<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, 2000 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 April 30, 2000 was 22,838,768.

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

<PAGE>   2

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>


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

Item 1.    Financial Statements


           Condensed Balance Sheets                                                                 1

           Condensed Statements of Operations                                                       2

           Condensed Statements of Cash Flows                                                       3

           Notes to Condensed Financial Statements                                                  4

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of
           Operations                                                                               6

Item 3.    Quantitative and Qualitative Disclosures About Market Risk                              24


PART II.  OTHER INFORMATION

Item 1.    Legal Proceedings                                                                       25

Item 2.    Changes in Securities and Use of Proceeds                                               25

Item 3.    Defaults upon Senior Securities                                                         25

Item 4.    Submission of Matters to a Vote of Security Holders                                     25

Item 5.    Other Information                                                                       25

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

           Signature Page                                                                          26

           Exhibit Index                                                                           27
</TABLE>



<PAGE>   3


                          PART I- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                                 INNERDYNE, INC.
                            CONDENSED BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>

                                                                        MARCH 31,          DECEMBER 31,
                                                                          2000               1999
                                                                       (UNAUDITED)         (*SEE NOTE)
                                                                      -------------       -------------
<S>                                                                   <C>                 <C>
Current assets:

   Cash and cash equivalents ...................................      $   7,934,671       $   6,862,313
   Accounts receivable, net ....................................          3,720,835           3,524,228
   Interest and other receivables ..............................            164,111             170,110
   Inventories .................................................          1,844,962           1,602,143
   Prepaid expenses and other ..................................            941,088             197,874
                                                                      -------------       -------------
                                                                         14,605,667          12,356,668
     Total current assets
Equipment and leasehold improvements, net ......................            610,105             721,846
Deposits .......................................................             69,167              67,167
                                                                      -------------       -------------
     Total assets                                                     $  15,284,939       $  13,145,681
                                                                      =============       =============


                                   LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

   Line of credit ..............................................      $     639,989       $     639,989
   Current installments of long-term debt ......................            235,731             284,816
   Accounts payable ............................................            274,280             234,911
   Accrued liabilities .........................................          1,575,375           1,189,836
                                                                      -------------       -------------
      Total current liabilities ................................          2,725,375           2,349,552

Long-term debt, excluding current installments .................            210,658             232,797

Stockholders' equity:
   Common stock ................................................            226,473             221,536
   Additional paid-in-capital ..................................         61,272,665          60,618,436
   Accumulated deficit .........................................        (49,150,232)        (50,276,640)
                                                                      -------------       -------------
      Net stockholders' equity .................................      $  12,348,906       $  10,563,332
                                                                      -------------       -------------

Total Liabilities and Stockholders equity ......................      $  15,284,939       $  13,145,681
                                                                      =============       =============
</TABLE>

* Condensed from audited financial statements.

See accompanying notes to condensed financial statements.


                                       1

<PAGE>   4


                                 INNERDYNE, INC.
                       CONDENSED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

<TABLE>
<CAPTION>


                                                                                THREE-MONTHS ENDED
                                                                                ------------------
                                                                         MARCH 31, 2000      MARCH 31, 1999
                                                                         --------------      --------------
Revenues:
<S>                                                                      <C>                 <C>
        Licensing, contract, and grant revenue ....................      $    5,588,287      $    4,503,794
Costs and expenses:

        Cost of product sales .....................................           1,452,327           1,335,984

        Research, development, regulatory, and clinical ...........             748,847             680,266

        Sales and marketing .......................................           2,253,381           1,671,985

        General and administrative ................................             625,842             504,931
                                                                         --------------      --------------

               Total costs and expenses ...........................           5,080,397           4,193,166
                                                                         --------------      --------------

               Operating profit (loss) ............................             507,890             310,628
Other income (expense):

        Interest/other income, net ................................              55,568              40,171
                                                                         --------------      --------------

Income before income taxes ........................................             563,458             350,799
                                                                         --------------      --------------

        Income tax benefit ........................................             562,951                  --
                                                                         --------------      --------------

               Net income .........................................           1,126,409      $      350,799
                                                                         ==============      ==============
Net income per share:

        Basic .....................................................      $         0.05      $         0.02
                                                                         --------------      --------------

        Diluted ...................................................      $         0.05      $         0.02
                                                                         ==============      ==============
Weighted average basic and diluted common shares outstanding:

        Basic .....................................................          22,307,440          21,891,630
                                                                         --------------      --------------

        Diluted ...................................................          24,847,091          23,060,584
                                                                         --------------      --------------

</TABLE>

            See accompanying notes to condensed financial statements.

                                       2
<PAGE>   5

                                 INNERDYNE, INC.
                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<TABLE>
<CAPTION>

                                                                               THREE-MONTHS ENDED
                                                                               ------------------
                                                                           MARCH 31,          MARCH 31,
                                                                             2000               1999
                                                                         ------------       ------------

Cash flows from operating activities:
<S>                                                                      <C>                <C>
Net income ........................................................      $  1,126,409       $    350,799
Adjustments to reconcile net income to net cash provided by
operating activities:
   Depreciation and amortization ..................................           139,038            125,070
   Compensation expense on stock options ..........................            15,612                  0
   Decrease (increase) in receivables .............................          (190,609)           114,257
   Increase in inventories ........................................          (242,819)           (37,258)
   Increase in prepaid expenses, other, and deposits ..............          (745,214)           (51,171)
   Increase (decrease) in accounts payable ........................            39,369            (56,297)
   Increase (decrease) in accrued liabilities .....................           385,539           (143,756)
                                                                         ------------       ------------

Net cash provided by operating activities .........................           527,325            301,644
                                                                         ------------       ------------

Cash flows used in investing activities:  Capital expenditures ....           (27,297)          (129,881)
                                                                         ------------       ------------

Cash flows from financing activities:
   Proceeds from issuance of common stock, net ....................           643,554             15,000
   Proceeds from issuance of long-term debt .......................                 -            418,016
   Principal payments on long-term debt ...........................           (71,224)          (191,999)
                                                                         ------------       ------------

Net cash provided by financing activities .........................           572,330            241,017
                                                                         ------------       ------------

Net increase in cash and cash equivalents .........................         1,072,358            412,780

Cash and cash equivalents at beginning of period ..................         6,862,313          5,757,538
                                                                         ------------       ------------

Cash and cash equivalents at end of period ........................      $  7,934,671       $  6,170,318
                                                                         ============       ============
</TABLE>


            See accompanying notes to condensed financial statements.


                                       3
<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, 2000 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, 1999.


(2)     INVENTORIES

        Inventories consist of the following:

<TABLE>
<CAPTION>

                                                                            MARCH 31,         DECEMBER 31,
                                                                              2000               1999
                                                                         --------------      --------------
                                                                          (UNAUDITED)

<S>                                                                      <C>                 <C>
Raw materials and supplies ........................................      $    1,455,033      $    1,339,016
Finished goods ....................................................             754,978             583,126
Reserve for obsolescence ..........................................            (365,049)           (319,999)
                                                                         --------------      --------------
Net inventory .....................................................      $    1,844,962      $    1,602,143
                                                                         ==============      ==============
</TABLE>


(3)     COMPREHENSIVE INCOME

        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, 2000 and
1999 comprehensive income was equal to the net income as presented in the
accompanying statement of operations.

(4)     NET INCOME PER COMMON SHARE

        Net income per common share is the amount of income for the period
available to each share of common stock outstanding during the reporting period.
Diluted net income per common share is the amount of income 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.


                                       4
<PAGE>   7

In calculating net income per common share, the net income 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, 2000 and 1999 is summarized as follows:


<TABLE>
<CAPTION>

                                                                           (Unaudited)
                                                                        Three Months Ended

                                                                  March 31, 2000   March 31, 1999
                                                                  --------------   --------------
<S>                                                               <C>              <C>
         Basic weighted average number of common shares
         outstanding during the period                              22,307,440       21,891,630

         Weighted-average number of dilutive common stock
         options outstanding during the period                       2,539,651        1,168,954
                                                                     ---------        ---------

         Diluted weighted average number of common and common
         equivalent shares outstanding during the period            24,847,091       23,060,584
                                                                    ==========       ==========
</TABLE>



        Common stock equivalents of approximately 96,450 and 634,885 outstanding
during the three month periods ended March 31, 2000 and 1999 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 M.I.S procedures. The Company has
and/or is also pursuing licensing opportunities related to its proprietary
radial dilation and biocompatible coating technologies. 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.


                                       5
<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 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, 1999
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. InnerDyne designs, develops, manufactures and
commercializes minimally invasive surgical access products incorporating its
proprietary radial dilation technology in the fields of general surgery,
gynecology, pediatric laparoscopy, and urology. The Company is beginning
programs to commercialize the application of its radial dilation technology to
enhance percutaneous access for vascular procedures. The Company has proprietary
technology in the areas of biocompatible coatings, radiation delivery for the
treatment of restenosis and cancer, and drug attachment and diffusion, which it
intends to continue to develop either internally or through strategic alliances.
InnerDyne, Inc. common stock is traded on the Nasdaq National Market under the
symbol IDYN.

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.



                                       6
<PAGE>   9

        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 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.

        In January 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. 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.

        By December 31, 1999 more than 30 peer reviewed papers or presentations
had been published or presented, concluding that patient safety is enhanced when
the Step product is used. A recent paper presented in November 1999 at the
American Association of Gynecological Laparoscopy Annual Meeting involved more
than 8,000 procedures and more than 21,000 Step insertions. The study concluded
that, based on a comparison to a control group where standard access devices of
various types were used, an adverse event was about ten times more likely to
occur with conventional trocars versus InnerDyne's product.


                                       7
<PAGE>   10

        Short Step(TM) 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 freestanding 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 continue to help the Company expand awareness and sales of
its Step product line for use in the pediatric environment.

        Reposable Step(TM). 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(TM). 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(TM). 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(TM). 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. Three
additional buying group agreements were signed in 1999, adding approximately
2,150 hospitals and surgery centers to those covered by agreements.

        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.


                                       8
<PAGE>   11

        Other Applications & Technology. 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 1997 and continued
testing the product concept in conjunction with cardiology advisors in early
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, and
limited domestic use evaluations have been ongoing throughout 1999. An
additional related 510(k) application was filed with the FDA in August 1999,
primarily to update labeling involving the most current version of the radially
expanding vascular access (InnerVasc(R)) product. In March, 2000 InnerDyne
announced the signing of an agreement with Maxxim Medical, Inc. covering the
distribution by Maxxim of the Company's InnerVasc vascular access product in the
United States and South America.

        Management believes that the positive attributes of the Step product
line may also enable minimally invasive access to organs within the abdominal
cavity. The 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. InnerDyne expects to continue expending development
resources through the first half of 2000 to determine the feasibility of
introducing an intra-organ access device based on its proprietary radially
expanding dilation technology.

        The Company has also evaluated the potential use of its proprietary
radial dilation technology to gain access for urologic procedures, and a related
510(k) pre-market notification was submitted to and subsequently cleared by the
FDA in mid-1999. The Company is completing the development process for a new
product intended to facilitate percutaneous access to the kidney and bladder,
and has conducted expanded human clinical evaluation of the product during 2000.
Based on the results of this evaluation, the Company plans to initiate
distribution of a urological access product in 2000.

        The Company also signed an agreement involving its radial dilation
access technology with a small private development-stage company during the
first quarter of 2000. This agreement will permit the partner entity to
potentially utilize InnerDyne's technology in the diagnosis and treatment of
selected cancer tumors.

        There can be no assurance that current or future new product
developments will generate product opportunities that can be commercially sold
in sufficient quantities; failure to achieve commercial success with any or all
new product applications could have a material adverse impact on the Company's
profitability and operations.

        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 termination of the EndoTex


                                       9
<PAGE>   12

agreement did not have a material impact 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
decide to develop a feeding tube placement system.

        During 1997 and early 1998, InnerDyne committed resources to an
investigation of the market opportunity for a radially dilatable access device
for arthroscopic procedures. Clinical evaluation of an FDA cleared arthroscopic
access product indicated that clinical benefits of the technology in this market
were not sufficient to warrant further investment, and the project was
terminated.

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 may utilize covalent bonds,
the Company believes that its coating process may result in a stronger bond to
the surface of a device than some other methods presently in use. 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
potentially reduce restenosis in patients who have undergone interventional
vascular procedures. InnerDyne completed the stent-based studies using
rhenium-188 for the treatment of restenosis in early 2000. Though the results of
this animal study demonstrated clinical efficacy, recently published human
clinical results from a competing catheter-based technology have likely reduced
the probability that the Company can attract a corporate stent partner that will
license the technology under acceptable terms, if at all.


        In the fourth quarter of 1999, the Company began to shift resources to
investigate a proprietary therapeutic coating which may potentially provide a
proprietary bioactive treatment for restenosis. If preliminary promising results
of this investigation are confirmed in further investigations, the Company may
increase associated resources, and endeavor to attract a corporate partner
interested in the technology. There can be no assurances that the results of
this further investigation will be positive, or that a corporate partner will be
interested in licensing or developing this technology on acceptable terms, if at
all.


        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


                                       10
<PAGE>   13

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 an
efficient mechanism to control cancer growth and limit cancer recurrence. 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,
either alone or in combination with a chemotherapy agent, may 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 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 was completed in early
2000.

        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.

        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 bioabsorbable 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 June 1999, the Company announced that the National Institutes of
Health awarded the Company a Small Business Innovation Research ("SBIR") phase 1
research grant to support development of a new form of cancer treatment. The
InnerDyne technology allows for the concurrent delivery of drugs and radiation
through the use of implantable devices that are absorbed by the body after
delivering their therapeutic payloads. The absorbable devices are expected to
differ from both current brachytherapy and drug-delivery sources, and could
potentially provide a highly efficient and flexible treatment mechanism for the
handling of focal 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 Company
licensed one of its 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


                                       11
<PAGE>   14

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, in exchange for an initial payment and continuing material
purchases, 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. If SENKO
continues to use the Company's technologies, royalties would be received through
2004.

        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, license fees and
future 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 was completed during
1999.

        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
constructed a custom coating system and provided coated product samples for
testing by U.S. Surgical, in exchange for payment of initial license fees and
capital equipment costs. If 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 some 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 may be coated with drugs and/or isotopes using InnerDyne's
proprietary technology. 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. However, there can be no assurance
that additional agreements with third parties, if any, will be on acceptable
terms.

Other Technologies

        In September 1999, the Company licensed to William Cook Europe A/S
("Cook") rights to a Rotatably Actuated Constricting Catheter Valve on a
non-exclusive basis for use in the treatment of aortic aneurysms. The agreement
requires that Cook pay InnerDyne a licensing fee in two installments, and annual
minimum royalty payments. InnerDyne has received the first license fee
installment.

        In December 1999, InnerDyne licensed to Alung Technologies, Inc. certain
assets related to the Company's earlier development of an implantable lung
assist product, and associated technologies. Under the terms of the agreement,
InnerDyne is to receive a license fee, payable in two installments in the fourth
quarters of 1999 (already received) and 2000.


                                       12
<PAGE>   15

        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, the amount and timing of the payments to be made to InnerDyne
pursuant to such agreements, and the ability of the parties to satisfy
performance milestones.

        The future success of the Company will depend upon its ability to
develop and gain regulatory clearance for new and enhanced versions of products
in a timely fashion and to attract corporate partners interested in licensing
its coating technologies. In addition, the Company may seek to identify
opportunities to obtain products or technologies from third parties. There can
be no assurance that the Company will be able to successfully develop or acquire
new products or technologies, license its proprietary technologies to third
parties, obtain regulatory clearance for its products, or gain market acceptance
of new and enhanced products. Delays in development, clearance or acceptance of
new products could have a material adverse effect on the Company's business,
results of operations and financial condition.

RESULTS OF OPERATIONS

        Total revenue for the three month period ended March 31, 2000 was
$5,588,287, compared to $4,503,794 for the corresponding period in 1999. Total
revenue is comprised of revenue from product sales and licensing and contract
revenue. Revenue from product sales increased to $5,492,735 for the three month
period ended March 31, 2000 from $4,431,699 for the corresponding period in
1999, reflecting increased sales of the Company's Step devices. Licensing and
contract revenue for the three month period ended March 31, 2000 was $95,552,
compared to $72,095 for the corresponding period in 1999. Licensing and contract
revenue for the March 31, 2000 and March 31, 1999 periods related to agreements
with third parties covering the licensing of the Company's proprietary
biocompatible coating and radial dilation technologies. 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 $1,452,327 for the three month period ended March 31,
2000, compared to $1,335,984 for the same period in 1999. The increase in cost
of sales for the three month period ended March 31, 2000 is attributable to the
increase in production and sales volume compared to the same period in 1999.
Cost of sales as a percentage of revenue was 26% for the three month period
ended March 31, 2000, compared to 29.7% for the same period in 1999. This
decrease reflects the impact of increased volume on the Company's manufacturing
overhead, which increased at a slower rate than revenues. Improvements in the
efficiency of the Company's manufacturing operations also positively impacted
the cost of goods as a percentage of revenue in the first quarter.

        Research, development, regulatory and clinical expenses for the three
month period ended March 31, 2000 were $748,847, compared to $680,266 for the
corresponding period in 1999. The Company expects that research, development,
regulatory and clinical expenditures are likely to 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
reducing expected costs.

        Sales and marketing expenses were $2,253,381 for the three month period
ended March 31, 2000, compared to $1,671,985 for the corresponding period ended
March 31, 1999, 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.


                                       13
<PAGE>   16

        General and administrative expenses were $625,842 for the three month
period ended March 31, 2000, compared to $504,931 for the corresponding period
ended March 31, 1999. The Company anticipates that general and administrative
expenses will generally increase in absolute dollars in future periods to
support expanding operations.

        The Company generated operating income, before interest and tax, of
$507,890 for the three month period ended March 31, 2000, compared to $310,628
in the corresponding period of 1999. The improvement in operating income
primarily reflected higher gross margins on higher revenues.

        The Company generated net income after tax of $1,126,409 for the three
month period ended March 31, 2000, compared to $350,799 in the corresponding
period of 1999. Results in the first quarter of 2000 included an income tax
benefit of $562,951. On December 31, 1999, the Company had a deferred tax asset
totaling $16.4 million, primarily a result of net operating loss carryforwards,
which was fully reserved. The deferred tax asset had a 100% reserve due to the
uncertainty of the Company's ability to generate future taxable income. Due to
the Company experiencing another quarter of positive operating results,
Management believes the company will have the ability to utilize a portion of
its deferred tax assets and has thus reduced the valuation allowance on the
Company's deferred tax asset. Management expects that the Company will generate
positive net income through 2000.

LIQUIDITY AND CAPITAL RESOURCES

        From its inception to March 31, 2000, the Company has incurred a
cumulative net loss of approximately $49.2 million. 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
underwriters commissions and offering expenses).

        At March 31, 2000, cash and cash equivalents totaled $7,934,671 compared
to a total cash and cash equivalents balance of $6,862,313 at December 31, 1999.
The Company had $27,297 in capital expenditures in the three months ended March
31, 2000. Working capital totaled $11,880,292 at March 31, 2000, and the Company
had long-term debt, excluding current installments, totaling $210,658 relating
to financing of equipment.

        The Company was able to borrow up to $2,000,000 on a revolving line of
credit with a commercial bank at prime plus one-quarter of one percent (9.25
percent at March 31, 2000) based on eligible receivables. This revolving line of
credit expired on April 23, 2000. The Company is currently in negotiations to
renew this revolving line of credit. The Company also has an equipment advance
line of credit that allows the Company to borrow up to $750,000 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 one-quarter of one percent. As of March 31, 2000, the Company had
drawn $639,989 for financing of working


                                       14
<PAGE>   17

capital needs on the revolving line of credit, secured by certain accounts
receivable, and had borrowed $446,389 for the financing of fixed assets. The
loans are subject to certain covenants and conditions.

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

        InnerDyne experienced operating losses from 1985 until mid 1998.
InnerDyne reported net income of $1.1 million on revenues of $5.6 million, $1.5
million on revenues of $20.4 million, $425,000 on revenues of $17.6 million and
a loss of $907,000 on revenues of $15.7 million for the three months ended March
31, 2000 and the fiscal years ended December 31, 1999, 1998 and 1997,
respectively. As of March 31, 2000, InnerDyne had an accumulated deficit of
approximately $49.2 million.

        Our operating results may fluctuate substantially from quarter to
quarter as a result of general economic conditions. Accordingly, the Company
could generate operating losses, and may 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, the market acceptance of the Company's products, and the
actions of competitors in the Company's primary markets. 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 three years. A number of other entities
participate in various segments of the M.I.S. market, including access.



                                       15
<PAGE>   18

        The Company's products will encounter competition from other companies
as its radial dilation platforms expand into new clinical areas. Within the
urology field, management expects its products will compete with product
offerings from Cook, Boston Scientific, and C.R. BARD, among others. In vascular
access, Maxxim Medical, Inc., will face competition from St. Jude/Daig,
Medtronic/AVE, Bard, Boston Scientific and others.

        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.

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

        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 2000, the Company expects to
commercially introduce urology and intra-organ access products, and through a
corporate partner, a vascular access product. 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.



                                       16
<PAGE>   19

        Limited Manufacturing Experience; Compliance with Quality Systems
Regulations. 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 relatively 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
acceptable product quality and 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.
Regulatory changes recently introduced by the FDA have resulted 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. The FDA may also periodically inspect the Company's
operations and business practices to evaluate conformance to these standards.
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, fluctuations in
production volumes can 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


                                       17
<PAGE>   20

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 or maintain 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


                                       18
<PAGE>   21

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 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).


                                       19
<PAGE>   22

        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, urological, 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 Quality Systems Regulations
("QSR") 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 QSR requirements, MDR requirements and other
applicable regulations. Failure of the Company to maintain satisfactory
regulatory 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 customers' demand
for product. In addition to



                                       20
<PAGE>   23

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 a portion of its revenue from international sales. To the extent that the
Company's international sales increase in future periods, a 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.


                                       21
<PAGE>   24

        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 $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. 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 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 2000,
directors and principal stockholders of the Company, and certain of their
affiliates, beneficially owned approximately 8% of the Company's outstanding
Common Stock. Accordingly, these persons, as a group, may be able to
significantly



                                       22
<PAGE>   25

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.

        Risks Associated With Computer Software and Hardware. InnerDyne relies
on a variety of internal computer systems and programs in the operations of its
business. The Company also utilizes outside computer systems in the management
of certain business functions. 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. These systems were extensively tested as part of the Company's
preparations for the Year 2000 changeover.

        The Company believes that the failure of a system would not materially
affect the Company's ability to conduct its business operations, though such
failure could cause the expenditure of significant funds to affect a rapid
remedy to a systems failure. However, should a system fail, and the Company was
unable to restore or replace its function within a reasonable time frame, such
failure could have a material impact upon the Company's business, financial
condition, or results of operations. Similarly, should the Company internal or
external computer systems experience widespread failure that could not be
remedied quickly, such failure could have a similar impact.


                                       23
<PAGE>   26

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 above under the heading "Additional Factors
That May Affect Future Results."


INTEREST RATE RISK


        As of March 31, 2000, InnerDyne had short-term investments of
$6,735,080. Substantially 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, 2000 rates would cause the fair market value of
these short-term investments to change by an immaterial amount. The Company has
the ability to hold these investments until maturity; and therefore, the value
of these investments is not expected to be affected to any significant degree by
sudden changes in market interest rates. Declines in interest rates over time
will, however, reduce interest income. The Company has not used derivative
financial instruments.

        InnerDyne does not own any equity investments; therefore, the Company is
not currently exposed to any direct equity price risk.

        All InnerDyne revenues are realized in U.S. dollars; therefore,
management believes that the Company currently is not subject to significant
direct foreign currency exchange rate risk.


FOREIGN CURRENCY RISK

        International revenues represented less than 10% of total revenues as of
March 31, 2000. International sales are made mostly through international
distributors with payments to the Company typically denominated 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. 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 three month period ended March 31, 2000 was not material.


                                       24
<PAGE>   27

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

               None.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

               None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

               None.

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

               None.

ITEM 5. OTHER INFORMATION

               None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

        10.2*         1991 Directors' Stock Option Plan, as amended
        10.26*        1996 Stock Option Plan, as amended
        10.47+        Development, License and Supply Agreement dated as of
                      February 11, 2000, by and between the Registrant and
                      Genesis Medical Technologies, Inc.
        10.48+        Supply, License and Distribution Agreement dated as of
                      March 27, 2000, by and between the Registrant and Maxxim
                      Medical, Inc.
        27.1          Financial Data Schedule

* Management compensatory plan or arrangement.
+ Confidential treatment requested as to certain portions of these Exhibits.

(b) Reports on Form 8-K:       The Company did not file any reports on Form 8-K
                                during the quarter ended March 31, 2000.


                                       25
<PAGE>   28


                                   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/ William G. Mavity
William G. Mavity
President, Chief Executive Officer
and acting Chief Financial Officer
(Duly Authorized Signatory and
Principal Financial Officer)






Date:   May 15, 2000


                                       26
<PAGE>   29

EXHIBIT INDEX

Exhibit Number        Description
--------------        -----------

        10.2*         1991 Directors' Stock Option Plan, as amended
        10.26*        1996 Stock Option Plan, as amended
        10.47+        Development, License and Supply Agreement dated as of
                      February 11, 2000, by and between the Registrant and
                      Genesis Medical Technologies, Inc.
        10.48+        Supply, License and Distribution Agreement dated as of
                      March 27, 2000, by and between the Registrant and Maxxim
                      Medical, Inc.
        27.1          Financial Data Schedule

* Management compensatory plan or arrangement.
+ Confidential treatment requested as to certain portions of these Exhibits.


                                       27