<PAGE>   1
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                                  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, 1998 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)

                    1244 REAMWOOD AVENUE, SUNNYVALE, CA 94089
                    (Address 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, 1998 was 21,753,251.

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



<PAGE>   2
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                               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. ..........................................7

Item 3.    Quantitative and Qualitative Disclosures About Market Risk .........21

PART II.   OTHER INFORMATION ..................................................22

Item 1.    Legal Proceedings                                                   22

Item 2.    Changes in Securities and use of Proceeds                           22

Item 3.    Defaults upon Senior Securities                                     22

Item 4.    Submission of Matters to a vote of Security Holders                 22

Item 5.    Other Items                                                         22

Item 6.    Exhibits and Reports on Form 8-K                                    22
</TABLE>

           Signature Page



                                      -2-
<PAGE>   3
                          PART I- FINANCIAL INFORMATION

Item 1. -  Financial Statements

                                 INNERDYNE, INC.
                            CONDENSED BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>
                                                                        MARCH 31,        DECEMBER 31,
                                                                          1998              1997
                                                                      (UNAUDITED)        (*SEE NOTE)
                                                                      ------------       ------------
<S>                                                                   <C>                <C>         
Current assets:

   Cash and cash equivalents ...................................      $  5,120,127       $  6,091,497
   Accounts receivable .........................................         2,533,088          1,920,966
   Interest and other receivables ..............................           649,912            702,606
   Inventory ...................................................         1,330,568          1,454,266
   Prepaid expenses and other ..................................           180,666            116,821
                                                                      ------------       ------------

     Total current assets ......................................         9,814,361         10,286,156

Equipment and leasehold improvements, net ......................           898,305            987,241
Other assets ...................................................            45,695             45,695
                                                                      ------------       ------------

     Total assets ..............................................      $ 10,758,361       $ 11,319,092
                                                                      ============       ============


                                 LIABILITIES AND
                              STOCKHOLDERS' EQUITY

Current liabilities:

   Line of credit ..............................................      $    300,000       $    300,000
   Current installments of long-term debt ......................           340,543            340,543
   Accounts payable ............................................           138,855            489,602
   Accrued liabilities .........................................         1,447,119          1,504,336
                                                                      ------------       ------------
      Total current liabilities ................................         2,226,517          2,634,481

Long-term debt, excluding current installments .................           582,783            649,061

Stockholders' equity:
   Common stock ................................................           217,621            217,549
   Additional paid-in- capital .................................        60,017,883         60,000,046
   Accumulated deficit .........................................       (52,286,443)       (52,182,045)
      Net stockholders' equity .................................      $  7,949,061       $  8,035,550
                                                                      ------------       ------------
Total Liabilities and Stockholders equity ......................      $ 10,758,361       $ 11,319,092
</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, 1998    MARCH 31, 1997
                                                           ------------       ------------
<S>                                                        <C>                <C>         
Product, licensing and contract revenue .............      $  4,205,772       $  2,951,204

  Cost of sales .....................................         1,306,245          1,240,938

  Research, development, regulatory and clinical ....           758,496            621,904

  Sales and marketing ...............................         1,735,439          1,271,780

  General and administrative ........................           552,573            526,316
                                                           ------------       ------------

     Total costs and expenses .......................         4,352,753          3,660,938
                                                           ------------       ------------

     Operating loss .................................          (146,981)          (709,734)

Other net ...........................................            42,583             56,223
                                                           ------------       ------------

     Net loss .......................................      $   (104,398)      $   (653,511)
                                                           ============       ============

Basic and Diluted loss per share ....................      $       (.00)      $       (.03)
                                                           ============       ============

Basic and Diluted weighted average shares outstanding        21,756,586         21,618,093
                                                           ============       ============
</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,
                                                                         1998              1997
                                                                     -----------       -----------
<S>                                                                  <C>               <C>         
Cash flows from operating activities:
Net loss ......................................................      $  (104,398)      $  (653,511)
Adjustments to reconcile net loss to net cash used in operating
activities:
   Depreciation and amortization ..............................          132,693           154,896
   Decrease (increase) in receivables .........................         (559,428)         (623,581)
   Decrease in inventories ....................................          123,698           168,059
   Increase in prepaid expenses, and other assets .............          (63,845)          (62,037)
   Increase (decrease) in accounts payable ....................         (350,746)           80,900
   Decrease in accrued expenses ...............................          (57,217)          (73,360)
                                                                     -----------       -----------

Net cash used in operating activities .........................         (879,243)       (1,008,634)
                                                                     -----------       -----------

Cash flows from investing activities:
Capital expenditures ..........................................          (43,757)          (94,825)
                                                                     -----------       -----------

Net cash used in investing activities .........................          (43,757)          (94,825)
                                                                     -----------       -----------

Cash flows from financing activities:
   Proceeds from issuance of common stock, net ................           17,909             5,966
   Principal payments on long-term debt, capital leases .......          (66,278)          (15,117)

Net cash used in financing activities .........................          (48,370)           (9,151)
                                                                     -----------       -----------


Net decrease in cash and cash equivalents .....................         (971,370)       (1,112,610)

Cash and cash equivalents at beginning of period ..............        6,091,497         7,270,285
                                                                     -----------       -----------

Cash and cash equivalents at end of period ....................      $ 5,120,127       $ 6,157,675
                                                                     ===========       ===========
</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, 1998 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, 1997.


(2)     INVENTORIES

        Inventories consist of the following:

<TABLE>
<CAPTION>
                                               MARCH 31,     DECEMBER 31,
                                                 1998          1997
                                             ----------      ----------
                                            (UNAUDITED)
<S>                                          <C>             <C>       
         Raw materials and supplies ...      $  882,324      $  870,627
         Finished goods ...............         448,244         583,639
                                             ----------      ----------

         Net inventory ................      $1,330,568      $1,454,266
                                             ==========      ==========
</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 ending March 31, 1998
and 1997 comprehensive loss was equal to the net loss as presented in the
accompanying statement of operations.




                                      -6-
<PAGE>   7

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 Step(TM)
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, 1997
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. In December 1996, the Company announced the
signing of an agreement which grants United States Surgical Corporation ("U.S.
Surgical") exclusive worldwide sales and marketing rights for the Company's
proprietary thermal ablation technology. 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 selected 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.

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, and the result is 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 at each site where it is utilized,
creating only a small puncture wound. Following removal of the needle, a sheath
that surrounds the 



                                      -7-
<PAGE>   8

needle is then dilated up 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 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 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.

        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.

        Mini Step. The Mini Step is a small-diameter radially dilating access
device designed for use in office micro-laparoscopic surgery utilizing small
instruments, and in tubal ligation and pediatric procedures. The working
diameter of the Mini Step ranges from a nominal 2mm to 8mm. Like the Step
device, the 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 is expected to be commercially introduced in
1998.




                                      -8-
<PAGE>   9

        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 is expected to be commercially introduced in the second quarter of 1998.

        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
by the scope. 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 filed a 510(k) application for intra-organ
indications of its Step products with the FDA 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. These
sales representatives are managed on a regional basis by InnerDyne management
employees. In order to attempt 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 and may allow the Company to more effectively compete for a portion of
the minimally invasive surgical access business in these hospitals.

        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. InnerDyne announced an agreement covering the
development and potential use of its proprietary radial dilation technology for
specialized vascular access with EndoTex Interventional Systems in 1996. The
agreement covers the development of access products expected to be used in
conjunction with EndoTex's technologies to treat carotid disease and aortic
aneurysms.

        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 as a result of the sale of SDG to another corporation.

        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, if the value statement is positive. The
Company proceeded with animal studies and device refinements in the third and
fourth quarters of 1997 and will continue testing the product concept in
conjunction with cardiology advisors. If the trial results are positive and
subsequent human use demonstrates clinical benefits, the Company will explore
alternative methods of effective distribution in the interventional vascular
marketplace and may launch a radial dilation vascular access device during 1998,
or in subsequent years.

        InnerDyne also committed resources to an investigation of the potential
market opportunity in arthroscopic procedures during 1997. Limited clinical
usage of the initial design accompanied by substantial exposure and feedback
from arthroscopic surgeons was completed during the last half of 1997. The
Company is exploring the potential this product may have, if any, and
alternative distribution methods in the arthroscopic marketplace. InnerDyne
expects to 


                                      -9-
<PAGE>   10

complete the arthroscopic market opportunity assessment by the end of the second
quarter of 1998. In addition, the Company is exploring the potential use of its
proprietary radial dilation technology in other applications, such as access for
thoracic and tracheal procedures, and is likely to increase resources associated
with the pursuit of one or more of these opportunities in the ensuing quarters.
Developmental expenditures for new applications for the Company's proprietary
radial dilation technology may impact the timing and achievement of sustained
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.

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. The EnAbl System,
which includes a control console, a reusable handpiece, and a disposable probe,
enables the clinician to fill the uterus with normal saline solution, which is
then heated. The heated solution ablates -- or destroys -- the uterine lining,
the source of the abnormal bleeding. The EnAbl System is designed to help
physicians treat women suffering from this common and often debilitating
condition in a minimally invasive and less costly manner, with potentially fewer
complications. The system is expected to be easy for the physician to use, and
to offer the possibility to conduct the procedure under local anesthesia. As a
result, the procedure may take less time than currently available therapies and
can potentially be performed in an outpatient surgery center or a physician's
office. Although this procedure is expected to result in the infertility of the
patient, the Company believes that the EnAbl System has the potential to result
in fewer complications and adverse side effects and reduced recovery times
compared to most current therapies. For these reasons the Company also believes
that the EnAbl System has the potential to be more cost-effective than many
current therapies. The Company has completed initial safety and preliminary
efficacy trials with this system. The results of these limited trials indicate
that the EnAbl System may represent a safe means of ablating uterine tissue.
However, there can be no assurance that the feasibility of this technology will
be satisfactorily demonstrated in expanded efficacy trials or that the system
will be successfully commercialized.

        In December 1996, InnerDyne announced that it had signed an agreement
which granted 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. As of
March 31, 1998, the Company had effectively transferred all technology and
related development responsibility for the EnAble project to U.S. Surgical.

        Licensing, contract and grant revenues will continue to fluctuate from
year to year, and 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, and depends on whether the licensee can satisfy
performance milestones.

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 


                                      -10-
<PAGE>   11

tether molecule is covalently bonded to the bioactive molecule or radioisotope.
Because both points of attachment utilize covalent 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.
The company developed a less complex method of coating devices with a TRC
coating which was commercially introduced in the first quarter of 1998.
InnerDyne is developing a proprietary coating technology to which rhenium-188 or
other radioisotope can be attached just prior to a therapeutic intervention to
possibly reduce restenosis in patients who have had interventional vascular
procedures. The isotope coating chemistry may also have applications in the
fields of oncology and the treatment of arthritis.

        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 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 March 1998, SENKO licensed InnerDyne's less complex
method of coating devices with a TRC coating on a non-exclusive basis.

        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 involves an equity investment
by Boston Scientific in InnerDyne, initial research support and future license
fees and royalty payments if Boston Scientific decides to proceed with
technology transfer. Boston Scientific is expected to make a decision with
respect to technology transfer in 1998.

        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 for the
development of InnerDyne's proprietary method of labeling or attaching
radioactivity to implantable devices. The ORNL researchers will help to optimize
chemical methods required to efficiently attach a radioactive source to stents.
Generators from ORNL and this new technology will be provided to investigators
at BNL who will, in conjunction with the Interventional Cardiology Group at the
State University of New York at Stonybrook, prepare the radioactive stents and
implant them into the arteries of swine and rabbits to evaluate the
effectiveness of this unique and potentially powerful new approach to inhibit
restenosis. Management believes that the combination of InnerDyne and Oak Ridge
National Laboratory technologies may positively impact the overall costs
associated with stenting procedures, if successful, by providing a method of
attaching a radioisotope just prior to implantation to inhibit restenosis.

        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 in several potential applications, including the coating of
vascular stents, grafts, vena cava filters and other implantable devices. 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 gas exchange, as well as
third parties interested in the possible coating of in-dwelling devices for
various applications.



                                      -11-
<PAGE>   12
RESULTS OF OPERATIONS

        Total revenue for the three month period ended March 31, 1998 was
$4,205,772, compared to $2,951,204 for the corresponding period in 1997. Total
revenue is comprised of revenue from product sales and licensing and contract
revenue. Revenue from product sales increased to $3,801,040 for the three month
period ended March 31, 1998, from $2,519,154 for the corresponding period in
1997, reflecting increased sales of the Company's Step devices, and a price
increase implemented January 1, 1998 to offset increased labor and raw material
costs. Licensing and contract revenue for the three month period ended March 31,
1998 was $404,732, compared to $432,050 for the corresponding period in 1997.
Licensing and contract revenue for the March 31, 1998 and March 31, 1997 periods
related to agreements with third parties covering the development of the
Company's proprietary thermal ablation technology, and the licensing of the
Company's proprietary biocompatible coating technology. Licensing and contract
revenue for the March 31, 1997 period also related to the development of
non-competing applications for the Company's radial dilation 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 $1,306,245 for the three month period ended March 31,
1998, compared to $1,240,938 for the same period in 1997. The increase in cost
of sales for the three month period ended March 31, 1998 is attributable to the
increase in production and sales volume compared to the same period in 1997.

        Research, development, regulatory and clinical expenses for the three
month period ended March 31, 1998 were $758,496, compared to $621,904 for the
corresponding period in 1997. 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 expected costs.

        Sales and marketing expenses were $1,735,439 for the three month period
ended March 31, 1998, compared to $1,271,780 for the corresponding period ended
March 31, 1997, reflecting the growth of the Company's sales and marketing
functions to support commercialization of its M.I.S. products. InnerDyne expects
that sales and marketing expenses will generally continue to increase in
absolute dollars in future periods.

        General and administrative expenses were $552,573 for the three month
period ended March 31, 1998, compared to $526,316 for the corresponding period
ended March 31, 1997. 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 $42,583 for the three month period ended March
31, 1998, compared to $56,223 for the same period in 1997, primarily as a result
of decreased interest income earned on lower average cash and cash equivalents
balances.

        The Company incurred a net loss of $104,398, or $0.00 per share, for the
three month period ended March 31, 1998, compared to a net loss of $653,511, or
$.03 per share, for the same period in 1997. Management believes that the
Company is likely to incur operating losses at least through 1998.


                                      -12-
<PAGE>   13
LIQUIDITY AND CAPITAL RESOURCES

        From its inception to March 31, 1998, the Company has incurred a
cumulative net loss of approximately $52 million. Since inception, the Company's
cash expenditures have 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 commissions 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 commissions and offering expenses).

        At March 31, 1998, cash and cash equivalents totaled $5,120,127 compared
to a total cash and cash equivalents balance of $6,091,497 at December 31, 1997.
The Company had $43,757 in capital expenditures in the three months ended March
31, 1998. Working capital totaled $7,587,844 at March 31, 1998, and the Company
had long-term debt, excluding current installments, totaling $582,783 relating
to financing of equipment.

        In June 1997, 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 June 18, 1998 on a revolving credit basis at prime plus
1% based on eligible receivables. The Company also has an equipment advance line
of credit, which allows the Company to borrow up to $500,000 per year based on
eligible equipment purchases. Amounts outstanding on this equipment advance line
of credit are periodically converted to 48 month term loans bearing interest at
prime plus 1%. As of March 31, 1998, the Company had drawn $300,000 for
financing of working capital needs on the revolving line of credit, secured by
certain accounts receivable, and had borrowed $216,793 under the current
agreement with Silicon Valley Bank for the financing of capital expenditures.
Debt balances as of March 31, 1998 on the Company's balance sheet also include
amounts loaned to the Company under previous equipment lines of credit
agreements with Silicon Valley Bank.

        In the future, the Company expects to incur substantial 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 progress of the
Company's research and development, and will include 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 Company's capital requirements will depend on numerous factors,
including market acceptance and demand for its products; the resources the
Company devotes to the development, manufacture and marketing of its products;
the progress of the Company's clinical research and product development
programs; the receipt of, and the time required to obtain regulatory clearances
and approvals; the resources required to protect the Company's intellectual
property; and other factors. The timing and amount of such capital requirements
cannot be accurately predicted. Funds may also be used for the acquisition of
businesses, products and technologies that are complementary to those of the
Company. Consequently, although the Company believes that the proceeds of the
public offering of shares of its Common Stock completed in May 1996, together
with revenues, credit facilities and other sources of liquidity, will provide
adequate funding for its capital requirements through at least 1998, the Company
may be required to raise additional funds through public or private financings,
collaborative relationships or other arrangements. There can be no assurance
that the Company will not require additional funding or that such additional
funding, if needed, will be available on terms attractive to the Company, or at
all. Any additional equity financings may be dilutive to stockholders, and debt
financing, if available, may involve restrictive covenants.


                                      -13-
<PAGE>   14
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

        History of Losses; Profitability Uncertain. InnerDyne has experienced
operating losses since its inception in December 1985. InnerDyne reported net
losses of $0.1 million on revenues of $4.2 million, $0.9 million on revenues of
$15.7 million, $4.6 million on revenues of $9.1 million and $5.6 million on
revenues of $5.3 million for the three months ended March 31, 1998 and the
fiscal years ended December 31, 1997, 1996 and 1995, respectively. As of March
31, 1998, InnerDyne had an accumulated deficit of approximately $52 million.

        In the future, the Company expects to incur substantial 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 continue to incur losses, that the Company
will be able to raise cash as necessary to fund operations or that the Company
will ever achieve 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.

        In the thermal ablation market, the primary competition for the EnAbl
System is current therapies for the treatment of excessive menstrual bleeding,
including drug therapy, dilatation and curettage, surgical endometrial ablation
and hysterectomy. The EnAbl System will also compete against other techniques
under development and initial introduction for the treatment of excessive
menstrual bleeding, including endometrial ablation techniques that employ RF
energy or freezing techniques ("cryoablation") and the uterine balloon therapy
system being commercialized by GyneCare, Inc., a division of Johnson & Johnson.


                                      -14-
<PAGE>   15
        Additionally, there are other companies developing alternative methods
of uterine tissue ablation that compete with the EnAbl System. There can be no
assurance that these companies will not succeed in developing technologies and
products that are more effective than any which have been or are being developed
by the Company and U.S. Surgical 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 and systems used to treat
excessive menstrual bleeding to increase.

        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, thermal ablation and biocompatible coatings. During 1998, the Company
expects to commercially introduce the Open-Step, and possibly the One-Step, each
of which is a further enhancement of its Step product line. The future success
of the Company will depend in part on the timely commercial introduction and
market acceptance of these 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 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 



                                      -15-
<PAGE>   16

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, 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.


                                      -16-
<PAGE>   17

        The Company expects to market 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.

        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, the EnAbl System 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 preclinical 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 premarket clearance or premarket
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



                                      -17-
<PAGE>   18

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. The
EnAbl System is subject to the PMA approval process prior to marketing by U.S.
Surgical within the United States. There can be no assurance that U.S. Surgical
will be able to obtain the necessary regulatory approval on a timely basis, or
at all, and a delay in receipt of or failure to receive such approval could have
a material adverse effect on the Company's business, financial condition and
results of operations.

        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 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 Medical Device Reporting ("MDR") 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.


                                      -18-
<PAGE>   19

        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 customers' 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 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



                                      -19-
<PAGE>   20

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 $2,000,000 per occurrence and $2,000,000 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. In
addition, the Company may require increased product liability insurance. 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
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 Company's 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, 1998,
directors and principal stockholders of the Company, and certain of their
affiliates, beneficially owned approximately 25% 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 



                                      -20-
<PAGE>   21

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.

        Year 2000. The Company has conducted a comprehensive review of its
computer systems to identify the systems that could be affected by the "Year
2000" issue and is developing an implementation plan to resolve the issue. The
Year 2000 problem is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a major system
failure or miscalculations. The Company presently believes that, with
modifications to existing software and converting to new software, the Year
2000 problem will not pose significant operational problems for the Company's
computer systems as so modified and converted. However, if such modifications
and conversions are not completed in a timely manner, the Year 2000 problem
could have a material impact on the operations of the Company.



Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

         Not Applicable.



                                      -21-
<PAGE>   22
Part II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

               Not Applicable.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

        (a)    Not Applicable.

        (b)    Not Applicable.

        (c)    Not Applicable.
        (d)    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 ITEMS

               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, 1998.



                                      -22-
<PAGE>   23
                                   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, 1998

                                      -23-
<PAGE>   24
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
Exhibit
Number                     Description
------                     -----------
<S>              <C>
27.01            Financial Data Schedule
</TABLE>