      $     47            $    59        $    (34)      $     72

Year ended June 30, 1997
  Allowance for doubtful accounts:      $     78            $      -       $    (31)       $    47

Year ended June 30, 1996
  Allowance for doubtful accounts:      $     17            $     68       $     (7)      $     78

</TABLE>



                                      S-2