<PAGE>   1

================================================================================

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

                                    FORM 10-Q
(Mark One)

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934

For the quarterly period ended March 31, 1999 or

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934

For the transition period from              to

                         Commission file number 0-19707

                                 INNERDYNE, INC.

             (Exact name of Registrant as specified in its charter)

                      DELAWARE                         87-0431168
                   (State or other                  (I.R.S. Employer
                   jurisdiction of                 Identification No.)
                   incorporation
                   or organization)

                    1244 REAMWOOD AVENUE, SUNNYVALE, CA 94089
          (Address, including zip code, of principal executive offices)

       Registrant's telephone number, including area code: (408) 745-6010

        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 [ ]

        The number of shares of Registrant's Common Stock issued and outstanding
as of March 31, 1999 was 21,902,297.


================================================================================

<PAGE>   2


<TABLE>
<CAPTION>

                                TABLE OF CONTENTS




                                                                                                                          PAGE
                                                                                                                          ----
<S>                                                                                                                       <C>
PART I.  FINANCIAL INFORMATION

Item 1.    Financial Statements


                                                                                   
           Condensed Balance Sheets..........................................................................................3

           Condensed Statements of Operations................................................................................4

           Condensed Statements of Cash Flows................................................................................5
           
           Notes to Condensed Financial Statements...........................................................................6

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.............................8


Item 3.    Quantitative and Qualitative Disclosures About Market Risk.......................................................23
           

PART II.  OTHER INFORMATION.................................................................................................24

Item 1.    Legal Proceedings................................................................................................24
           
Item 2.    Changes in Securities and Use of Proceeds........................................................................24

Item 3.    Defaults upon Senior Securities..................................................................................24

Item 4.    Submission of Matters to a Vote of Security Holders..............................................................24

Item 5.    Other Information................................................................................................24

Item 6.    Exhibits and Reports on Form  8-K................................................................................24
          
           Signature Page...................................................................................................25

</TABLE>

                                      -2-

<PAGE>   3



                 PART I- FINANCIAL INFORMATION

ITEM 1. -  FINANCIAL STATEMENTS

                         INNERDYNE, INC.
                    CONDENSED BALANCE SHEETS

                             ASSETS
<TABLE>
<CAPTION>

                                                            MARCH 31,           DECEMBER 31,
                                                               1999                 1998
                                                           (UNAUDITED)          (*SEE NOTE)
                                                           ------------          ------------
<S>                                                        <C>                   <C>         
Current assets:

   Cash and cash equivalents ..........................    $  6,170,318          $  5,757,538
   Accounts receivable ................................       2,695,606             2,670,811
   Interest and other receivables .....................         244,674               383,726
   Inventory ..........................................       1,240,240             1,202,982
   Prepaid expenses and other .........................         265,730               213,831
                                                           ------------          ------------

     Total current assets .............................      10,616,568            10,228,888

Equipment and leasehold improvements, net .............         818,931               814,120
Other assets ..........................................          44,967                45,695
                                                           ------------          ------------

     Total assets .....................................    $ 11,480,466          $ 11,088,703
                                                           ============          ============


                                 LIABILITIES AND
                               STOCKHOLDERS'EQUITY
Current liabilities:

   Line of credit .....................................    $    639,989          $    300,000
   Current installments of long-term debt .............         265,388               391,040
   Accounts payable ...................................         203,835               260,132
   Accrued liabilities ................................         976,288             1,120,044
                                                           ------------          ------------
      Total current liabilities .......................       2,085,500             2,071,216

Long-term debt, excluding current installments ........         360,403               348,723

Stockholders' equity:
   Common stock .......................................         219,023               218,914
   Additional paid-in- capital ........................      60,221,756            60,206,865
   Accumulated deficit ................................     (51,406,216)          (51,757,015)
                                                           ------------          ------------
      Net stockholders' equity ........................    $  9,034,563          $  8,668,764
                                                           ------------          ------------
Total Liabilities and Stockholders' equity ............    $ 11,480,466          $ 11,088,703
                                                           ============          ============
</TABLE>

* Condensed from audited financial statements

See accompanying notes to condensed financial statements.

                                      -3-
<PAGE>   4





                                 INNERDYNE, INC.
                       CONDENSED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)



<TABLE>
<CAPTION>

                                                                             THREE MONTHS ENDED
                                                                      -----------------------------------
                                                                      MARCH 31, 1999       MARCH 31, 1998
                                                                      --------------       --------------

<S>                                                                   <C>                  <C>         
Product, licensing and contract revenue ............................  $  4,503,794         $  4,205,772

  Cost of sales ....................................................     1,335,984            1,306,245

  Research, development, regulatory and clinical ...................       680,266              758,496

  Sales and marketing ..............................................     1,671,985            1,735,439

  General and administrative .......................................       504,931              552,573
                                                                      ------------         ------------

       Total costs and expenses ....................................     4,193,166            4,352,753
                                                                      ------------         ------------

       Operating income (loss) .....................................       310,628             (146,981)

Other, net .........................................................        40,171               42,583
                                                                      ------------         ------------

       Net income (loss) ...........................................  $    350,799         $   (104,398)
                                                                      ============         ============

Basic and diluted net income (loss) per share ......................  $       0.02         $      (0.00)
                                                                      ============         ============

Weighted average basic and diluted common shares outstanding:


                Basic ..............................................    21,891,630           21,756,586
                                                                      ============         ============

                Diluted ............................................    23,060,584           21,756,586
                                                                      ============         ============

</TABLE>

See accompanying notes to condensed financial statements.

                                      -4-
<PAGE>   5





                                 INNERDYNE, INC.
                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                                           THREE MONTHS ENDED
                                                                                     -------------------------------
                                                                                      MARCH 31,           MARCH 31,
                                                                                         1999                 1998
                                                                                     -----------          -----------
<S>                                                                                  <C>                  <C>         
Cash flows from operating activities:

Net income (loss) ..............................................................     $   350,799          $  (104,398)

Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:

        Depreciation and amortization ..........................................         125,070              132,693

        Decrease (increase) in receivables .....................................         114,257             (559,428)

        Decrease (increase) in inventories .....................................         (37,258)             123,698

        Increase in prepaid expenses, and other assets .........................         (51,171)             (63,845)

        Decrease in accounts payable ...........................................         (56,297)            (350,746)

        Decrease in accrued expenses ...........................................        (143,756)             (57,217)
                                                                                     -----------          -----------

Net cash provided by (used in) operating activities ............................         301,644             (879,243)
                                                                                     -----------          -----------

Cash flows from investing activities capital expenditures ......................        (129,881)             (43,757)
                                                                                     -----------          -----------

Cash flows from financing activities:

        Proceeds from issuance of common stock .................................          15,000               17,909

        Proceeds from issuance of long-term debt ...............................         418,016                   --

        Principal payments on long-term debt ...................................        (191,999)             (66,278)
                                                                                     -----------          -----------


Net cash provided by (used in) financing activities ............................         241,017              (48,370)
                                                                                     -----------          -----------

Net increase (decrease) in cash and cash equivalents ...........................         412,780             (971,370)

Cash and cash equivalents at beginning of period ...............................       5,757,538            6,091,497
                                                                                     -----------          -----------

Cash and cash equivalents at end of period .....................................     $ 6,170,318          $ 5,120,127
                                                                                     ===========          ===========
</TABLE>

See accompanying notes to condensed financial statements.

                                      -5-

<PAGE>   6






                                 INNERDYNE, INC.
                     NOTES TO CONDENSED FINANCIAL STATEMENTS

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The accompanying interim condensed financial statements and notes are
unaudited, but in the opinion of management reflect all adjustments (consisting
of normal recurring adjustments) necessary for a fair presentation of the
results of such periods. The results of operations for any interim period are
not necessarily indicative of results for the respective full year. These
condensed financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations (MD&A) for the three-month period
ended March 31, 1999 should be read in conjunction with the audited financial
statements and notes thereto and MD&A included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998.

(2) INVENTORIES

        Inventories consist of the following:


<TABLE>
<CAPTION>
                                                                            MARCH 31,
                                                                               1999            DECEMBER 31,
                                                                            (UNAUDITED)            1998
                                                                           -----------          -----------

<S>                                                                        <C>                  <C>        
Raw materials and supplies .............................................   $   999,801          $   936,191
Finished goods .........................................................       561,664              551,791
Reserve for obsolescence ...............................................      (321,225)            (285,000)
                                                                           -----------          -----------
Net inventory ..........................................................   $ 1,240,240          $ 1,202,982
                                                                           ===========          ===========

</TABLE>


(3) COMPREHENSIVE INCOME (LOSS)

        The Company adopted Statement of Financial Accounting Standard No.130
("SFAS 130"), "Reporting Comprehensive Income," effective January 1, 1998. SFAS
130 establishes standards for reporting and display of comprehensive income and
its components in financial statements. For the periods ended March 31, 1999 and
December 31, 1998 comprehensive loss was equal to the net loss as presented in
the accompanying statement of operations.

(4) NET INCOME (LOSS) PER COMMON SHARE

        Basic earnings (loss) per common share is the amount of earnings (loss)
for the period available to each share of common stock outstanding during the
reporting period. Diluted earnings (loss) per common share is the amount of
earnings for the period available to each share of common stock outstanding
during the reporting period and to each share that would have been outstanding
assuming the issuance of common shares for all dilutive potential common shares
outstanding during the period.

                                      -6-

<PAGE>   7





In calculating net income (loss) per common share, the net income (loss) was the
same for both the basic and diluted calculation. A reconciliation between the
basic and diluted weighted-average number of common shares for the three months
ended March 31, 1999 and 1998 is summarized as follows:

<TABLE>
<CAPTION>

                                                                            (Unaudited)
                                                                         Three Months Ended
                                                                  March 31, 1999      March 31, 1998
                                                                  --------------      --------------

<S>                                                               <C>                 <C>       
         Basic weighted average number of common shares
         outstanding during the period                                21,891,630          21,756,586

         Weighted-average number of dilutive common stock
         options outstanding during the period                         1,168,954               --
                                                                       ---------          ----------

         Diluted weighted average number of common and common
         equivalent shares outstanding during the period              23,060,584          21,756,586
                                                                      ==========          ==========
</TABLE>


        Common stock equivalents of approximately 634,885 and 3,195,011
outstanding during the three month periods ended March 31, 1999 and 1998 that
could potentially dilute basic earnings per share in the future were not
included in the computation of diluted earnings per share because to do so would
have been anti-dilutive for the period.

(5)     OPERATING SEGMENTS

        The Company operates in one line of business, the development, and
commercialization of access products for MIS procedures. The Company has and/or
is also pursuing licensing opportunities related to its proprietary radial
dilation, biocompatible coating, and thermal ablation technologies previously
developed in connection with related product development. As such, the Company
has only one reportable operating segment as defined by the Financial Accounting
Standards Board Statement No. 131, Disclosures About Segments of an Enterprise
and Related Information.


                                      -7-
<PAGE>   8




ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

        Except for the historical information contained in this Quarterly Report
on Form 10-Q, the matters discussed throughout this Quarterly Report on Form
10-Q 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, the impact of intense competition in the
Company's market, the extent of market acceptance of the Company's StepTM family
of products, the timely development and market acceptance of new products, the
compliance of the Company's manufacturing facilities with Good Manufacturing
Practices ("GMP") regulations, the continued acceptance of minimally invasive
surgical procedures, the Company's ability to further expand into international
markets, public policy relating to healthcare reform in the United States and
other countries, approval of the Company's products by government agencies such
as the United States Food and Drug Administration (the "FDA") and the risks set
forth in greater detail below under the heading "Additional Factors that May
Affect Future Results", as well as those set forth in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998 and included from time
to time in the Company's other Securities and Exchange Commission ("SEC")
reports and press releases, copies of which are available from the Company upon
request. The Company undertakes no obligation to publicly release the result of
any revisions to these forward-looking statements that may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

INTRODUCTION

        InnerDyne, Inc. (the "Company" or "InnerDyne") is primarily focused upon
the development and commercialization of access products based on its
proprietary radial dilation technology used to perform minimally invasive
surgical ("M.I.S.") procedures. The Company also possesses biocompatible coating
technologies which have utility in enhancing the compatibility and performance
of devices placed in contact with human body fluids and tissues, and in
delivering pharmaceuticals and radioactive isotopes to selected areas within a
human body. The Company intends to continue developing its radial dilation and
biocompatible coating technologies, internally or through strategic alliances.

INNERDYNE'S PRODUCTS AND TECHNOLOGY

Radial Dilation Technology

        The primary focus of the Company is the development and commercial
application of its proprietary radial dilation technology. The key feature of
this proprietary technology is the capability to enter the body of a patient by
creating a small puncture wound which can subsequently be dilated, or increased
in size, to create a larger working channel. Employment of radial dilation
within an expandable sheath permits the dilation to be accomplished in a manner
that tends to minimize tissue trauma. Upon completion of a procedure, the
dilation sequence is reversed; resulting in a smaller residual wound than would
be experienced through the employment of similarly sized conventional access
devices. Potential benefits of radial dilation technology include reduced risk,
less patient trauma and reduced procedure time.

        Step Product Line. The Company has developed a family of products
utilizing InnerDyne's proprietary radial dilation technology. The initial Step
products were introduced commercially in late 1994 and are designed to provide
access to the abdominal cavity in order to facilitate the visualization and
treatment of target areas within the cavity while minimizing the tissue trauma
associated with such access.

        Step. The Step device incorporates the Company's proprietary radial
dilation technology and was InnerDyne's first product to be launched on a
commercial basis. The Company has received 510(k) clearances from the FDA to
market this device for laparoscopic and thorascopic M.I.S. procedures. The
Company's Step access device replaces trocars, eliminating the risk of internal
organ damage from contact with the sharp surfaces of a trocar. In contrast to
conventional trocars, the Step device utilizes a standard insufflation needle
for penetration through the abdominal wall, creating only a small puncture
wound. Following removal of the needle, a sheath that surrounds the needle is
then dilated to a larger working channel through the insertion of a tapered
dilator and cannula. Following dilation, the dilator is removed, leaving a rigid
sheath that 

                                      -8-


<PAGE>   9

serves as a working channel with an integral insufflation valve at the proximal
end. The radial dilation of tissue to an appropriately sized working channel
holds the cannula in place and obviates the need for an anchoring system, which
may cause a larger residual wound. After completion of a procedure, the rigid
cannula is removed and the sheath retracts permitting the opening in each of the
muscular layers of the abdominal wall to recover. The residual wound is
approximately half the size of that made using a conventional trocar of similar
size. The Step product is currently utilized primarily in minimally invasive
general, gynecological and pediatric surgical procedures.

        Management believes that positive attributes of the Step product could
significantly affect health care system costs and patient satisfaction with
M.I.S. procedures in which trocars have traditionally been used. The results of
a Company-sponsored retrospective comparative outcome study examining this issue
were released during late 1995. The study included 98 patients and compared an
almost equal number of procedures performed using Step devices and conventional
trocars for access. Statistically significant results of that study indicated
that Step reduced device-related complications during surgery by over 90% and
resulted in an approximate 22% savings in surgery time. Based upon published
operating room costs, this time savings would equate to dollar savings of $345
to $515 per procedure, a substantial outcome for a product that is believed to
be competitively priced with conventional trocars. Management also believes that
post-procedure complications, such as infection and incisional hernias at access
sites, may be reduced with the use of the Step device as compared to
conventional trocars. Two randomized prospective studies involving 331 patients
intended to replicate the findings of the initial outcome study were completed
during 1997. Results of both studies indicate that Step virtually eliminates
complications associated with the use of conventional trocars. These results
have been presented at major international conferences and have been submitted
for publication.

        On January 13, 1999, InnerDyne reported the acceptance by the FDA of the
Company's 510(k) premarket notification based on the demonstrated safety and
clinical performance of the Step line of minimally invasive surgical access
devices based on InnerDyne's proprietary radial dilation technology. The product
safety premarket notification resulted from the submittal of substantial
information related to the comparative safety of the Step radially expanding
dilation technology for surgical access versus standard cutting trocars. The FDA
clearance acknowledged that the Step radially expanding surgical access
technology had been shown in independent clinical comparative studies versus
conventional cutting trocars to provide safety benefits including, but not
limited to: (1) a lower prevalence of abdominal wall bleeding; (2) a lower
prevalence of bowel and bladder injuries; (3) a lower incidence of post
operative incisional hernias; and (4) a lower prevalence of major vascular
injury. In addition, the FDA clearance noted that a substantial number of
patients reported reduced pain from Step access sites when compared to
conventional trocar sites.

        Short Step. The Short Step is a conventional Step device that has been
reduced in length to be particularly suitable for M.I.S. procedures involving
smaller individuals, especially children and thin females. The Short Step was
commercially introduced in 1995. In January 1996, the Company announced that its
Short Step device had been awarded the Seal of Acceptance by the Alliance of
Children's Hospitals, Inc. ("Alliance"). The Alliance is a wholly owned
subsidiary of Child Health Corporation of America, which is comprised of 35
free-standing children's hospitals across the United States. The Alliance
selected the Step system, after extensive research and review, based upon its
ability to reduce both the trauma and operative complications associated with
pediatric laparoscopic surgical procedures. In exchange for an ongoing royalty
payment, the Company is entitled to use this seal in connection with the
marketing and sale of its Step line of products. The Company hopes that the Seal
of Acceptance will help the Company expand awareness and sales of its Step
product line for use in the pediatric environment.

        Reposable Step. Launched in 1996, the Reposable Step incorporates the
radial dilation features of disposable Step devices in a partially reusable
access device. A substantial market for reusable trocars exists, and management
expects a trend toward a somewhat more frequent usage of reusable devices. The
Reposable Step includes a number of reusable components consisting of a
combination of metal and plastic parts that may be cleaned and sterilized by
most conventional methods. The dilator, cannula and needle are reusable, while
the sheath and valve are single use components designed to be disposed of
following surgery.


                                      -9-

<PAGE>   10

        Mini Step. The Mini Step is a small-diameter radially dilating access
device designed for use in tubal ligation, pediatric procedures, and
micro-laparoscopic surgeries utilizing small instruments. The working diameter
of the Mini Step ranges from a nominal 2mm to 8mm. Like the Step device, Mini
Step is expected to offer clinicians the potential to reduce device-related
surgical complications and surgery time. The Mini Step devices were commercially
introduced in 1997.

        One-Step. The One-Step is a device with a universally adjustable valve
and seal system designed to eliminate the need for a reducer. The device is
intended to maintain insufflation while accommodating most conventional surgical
instruments. The One-Step device was commercially introduced in 1998.

        Open Step. The Open-Step is a device designed to establish access into
the abdominal cavity using a technique known as open laparoscopy. The Open-Step
device was commercially introduced in 1998.

        Distribution of Step Products. The Step family of products is
distributed to health care professionals in both domestic and international
markets. In the United States, the Company's M.I.S. access product line is
generally sold directly to health care professionals by a network of sales
representatives, a limited number of whom are employees of the Company.
InnerDyne management employees manage these sales representatives on a regional
basis. In order to enhance the effectiveness of these domestic sales activities,
agreements with buying groups that represent multiple provider institutions have
been pursued. InnerDyne signed two buying group agreements in 1997. These
agreements cover approximately 1,350 hospitals across the United States. In
selected foreign countries, local distributors purchase products from the
Company for subsequent resale to their respective countries health care systems.
Distributors in selected foreign markets can and have been changed when the
Company has deemed the performance of individual distributor organizations to be
unsatisfactory.

        Other Applications. During the second quarter of 1997, InnerDyne
established a business unit to better define the value that radial dilation
technology can bring to interventional cardiology and radiology procedures and
to develop access products based on this assessment. The Company proceeded with
animal studies and device refinements in the third and fourth quarters of 1997
and continued testing the product concept in conjunction with cardiology
advisors in the first quarter of 1998. The study results were positive and human
use trials to demonstrate the clinical benefits were initiated in Europe during
the second quarter of 1998. In September 1998, InnerDyne announced that it had
received clearance from the FDA of a 510(k) application for its radially
dilatable access device for use in gaining percutaneous access for the
performance of vascular procedures. If clinical benefits are confirmed in
continuing usage, the Company will explore alternative methods of effective
distribution in the interventional vascular marketplace and may launch a radial
dilation vascular access device in the United States in 1999 or subsequent
years.

        Management believes that the positive attributes of the Step product
line may also enable minimally invasive access to organs within the abdominal
cavity. The only current alternative for this type of access involves the
insertion of a long flexible channel and scope through a natural body orifice
such as the mouth or the rectum, and only limited procedures are possible due to
the restricted size of the channel and the tortuous path that must be navigated.
The Step product line has been shown to enable laparoscopic access through the
abdominal wall and across the peritoneal space into the stomach for the
treatment of benign tumors. InnerDyne believes that the use of Step products
could substantially reduce recovery times for these types of procedures. The
Company expects that the enhanced capabilities of radially expanding dilation
may enable additional surgical procedures to be performed through minimally
invasive techniques.

        The Company may file an additional 510(k) with respect to intra-organ
access in 1999. The Company anticipates that market evaluation and testing of
the product concept in conjunction with surgical advisors will be concluded in
late 1999. If the trial results are positive and subsequent human use
demonstrates clinical benefits, the Company may begin distribution in the
marketplace and may launch an intra-organ access device during 1999 or in
subsequent years.

        Additionally, the Company is exploring the potential use of its
proprietary radial dilation technology in other applications such as access for
urologic, thoracic and tracheal procedures, and plans to increase resources
associated with 

                                      -10-

<PAGE>   11

the pursuit of percutaneous kidney and bladder access in the ensuing quarters.
The Company filed an additional 510(k) for urologic access in 1999.
Developmental expenditures for new applications for the Company's proprietary
radial dilation technology may reduce the Company's level of profitability.
There can be no assurance that these new applications will demonstrate clinical
benefits or that the Company can develop a product that will be commercially
accepted.

        InnerDyne announced an agreement covering the development and potential
use of its proprietary radial dilation technology for specialized vascular
access with EndoTex Interventional Systems ("EndoTex") in 1996. In January 1999,
the management of EndoTex notified InnerDyne that it was ceasing to make
payments required for EndoTex to use radial dilation for specialized vascular
access. The Company does not expect the termination of the EndoTex agreement to
have a material adverse affect on the Company's business, financial condition,
and results of operations.

        The Company entered into an agreement covering the development of a less
traumatic means of placing enteral feeding tubes with Sherwood-Davis & Geck
("SDG") in 1997. The Company announced that it had received the single
regulatory milestone payment associated with the SDG agreement during the second
quarter of 1997. In the first quarter of 1998, InnerDyne and SDG terminated the
development agreement when SDG was acquired. In the future, the Company may
continue to develop a feeding tube placement system.

        InnerDyne also committed resources to an investigation of the potential
market opportunity in arthroscopic procedures during 1997 and early 1998.
Limited clinical usage of the initial design accompanied by substantial exposure
and feedback from arthroscopic surgeons was completed during the last half of
1997. InnerDyne completed the arthroscopic market opportunity assessment in the
second quarter of 1998. The Company is exploring the potential this product may
have, if any, and alternative distribution methods in the arthroscopic
marketplace. It is unlikely that an arthroscopic access product will be brought
to market unless a suitable distribution partner can be found.

Thermal Ablation Technology

        The Company has developed proprietary technology that is intended to
thermally ablate the lining of a body organ. The Company's EnAbl (TM) Thermal
Ablation System (the "EnAbl System") is based on this proprietary technology and
is designed to treat menorrhagia, or excessive uterine bleeding, by thermally
ablating the endometrial lining of the uterus through the controlled
introduction and heating of a normal saline solution in situ.

        In December 1996, InnerDyne announced that it had signed an agreement
which granted U.S. Surgical Corporation ("U.S. Surgical") exclusive worldwide
sales and marketing rights for the EnAbl System. Under the terms of the
agreement, in exchange for initial license fees, milestone payments, and
royalties based upon future sales, U.S. Surgical gained the rights to complete
development of the EnAbl system and to manufacture and market the technology on
a worldwide basis. The agreement also provides U.S. Surgical with an option to
purchase rights to the technology for defined applications. In July 1997, the
Company announced that U.S. Surgical had made the first milestone payment due
under the terms of the agreement. In August 1998, InnerDyne announced it had
received notification from U. S. Surgical indicating they would not pursue
development or commercialization of the Company's EnAbl System. The Company does
not presently intend to proceed with commercial development of this product
without a corporate partner.

Biocompatible Coating Technologies

        The Company possesses certain proprietary technologies in the area of
biocompatible coatings. The technologies that comprise the Company's
thromboresistant coating ("TRC") capability are believed to have application
when foreign objects remain in contact with various areas of the body,
particularly within the blood stream, for sustained periods of time. These
technologies include the ability to deposit an extremely thin layer
(approximately one micron) of siloxane on a surface and the ability to graft a
bioactive substance, such as the drug heparin, to that siloxane layer. The
Company's TRC utilizes a "tether" molecule to attach heparin, other bioactive
molecules or radioisotopes to the previously applied siloxane subsurface. One
end of the tether molecule is covalently bonded to the siloxane coating and the
other end of the tether molecule is covalently bonded to the bioactive molecule
or radioisotope. Because both points of attachment utilize covalent 

                                      -11-


<PAGE>   12

bonds, the Company believes that its coating process may result in a stronger
bond to the surface of a device than many other methods presently in use, which
it believes generally use a weaker ionic bond in at least one of the attachment
points. TRC coatings, employed with the siloxane layer alone or in combination
with bioactive substances, can extend the life of blood-gas exchange devices or
provide the capability to extend the duration of contact of a coated device with
blood or other body fluids while minimizing the physiological impacts of such
contact. InnerDyne is developing a proprietary technology that coats materials
with a coating to which rhenium-188 or another radioisotope can be attached to
reduce restenosis in patients who have had interventional vascular procedures.


        The Company has begun a research program aimed at developing absorbable
brachytherapy products for the treatment of focal or site-specific cancers such
as breast, prostate, cervical, and neurological cancers. The program's goal is
to develop biocompatible and bio-absorbable brachytherapy sources for use in
radiotherapy or simultaneous radiotherapy and chemotherapy drug delivery. These
novel combined brachytherapy/chemotherapeutic drug sources are being designed
for use in the local-regional treatment of primary cancer, including treatment
of the tumor bed after removal of a tumor. The final product could fundamentally
differ from both current brachytherapy sources and drug-delivery sources and
could provide a highly efficient mechanism to control cancer growth and limit
cancer reccurrence. The advantage of localized radiotherapy over other therapies
is that local radiotherapy can eliminate cancerous cells while sparing normal
cells. Other therapies, such as systemic chemotherapy and external beam
radiation, affect both cancerous and non-cancerous cells and can result in
greater pain, longer recovery times, and higher treatment costs. In contrast,
local radiotherapy can lower the cost of the therapeutic procedure, reduce
hospital stays, and reduce the pain and suffering experienced by the patient.

        In December 1997, InnerDyne and Oak Ridge National Laboratory ("ORNL")
announced that the Department of Energy had awarded ORNL and Brookhaven National
Laboratories ("BNL") a cooperative research and development agreement ("CRADA")
for the development of InnerDyne's proprietary method of labeling or attaching
radioactivity to implantable devices. Initially, the ORNL researchers helped to
optimize chemical methods required to efficiently attach a radioactive source to
stents. Generators from ORNL and the new technology were provided to
investigators at BNL who, in conjunction with the Interventional Cardiology
Group at the State University of New York at Stonybrook, prepared
radioactive stents and implanted them into the arteries of swine and rabbits to
evaluate the effectiveness of this unique and potentially powerful new approach
to inhibit restenosis. Initial testing confirmed the Company's ability to attach
radionuclides to metal stents and other substrates. Additional testing to
demonstrate the efficacy in animals of InnerDyne's technology for the treatment
of restenosis continues at the Washington Heart Center (WHC) and BNL.

        In October 1998, the CRADA's scope of work was modified to include the
development of absorbable brachytherapy devices for the treatment of focal
cancers because of the rapid strides made under the radiation coated stent
development program.

        Management believes that the combination of InnerDyne and Oak Ridge
National Laboratory technologies, if successful, may positively impact the
overall costs associated with stenting procedures by providing a method of
attaching a radioisotope just prior to implantation to inhibit restenosis.
Additionally, management believes that an absorbable brachytherapy device which
can deliver both radiation and a drug or chemotherapy agent concurrently could
positively impact the treatment outcomes of focal cancers by lowering the cost
of the therapeutic procedure, reducing hospital stays, and reducing the pain and
suffering experienced by the patient.

        In January 1999, InnerDyne announced that it had been awarded a
California Cancer Research Program (CRP) Cycle I grant, a Community Initiated
Research Collaboration Award (CIRCA), to examine the clinical benefits and the
development of absorbable brachytherapy devices. The commercial objective of
this project is to develop bio-absorbable brachytherapy sources for use in
radiotherapy or simultaneous radiotherapy and chemotherapy drug delivery. These
novel combined brachytherapy/chemotherapeutic drug sources will be designed
utilizing a proprietary InnerDyne technology for potential use in the treatment
of site-specific prostate, breast, and neurological cancers.

        In 1994, the Company signed a license agreement with SENKO Medical
Manufacturing Co., Ltd. ("SENKO"), a Japan-based manufacturer and marketer of
membrane oxygenators used in open-heart surgery, pursuant to which the 

                                      -12-


<PAGE>   13

Company licensed one of its TRC technologies to SENKO. In connection with this
agreement, the Company transferred its siloxane coating technology to SENKO for
the coating of microporous hollow fibers used in production of oxygenators. The
initial technology transfer was completed during the first quarter of 1995, at
which time the Company received the balance of an initial payment from SENKO,
and the royalty payment period commenced. In 1996, InnerDyne received an order
from SENKO to build a second fiber coating system which was delivered during the
first half of 1997. In April 1998, SENKO licensed InnerDyne's less complex
method for coating devices with heparin on a non-exclusive basis. The addition
of this new means of attaching the drug heparin to prevent the formation of
blood clots on a surface is expected to further enhance SENKO's oxygenator
product offering.

        In April 1996, the Company announced the signing of an agreement with
Boston Scientific Corporation ("Boston Scientific") covering the potential
application and use of InnerDyne's proprietary biocompatible coating
technologies with Boston Scientific's stents, grafts, vena cava filters and
other implantable medical devices. The agreement involved an equity investment
by Boston Scientific in InnerDyne, initial research support and future license
fees and royalty payments. Boston Scientific Corporation notified InnerDyne in
August 1998 that it had decided to proceed with the transfer of technology for
the application and use of InnerDyne's proprietary biocompatible coating
technology with Boston Scientific's stents, grafts, vena cava filters, and other
implantable medical devices. The transfer of the technology is expected to be
completed during 1999, though the Company may continue to conduct related
research if requested by Boston Scientific.

        In June 1998, InnerDyne announced the signing of an agreement with U.S.
Surgical covering the licensing of InnerDyne's proprietary siloxane coating
technology to enhance the performance of selected products used in minimally
invasive surgical procedures. Under the terms of the agreement, InnerDyne will
construct a custom coating system and provide coated product samples for testing
by U.S. Surgical in exchange for payment of initial license fees and capital
equipment costs. Assuming the testing confirms that coated samples meet U.S.
Surgical's requirements, InnerDyne will receive a final license fee payment and
will assist in the transfer of the system to a location designated by U.S.
Surgical. Coincident with transfer and system startup, a royalty payment period
would begin.

        Because of the strength of the covalent bonds used in the Company's TRC
technology and other properties noted above, the Company believes that its
technology may have advantages over presently available bioactive coating
technologies. Potential applications include the treatment of restenosis and
specific focal cancers when vascular stents, grafts, vena cava filters and other
implantable devices are coated using InnerDyne's proprietary technology with
drugs and/or isotopes. The Company has undertaken a number of discussions with
potential licensees of the Company's coating technologies, and samples of coated
products have been provided to several companies. These discussions have been
with parties interested in the use of the technologies to enhance drug delivery
or gas exchange, as well as third parties interested in the possible coating of
in-dwelling devices for various applications.

RESULTS OF OPERATIONS

        Total revenue for the three month period ended March 31, 1999 was
$4,503,794, compared to $4,205,772 for the corresponding period in 1998. Total
revenue is comprised of revenue from product sales and licensing and contract
revenue. Revenue from product sales increased to $4,431,699 for the three month
period ended March 31, 1999, from $3,801,040 for the corresponding period in
1998, reflecting increased unit sales of the Company's Step devices. Licensing
and contract revenue for the three month period ended March 31, 1999 was
$72,095, compared to $404,732 for the corresponding period in 1998. Licensing
and contract revenue for the March 31, 1999 and March 31, 1998 periods related
to agreements with third parties covering the licensing of the Company's
proprietary biocompatible coating technology. Licensing and contract revenue
fluctuates from quarter to quarter, based upon the number of agreements in
effect and the amount and timing of the payments to be made to InnerDyne
pursuant to such agreements.

        Cost of sales was $1,335,984 for the three-month period ended March 31,
1999, compared to $1,306,245 for the same period in 1998. The increase in cost
of sales for the three-month period ended March 31, 1999 is attributable to an
increase in production and sales volume compared to the same period in 1998.


                                      -13-

<PAGE>   14

        Research, development, regulatory and clinical expenses for the three
month period ended March 31, 1999 were $680,266, compared to $758,496 for the
corresponding period in 1998. The Company expects that research, development,
regulatory and clinical expenditures will increase in absolute dollars in future
periods, though it is possible that expenses associated with one or more
research programs could be funded from outside the Company, thereby possibly
reducing research and development costs funded by the Company.

        Sales and marketing expenses were $1,671,985 for the three month period
ended March 31, 1999, compared to $1,735,439 for the corresponding period ended
March 31, 1998, reflecting changes in sales management costs, and expenditures.
InnerDyne expects that sales and marketing expenses will increase in absolute
dollars in future periods reflecting the growth of the Company's sales and
marketing functions to support commercialization of its M.I.S. products.

        General and administrative expenses were $504,931 for the three-month
period ended March 31, 1999, compared to $552,573 for the corresponding period
ended March 31, 1998. The reduction was primarily due to broad-based expense
controls and a reduction in outside professional services. The Company
anticipates that general and administrative expenses will generally increase in
absolute dollars in future periods to support expanding operations.

        Other, net decreased to $40,171 for the three month period ended March
31, 1999, compared to $42,583 for the same period in 1998, primarily as a result
of decreased interest income earned on average cash and cash equivalents
balances.

LIQUIDITY AND CAPITAL RESOURCES

        From its inception to March 31, 1999 the Company has incurred a
cumulative deficit of approximately $51.4 million. Prior to fiscal year 1998,
the Company's cash expenditures exceeded its revenues. Prior to 1992, the
Company was funded primarily through private placements of equity securities. In
1992, the Company completed an initial public offering of 2,875,000 shares of
its Common Stock at $11.00 per share, which raised approximately $28.8 million
(net of underwriter's discounts and offering expenses). The 1994 acquisition of
InnerDyne Medical, Inc. was accomplished through the issuance of additional
Common Stock of the Company. In June 1995, the Company closed a private
placement of 1,435,599 shares of the Company's Common Stock and warrants to
purchase 287,200 additional shares of Common Stock, with gross proceeds to the
Company of approximately $3.2 million. In March and April of 1996, holders of
warrants to purchase an aggregate of 242,952 shares of Common Stock exercised
such warrants, resulting in gross proceeds to the Company of $704,561. The
Company concluded a public offering on May 20, 1996, with the sale of 2,650,000
shares of Common Stock at $3.50 per share, which raised $8,015,268 (net of
underwriter's discounts and offering expenses).

        At March 31, 1999, cash and cash equivalents totaled $6,170,318 compared
to a total cash and cash equivalents balance of $5,757,538 at December 31, 1998.
The Company had $129,881 in capital expenditures in the three months ended March
31, 1999. Working capital totaled $8,531,068 at March 31, 1999, and the Company
had long-term debt, excluding current installments, totaling $360,403 relating
to financing of equipment.

        In April 1999, the Company renewed its credit facility with Silicon
Valley Bank. Subject to certain covenants and conditions, the Company may borrow
up to $2,000,000 through April 23, 2000 on a revolving credit basis at prime
plus .25% based on eligible receivables. The Company also has an equipment
advance line of credit, which allows the Company to borrow up to $750,000 per
year based on eligible equipment purchases. Amounts outstanding on this
equipment advance line of credit are periodically converted to 36 month term
loans bearing interest at prime plus .25%.

        As of March 31, 1999, the Company had drawn $639,989 for financing of
working capital needs on the revolving line of credit, secured by certain
accounts receivable. Debt balances as of March 31, 1999 on the Company's balance
sheet also include amounts loaned to the Company under previous equipment lines
of credit agreements with Silicon Valley Bank.


                                      -14-
<PAGE>   15


RISK FACTORS

        History of Losses; Profitability Uncertain. InnerDyne experienced
operating losses from 1985 into mid 1998. InnerDyne reported net income of
$350,799 on revenues of $4,503,794, $425,030 on revenues of $17.6 million,
losses of $907,466 on revenues of $15.7 million, and losses of $4.6 million on
revenues of $9.1 for the three months ended March 31, 1999 and the fiscal years
ended December 31, 1998, 1997, and 1996, respectively. As of March 31, 1999,
InnerDyne had an accumulated deficit of approximately $51.4 million.

        In the future, the Company may incur additional operating losses and
have cash outflow requirements as a result of expenditures related to expansion
of sales and marketing capability, expansion of manufacturing capacity, research
and development activities, compliance with regulatory requirements, and
possible investment in or acquisition of additional complementary products,
technologies or businesses. The timing and amounts of these expenditures will
depend upon many factors, such as the availability of capital, progress of the
Company's research and development, and factors that may be beyond the Company's
control, such as the results of product trials, the requirements for and the
time required to obtain regulatory approval for existing products and any other
products that may be developed or acquired, and the market acceptance of the
Company's products. The cash needs of the Company have changed significantly as
a result of the merger completed during 1994 and the support requirements of the
added business focus areas. There can be no assurance that the Company will not
incur future losses, that the Company will be able to raise cash as necessary to
fund operations or that the Company will maintain profitability.

        Intense Competition. The primary industry in which the Company competes,
minimally invasive surgery, is dominated by two large, well-positioned entities
that are intensely competitive and frequently offer substantial discounts as a
competitive tactic. U.S. Surgical is primarily engaged in developing,
manufacturing and marketing surgical wound management products, and has
historically been the firm most responsible for providing products that have led
to the growth of the industry. U.S. Surgical supplies a broad line of products
to the M.I.S. industry, including products which facilitate access, assessment
and treatment. Ethicon has made a major investment in the M.I.S. field in recent
years and is one of the leading suppliers of hospital products in the world.
Furthermore, U.S. Surgical and Ethicon each utilize purchasing contracts that
link discounts on the purchase of one product to purchases of other products in
their broad product lines. Substantially all of the hospitals in the United
States have purchasing contracts with one or both of these entities.
Accordingly, customers may be dissuaded from purchasing access products from the
Company rather than U.S. Surgical or Ethicon to the extent it would cause them
to lose discounts on products that they regularly purchase from U.S. Surgical or
Ethicon.

        The Company faces a formidable task in successfully gaining significant
revenues within the M.I.S. access market. In order to succeed, management
believes that the Company will need to objectively demonstrate substantial
product benefits, and its sales effort must be able to effectively present such
benefits to both clinicians and health care administrators. The M.I.S. access
market is dominated by U.S. Surgical and Ethicon. Both entities introduced new
access devices during the past two years. A number of other entities participate
in various segments of the M.I.S. market, including access.

        There can be no assurance that the Company will be able to successfully
compete in the M.I.S. access market, and failure to do so would have a material
adverse effect on the Company's business, financial condition and results of
operations.

        There can be no assurance that competitors will not succeed in
developing technologies and products that are more effective than any which have
been or are being developed by the Company or that would render the Company's
technologies or products obsolete or not competitive. Such competition could
have a material adverse effect on the Company's business, financial condition
and results of operations. As a result of the entry of large and small companies
into the market, the Company expects competition for devices to increase.

                                      -15-
<PAGE>   16

        Continued Dependence on Step Products. To date, substantially all of the
Company's revenues from product sales are attributable to Step products, and
InnerDyne currently anticipates that sales of Step products will represent the
majority of the Company's revenues for the immediate future. Accordingly, the
success of the Company is largely dependent upon increased market acceptance of
its Step product line by the medical community as a reliable, safe and
cost-effective access product for minimally invasive surgery. InnerDyne
commenced commercial sales of its Step product in the fourth quarter of 1994
and, to date, sales have been made to a relatively limited number of physicians
and hospitals. Recommendations and endorsements by influential members of the
medical community are important for the increased market acceptance of the
Company's Step products, and there can be no assurance that existing
recommendations or endorsements will be maintained or that new ones will be
obtained. Failure to increase market acceptance of the Company's Step products
would have a material adverse effect upon the Company's business, financial
condition and results of operations.

        Reliance on Future Products and New Applications; Uncertainty of
Technology Changes. The medical device industry is characterized by innovation
and technological change. The Company has made significant investments in
researching and developing its proprietary technologies, including radial
dilation and biocompatible coatings. During 1999, the Company expects to
commercially introduce an intra-organ product, and possibly the REVAS vascular
access product, each of which is a further enhancement of its radial dilation
technology. The future success of the Company will depend in part on the timely
commercial introduction and market acceptance of these and other possible
products. There can be no assurance that these products will be timely
introduced in commercial quantities, if at all, or that such products will
achieve market acceptance. A failure by the Company to timely introduce such
products or a failure of such products to achieve market acceptance could have a
material adverse effect on the Company's business, financial condition and
results of operations. The future success of the Company will also depend upon,
among other factors, the ability to develop and gain regulatory clearance for
new and enhanced versions of products in a timely fashion. There can be no
assurance that the Company will be able to successfully develop new products or
technologies, manufacture new products in commercial volumes, obtain regulatory
approvals on a timely basis or gain market acceptance of such products. Delays
in development, manufacturing, regulatory approval or market acceptance of new
or enhanced products could have a material adverse impact on the Company's
business, financial condition and results of operations.

        Limited Manufacturing Experience; Compliance with Good Manufacturing
Practices. The Company initiated manufacture of commercial quantities of its
Step access device in its Salt Lake City, Utah facility during late 1994.
Accordingly, the Company has limited experience in manufacturing M.I.S. access
products or other products in commercial quantities at acceptable costs. The
Company's success will depend in part on its ability to manufacture its products
in compliance with the FDA's GMP regulations and other regulatory requirements
in sufficient quantities and on a timely basis, while maintaining product
quality and acceptable manufacturing costs. 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. In connection with its ISO 9001 certification,
InnerDyne now undergoes periodic audits by a regulatory body. The Company
believes that regulatory changes currently being introduced by the FDA will
result in a system of United States regulatory requirements for manufacturers of
medical devices which more closely resembles the ISO 9000 series of quality
systems standards adopted by most European countries. Failure to maintain
satisfactory regulatory system compliance could have a significant impact on the
Company's ability to continue to manufacture and distribute its products and, in
the most serious cases, result in the seizure or recall of products. Failure to
maintain production volumes or increase production volumes in a timely or
cost-effective manner would have a material adverse effect on the Company's
business, financial condition and results of operations.

        Potential Fluctuations in Operating Results. The Company's quarterly
operating results have in the past fluctuated and will continue to fluctuate
significantly in the future depending on the timing and shipment of product
orders, new product introductions and changes in pricing policies by the Company
or its competitors, the timing and market acceptance of the Company's new
products and product enhancements, the continued market acceptance of
InnerDyne's Step product line by the medical community, the Company's product
mix, the mix of distribution channels through which the Company's products are
sold, the extent to which the Company recognizes non-product revenues during a
quarter, and the Company's ability to obtain sufficient supplies of sole or
limited source components for its products. In particular, 


                                      -16-
<PAGE>   17

fluctuations in production volumes affect gross margins from quarter to quarter.
Furthermore, gross margins and net income or loss can fluctuate from quarter to
quarter to the extent the Company recognizes non-product revenue during a
quarter because the Company typically derives higher margins from non-product
revenue than from product sales. In response to competitive pressures or new
product introductions, the Company may take certain pricing or other actions
that could materially and adversely affect the Company's operating results. In
addition, new product introductions by the Company could contribute to quarterly
fluctuations in operating results as orders for new products commence and orders
for existing products decline.

        The Company's expense levels are based, in part, on its expectations of
future revenues. Because a substantial portion of the Company's revenue in each
quarter normally results from orders booked and shipped in the final weeks of
that quarter, revenue levels are extremely difficult to predict. If revenue
levels are below expectations, net income will be disproportionately affected
because only a small portion of the Company's expenses varies with its revenue
during any particular quarter. In addition, the Company typically does not
operate with any material backlog as of any particular date.

        As a result of the foregoing factors and potential fluctuations in
operating results, results of operations in any particular quarter should not be
relied upon as an indicator of future performance. In addition, in some future
quarter the Company's operating results may be below the expectations of public
market analysts and investors. In such event, the price of the Company's Common
Stock would likely be materially and adversely affected.

        Reliance on Collaborative Relationships; Restrictions on Activities. The
Company has entered into, and intends to continue to pursue, collaborative
arrangements with corporations and research institutions with respect to the
research, development, regulatory approval and marketing of certain of its
potential products. InnerDyne's future success may depend, in part, on its
relationship with such third parties, their strategic interest in the potential
products under development and, eventually, their success in marketing or
willingness to purchase any such products. The Company's existing and
anticipated contracts with such third parties may restrict the rights of
InnerDyne to engage in certain areas of product development, manufacturing and
marketing. In addition, these third parties may have the unilateral right to
terminate any such arrangement without significant penalty. There can be no
assurance that InnerDyne will be successful in establishing or maintaining any
such collaborative arrangements or that any such arrangements will be
successful.

        Limited Sales, Marketing and Distribution Experience. InnerDyne began
commercial sales of its first M.I.S. access product in the fourth quarter of
1994 and, therefore, has limited sales, marketing and distribution experience.
The Company is marketing its M.I.S. access products mainly to general surgeons,
gynecologists and pediatric laparoscopists. In the United States, InnerDyne
markets its products primarily through direct representatives who are employed
by the Company within selected geographical areas and a network of independent
sales representatives who typically sell other complementary M.I.S. products to
the same customer base. If the need arises, the Company may expand its sales
force, which will require recruiting and training additional personnel. There
can be no assurance that the Company will be able to recruit and train such
additional personnel in a timely fashion. Loss of a significant number of
InnerDyne's current sales personnel or independent sales representatives, or
failure to attract additional personnel, could have a material adverse effect on
the Company's business, financial condition and results of operations.

        The Company markets its products outside of the United States through
international distributors in selected foreign countries after regulatory
approvals, if necessary, are obtained. Although InnerDyne currently has
relationships with a limited number of international distributors, there can be
no assurance that the Company will be able to build a network of international
distributors capable of effectively marketing its M.I.S. access products or that
such distributors will generate significant sales of such products. The Company
has limited experience in marketing its products and faces substantial
competition from well-entrenched and formidable competitors. As a result, there
can be no assurance that the Company will successfully achieve acceptable levels
of product sales at prices which provide an adequate return. Failure to do so
would have a material adverse effect on the Company's business, financial
condition and results of operations.



                                      -17-
<PAGE>   18

        Patents and Proprietary Rights. The Company's success will depend in
large part on its ability to obtain patent protection for products and
processes, to preserve its trade secrets and to operate without infringing the
proprietary rights of third parties. Although InnerDyne has obtained certain
patents and applied for additional United States and foreign patents covering
certain aspects of its technology, no assurance can be given that any additional
patents will be issued or that the scope of any patent protection will exclude
competitors or provide a competitive advantage, or that any of the Company's
patents will be held valid if subsequently challenged. The validity and breadth
of claims covered in medical technology patents involves complex legal and
factual questions and therefore may be highly uncertain. InnerDyne also relies
upon unpatented trade secrets, and no assurance can be given that others will
not independently develop or otherwise acquire substantially equivalent trade
secrets. In addition, whether or not the Company's patents are issued, others
may hold or receive patents that contain claims having a scope that covers
products developed by InnerDyne.

        There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry, and companies in
the medical device industry have used litigation to gain competitive advantage.
Litigation involving the Company would result in substantial cost to and
diversion of management attention from the day-to-day operation of the business,
but could be necessary to enforce patents issued to the Company, to protect
trade secrets and other specialized knowledge unknown to outside parties, to
defend the Company against claimed infringement of the rights of others or to
determine the scope and validity of the proprietary rights of others. An adverse
determination in litigation could subject the Company to significant liabilities
to third parties, could require the Company to seek licenses from third parties
under less favorable terms than might otherwise be possible and could prevent
the Company from manufacturing, selling or using its products, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.

        The Company has in the past, and may in the future, receive
correspondence from third parties claiming that the Company's products or
technology infringe intellectual property rights of such third parties. The
Company and its patent counsel thoroughly review such claims and no such
outstanding claims currently exist. However, there can be no assurance that
InnerDyne will not receive additional claims that its products or technology
infringe third party rights or that third parties will not litigate such claims.
Any such occurrence could have a material adverse effect on the Company's
business, financial condition and results of operations.

        Government Regulation. Clinical testing, manufacture and sale of the
Company's products, including the Step product line, and the Company's
biocompatible coating technology, are subject to regulation by the FDA and
corresponding state and foreign regulatory agencies. Pursuant to the Federal
Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the
FDA regulates the pre-clinical and clinical testing, manufacture, labeling,
distribution and promotion of medical devices. Noncompliance with applicable
requirements can result in, among other things, fines, injunctions, civil
penalties, recall or seizure of products, total or partial suspension of
production, failure of the government to grant pre-market clearance or
pre-market approval for devices, withdrawal of marketing approvals and criminal
prosecution. The FDA also has the authority to request recall, repair,
replacement or refund of the cost of any device manufactured or distributed by
the Company.

        Before a new device can be introduced in the market, the manufacturer
must generally obtain FDA clearance of 510(k) notification or approval of a PMA.
A PMA application must be filed if a proposed device is not "substantially
equivalent" to a legally marketed Class I or Class II device, or if it is a
Class III device for which the FDA has called for PMAs. The PMA process can be
expensive, uncertain and lengthy, and a number of devices for which FDA approval
has been sought by other companies have never been approved for marketing.

        A 510(k) clearance will be granted if the submitted information
establishes that the proposed device is substantially equivalent to a legally
marketed Class I or Class II medical device or a Class III medical device for
which the FDA has not called for PMAs. For any of the Company's devices 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 


                                      -18-
<PAGE>   19

device will require a new 510(k) submission. There can be no assurance that the
Company will obtain 510(k) premarket clearance within a reasonable time frame,
or at all, for any of the devices or modifications for which it may file a
510(k).

        The Company has received clearance from the FDA for the marketing of its
Step device for use in accessing the abdominal and thoracic cavities for the
performance of minimally invasive surgical procedures. The Company has also
received FDA clearance for the marketing of its R.E.D. product for use in the
areas of gastrostomy, cystostomy, cholecystotomy, the dilation of biliary and
urethral strictures, laparoscopy and enterostomy. The Company has also received
market clearance for alternative versions of its Step and R.E.D. products,
including products designed to employ its radial dilation technology in vascular
and arthroscopic applications and for biliary indications. Although the Company
has been successful in preparing requests for 510(k) clearance, there can be no
assurance that 510(k) clearances for future products or product modifications
can be obtained in a timely manner or at all, or that any existing clearance can
be successfully maintained. A delay in receipt of, or failure to receive or
maintain, such clearances would have a material adverse effect on the Company's
business, financial condition and results of operations. Although the Company is
strictly limited to marketing its products for the indications for which they
were cleared, physicians are not prohibited by the FDA from using the products
for indications other than those cleared by the FDA. There can be no assurance
that the Company will not become subject to FDA action resulting from physician
use of its products outside of their approved indications.

        The Company has made modifications to its cleared devices that the
Company believes do not require the submission of new 510(k) notices. There can
be no assurance, however, that the FDA would agree with any of the Company's
determinations not to submit a new 510(k) notice for any of these changes or
would not require the Company to submit a new 510(k) notice for any of the
changes made to the device. If the FDA requires the Company to submit a new
510(k) notice for any device modification, the Company may be prohibited from
marketing the modified device until the 510(k) notice is cleared by the FDA.

        Any devices manufactured or distributed by the Company pursuant to FDA
clearance or approval are subject to pervasive and continuing regulation by the
FDA and certain state agencies and various foreign governments. Manufacturers of
medical devices for marketing in the United States are required to adhere to
applicable regulations setting forth detailed GMP requirements, which include
testing, control and documentation requirements. Manufacturers must also comply
with requirements that a firm report to the FDA any incident in which its
product may have caused or contributed to a death or serious injury, or in which
its product malfunctioned and, if the malfunction were to recur, it would be
likely to cause or contribute to a death or serious injury.

        The Company is registered as a manufacturer of medical devices with the
FDA. The Company is subject to routine inspection by the FDA and certain state
agencies for compliance with GMP requirements, MDR requirements and other
applicable regulations. Failure of the Company to maintain satisfactory GMP
compliance could have a significant adverse effect on the Company's ability to
continue to manufacture and distribute its products and, in the most serious
cases, could result in the seizure or recall of products, injunctions and/or
civil fines.

        Dependence on Sole Sources. The materials utilized in the Company's
M.I.S. products consist of both standard and custom components that are
purchased from a variety of independent sources. The plastic parts used in the
Step product are injection molded by outside vendors. The majority of these
parts are produced utilizing molds that have been specially machined for and are
owned by the Company. Although the Company maintains significant inventories of
molded parts, any inability to utilize these molds for any reason might have a
material adverse effect on the Company's ability to meet its customer's demand
for product. In addition to plastic parts produced from injection molds owned by
the Company, a number of other materials are available only from a limited
number of sources at the present time, including the sheath component of the
Company's Step products. Efforts to identify and qualify additional sources of
this sheath component and other key materials and components are underway.
Although InnerDyne believes that alternative sources of these components can be
obtained, internal testing and qualification of substitute vendors could require
significant lead times and additional regulatory submissions. There can be no
assurance that such internal testing and qualification or additional regulatory
approvals will be obtained in a timely fashion, if at all. Any interruption of
supply of raw materials could have a 



                                      -19-
<PAGE>   20

material adverse effect on the Company's ability to manufacture its products
and, therefore, on its business, financial condition and results of operations.

        Uncertainty Relating to Third Party Reimbursement. In the United States,
health care providers that purchase medical devices, such as the Company's
products, generally rely on third-party payors, principally federal Medicare,
state Medicaid and private health insurance plans, to reimburse all or part of
the cost of the procedure in which the medical device is being used. In
addition, certain health care providers are moving toward a managed care system
in which such providers contract to provide comprehensive health care for a
fixed cost per person. Managed care providers are attempting to control the cost
of health care by authorizing fewer elective surgical procedures. The Company is
unable to predict what changes will be made in the reimbursement methods
utilized by third-party health care payors. Furthermore, the Company could be
adversely affected by changes in reimbursement policies of governmental or
private health care payors, particularly to the extent any such changes affect
reimbursement for procedures in which the Company's products are used. Failure
by physicians, hospitals and other users of the Company's products to obtain
sufficient reimbursement from health care payors for procedures in which the
Company's products are used or adverse changes in governmental and private
third-party payors' policies toward reimbursement for such procedures would have
a material adverse effect on the Company's business, financial condition and
results of operations.

        If the Company obtains the necessary foreign regulatory approvals,
market acceptance of the Company's products in international markets would be
dependent, in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country, and include both
government-sponsored health care and private insurance. The Company intends to
seek international reimbursement approvals, although there can be no assurance
that any such approvals will be obtained in a timely manner, if at all, and
failure to receive international reimbursement approvals could have an adverse
effect on market acceptance of the Company's products in the international
markets in which such approvals are sought.

        Dependence on International Sales. In the future, the Company expects to
derive an increasing portion of its revenue from international sales. To the
extent that the Company's international sales increase in future periods, a
significant portion of the Company's revenues could be subject to the risks
associated with international sales, including economic or political
instability, shipping delays, changes in applicable regulatory policies,
fluctuations in foreign currency exchange rates and various trade restrictions,
all of which could have a significant impact on the Company's ability to deliver
products on a competitive and timely basis. Future imposition of, or significant
increases in the level of, customs duties, import quotas or other trade
restrictions could have an adverse effect on the Company's business, financial
condition and results of operations. The regulation of medical devices,
particularly in the European Economic Community, continues to expand, and there
can be no assurance that new laws or regulations will not have an adverse effect
on the Company.

        Dependence on Key Personnel. InnerDyne is dependent upon a limited
number of key management and technical personnel. The Company's future success
will depend in part upon its ability to attract and retain highly qualified
personnel. The Company will compete for such personnel with other companies,
academic institutions, government entities and other organizations. There can be
no assurance that the Company will be successful in hiring or retaining
qualified personnel. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect on the Company's
business, financial condition and results of operations.

        Product Liability; Claims in Excess of Insurance Coverage. The
development, manufacture and sale of the Company's products entail the risk of
product liability claims, involving both potential financial exposure and
associated adverse publicity. The Company's current product liability insurance
coverage limits are $3,000,000 per occurrence and $3,000,000 in the aggregate,
and there can be no assurance that such coverage limits are adequate to protect
the Company from any liabilities it might incur in connection with the
development, manufacture and sale of its current and potential products. Product
liability insurance is expensive and may not be available in the future on
acceptable terms, or at all. In addition, if such insurance is available, there
can be no assurance that the limits of coverage of such policies will be


                                      -20-
<PAGE>   21

adequate. A successful product liability claim in excess of the Company's
insurance coverage could have a material adverse effect on the Company's
business, financial condition and results of operations.

        Stock Price Volatility. The stock market in general and stocks of
medical device companies in particular, have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock. In addition,
the market price of the Company's Common Stock has been and is likely to
continue to be highly volatile. Factors such as fluctuations in the Company's
operating results, announcements of technological innovations or new products by
the Company or its competitors, FDA and international regulatory actions,
actions with respect to reimbursement matters, developments with respect to
patents or proprietary rights, public concern as to the safety of products
developed by the Company or others, changes in health care policy in the United
States and internationally, changes in stock market analyst recommendations
regarding the Company, other medical device companies or the medical device
industry generally or general market conditions may have a significant effect on
the market price of the Common Stock.

        Environmental Regulations. The Company is subject to a variety of local,
state and federal governmental regulations relating to the use, storage,
handling, manufacture and disposal of toxic and other hazardous substances used
to manufacture the Company's products. The Company believes that it is currently
in compliance in all material respects with applicable governmental
environmental regulations. Nevertheless, the failure by the Company to comply
with current or future environmental regulations could result in the imposition
of substantial fines on the Company, suspension of production, alteration of its
manufacturing processes or cessation of operations. Compliance with such
regulations could require the Company to acquire expensive remediation equipment
or to incur substantial expenses. Any failure by the Company to control the use,
disposal, removal or storage of, or to adequately restrict the discharge of, or
assist in the cleanup of, hazardous or toxic substances, could subject the
Company to significant liabilities, including joint and several liability under
certain statutes. The imposition of such liabilities could have a material
adverse effect on the Company's business, financial condition, and results of
operations.

        Control by Directors and Principal Stockholders. As of March 31, 1999,
directors and principal stockholders of the Company, and certain of their
affiliates, beneficially owned approximately 26% of the Company's outstanding
Common Stock. Accordingly, these persons, as a group, may be able to control the
Company and significantly affect the direction of the Company's affairs and
business, including any determination with respect to the acquisition or
disposition of assets by the Company, future issuances of Common Stock or other
securities by the Company and the election of directors. Such concentration of
ownership may also have the effect of delaying, deferring or preventing a change
in control of the Company.

        Anti-Takeover Effect of Certain Charter Provisions of Common Stock.
Provisions of the Company's Certificate of Incorporation that allow the Company
to issue Preferred Stock without any vote or further action by the stockholders,
the fact that the Company's Certificate of Incorporation does not permit
stockholders to cumulate votes in the election of directors as well as the
Company's adoption of a poison pill Preferred Share Purchase Rights plan in
September 1997 may have the effect of making it more difficult for a third party
to acquire, or of discouraging a third party from attempting to acquire, control
of the Company. Certain provisions of Delaware law applicable to the Company
could also delay or make more difficult a merger, tender offer or proxy contest
involving the Company, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years unless certain conditions are met. The
possible issuance of Preferred Stock, the inability of stockholders to cumulate
votes in the election of directors, the poison pill and provisions of Delaware
law could have the effect of delaying, deferring or preventing a change in
control of the Company, including without limitation, discouraging a proxy
contest or making more difficult the acquisition of a substantial block of the
Company's Common Stock. The possible issuance of Preferred Stock, the poison
pill and these provisions could also limit the price that investors might be
willing to pay in the future for shares of the Company's Common Stock.

                                      -21-
<PAGE>   22

        Risks Associated With Software and Hardware and the Year 2000. InnerDyne
relies on a variety of internal computer systems and programs in the operation
of its business. The Company is currently in the process of testing and
upgrading, where necessary, the software and hardware products used in its
operations with respect to the year 2000 issue. The Company's internal systems
run on personal computers and microprocessor-based computer servers set up in a
workstation environment which the Company believes are not susceptible to
universal failures. Were system failures to occur as a result of the year 2000
issue, the Company believes that its on-site engineers and technical personnel
should be able to address and resolve such issues prior to the occurrence of any
material adverse effect on the Company's business operations.

        The failure of certain of the systems upon which the Company relies,
such as payroll and banking services, could be disruptive to the Company's
business operations if such systems were unavailable for an extended period of
time. The Company is in the process of making inquiries with the providers of
such types of services to determine their year 2000 readiness. However, the
Company believes that its business operations would not be materially adversely
effected by short disruptions in such services and that the providers of such
services (who also typically service many other business customers) will take
steps to rectify any failures as soon as possible. More generally, the Company
does not believe that the power grid or general communications, building
security and similar systems expose the Company to any unique year 2000 risks as
compared to other businesses.

        The Company faces year 2000 risk from third-party suppliers.
Notwithstanding written assurances from the Company's vendors regarding year
2000 compliance, there is no guarantee that the year 2000 will not cause a
disruption in the supply of critical components necessary for the Company's
products. Given the Company's reliance on suppliers of critical, sole-sourced
components, the Company is relying on these suppliers to address the year 2000
issues in their own products and operations, and the failure of such suppliers
to adequately address these issues could have a material adverse effect on the
Company's business, financial condition and results of operations. As a
contingency plan in the event that any of such suppliers do not or are unable to
address material year 2000 issues, the Company intends to stockpile an inventory
of raw materials and molded parts in order to maintain a one month backlog of
such components.

        The Company has not incurred substantial costs to date to address the
year 2000 issue and estimates that the additional cost, if any, arising from
actions taken by the Company to address year 2000 problems will not be material.

        Despite the Company's efforts to address the year 2000 impact on its
internal systems and business operations, the year 2000 issue may result in a
material disruption of its business or have a material adverse effect on the
Company's business, financial condition or results of operations.


                                      -22-
<PAGE>   23


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

        The following discusses our exposure to market risk related to changes
in interest rates, equity prices, and foreign currency exchange rates. This
discussion contains forward-looking statements that are subject to risks and
uncertainties. Actual results could vary materially as a result of a number of
factors including those set forth in the Risk Factors section.

        Interest Rate Risk: As of March 31, 1999, InnerDyne had short-term
investments of $5,862,608. Substantially all of these short-term investments
consist of highly liquid money market funds and commercial paper investments
with remaining maturities at the date of purchase of less than ninety days.
These investments are subject to interest rate risk and will decrease in value
if market interest rates increase. A hypothetical increase or decrease in market
interest rates by 10 percent from the March 31, 1999 rates would cause the fair
market value of these short-term investments to change by an immaterial amount.
We have the ability to hold these investments until maturity, and therefore, we
do not expect the value of these investments to be affected to any significant
degree by the effect of a sudden change in market interest rates. Declines in
interest rates over time will, however, reduce our interest income. The Company
has not used derivative financial instruments.

        InnerDyne does not own any equity investments. Therefore, we do not
currently have any direct equity price risk. All InnerDyne revenues are realized
in U.S. dollars; therefore, we do not believe that the Company currently has any
significant direct foreign currency exchange rate risk.

        Foreign Currency Risk: International revenues were less than 10% of
total revenue for the quarter ended March 31, 1999. International sales are made
mostly through international distributors with payments to the Company typically
in U.S. dollars. The Company's international business is subject to risks
typical of an international business, including, but not limited to differing
economic conditions, changes in political climate, differing tax structures,
other regulations and restrictions, and foreign exchange rate volatility.
Accordingly, the Company's future results could be materially adversely impacted
by changes in these or other factors. The effect of foreign exchange rate
fluctuations on the Company during the first quarter of 1999 was not material.



                                      -23-
<PAGE>   24





PART II. OTHER INFORMATION

Item 1. Legal Proceedings

        Not Applicable.

Item 2. Changes in Securities and Use of Proceeds

        Not Applicable.

Item 3. Defaults upon Senior Securities

        Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders

        Not Applicable.

Item 5. Other Information

        Not Applicable.

Item 6. Exhibits and Reports on Form 8-K

(a)     Exhibits:
        Exhibit Number 27.01:       Financial Data Schedule

(b)     Reports on Form 8-K:        The Company did not file any reports on 
                                    Form 8-K during the quarter ended March 31, 
                                    1999.




                                      -24-
<PAGE>   25

                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.


INNERDYNE, INC.



/s/ Robert A. Stern
-------------------------------------------
Robert A. Stern
Vice President and Chief
Financial Officer
(Duly Authorized Signatory,
Principal Financial and Accounting Officer)





Date:   May 13, 1999




                                      -25-
<PAGE>   26
                                EXHIBIT INDEX

Exhibit 
Number                           Description
-------                         -------------
27.01                      Financial Data Schedule