<PAGE>   1
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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

   
                                FORM 10-KSB/A
    

(MARK ONE)
   [X]          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                   OF THE SECURITIES EXCHANGE ACT OF 1934
                 For the fiscal year ended December 31, 1997

                                     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 0-20532

                           LIFEQUEST MEDICAL, INC.
           (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                DELAWARE                                          74-2559866
     (STATE OR OTHER JURISDICTION OF                           (I.R.S. EMPLOYER
     INCORPORATION OR ORGANIZATION)                          IDENTIFICATION NO.)

     12961 PARK CENTRAL, SUITE 1300
           SAN ANTONIO, TEXAS                                        78216
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                          (ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 495-8787

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

       SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:  NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                         Common Stock, $.001 par value
                                (TITLE OF CLASS)

         INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL
REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.  YES [X]   NO [ ].

         INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO
ITEM 405 OF REGULATION S-B IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED,
TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-KSB OR ANY
AMENDMENT TO THIS FORM 10-KSB  [X]

         REGISTRANT'S REVENUES FOR FISCAL YEAR ENDED DECEMBER 31, 1997:
$14,336,828

         AT MARCH 18, 1998 (BASED UPON THE LAST REPORTED SALES PRICE OF $4.375
PER SHARE), THE AGGREGATE MARKET VALUE OF THE COMMON STOCK, $.001 PAR VALUE, OF
THE REGISTRANT HELD BY NON-AFFILIATES WAS APPROXIMATELY $24.2 MILLION.  AT
MARCH 18, 1998, THERE WERE OUTSTANDING 6,899,742 SHARES OF COMMON STOCK, $.001
PAR VALUE, OF THE REGISTRANT.
<PAGE>   2
                      DOCUMENTS INCORPORATED BY REFERENCE

<TABLE>
<CAPTION>
                   DOCUMENT                                    FORM 10-KSB PART
                   --------                                    ----------------
<S>                                                    <C>
Definitive Proxy Statement for 1998 Annual Meeting     Part III, Items 9, 10, 11 and 12
</TABLE>

Transitional Small Business Disclosure Format.  YES [ ]   NO [X].

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

                                     PART I

ITEM 1.                             BUSINESS


         Certain statements contained in this Form 10-KSB, including but not
limited to statements made in this Item 1, "Business" and those made in Item 6,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," are "forward-looking statements" within the meaning of Section 27A
of the Securities Act and Section 21E of the Exchange Act.  Specifically, all
statements other than statements of historical facts included in this Form
10-KSB regarding the Company's financial position, business strategy and plans
and objectives of management of the Company for future operations are
forward-looking statements.  These forward-looking statements are based on the
beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management.  When used in this
report, the words "anticipate," "believe," "estimate," "expect" and "intend"
and words or phrases of similar import, as they relate to the Company or
Company management are intended to identify forward-looking statements.  Such
statements reflect the current view of the Company with respect to future
events and are subject to certain risks, uncertainties and assumptions related
to certain factors including, without limitation, competitive factors, general
economic conditions, customer relations, relationships with vendors, the
interest rate environment, governmental regulation and supervision, product
introductions and acceptance, technological change, changes in industry
practices, one-time events and other factors described herein, in the Company's
Registration Statement on Form S-3 filed on February 7, 1997, and in the
Company's annual, quarterly and other reports filed with the Securities and
Exchange Commission (collectively, "cautionary statements").  Although the
Company believes that its expectations are reasonable, it can give no assurance
that such expectations will prove to be correct.  Based upon changing
conditions, should any one or more of these risks or uncertainties materialize,
or should any underlying assumptions prove incorrect, actual results may vary
materially from those described herein as anticipated, believed, estimated,
expected or intended.  All subsequent written and oral forward-looking
statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by the applicable cautionary statements.
The Company does not intend to update these forward-looking statements.


GENERAL

   
         LifeQuest Medical, Inc. (the "Company") and its subsidiary ValQuest
Medical, Inc. are engaged in the development, manufacture and distribution of
instruments, equipment and surgical supplies used in minimally invasive surgery
("MIS").  A glossary of technical terms used herein can be found on page 17 of
this Form 10-KSB.
    

         MIS, a rapidly growing field, involves surgical procedures,
accomplished without a major incision, through strategically placed punctures
in a patient's body.  These procedures generally result in reduced patient
discomfort, reduced risks of infection and greatly shortened hospitalization,
thereby decreasing overall costs.  MIS products include a wide variety of
reusable and disposable items such as endoscopes, trocars, trocar
sleeves/cannulas, video systems, mechanical and laser-related cutting devices,
stapling systems, electrocautery systems, suction and irrigation systems,
graspers and dissectors, and hand-operated retractors.  The products are used
by surgeons in hospitals and outpatient surgery facilities.

         The Company acquired Mishbucha, Inc. d/b/a Medex Surgical, a Texas
corporation ("Medex Surgical"), effective September 1997.  Medex Surgical is
located in Dallas, Texas, and distributes instruments, equipment and surgical
supplies used in MIS.


                                      -1-
<PAGE>   3
         The Company acquired W.H. Bookwalter and Associates, Inc., a Vermont
corporation ("Bookwalter"), in September 1997.  Bookwalter is located in
Milford, Massachusetts, and develops, manufactures, distributes and repairs
equipment, instruments and surgical supplies used in MIS.

         In June 1997, the Company acquired Trimedica, Inc., a Colorado
corporation ("Trimedica") located in Colorado Springs, Colorado, which
distributes instruments, equipment and surgical supplies used in MIS.

         In December 1996, the Company acquired Val-U-Med, Inc. ("VMI"), and in
November 1996 the Company acquired Klein Medical, Inc. ("KMI").  KMI and VMI
were private companies located in San Antonio, Texas and Atlanta, Georgia,
respectively.  Both companies, which are wholly owned subsidiaries of the
Company, distribute instruments, equipment and surgical supplies used in MIS.

         In February 1996, the Company completed the merger of GM Engineering,
Inc., ("GME") a private company, with and into LifeQuest Endoscopic
Technologies, Inc. ("LQET"), a wholly owned subsidiary of the Company.

         In May 1994, the Company and Valdor Fiber Optics ("Valdor") of San
Jose, California, formed a corporate venture, ValQuest, which is an 82% owned
subsidiary of the Company.  ValQuest's patented Impact Mount(TM) technology is
being used to develop proprietary, autoclavable (heat sterilizable) flexible
fiber optic endoscopes which are expected to have broad applications in the MIS
field.

         The Company intends to continue to allocate its resources toward
becoming a significant competitor in the MIS market by utilizing the combined
capabilities of its subsidiaries to expand its geographical distribution
coverage in the U.S. and add relevant new products to its existing line through
internal development, licensing and acquisition.

         The Company is also a party to manufacturing agreements with various
companies in the medical instrument industry, under which the Company produces
selected MIS products for private labeling.  In the future, the Company intends
to introduce a number of additional MIS products for the domestic and
international MIS markets.

         The Company was incorporated on December 23, 1988 as a Delaware
corporation and commenced operations on January 1, 1989.  In August 1992, the
Company completed its initial public offering of Common Stock which is quoted
on the NASDAQ SmallCap Market.  Effective January 1, 1998, the Company merged
each of its wholly-owned subsidiaries, LQET, Klein Medical, Inc. ("Klein") and
Val-U-Med, Inc., ("Val-U-Med") into the Company.  The Company's executive
offices are located at 12961 Park Central, Suite 1300, San Antonio, Texas
78216, and its telephone number is (210) 495-8787.


RECENT ACQUISITIONS

         Dexterity

         In January 1998, the Company acquired 21.5% of the voting common stock
of TFX Holding Co. ("TFX"), a business development subsidiary of Teleflex, Inc.
TFX owns the Dexterity(R) Pneumo Sleeve and the Dexterity(R) Protractor, which
the Company distributes pursuant to a distribution agreement with TFX.  The
Company launched distribution of the Dexterity(R) Pneumo Sleeve and
Dexterity(R) Protractor in March 1998 in the United States.

   
         The Pneumo Sleeve is a device that allows the surgeon to insert one
hand into the abdominal cavity while preserving pneumoperitoneum during
laparoscopic surgery.  This new surgical modality, called Hand Assisted
Laparoscopic Surgery (HALS), is a hybrid between open and laparoscopic surgery.
This enabling technology is expected to greatly increase the number of advanced
minimal access surgeries as well as the number of surgeons who perform these
procedures.  According to the Private Placement Memorandum (the "PPM") prepared
by or on behalf of TFX, the U.S. market potential for the Dexterity(R) Pneumo
Sleeve is estimated at more than 580,000 procedures annually, including
digestive tract surgery, urinary tract surgery, organ transplants, cancer
surgery and vascular surgery.  This translates into an estimated $600 million
U.S. market for Dexterity(R) procedural kits, which include accessory devices
such as hand-held surgical instruments.

         In addition to being used with the Dexterity(R) Pneumo Sleeve, the
Dexterity(R) Protractor is used as a stand- alone product for open surgery,
providing atraumatic retraction and wound protection.  According to the PPM,
the
    


                                      -2-
<PAGE>   4

   
market potential for the Dexterity(R) Protractor is estimated at 2.4 million
surgical procedures per year in the United State, representing a dollar market
potential in excess of $200 million.
    

         The Company believes the potential exists for significant market
penetration by the Dexterity(R) products, and that sales of the Company's
existing product lines should benefit from these product introductions.  The
Company expects that these products, along with the surgical clip applier
discussed below, shall become integral components of LifeQuest's Lapro-PAK
surgical procedure kits.

         Canwell Surgical, Inc.

   
         In December 1997 the Company and Canwell Medical, Inc., a Canadian
corporation ("Canwell Medical"), established a joint venture, Canwell Surgical,
Inc. ("Canwell"), owned equally by the Company and Canwell Medical.  In August
1998, the Company made the determination to dissolve Canwell in order to focus
on U.S. markets.
    

         Medex Surgical

         Effective September 1997, the Company completed the merger (the "Medex
Merger") of Medex Surgical with and into Klein, a Nevada corporation and wholly
owned subsidiary of the Company, with Klein as the surviving corporation.
Medex Surgical distributes instruments, equipment and supplies used in MIS.
The Medex Merger was consummated under a Plan of Merger and Acquisition
Agreement among the Company, Medex Surgical, Klein, Robert Kraus and Edward
Kraus, as shareholders of Medex Surgical, pursuant to which Robert and Edward
Kraus received an aggregate of 98,246 shares of the Company's Common Stock.

         W.H. Bookwalter and Associates, Inc.

   
         In September 1997, the Company completed the merger (the "Bookwalter
Merger") of Bookwalter with and into Val- U-Med, a Nevada corporation and
wholly owned subsidiary of the  Company, with Val-U-Med as the surviving
corporation.  Bookwalter distributes instruments, equipment and surgical
supplies used in MIS.  The Bookwalter Merger was consummated under a Plan of
Merger and Acquisition Agreement among the Company, Bookwalter, Val-U-Med, and
the shareholders of Bookwalter, pursuant to which  such shareholders received
an aggregate of 466,473 shares of the Company's Common Stock.
    

         Trimedica

         In June 1997, the Company completed the merger (the "Trimedica
Merger") of Trimedica with and into Klein, with Klein as the surviving
corporation.  Trimedica distributes instruments, equipment and surgical
supplies used in MIS.  The Trimedica Merger was consummated under a Plan of
Merger and Acquisition Agreement among the Company, Trimedica, Klein, and Mark
Lovejoy, the sole shareholder of Trimedica, pursuant to which Mark Lovejoy
received 57,143 shares of the Company's Common Stock.

         Klein Medical

         In November 1996, the Company completed the merger (the "Klein
Merger") of KMI with and into Klein, with Klein as the surviving corporation.
The Klein Merger was consummated under a Plan of Merger and Acquisition
Agreement among the Company, Klein, KMI and Richard H. Klein, as sole
shareholder of KMI, pursuant to which Richard H. Klein received an aggregate of
600,000 shares of the Company's Common Stock.

   
         In connection with the acquisition of KMI, the Company obtained the
option to acquire the exclusive U.S.  distribution rights to a patented
state-of-the-art clip applier which management believes is superior to
currently available clip appliers.  The 5mm clip applier is less invasive than
the 10mm clip appliers which currently dominate the U.S. market.  LifeQuest
plans to exercise such option and introduce this product as soon as the
supplier's manufacturing assembly line preparations are complete, which the
Company estimates will be in the fourth quarter of 1998.  Clip appliers are
crucial instruments for surgeons working in the abdomen and chest because they
provide the simplest, quickest and most effective means of occluding structures
such as small blood vessels and ducts, thus decreasing total surgical and
anesthesia time.
    



                                      -3-
<PAGE>   5
         The Company believes the potential exists for significant market
penetration by both the clip applier and the Dexterity(R) products discussed
above, and that sales of the Company's existing product lines should benefit
from these product introductions.  The Company expects that these products
shall become integral components of LifeQuest's Lapro- PAK surgical procedure
kits.

         Val-U-Med

         In December 1996, the Company completed the merger (the "Val-U-Med
Merger") of VMI with and into Val-U-Med, with Val-U-Med as the surviving
corporation.  The Val-U-Med Merger was consummated under a Plan of Merger and
Acquisition Agreement among the Company, Val-U-Med, VMI and the shareholders of
VMI, pursuant to which such shareholders received an aggregate of 1,200,000
shares of the Company's Common Stock and an aggregate of $400,000.

         GM Engineering

         In February 1996, the Company completed the merger (the "GM Merger")
of GME with and into LQET.  Prior to the GM Merger, GME, a private company
located in La Verne, California, was primarily engaged in the development,
manufacture and marketing of surgical and related instruments used in MIS.
Under the terms of the Plan of Merger and Acquisition Agreement the principal
shareholders of GME received 350,000 shares of the Company's Common Stock.

         The ValQuest Venture

         In May 1994, the Company and Valdor formed ValQuest as a corporate
venture between the two companies.  In accordance with the terms of the venture
agreement, Valdor transferred to ValQuest the exclusive worldwide rights to
develop, manufacture, and market all medical applications of Valdor's patented
Impact Mount(TM) fiber optic connector technology.  The Company paid $100,000
to Valdor in connection with the transfer of these rights and contributed
$400,000 to be used as working capital in exchange for a 55% interest in
ValQuest.  Subsequent purchases of the stock of ValQuest by the Company have
increased the Company ownership, making ValQuest an 82% owned subsidiary of the
Company.

INDUSTRY BACKGROUND

         The health care industry continues to undergo change, led primarily by
market forces which are demanding greater efficiencies and reduced costs.
Government proposed health care mandates in the United States have not
occurred, and it is unclear whether, and to what extent, any future government
mandate will affect the domestic health care market.  Industry led changes are
expected to continue irrespective of any governmental efforts toward health
care reform.  The scope and timing of any further government sponsored
proposals for health care reform are presently unclear.

         The primary trend in the industry is toward cost containment.  Payors
and managed care organizations have been able to exercise greater influence
through managed treatment and hospitalization patterns, including a shift from
reimbursement on a retrospective basis to prospective limits for patient
treatment.  Hospitals have been severely impacted by the resulting cost
restraints and are competing for business and becoming more sophisticated in
management and marketing.  The increasing use of managed care, centralized
purchasing decisions, consolidations among hospitals and hospital groups, and
integration of health care providers, are continuing to affect purchasing
patterns in the health care system.  Purchasing decisions are often shared by a
coalition of surgeons, nursing staff, and hospital administrators, with
purchasing decisions taking into account whether a product reduces the cost of
treatment and/or attracts additional patients to a hospital.  All of these
factors, along with competition, have contributed to continuing reductions in
prices for the Company's products and, in the near term, to slower acceptance
of more advanced surgical procedures in which the Company's products are used,
given hospital and surgeon concerns as to the costs of training and
reimbursement by payors.  In addition, the primary care physician is expected
to exercise significant influence on referrals of patients for surgical
procedures under managed care.

         The Company could potentially benefit from this focus on cost
containment and on managed care.  MIS decreases operating room time including
anesthesia and patient recovery time and is highly cost effective.  Doctors,
patients, employers and payors all value decreased patient recovery time.  This
could lead to potential increases in



                                      -4-
<PAGE>   6

   
volume as minimally invasive procedures are selected over alternative
techniques.  However, an undue focus on discrete costs or similar limits which
fail to consider the overall value of these advanced procedures could adversely
impact the Company.  Some hospitals may also lose per night revenues through
reduced post-operative care requirements as to procedures performed by MIS,
which could influence their analysis of acceptance of newer procedures.  The
Company is adapting itself to this environment by promoting the cost
effectiveness of its products, by striving to efficiently produce and/or
distribute the highest quality products at the lowest cost, and by assisting
hospitals and payors in achieving meaningful cost reductions for the health
care system while retaining the quality of care permitted by the Company's
products.
    

         MIS refers to surgical procedures which can be accomplished without a
major incision or other traumatization to the patient, in some cases without
general anesthesia.  Endoscopy is one of the most important minimally invasive
surgical techniques.  In addition to decreasing patient trauma or frequently
avoiding general anesthesia, endoscopy can substantially reduce or eliminate
postoperative hospitalization, thereby decreasing overall costs.  The Company
believes that the current pressures for medical cost containment could result
in greater utilization of cost-effective, less invasive procedures.  There can
be no assurance, however, that greater utilization of such procedures will
result.

         The availability of innovative medical technologies, patient demand
and the motivation of physicians and payors are among the driving forces behind
the movement toward, and the wide acceptance of, minimally invasive surgical
procedures.  The Company believes that these minimally invasive techniques are
desired because they benefit all significant participants in the healthcare
system: the patient experiences less pain and trauma and enjoys a more rapid
recovery; surgeons and hospitals or other surgical centers that adopt these
techniques enhance their practices and reputations; and the healthcare payor
incurs lower overall costs.  The Company believes that the growing acceptance
of minimally invasive surgical procedures is changing the standards of practice
over a wide range of surgical specialties and that this trend should create
significant business opportunities for manufacturers of minimally invasive
surgical products.

         According to a 1995 market research report by Theta Corporation, the
United States MIS market exceeded $2 billion in 1994 and is forecast to grow at
a 17 to 22 percent rate through 1998.  MIS instruments include a wide variety
of reusable and disposable items such as trocars, trocar sleeves/cannulas,
video systems, mechanical and laser-related cutting devices, stapling systems,
electrocautery systems, suction and irrigation systems, graspers and
dissectors, hand-operated retractors and insufflation devices.

PRODUCTS

   
         The Company distributes a variety of products used primarily for
minimally invasive surgical procedures, including branded products manufactured
and owned by other companies as well as branded products owned and manufactured
by the Company.  The list of companies which utilize LifeQuest to distribute
selected products includes the following: Origin MedSystems, Inc., ConMed
Corporation, Sony Medical Products Division, Fischer Imaging Products, Welch
Allyn Imaging, MicroAire Surgical Instruments, Endo-LTD, Microline, Inc.,
Innerdyne, Inc. and Bionx Implants, Inc.
    

         The Company distributes disposable instruments, durable (reusable)
instruments and capital equipment.  The first two categories include the
following: surgical hand instruments such as scissors, forceps, clip appliers,
tackers, and suction irrigators; surgical entry instrumentation such as
trocars, cannulas and dissection balloons; endoscopes; surgical accessories
such as insufflation tubing, Endofog and electrosurgical pens and pads;
electrosurgical instruments; and pneumatic small bone surgical instruments for
driving wire, drilling, and sawing.  Capital equipment includes cameras,
electrosurgical generators, pumps, monitors, printers, telemedicine systems and
breast biopsy systems.

         In addition to manufacturing selected products and components for
distribution, LifeQuest also operates as an Original Equipment Manufacturer
("OEM") of MIS products such as trocars, cannulas, etc. for several U.S.
medical device companies.

BIOMEDICAL AND TECHNICAL SERVICES

         The Company employs qualified technicians who provide its customers
with testing, repair and maintenance service for a wide variety of instruments,
endoscopes and capital equipment items such as generators and cameras.



                                      -5-
<PAGE>   7
SALES AND MARKETING

         The Company began commercial sales of its first MIS access product in
the first quarter of 1996 following the GM Merger, and, therefore, has limited
sales, marketing and distribution experience.  In 1997, the Company completed
the Trimedica Merger, the Bookwalter Merger and the Medex Surgical Merger.
These acquisitions, along with the Klein Merger, the Val-U-Med Merger and the
GM Merger, allow LifeQuest to specialize in the sales and marketing and
distribution of MIS devices.  The Company is marketing its MIS access products
as well as the MIS products of other manufacturers, to hospitals, purchasing
groups and surgeons throughout the United States by demonstrating the economic
efficiencies of the Company's products and by assisting hospital management in
realizing the benefits associated with MIS.  In the United States, the Company
markets MIS products primarily through direct representatives who are employed
by the Company within selected geographical areas and independent sales
representatives who typically sell other complementary MIS 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 the Company'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.

BUSINESS STRATEGY

   
         The Company plans to utilize the combined capabilities of Trimedica,
Bookwalter and Medex Surgical to expand its geographical coverage in the U.S.
and add significant new products to its existing line through internal
development, licensing and acquisition.  In 1997, the combined distribution
coverage of the Company included 32 U.S.  states and one Canadian province.
Management intends to add a significant number of direct sales representatives
in 1998 to achieve national distribution coverage.  The table below set forth
the Company's sales force distribution as of August 15, 1998:

                           SALES FORCE DISTRIBUTION
    

   
<TABLE>
<CAPTION>
           STATE                                          SALES REPRESENTATIVES
         <S>                                                        <C>
                                                                    
         Colorado                                                    3
         Connecticut                                                 1
         Florida                                                     3
         Georgia                                                     4
         Illinois                                                    3
         Indiana                                                     2
         Iowa                                                        1
         Louisiana                                                   1
         Massachusetts                                               2
         Maryland                                                    1
         Michigan                                                    1
         Minnesota                                                   1
         Mississippi                                                 1
         New York                                                    1
         North Carolina                                              1
         North Dakota                                                1
         New Hampshire                                               1
         Oklahoma                                                    1
         South Carolina                                              1
         Tennessee                                                   2
         Texas                                                      14
         Virginia                                                    2
         Washington                                                  1
         Wisconsin                                                   3
                                                                   ---
         Total                                                      52
</TABLE>
    


                                      -6-
<PAGE>   8
COMPETITION

           The primary industry in which the Company competes, minimally
invasive surgery, is highly competitive and in the current healthcare
environment, cost containment has become a significant factor in purchasing
decisions by hospitals.  The MIS market is dominated by two large,
well-positioned entities that are intensely competitive and frequently offer
substantial discounts as a competitive tactic.  The United States Surgical
Corporation ("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 MIS industry, including products which facilitate access,
assessment and treatment.  Ethicon Endo-Surgery ("Ethicon"), a Johnson &
Johnson company, has made a major investment in the MIS 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 believes that the primary competitive factors affecting
its business are the safety and effectiveness of the products offered, ease of
product use, product reliability, price, physician familiarity with the
manufacturer and its products, distribution channels and third party
reimbursement policies.  For certain of the Company's potential products, an
important factor in competition may be the timing of market introduction of its
or its competitors' products.  Accordingly, the relative speed with which the
Company can develop products and complete approval or clearance processes and
supply commercial quantities of the products to the market are important
competitive factors.  The Company believes that its competitive success will be
based on its ability to create and maintain scientifically advanced technology,
develop proprietary products, attract and retain scientific personnel, obtain
patent or other protection for its products, obtain required regulatory
approvals and manufacture and successfully market its products.

         Many of the Company's competitors and potential competitors have
substantially greater resources, including easy access to capital, research and
development personnel, extensive manufacturing and marketing capabilities,
broad and well established product lines as well as ancillary services, such as
training programs.  Some of the Company's competitors have long-term or
preferential supply arrangements with hospitals.  Such arrangements may act as
a barrier to market entry.  In addition, it is possible that other large
healthcare companies may enter the MIS device market in the future.  Competing
companies may succeed in developing products that are more efficacious or less
costly than any that may be developed or distributed by the Company and such
companies also may be more successful than the Company in production and
marketing.  Rapid technological development by others may result in the
Company's products becoming obsolete before the Company recovers a significant
portion of the development and commercialization expenses incurred with respect
to those products.

         The impact of competition will likely have a continuing effect on
sales volumes and on prices charged by the Company.  The Company faces a
formidable task in successfully gaining significant revenues within the MIS
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 MIS market is dominated by U.S. Surgical and Ethicon.
Both entities introduced new access devices, trocars with added features,
during the past two years.  A number of other entities participate in various
segments of the MIS market.

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

PRODUCTS SUPPLY: DEPENDENCE ON KEY SUPPLIERS

   
         The ability of the Company to obtain particular products or product
lines in the required quantities to fulfill customer orders for MIS devices on
a timely basis is critical to the Company's success.  In most cases, the
Company has no guaranteed price or delivery agreements with its MIS device
suppliers.  As a result, the Company may experience short-term inventory
shortages.  In addition, manufacturers of MIS devices who currently distribute
their products through the Company may decide to distribute, or to
substantially increase their existing distribution through
    



                                      -7-
<PAGE>   9
other distributors, their own dealer networks, or directly to resellers.  The
Company's primary supplier, Origin MedSystems, Inc., provided products which
accounted for 38% of the Company's revenues in 1997 and 42% of the Company's
revenues through June 30, 1998.  The Company is a party to a distribution
agreement with such supplier which terminates in May 1999.  There can be no
assurance that the Company will be able to renew the distribution agreement
with its primary supplier and the failure to do so will have an adverse impact
on the Company's business, financial condition and results of operations.
There can be no assurance that suppliers will be able to maintain an adequate
supply of products to fulfill the Company's customer orders on a timely basis
or that the Company will be able to obtain particular products or that a
product line currently offered by suppliers will continue to be available.
Failure of the Company to obtain particular products or product lines in the
required quantities or to fulfill customer orders on a timely basis could have
a material adverse effect on its business, financial condition or results of
operation.

         The Company's ability to achieve increases in net sales or to sustain
current net sales levels depends in part on the ability and willingness of the
Company's suppliers to provide products in the quantities the Company requires.
Although the Company has written distribution agreements with many of its
suppliers, these agreements in certain instances provide for non-exclusive
distribution rights and often include territorial restrictions that limit the
geographical area in which the Company is permitted to distribute the products.
The agreements are also generally short-term, subject to periodic renewal and
often contain provisions permitting termination by either party without cause
upon relatively short notice.  The termination of an agreement may have a
material adverse impact on the Company's business, financial condition or
result of operations.

DEPENDENCE UPON INDEPENDENT SHIPPING COMPANIES

   
         The Company relies heavily on arrangements with independent shipping
companies for the delivery of its products.  In order to meet customer demand,
products are shipped from suppliers through independent shipping companies.
Currently, the Company's management estimates that United Parcel Service
("UPS") delivers approximately 90% of the Company's products to its customers.
The termination of the Company's relationship with UPS, or the failure of one
or more other independent shipping companies to deliver products from suppliers
to the Company or products from the Company to its customers could have a
material adverse effect on the Company's business, financial condition or
results of operations.  For instance, another employee work stoppage at UPS or
an employee work stoppage or slow-down at one or more of these independent
shipping companies could materially impair the shipping company's ability to
perform the services required by the Company.  There can be no assurance that
the services of these independent shipping companies will continue to be
available to the Company on terms as favorable as those currently available or
that these companies will choose or be able to perform the required shipping
services for the Company.
    

DEPENDENCE ON KEY PERSONNEL

   
         The success of the Company will be largely dependent on the efforts of
a number of key management and technical personnel, including Richard A.
Woodfield, President and Chief Executive Officer of the Company and Randall K.
Boatright, Executive Vice-President, Chief Financial Officer and Secretary of
the Company.  The Company has entered into employment agreements with each of
Mr. Woodfield and Mr. Boatright.  The Company does not maintain key man life
insurance on either Mr. Boatright or Mr. Woodfield.  The loss of the services
of one or more key employees could have an adverse effect on the Company.  The
Company believes that its future success will depend in large part upon its
ability to hire and retain suitable operating, marketing, financial and
technical personnel.  The competition for qualified personnel in the medical
device industry is intense and, accordingly, there can be no assurance that the
Company will be able to hire or retain necessary personnel.
    

   
    


                                      -8-
<PAGE>   10
PRODUCT DEVELOPMENT AND MANUFACTURING

         Working from an idea, sketch, or rough model, the Company can take a
project through all the steps of product development, engineering, and
industrial design, culminating in an exact working prototype.  The Company's
mold design, tooling, assembly, packaging and regulatory staff can develop
necessary plans to transform the prototype into a market ready, versatile,
medical device.  The Company utilizes the latest in design hardware and
software, as well as a complete machine shop.

         The Company's manufacturing strategy has four primary goals: (i) to
provide its customers with high quality products and services; (ii) to improve
the performance of its products over time through design and manufacturing
innovation; (iii) to continuously improve manufacturing efficiency and lower
costs; and (iv) to improve product quality.  The Company's manufacturing
operations include machining of various components, assembly, testing,
inspection and packaging.  Most operations are conducted by the Company at its
principal offices in San Antonio, Texas.  Sterilization of certain products is
performed by a subcontractor.

         The Company meets the required Food and Drug Administration ("FDA")
manufacturing requirements.  These requirements include the need for lot
traceability, clean environment and institution of the FDA's Good Manufacturing
Practices ("GMP") in assembly and manufacturing procedures.  FDA requirements
consists of four functions: documentation, quality engineering, inspection and
regulatory affairs.  The Company has personnel dedicated to maintaining
compliance with each of these areas.

         The Company utilizes steel, aluminum and other raw materials in its
manufacturing process.  All raw materials are sourced from several different
suppliers and the Company has rarely experienced a significant manufacturing
delay as a result of a disruption of its sources for raw materials or other
product components.  The Company currently maintains small finished goods
inventories.  Most products are produced and shipped in direct response to
customer product requests on a "Just in Time" basis.

   
         From its inception through 1996, the Company focused its efforts on
research and development of certain proprietary technologies which the Company
was developing in an effort to bring such technologies to the marketplace.  In
1996, the Company decided to reduce continuing investment in research and
development related to such technologies and to focus its efforts on
distributing MIS devices.  Accordingly, during the last two fiscal years, the
Company has continued to decrease its engagement in company sponsored research
and development, and in fiscal 1997, eliminated virtually all expenditures in
this area.  The Company intends to develop new products for manufacturing
through acquisition or by entering into private manufacturing agreements.
There can be no assurance that the Company will be able to acquire new products
for manufacturing or enter into any private manufacturing agreements.  See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
    

   
    

GOVERNMENT REGULATION

         As a manufacturer of medical devices, the Company is subject to
regulation by, among other governmental entities, the FDA and the corresponding
agencies of states and foreign countries in which the Company sells its
products.  These regulations govern the introduction of new medical devices,
the observance of certain standards with respect to the manufacture and
labeling of such devices, the maintenance of certain records and the reporting
of potential product defects and other matters.  Failure to comply with such
regulations may have a material adverse effect on the Company.

   
    

         With the enactment of the Medical Device Amendments in May 1976 to the
Federal Food, Drug and Cosmetic Act (the "FDC Act"), the FDA classified medical
devices in commercial distribution into three classes, Class I, II or III.
This classification is based on the controls necessary to reasonably ensure the
safety and effectiveness of the medical device.  Class I devices are those
devices whose safety and effectiveness can reasonably be ensured through
general controls such as adequate labeling, premarket notification and
adherence to GMP regulations.  Some Class I devices are further exempted from
some of the general controls.  Class II devices are those devices whose safety
and effectiveness can reasonably be ensured through the use of special controls
such as performance standards, post-market surveillance, patient registries and
FDA guidelines.  Class III devices are devices which must receive premarket
approval by the FDA pursuant to a Premarket Approval ("PMA") application to
ensure their safety and effectiveness.  Generally, Class III devices are
limited to life-sustaining, life-supporting or implantable devices.



                                      -9-
<PAGE>   11

   
         Most medical instruments introduced to the United States market are
required by the FDA, as a condition of marketing, to secure either clearance of
a premarket notification pursuant to Section 510(k) of the FDC Act (a "510(k)
Notification") or an approved PMA.  Obtaining  PMA can take several years.  In
contrast, the process of obtaining a 510(k) Notification clearance requires the
submission of substantially less data and generally involves a shorter review
period.  The Company has received 510(k) Notifications for the following
products:
    

   
<TABLE>
<CAPTION>
         510(k) Number       Description
         -------------       -----------
         <S>                 <C>
         K930756             Endo Aid Aspiration Irrigation Device
         K942703             Disposable and Reusable Trocar Disposable and Reusable 
                             Light Cannula System
         K974139             LQET Cannula/Trocar System
         K934035             Monopolar Cautery/Suction Probe
         K979335             Reusable Palpation Probe
</TABLE>
    

         In general, clearance of a 510(k) Notification may be obtained if a
manufacturer or distributor of medical devices can establish that a new device
is "substantially equivalent" to a legally marketed medical device.  The 510(k)
Notification and the claim of substantial equivalence may have to be supported
by various types of information indicating that the device is as safe and
effective for its intended use as a legally marketed predicate device.  In
addition to requiring clearance for new products, FDA rules typically require a
filing and a waiting period prior to marketing modified versions of existing
products.  The Company anticipates that most of its products will be eligible
for the 510(k) Notification procedure.  At this time, the FDA typically
responds to a submission of a 510(k) Notification within 180 to 360 days.
Market clearance may take three to 12 months or longer.  In the event that the
shorter 510(k) Notification procedure is not available, the Company will be
required to file a PMA.

         Under the Safe Medical Devices Act of 1990 ("SMDA"), the FDA is
directed to adopt new 510(k) Notification regulations which could potentially
make the approval process for the Company's products more time-consuming,
difficult and expensive.  The SMDA includes new provisions relating to
post-market surveillance requirements for certain types of devices and
authorizes the FDA to adopt new controls to be applied to certain devices such
as some currently being developed by the Company, including the promulgation of
a performance standard, requirements for patient registries, distributor and
purchaser reporting and imposition of guidelines.

         The process of obtaining necessary government approvals can be
time-consuming and expensive.  There can be no assurance that the necessary
approvals will be obtained by the Company or, if they are obtained, that they
will be obtained on a timely basis.  Furthermore, the Company or the FDA may
suspend clinical trials at any time upon a determination that the subjects or
patients are being exposed to an unacceptable health risk.  The FDA may also
require post-approval testing and surveillance programs to monitor the effects
of the Company's products and the products it distributes as a condition of
approval.  Approvals that have been or may be granted are subject to continual
review and surveillance programs required by regulatory agencies, and later
discovery of previously unknown problems may result in product labeling
restrictions or withdrawal of products from marketing.

   
         Manufacturers of medical devices marketed in the United States are
required to adhere to applicable regulations setting forth detailed Good
Manufacturing Practices ("GMP") requirements, which include testing, control
and documentation requirements.  Manufacturers also must comply with Medical
Device Reporting ("MDR") requirements which require that a firm report to the
FDA certain adverse events associated with the Company's devices.  The Company
is subject to routine inspection by the FDA and certain state agencies for
compliance with GMP requirements, MDR requirements and other applicable
regulations.  The FDA is using its statutory authority more vigorously during
inspections of companies and in other enforcement matters.  The FDA has
promulgated new GMP regulations and MDR regulations, both of which will likely
increase the cost of compliance with GMP requirements.  The Company also is
subject to numerous federal, state and local laws relating to matters such as
safe working conditions, manufacturing practices, environmental protection,
fire hazard control and disposal of hazardous or potentially hazardous
substances.  Changes in existing requirements or adoption of new requirements
could have a material adverse effect on the Company's business, financial
condition or results of operations.  Although the Company believes that it is
in compliance with all applicable regulations of the FDA and the various states
in which it operates, current regulations depend heavily on administrative
interpretation and there can be no assurance that the Company will not incur
significant costs to comply with laws and regulations in the future or that
laws and regulations will not have a material adverse effect upon the Company's
business, financial condition or results of operations.  In addition, the
potential effects on the Company of heightened enforcement of federal and state
regulations cannot be predicted.
    


                                      -10-
<PAGE>   12

   
         All of the products manufactured by the Company have received all
regulatory approvals as required, and the Company believes, to its best
knowledge, that all of the products it distributes but does not manufacture
have received all regulatory approvals as required.  The Company has no
applications for approval before either the FDA or any similar regulatory body
in other countries nor does the Company anticipate filing any applications in
the near future.  The Company has never had any sales in Europe nor has it ever
applied for the CE mark for sales in Europe.  In addition, the Company has no
plans to conduct any operations in Europe.
    

         In addition to the statutes and regulations enforced by the FDA, the
Company is also subject to regulation under the Occupational Safety and Health
Act, the Environmental Protection Act, the Toxic Substances Control Act, the
Resource Conservation and Recovery Act and other present and potential future
federal, state and local statutes, regulations and ordinances, including those
promulgated by the Environmental Protection Act and the Department of Labor.
Regulations regarding the manufacture and sale of the Company's products are
subject to change.  The Company cannot predict what impact, if any, such
changes might have on its business.

THIRD-PARTY REIMBURSEMENT

   
         The health care industry continues to undergo change, led primarily by
market forces which are demanding greater efficiencies and reduced costs.
Government proposed health care mandates in the United States have not
occurred, and it is unclear whether, and to what extent, any government mandate
will affect the domestic health care market.  Industry led changes are expected
to continue irrespective of any governmental efforts toward health care reform.
The scope and timing of any further government sponsored proposals for health
care reform are presently unclear.

         The primary trend in the industry is toward consolidation and cost
containment.  Third-party payors, principally federal Medicare, state Medicaid
and private health insurance plans, have been able to exercise greater
influence through managed treatment and hospitalization patterns, including a
shift from reimbursement on a cost basis to per capita limits for patient
treatment.  Hospitals have been severely impacted by the resulting cost
restraints.  The increasing use of managed care, centralized purchasing
decisions through group purchasing organizations, consolidations among
hospitals and hospital groups, and integration of health care providers are
continuing to affect purchasing patterns in the health care system.  Purchasing
decisions are often shared by a coalition of surgeons, nursing staff, and
hospital administrators, with purchasing decisions taking into account whether
a product reduces the cost of treatment and/or attracts additional patients to
a hospital.  Managed care providers are attempting to control the cost of
health care by authorizing fewer elective surgical procedures.  All of these
factors have contributed to reductions in prices for the Company's products, to
a reduction in the volume of hospital purchasing and, in the near term, slower
acceptance of more advanced surgical procedures in which the Company's products
are used, given hospital and surgeon concerns as to the costs of training and
reimbursement by payors.  While the Company has implemented programs to assist
hospitals in cost containment through more efficient surgical practices and
application of minimally invasive surgery, there can be no assurance that the
Company will not continue to be adversely affected by these matters.  There can
be no assurance as to the impact of cost containment on the Company's future
operations.

         The Company's products are purchased by hospitals, physicians, and
other health care providers, which bill various third-party payors, such as
government health programs, private health insurance plans, managed care
organizations and other similar programs, for the health care goods and
services provided to their patients.  Third- party payors may deny
reimbursement if they determine that a product was not used in accordance with
established payor protocol regarding cost-effective treatment methods, or was
used for an unapproved treatment.  Increasingly, third-party payors are also
contesting the prices charged for medical products and services and, in some
instances, have put pressure on medical device suppliers to lower their prices.
There is no assurance that reimbursement for the Company's products will be
available or, if available, that payors' reimbursement levels will not
adversely affect the Company's ability to sell its products on a profitable
basis.  Failure by hospitals and other users of the Company's products to
obtain reimbursement from third-party payors, and changes in third-party
payors' policies towards reimbursement for procedures using the Company's
products, could have a material adverse effect on the Company's financial
position, results of operations and cash flows.
    

PRODUCT LIABILITY AND INSURANCE

         The development, manufacture and sale of MIS products by the Company
entails the risk of product liability claims, involving both potential
financial exposure and associated adverse publicity.  The Company's current
product


                                      -11-
<PAGE>   13
liability insurance coverage limits are $1,000,000 per occurrence and
$2,000,000 in the aggregate, and there can be no assurance that such coverage
limits are adequate to protect the Company from any liabilities it might incur
in connection with the development, manufacture and sale of its current and
potential products.  In addition, the 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 or results of operations.

   
         The Company's products are purchased by hospitals, physicians, and
other health care providers, which in turn bill various third-party payors,
such as government health programs, private health insurance plans, managed
care organizations and other similar programs, for the health care goods and
services provided to their patients.  Third- party payors may deny
reimbursement if they determine that a product was not used in accordance with
established payor protocol regarding cost-effective treatment methods, or was
used for an unapproved treatment.  Increasingly, third-party payors are also
contesting the prices charged for medical products and services and, in some
instances, have put pressure on medical device suppliers to lower their prices.
There is no assurance that reimbursement for procedures performed by healthcare
providers utilizing the Company's products will be available or, if available,
that the third- party payors' reimbursement levels will not adversely affect
the Company's ability to sell its products on a profitable basis.  Failure by
hospitals and other users of the Company's products to obtain reimbursement
from third-party payors, and changes in third-party payors' policies towards
reimbursement for procedures utilizing the Company's products, could have a
material adverse effect on the Company's financial position, results of
operations and cash flows.
    

ADDITIONAL BUSINESS RISKS

         HISTORY OF LOSSES; PROFITABILITY UNCERTAIN.  The Company has
experienced operating losses since its inception on January 1, 1989.  At
December 31, 1997, the Company had an accumulated deficit of approximately
$17.35 million.  Prior to the acquisitions of GME, KMI and VMI, the Company was
a development stage company focused primarily on obtaining FDA approval of two
medical devices.  However, the Company has determined not to initiate any
further work on obtaining FDA approval of the devices unless an appropriate
corporate partner can be identified.  Primarily as a result of its acquisitions
in 1996 and 1997, the Company generated revenues of approximately $14.3 million
during the year ended December 31, 1997.

         In the future, the Company expects to have increased cash outflow
requirements as a result of expenditures related to the expansion of sales and
marketing activity, expansion of manufacturing capacity, compliance with
regulatory requirements, and possible investment in or acquisition of
additional complementary products, technologies or businesses.  The cash needs
of the Company have changed significantly as a result of the acquisitions
completed during the last two years and the support requirements of the added
business focus areas.  There can be no assurance that the Company will not
continue to incur losses, that the Company will be able to raise cash as
necessary to fund operations or that the Company will ever achieve
profitability.

   
         RECENT PRIVATE PLACEMENTS.  In August 1998, pursuant to the terms of a
private placement, the Company issued to two affiliates of Renaissance Capital
Group, Inc. (collectively, such affiliates referred to herein as "Renaissance")
and two individuals, including one who is an officer and director of the
Company, an aggregate of 1,170 shares of 8% Series A Cumulative Preferred
Stock, $.001 par value ("Series A Preferred Stock), for aggregate proceeds of
$1,170,000.  On the date the Company closed such private placement, August 11,
1998, the closing per share price of Common Stock on the NASDAQ SmallCap Market
was $1.75.  The Company intends to use such proceeds for working capital.
Annual dividends on the Series A Preferred Stock are cumulative at a rate of
$80 per share.  The Series A Preferred Stock is initially convertible into
shares of Common Stock at a conversion price of $2 per share, for an aggregate
of 585,000 shares of Common Stock.  The conversion price for the Series A
Preferred Stock is subject to downward adjustment in the event the Company
sells shares of Common Stock, or securities convertible into shares of Common
Stock, at a per share price less than $2.  The conversion price for the Series
A Preferred Stock is subject to a one-time downward adjustment in the event (i)
the Company does not have pre-tax income, excluding extraordinary gains, of at
least $4,400,000 in 1998 and (ii) following the Company's public release of its
1998 financial results, the then current market price of Common Stock, as
defined in the Company's Certificate of Incorporation, is less than $2 per
share.  The holders of Series A Preferred Stock are entitled to one vote per
share on all matters submitted to a vote of the stockholders of the Company,
and the affirmative vote of the holders of 66 2/3% of the votes entitled to be
cast by the holders of the Series A Preferred Stock is required in order to
amend the Company's Certificate of Incorporation or Bylaws to materially affect
the rights of the holders of Series A Preferred Stock,
    


                                      -12-
<PAGE>   14

   
including authorizing and creating a class of stock having rights prior to or
senior to the Series A Preferred Stock.  In the event two quarterly dividends
payable on the Series A Preferred Stock are in arrears, the holders of Series A
Preferred Stock, by a majority vote, shall be entitled to designate two
additional directors to serve on the Company's Board of Directors.

         In December 1997, the Company sold 250,000 shares of Common Stock to
Renaissance in a private placement for aggregate proceeds of $1,000,000 and
placed $3,000,000 in 9 % Convertible Debentures (the "Debentures") with
Renaissance.  The proceeds from the private placement were used to repay the
Company's line of credit with another financial institution, to make an equity
investment in TFX, and for working capital purposes.  The Debentures are
secured by substantially all of the assets of the Company and require monthly
payments of interest beginning in February 1998 and, unless sooner paid,
redeemed or converted, require monthly principal payments commencing in
December 2000 of $10 per $1000 of the then remaining principal amount.  The
remaining principal balance will mature in December 2004.  The Debentures
require the Company to comply with the following financial covenants (all as
defined in the Debentures): (i) a Debt to Net Worth Ratio of no greater than
 .85:1; (ii) an Interest Coverage Ratio of at least 5:1; (iii) a Debt Coverage
Ratio of at least .10:1; and (iv) a Current Ratio of at least 1.8:1.  The
Company is currently not in compliance with and has obtained a waiver from
Renaissance to suspend the Interest Coverage Ratio and Debt Coverage Ratio
covenants through December 31, 1998. The holders of the Debentures have the
option to convert at any time all or a portion of the Debentures into shares of
Common Stock at an initial price of $4 per share of Common Stock.  On the date
the Company closed such private placement, December 19, 1997, the closing per
share price of the Company's Common Stock on the NASDAQ SmallCap Market was
$4.063.  The conversion price is subject to downward revision if the Company
sells shares of its Common Stock, or securities convertible into Common Stock,
at a price less than $4 per share of Common Stock, subject to certain allowed
exceptions, during the term of the Debentures.  Accordingly, the conversion
price for the Debentures was reduced to $2 per share of Common Stock in
connection with the August 1998 private placement.  The Debentures are also
subject to a one-time adjustment to the conversion price whereby the price will
be reduced if (i) the Company does not have pre-tax income, excluding
extraordinary gains, of at least $4,400,000 in 1998 and (ii) following the
Company's public release of its 1998 financial results, the then current market
price of Common Stock, as defined in the Debentures, is less than $2 per share.
The Debentures are currently convertible for an aggregate of 1,500,000 shares
of Common Stock; however, since the conversion price is subject to downward
adjustment as described above, and there is no minimum conversion price, the
maximum number of shares of Common Stock which may be issued pursuant to the
Debentures is undeterminable.  The provisions of the Debentures provide that
the holders of the Debentures have an option to redeem the Debentures, in an
amount equal to an 18 percent annual yield on the principal balance, upon the
occurrence of certain events, including the delisting of Common Stock from the
NASDAQ SmallCap Market and certain "change of control" provisions, as defined
in the Debentures, as they relate to the Company.  The Company may redeem the
Debentures at its option subject to certain share price and market activity
levels being obtained.  The Company's right of redemption is subject to the
holder's prior right of conversion of the Debenture.

         POTENTIAL ADVERSE EFFECTS OF CONVERSION OF DEBENTURES AND SERIES A
PREFERRED STOCK. The Company's capital requirements will depend on numerous
factors, including market acceptance and demand for its products; the resources
the Company devotes to the development, manufacture and marketing of its
products; the resources required to protect the Company's intellectual
property; the resources expended, if any, to acquire complementary businesses,
products and technologies; and other factors.  The timing and amount of such
capital requirements cannot be accurately predicted.  Funds may also be used
for the acquisition of businesses, products and technologies that are
complementary to those marketed by the Company.  Consequently, although the
Company believes that its revenues and other sources of liquidity will provide
adequate funding for its capital requirements through at least 1998, the
Company may be required to raise additional funds through public or private
financings, collaborative relationships or other arrangements.  There can be no
assurance that the Company will not require additional funding or that such
additional funding, if needed, will be available on terms attractive to the
Company or at all.  In the event that substantial amounts of additional
financing are required, including amounts that may be required for any
potential redemption of the Debentures described above, the Company does not
believe it will be able to obtain such financing from traditional commercial
lenders.  Rather, the Company likely will have to conduct additional sales of
its equity and/or debt securities.  In two private placements since December
1997, the Company has issued securities currently convertible into 2,085,000
shares of Common Stock.  If the holders of such securities were to convert them
into shares of Common Stock and sell a large number of shares of Common Stock
on the public market, the market price for the Common Stock could decline, thus
making additional equity financings more difficult for the Company to obtain on
an acceptable basis, if at all.  There can be no assurance that such additional
financing will be available if and when, and in the amounts required, by the
Company.  Moreover, even if such financing is available if and when required,
there
    



                                      -13-
<PAGE>   15

   
can be no assurance that such financing will be obtained on terms that are
favorable to the Company, and substantial and immediate dilution to existing
stockholders likely would result from any sales of equity securities or other
securities convertible into equity securities.  Any additional debt financings,
if available, may involve restrictive covenants.

         FUTURE ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL
WILL BE AVAILABLE. The Company's capital requirements will depend on numerous
factors, including market acceptance and demand for its products; the resources
the Company devotes to the development, manufacture and marketing of its
products; the resources required to protect the Company's intellectual
property; the resources expended, if any, to acquire complementary businesses,
products and technologies; and other factors.  The timing and amount of such
capital requirements cannot be accurately predicted.  Funds may also be used
for the acquisition of businesses, products and technologies that are
complementary to those marketed by the Company.  Consequently, although the
Company believes that its revenues and other sources of liquidity will provide
adequate funding for its capital requirements through at least 1998, the
Company may be required to raise additional funds through public or private
financings, collaborative relationships or other arrangements.  There can be no
assurance that the Company will not require additional funding or that such
additional funding, if needed, will be available on terms attractive to the
Company or at all.  In the event that substantial amounts of additional
financing are required, including amounts that may be required for any
potential redemption of the Debentures described above, the Company does not
believe it will be able to obtain such financing from traditional commercial
lenders.  Rather, the Company likely will have to conduct additional sales of
its equity and/or debt securities.  In two private placements since December
1997, the Company has issued securities currently convertible into 2,085,000
shares of Common Stock.  If the holders of such securities were to convert them
into shares of Common Stock and sell a large number of shares of Common Stock
on the public market, the market price for the Common Stock could decline, thus
making additional equity financings more difficult for the Company to obtain on
an acceptable basis, if at all.  There can be no assurance that such additional
financing will be available if and when, and in the amounts required, by the
Company.  Moreover, even if such financing is available if and when required,
there can be no assurance that such financing will be obtained on terms that
are favorable to the Company, and substantial and immediate dilution to
existing stockholders likely would result from any sales of equity securities
or other securities convertible into equity securities.  Any additional debt
financings, if available, may involve restrictive covenants.

         ACQUISITION INTEGRATION. The Company's growth in recent years has
resulted from acquisitions, which involve certain operational and financial
risks.  This growth has resulted in a significant increase in responsibility
for existing management which has placed, and may continue to place, a
significant strain on the Company's limited personnel and management,
manufacturing and other resources.  The integration of these acquisitions has
required a significant expansion, and in some instances the replacement, of the
Company's accounting and other internal management systems and the
implementation of a variety of procedures and controls, including systems and
procedures designed to harmonize (i) the various management systems of the
acquired companies and (ii) the management styles of management personnel of
the acquired companies.  There can be no assurance that significant problems in
these areas will not occur.  Any failure to continue to expand or replace, as
applicable, these systems and implement such procedures and controls in an
efficient manner and at a pace consistent with the Company's business could
have a material adverse effect on the Company's business, financial condition
and results of operations.

         In connection with the Company's acquisitions and growth, the
Company's operating expenses have increased significantly, and the Company
anticipates that operating expenses will continue to increase in absolute
dollars in the future.  In particular, in order to continue to provide quality
products and customer service and to meet anticipated demands of its customers,
the Company will be required to continue to increase staffing and other
expenses, including expenditures on sales and marketing and the infrastructure
to support them.  Should the Company increase its expenditures in anticipation
of a future level of sales that does not materialize, the Company's business,
financial condition and results of operations would be materially and adversely
affected.  Certain customers have required and may continue to require rapid
increases in production and accelerated delivery schedules which have placed
and may continue to place a significant burden on the Company's resources.  In
order to achieve anticipated sales levels and profitability, the Company will
continue to be required to manage its assets and operations efficiently.  In
addition, should the Company continue to expand geographically, it may
experience certain inefficiencies from the management of geographically
dispersed personnel and other resources.

         Although many of the companies acquired by the Company had significant
operating histories, the Company has limited experience owning and operating
them on a consolidated basis.  Operational risks associated with an acquisition
include the possibility that an acquisition does not ultimately provide the
benefits originally anticipated by the Company's management, while the Company
continues to incur operating expenses to provide the services formerly
    


                                      -14-
<PAGE>   16

   
provided by the acquired company.  Financial risks involve the incurrence of
indebtedness as a result of the acquisition and the consequent need to service
that indebtedness.  In connection with an acquisition made in December 1996,
the Company paid an aggregate of $400,000 in cash.  In addition, pursuant to
the exemptions from registration provided for in Section 4(2) of the Securities
Act, the Company has issued approximately 2.8 million shares of Common Stock,
which represents approximately 38% of its outstanding and issued shares of
Common Stock at June 30, 1998, in connection with its six acquisitions since
February 1996.  The issuance of Common Stock dilutes the voting power and may
dilute the economic interests of existing stockholders.  As part of the
Company's growth strategy, the Company will continue to review acquisition
opportunities in the future, and in making acquisitions, if any, the Company
may issued additional shares of Common Stock, other equity securities, debt
securities or equity or debt securities convertible into shares of Common
Stock.  In carrying out its acquisition strategy, the Company attempts to
minimize the risk of unexpected liabilities and contingencies associated with
acquired businesses through planning, investigation and negotiation, but there
is no assurance that it will be successful in doing so.  There can be no
assurance that recent or future acquisitions can be readily assimilated into
the Company's operating structure.  Inability to efficiently integrate acquired
companies could have a material adverse effect on the Company's financial
condition and results of operations.  The Company does not currently have any
commitments or agreements with respect to any material acquisitions.
    

         MANAGEMENT OF GROWTH.  The rapid growth of the Company's business has
required the Company to make significant additions in personnel and has
significantly increased the Company's working capital requirements.  Although
the Company has experienced significant sales growth in 1996 and 1997, such
growth should not be considered indicative of future sales growth.  Such growth
has resulted in new and increased responsibilities for management personnel and
has placed and continues to place a significant strain upon the Company's
management, operating and financial systems, and other resources.  There can be
no assurance that the strain placed upon the Company's management, operating
and financial systems, and other resources will not have a material adverse
effect on the Company's business, financial condition, and results of
operations, nor can there be any assurance that the Company will be able to
attract or retain sufficient personnel to continue the expansion of its
operations.  Also crucial to the Company's success in managing its growth will
be its ability to achieve additional economies of scale.  There can be no
assurance that the Company will be able to achieve such economies of scale, and
the failure to do so could have a material adverse effect on the Company's
business, financial condition, and results of operations.

         To manage the expansion of its operations, the Company must
continuously evaluate the adequacy of its management structure and its existing
systems and procedures, including, among others, its data processing,
financial, and internal control systems.  When entering new geographic markets,
the Company will be required, on a timely and cost- effective basis, to hire
personnel, establish suitable distribution centers, and adapt the Company's
distribution systems and procedures to these new markets.  There can be no
assurance that management will adequately anticipate all of the changing
demands that growth could impose on the Company's systems, procedures, and
structure.  In addition, the Company will be required to react to changes in
the MIS distribution industry, and there can be no assurance that it will be
able to do so successfully.  Any failure to adequately anticipate and respond
to such changing demands may have a material adverse effect on the Company's
business, financial condition, or results of operations.

         EFFECTS OF DELISTING FROM NASDAQ SMALLCAP MARKET; LACK OF LIQUIDITY OF
LOW PRICED STOCKS.  If the Company fails to maintain the qualification for its
Common Stock to trade on the Nasdaq SmallCap Market, its securities could be
subject to delisting.  The Nasdaq Stock Market recently announced increases in
the quantitative standards for maintenance of listings on The Nasdaq SmallCap
Market.  The revised standards for continued listing, which became effective in
February 1998, include maintenance of any of (x) $2,000,000 of net tangible
assets, (y) $35,000,000 of market capitalization or (z) $500,000 of net income
for two of the last three years and a minimum bid price per share of $1.00.
Although the Company is currently in compliance with the new Nasdaq SmallCap
Market continued listing requirements, no assurances can be given that the
Company will be able to maintain such compliance in the future.  In the event
the Company is unable to satisfy the continued listing requirements, trading,
if any, in the Common Stock would thereafter be conducted in the
over-the-counter markets in the so-called "pink sheets" or the National
Association of Securities Dealer's "Electronic Bulletin Board."  Consequently,
the liquidity of the Company's Common Stock would likely be impaired, not only
in the number of shares which could be bought and sold, but also through delays
in the timing of the transactions, reduction in security analysts' and the news
media's coverage, if any, of the Company and lower prices for the Company's
securities than might otherwise prevail.

         In addition, if the Common Stock were to become delisted from trading
on the Nasdaq SmallCap Market and the trading price of the Common Stock were
below $5.00 per share, trading in the Common Stock would also be subject



                                      -15-
<PAGE>   17
to the requirements of certain rules promulgated under the Exchange Act, which
require additional disclosures by broker- dealers in connection with any trades
involving a stock defined as a penny stock (generally, any non-Nasdaq equity
security that has a market price of less than $5.00 per share, subject to
certain exceptions).  Such rules require the delivery, prior to any penny stock
transaction, of a disclosure schedule explaining the penny stock market and the
risks associated therewith, and impose various sales practice requirements on
broker-dealers who sell penny stock to persons other than established customers
and accredited investors (which are generally institutions).  For these types
of transactions, the broker-dealer must make a special suitability
determination for the purchase and have received the purchaser's written
consent to the transaction prior to the sale.  The additional burdens imposed
upon broker-dealers by such requirements may discourage broker-dealers from
effecting transactions in the Common Stock which could severely limit the
market liquidity of Common Stock and the ability of purchasers in this offering
to sell their shares of Common Stock in the secondary market.

         RELIANCE ON FUTURE PRODUCTS AND NEW APPLICATIONS; UNCERTAINTY OF
TECHNOLOGY CHANGES.  The markets for the Company's products are characterized
by rapid, unpredictable and significant technological change.  Competition in
the Company's industry is intense.  Many of the Company's competitors have
greater financial resources, research and development capabilities and more
experience in obtaining regulatory approvals, manufacturing and marketing than
the Company.  Accordingly, these competitors may succeed in developing,
obtaining regulatory approval for and some have commercialized their products
more rapidly than the Company.  There can be no assurance that developments by
the Company's competitors or potential competitors will not render the
Company's MIS products non-competitive, uneconomical or obsolete.  There can be
no assurance that the Company will be able to successfully obtain new MIS
products or technologies, manufacture products in commercial volumes or gain
market acceptance of its products or the products of others.  Delays in
development, manufacturing or market acceptance of new or enhanced products
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, its ability to obtain and distribute new
and enhanced versions of products in a timely fashion.

   
         RISK RELATED TO INTANGIBLE ASSETS.  Largely as a result of
acquisitions, goodwill accounts for approximately 17% and 37% of the Company's
total assets and stockholders' equity, respectively, at June 30, 1998.
Goodwill was approximately $1.8 million at June 30, 1998.  Goodwill arises when
an acquirer pays more for a business than the fair value of the tangible and
separately measurable intangible net assets acquired.  The Company periodically
evaluates whether events and circumstances have occurred indicating that any
portion of the remaining balance of amounts allocable to the Company's
intangible assets may not be recoverable.  If factors indicate that the
carrying value of the Company's intangible assets has been impaired, the
Company would be required to reduce the carrying value of such assets.  Any
future determination requiring the write-off of a significant portion of the
unamortized intangible assets could have a material adverse effect on the
Company's business, results of operations or financial condition.  A reduction
in net income resulting from the amortization of goodwill may have an adverse
impact upon the market price of the Company's Common Stock.
    

         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 have in
the past and may continue in the future to adversely affect the market price of
the Company's Common Stock.  In addition, the market price of the 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, the FDA and
international regulatory actions, actions with respect to reimbursement
matters, developments with respect to patents of proprietary rights, public
concern as to the safety of products developed or marketed 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, or the
medical device industry generally or general market conditions may have a
significant effect on the market price of the Company's Common Stock.

   
         SHARES ELIGIBLE FOR FUTURE SALE OR ISSUANCE.   Sales of shares of
Common Stock by existing stockholders under Rule 144 of the Securities Act, or
through the exercise of outstanding vested options or the conversion of the
Debentures or Series A Preferred Stock, could have an adverse effect on the
price of the Common Stock.  At August 15, 1998, approximately 870,000 shares of
Common Stock held by affiliates of the Company are eligible for sale in the
public market upon compliance with the volume and other limitations contained
in Rule 144 of the Securities Act.  In addition, on the date of this
Prospectus, there were outstanding options to acquire up to approximately
437,000 shares of Common Stock under the Company's stock option plan, options
to acquire up to approximately 762,000
    



                                      -16-
<PAGE>   18

   
additional shares of Common Stock under option agreements entered into outside
of such plan, 1,500,000 shares of Common Stock issuable upon conversion of the
Debentures and 585,000 shares of Common Stock issuable upon conversion of
Series A Preferred Stock.  In the event a large number of shares are sold in
the public market over a short period of time, the market price for Common
Stock could decline.

         LIMITED MANUFACTURING EXPERIENCE.  The Company maintains limited
manufacturing facilities.  Although certain members of the Company's management
have manufacturing experience, the operation of the Company's manufacturing
facilities will subject the Company to numerous risks, including unanticipated
technological problems or delays.  In the event that the Company is unable to
efficiently operate its manufacturing facilities, the Company will be required
to enter into arrangements with others for the manufacture and packaging of the
products it currently manufactures.  There can be no assurance that the Company
will be able to enter into any such arrangements on commercially reasonable
terms, or at all, or that the Company will ever be able to establish the
capability to manufacture all of its products on a commercial basis.
    

         RIGHTS AGREEMENT.  On June 21, 1995, the Board of Directors of the
Company declared a dividend of one Common Stock purchase right (a "Right") for
each share of Common Stock outstanding.  Each Right entitles the holder to
purchase one share of the Company's Common Stock at an initial exercise price
of $7.00 per share, subject to adjustment, upon the terms and subject to the
conditions set forth in a Rights Agreement dated as of June 20, 1995, between
the Company and American Stock Transfer & Trust Company, as the Rights Agent.
The Rights trade with the Common Stock and will not detach from the Common
Stock or become exercisable until the earlier of (i) ten business days after a
public announcement that a person or group of affiliated or associate persons
("Acquiring Person") has acquired beneficial ownership of 15% or more of the
Company's Common Stock (a "Shares Acquisition Date") and (ii) ten business days
after the commencement of, or the first public announcement of an intention to
make, a tender offer or exchange offer for the Common Stock, the consummation
of which would result in beneficial ownership by a person or group.

         If any person or group which acquires beneficial ownership of 15% or
more of the outstanding shares of the Company's Common Stock, each Right (other
than the Rights held by the Acquiring Person, which shall be void), will
entitle its holder to purchase at the exercise price an additional number of
shares of Common Stock equal to the amount determined by dividing the exercise
price by 50% of the then current market price of the Common Stock.

         In addition, if following the Shares Acquisition Date, the Company is
acquired in a merger or other business- combination transaction, or sells more
than 50% of its assets or earning power to any person, each Right (other than
those beneficially held by an Acquiring Person) will entitle its holder to
purchase at the existing exercise price a number of shares of common stock of
the acquiring company having twice the value of the exercise price.

         The Company may redeem the Rights at $.02 per Right at any time on or
prior to the tenth business day following the first public announcement of the
acquisition by a person of 15% or more of its Common Stock or the commencement
of a tender offer or exchange offer for such 15% ownership.

   
         The Rights have certain anti-takeover effects.  The Rights will cause
substantial dilution to a person or group who attempts to acquire the Company
without conditioning the offer on a substantial number of Rights being
acquired.  The Rights may also deter a person or group from attempting to
acquire the Company and therefore may inhibit the ability of stockholders of
the Company to sell their shares of Common Stock at a premium price in a
takeover situation.  The Rights should not interfere with any merger or other
business combination approved by the Board of Directors of the Company since
the Board of Directors may, at its option, at any time prior to the close of
business on the tenth business day after the Shares Acquisition Date, redeem
all the then outstanding Rights at a price of $.02 per Right.

         CERTAIN ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF
INCORPORATION AND DELAWARE LAW.  Certain provisions of the Delaware General
Corporation Law ("DGCL") and the Company's Certificate of Incorporation could
have the effect of making it more difficult for a third party to acquire, or of
discouraging a third party from acquiring, control of the Company.  Such
provisions could limit the price that certain investors might be willing to pay
in the future for shares of Common Stock.  These provisions of the DGCL and
provisions of the Company's Certificate of Incorporation may also have the
effect of discouraging or preventing certain types of transactions involving an
actual or threatened change of control of the Company (including unsolicited
takeover attempts), even though such a transaction may offer the Company's
stockholders the opportunity to sell their stock at a price above the
prevailing market price.  The Company is subject to the provisions of Section
203 of the DGCL.  In general, Section 203 prohibits
    



                                      -17-
<PAGE>   19

   
a publicly held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date
that the person became an interested stockholder unless (with certain
exceptions) the business combination or the transaction in which the person
became an interested stockholder is approved in a prescribed manner.
Generally, a "business combination" includes a merger, asset or stock sale, or
other transaction resulting in a financial benefit to the stockholder.
Generally, an "interested stockholder" is a person who, together with
affiliates and associates, owns (or within three years prior to such
transaction, did own) 15% or more of the corporation's voting stock.

         The Company's Certificate of Incorporation authorizes the issuance of
preferred stock with designations, rights and preferences determined from time
to time by its Board of Directors.  The Board of Directors may issue one or
more series of preferred stock, without any action on the part of the
stockholders of the Company, the terms of which may adversely affect the rights
of holders of Common Stock.  Issuance of preferred stock, which may be
accomplished through a public offering or a private placement, may dilute the
voting power of holders of Common Stock (such as by issuing preferred stock
with super voting rights) and may render more difficult the removal of current
management, even if such removal may be in the stockholders' best interests.

         The issuance of preferred stock, for example, could decrease the
amount of earnings or assets available for distribution to the holders of
Common Stock or could adversely affect the rights and powers, including voting
rights, of the holders of Common Stock.  In certain circumstances, such
issuance could have the effect of decreasing the market price of the Common
Stock, as well as having the anti-takeover effect discussed above.  Further,
the issuance of preferred stock may be used as an "anti-takeover" device
without further action on the part of the stockholders.  Although the Company
issued 1,170 shares of preferred stock in August 1998, it has no present
intention to issue any additional shares of its preferred stock, however, there
can be no assurance that it will not do so in the future.

         NONPAYMENT OF DIVIDENDS.  The Company has never declared or paid
dividends on Common Stock and does not anticipate paying dividends on Common
Stock at any time in the foreseeable future.  The terms of the convertible
debentures and certain of the Company's loan agreements restrict the payment of
dividends on Common Stock.
    



                                      -18-
<PAGE>   20

   
                          GLOSSARY OF TECHNICAL TERMS
    

   
<TABLE>
<S>                         <C>
autoclave                   an apparatus for effecting sterilization by steam under pressure; it is fitted with a gauge
                            that automatically regulates the pressure, and therefore the degree of heat to which the
                            contents are subjected.

cannula                     a tube for insertion into a duct or cavity; during insertion its lumen is usually occupied
                            by a trocar.

electrocautery              an apparatus for cauterizing tissue, consisting of a platinum wire in a holder which is
                            heated to a red or white heat when the instrument is activated by an electric current.

endoscope                   an instrument for the examination of the interior of a hollow viscus, such as the bladder.

laparoscope                 an instrument comparable to an endoscope which, when inserted into the peritoneal cavity,
                            permits it to be inspected; peritoneoscope.

laparoscopy                 examination of the interior of the abdomen by means of a laparoscope.

peperitoneal                situated between the parietal peritoneum and the abdominal wall, or occurring anterior to
                            the peritoneum.

peritoneum                  the serous membrane lining the abdominopelvic walls and investing the viscera.  A strong,
                            colorless membrane with a smooth surface, it forms a double-layered sac that is closed in
                            the male and it continuous with the mucous membrane of the uterine tubes in the female.  The
                            potential space between the parietal and visceral peritoneum is called the peritoneal
                            cavity.

pneumopreperitoneum         the presence of air or gas in the preperitoneal space; it may occur spontaneously or be
                            deliberately introduced as an aid to radiologic examination and diagnosis.

retractor                   an instrument for maintaining operative exposure by separating the edges of a wound and
                            holding back underlying organs and tissues; many shapes, sizes, and styles are available;
                            any retractile muscle.

stapling                    the act or process of closing a wound fastening with staples instead of sutures.

trocar                      a sharp-pointed instrument equipped with a cannula, used to puncture the wall of a body
                            cavity and withdraw fluids.
</TABLE>
    



                                      -19-
<PAGE>   21
EMPLOYEES

         As of March 16, 1998, the Company employed approximately 91 persons.
None of the Company's employees are represented by a union for collective
bargaining purposes.  The Company considers its relations with its employees to
be satisfactory.

EXECUTIVE OFFICERS OF THE REGISTRANT

         The current executive officers of the Company and their names, ages,
positions and tenure with the Company are as follows:

   
<TABLE>
<CAPTION>
                                                                                              OFFICER
         NAME                        AGE                   POSITION                            SINCE
         ----                        ---                   --------                            -----
 <S>                                 <C>     <C>                                               <C>
 Richard A. Woodfield                55      President and Chief Executive Officer              1998

 Randall K. Boatright                49      Executive Vice President, Chief                    1992
                                             Financial Officer and Secretary

 Richard H. Klein                    45      Vice President                                     1996

 K.C. Fadem                          39      Vice President                                     1996

 Robert Fadem                        36      Vice President                                     1996

 William H. Bookwalter               32      Vice President                                     1997
</TABLE>
    

         K.C. Fadem and Robert Fadem are brothers.  There are no other family
relationships among the officers listed.  In connection with the Klein Merger,
Richard H. Klein was made a Vice President of the Company.  In connection with
the Val-U-Med Merger, K.C. Fadem and Robert Fadem were made Vice Presidents of
the Company.  In connection with the Bookwalter Merger, William H. Bookwalter
was made a Vice President of the Company.  There are no other arrangements or
understandings pursuant to which any of the other officers listed were elected
as officers.  Officers are elected annually by the Board of Directors at its
first meeting following the Annual Meeting of Stockholders, each to hold office
until the corresponding meeting of the Board in the next year or until his
successor shall have been elected or shall have been qualified.


ITEM 2.                          PROPERTIES

         The Company currently leases corporate headquarters and distribution
facilities in San Antonio, Texas, under a lease expiring in May 2002.  The
Company currently leases office and distribution facilities in Atlanta,
Georgia, under a lease expiring in March 2002, and office and distribution
facilities in Milford, Massachusetts under a lease expiring in March 2002.
During 1997 the Company paid aggregate rentals of approximately $249,000.


ITEM 3.                       LEGAL PROCEEDINGS

         Not applicable.


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

         Not applicable.



                                      -20-
<PAGE>   22
                                    PART II

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

         The Common Stock, $.001 par value ("Common Stock"), of the Company
trades on the Nasdaq SmallCap Market under the symbol "LQMD" and commenced
trading in August 1992.  The following table presents the range of high and low
sales prices for the Common Stock as reported by the Nasdaq Stock Market for
the periods indicated.  The quotations represent prices in the over-the-counter
market between dealers in securities, do not include retail markup, markdown or
commissions and may not necessarily represent actual transactions.

<TABLE>
<CAPTION>
 QUARTER ENDED              HIGH                  LOW
 -------------              ----                  ---

 Fiscal 1997:
 ------------ 
 <S>                       <C>                  <C>
 Fourth Quarter            $5  3/8              $3  5/8

 Third Quarter              5  1/4               4  1/8

 Second Quarter             5  1/8               4  1/8

 First Quarter              5  1/2               2  7/8


 Fiscal 1996:
 ------------ 

 Fourth Quarter            $3  3/4              $1  7/8

 Third Quarter              2  1/2               1  3/8

 Second Quarter             3  5/8               2

 First Quarter              4  1/8               2  1/4
</TABLE>


         At March 18, 1998, there were approximately 200 record holders of
Common Stock and approximately 1,560 beneficial holders of Common Stock.

         The Company has not in the past declared any cash dividends on the
Common Stock, and does not anticipate paying dividends on the Common Stock at
any time in the foreseeable future.



                                      -21-
<PAGE>   23
ITEM 6.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                     CONDITION AND RESULTS OF OPERATIONS


OVERVIEW

   
         From inception through December 31, 1995, the Company was a
development stage enterprise whose efforts and resources were devoted primarily
to research and development activities related to its initial products.  During
this development stage, the Company generated minimal operating revenues and,
thus, was unprofitable.  In 1996, the Company decided to reduce continuing
investment in research and development related to such technologies and to
focus its efforts on distributing MIS devices.  Accordingly, during the last
two fiscal years, the Company has continued to decrease its engagement in
company sponsored research and development, and in fiscal 1997, eliminated
virtually all expenditures in this area.  The Company intends to develop any
new products for manufacturing through acquisition or by entering into private
manufacturing agreements.  There can be no assurance that the Company will be
able to develop new products for manufacturing or enter into any private
manufacturing agreements.  As of December 31, 1997, the Company had an
accumulated deficit of approximately $17,353,000.  There can be no assurance
that the Company will not continue to incur losses, that the Company will be
able to raise cash as necessary to fund operations or that the Company will
ever achieve profitability.
    

         The Company's future operating results will depend on many factors,
including the Company's ability to manufacture, market and distribute safe and
effective products on a cost-effective basis, demand for and acceptance of the
Company's products, the level of competition in the marketplace, the ability of
the Company to create, obtain and maintain scientifically advanced technology,
the ability of the Company's customers to be reimbursed by third-party payors
and other factors described in this Annual Report on Form 10-KSB.

         Effective September 1997, W. H. Bookwalter and Associates, Inc., a
Vermont corporation ("Bookwalter"), was acquired by the Company and merged into
Val-U-Med, Inc., a Nevada corporation and a wholly-owned subsidiary of the
Company ("Val-U-Med"), in consideration for an aggregate of 466,473 shares of
Common Stock.  The transaction was accounted for using the pooling-of-interests
accounting method; therefore, the assets, liabilities and operations of
Bookwalter are included in the consolidated financial statements contained
herein for all periods reported therein.  Bookwalter business activity will
provide the Company with distribution coverage in the northeastern region of
the United States.

   
         Effective September 1997, Mishbucha, Inc., a Texas corporation d/b/a
Medex Surgical ("Medex Surgical"), was acquired by the Company and merged into
Klein Medical, Inc., a Nevada corporation and a wholly-owned subsidiary of the
Company ("Klein"), in consideration for an aggregate of 98,246 shares of Common
Stock.  Medex Surgical was formed during 1997 and the transaction was accounted
for using the pooling-of-interests accounting method; therefore, the assets,
liabilities, and operations of Medex Surgical are included in the consolidated
financial statements contained herein for 1997.  Medex Surgical business
activity provides the Company with distribution coverage in the Dallas/Fort
Worth and North Texas area.
    

         Effective June 1997, Trimedica, Inc., a Colorado corporation
("Trimedica"), was acquired by the Company and merged into Klein in
consideration for an aggregate of 57,143 shares of Common Stock.  The
transaction was accounted for using the pooling-of-interests accounting method;
therefore, the assets, liabilities, and operations of Trimedica are included in
the consolidated financial statements contained herein for all periods reported
therein.  Trimedica business activity provides the Company with distribution
coverage in the Rocky Mountain region, and is managed by the Company's
Orthopedic Sales Division.

         In December 1996, Val-U-Med, Inc., a Georgia corporation ("VMI"), was
acquired by the Company and merged into Val-U-Med in consideration for an
aggregate of 1,200,000 shares of Common Stock and an aggregate of $400,000.
The transaction was accounted for using the purchase method of accounting;
therefore, the assets, liabilities and operations of VMI prior its acquisition
by the Company are not included in the consolidated financial statements
contained herein.

         In November 1996, Klein Medical, Inc., a Texas corporation ("KMI"),
was acquired by the Company and merged into Klein in consideration for an
aggregate of 600,000 shares of Common Stock.  The transaction was



                                      -22-
<PAGE>   24
accounted for using the pooling-of-interests accounting method; therefore, the
assets, liabilities, and operations of KMI are included in the consolidated
financial statements contained herein for all periods reported therein.

         In February 1996, the Company completed the merger of GM Engineering,
Inc., a California corporation ("GME"), with and into LifeQuest Endoscopic
Technologies, Inc., ("LQET") a Nevada corporation and wholly owned subsidiary
of the Company, in consideration for 350,000 shares of Common Stock.  The
transaction was recorded using the pooling-of- interests method of accounting;
therefore, the assets, liabilities, and operations of GME are included in the
consolidated financial statements contained herein for all periods reported
therein.

         In May, 1994, the Company and Valdor Fiber Optics ("Valdor") of San
Jose, California, formed a corporate joint venture called ValQuest Medical,
Inc. ("ValQuest").  In accordance with the terms of the joint venture
agreement, Valdor transferred to ValQuest the exclusive worldwide rights to
develop, manufacture, and market all present and future medical applications of
Valdor's patented fiber optic connector technology.  The Company paid $100,000
to Valdor in consideration for the transfer of these rights to ValQuest.
Valdor contributed such rights, which had an initial value of $327,273 in the
consolidated financial statements, to ValQuest in exchange for a 45 percent
interest in ValQuest.  The Company contributed $400,000 to be used as working
capital in exchange for a 55 percent interest in ValQuest.  Subsequent
purchases of stock have increased the Company's current ownership interest in
ValQuest to 82 percent.

LIQUIDITY AND CAPITAL RESOURCES

         At December 31, 1997, the Company had current assets of $7,614,000 and
current liabilities of $3,439,000 resulting in working capital of $4,175,000.
This compares to a working capital position of $3,000,000 at December 31, 1996.
The increase in working capital is primarily due to a $4,000,000 private
placement of shares of Common Stock and 9% convertible debentures with two
affiliates of Renaissance Capital Group, Inc. ("Renaissance") in December 1997.

   
         In August 1998, pursuant to the terms of a private placement, the
Company issued to two affiliates of Renaissance Capital Group, Inc.
(collectively, such affiliates referred to herein as "Renaissance") and two
individuals, including one who is an officer and director of the Company, an
aggregate of 1,170 shares of 8% Series A Cumulative Preferred Stock, $.001 par
value ("Series A Preferred Stock), for aggregate proceeds of $1,170,000.  On
the date the Company closed such private placement, August 11, 1998, the
closing per share price of Common Stock on the NASDAQ SmallCap Market was
$1.75.  The Company intends to use such proceeds for working capital.  Annual
dividends on the Series A Preferred Stock are cumulative at a rate of $80 per
share.  The Series A Preferred Stock is initially convertible into shares of
Common Stock at a conversion price of $2 per share, for an aggregate of 585,000
shares of Common Stock.  The conversion price for the Series A Preferred Stock
is subject to downward adjustment in the event the Company sells shares of
Common Stock, or securities convertible into shares of Common Stock, at a per
share price less than $2.  The conversion price for the Series A Preferred
Stock is subject to a one-time downward adjustment in the event (i) the Company
does not have pre-tax income, excluding extraordinary gains, of at least
$4,400,000 in 1998 and (ii) following the Company's public release of its 1998
financial results, the then current market price of Common Stock, as defined in
the Company's Certificate of Incorporation, is less than $2 per share.  The
holders of Series A Preferred Stock are entitled to one vote per share on all
matters submitted to a vote of the stockholders of the Company, and the
affirmative vote of the holders of 66 2/3% of the votes entitled to be cast by
the holders of the Series A Preferred Stock is required in order to amend the
Company's Certificate of Incorporation or Bylaws to materially affect the
rights of the holders of Series A Preferred Stock, including authorizing and
creating a class of stock having rights prior to or senior to the Series A
Preferred Stock.  In the event two quarterly dividends payable on the Series A
Preferred Stock are in arrears, the holders of Series A Preferred Stock, by a
majority vote, shall be entitled to designate two additional directors to serve
on the Company's Board of Directors.

         In December 1997, the Company sold 250,000 shares of Common Stock to
Renaissance in a private placement for aggregate proceeds of $1,000,000 and
placed $3,000,000 in 9 % Convertible Debentures (the "Debentures") with
Renaissance.  The proceeds from the private placement were used to repay the
Company's line of credit with another financial institution, to make an equity
investment in TFX, and for working capital purposes.  The Debentures are
secured by substantially all of the assets of the Company and require monthly
payments of interest beginning in February 1998 and, unless sooner paid,
redeemed or converted, require monthly principal payments commencing in
December 2000 of $10 per $1000 of the then remaining principal amount.  The
remaining principal balance will mature in December 2004.  The Debentures
require the Company to comply with the following financial covenants
    



                                      -23-
<PAGE>   25

   
(all as defined in the Debentures): (i) a Debt to Net Worth Ratio of no greater
than .85:1; (ii) an Interest Coverage Ratio of at least 5:1; (iii) a Debt
Coverage Ratio of at least .10:1; and (iv) a Current Ratio of at least 1.8:1.
The Company is currently not in compliance with and has obtained a waiver from
Renaissance to suspend the Interest Coverage Ratio and Debt Coverage Ratio
covenants through December 31, 1998. The holders of the Debentures have the
option to convert at any time all or a portion of the Debentures into shares of
Common Stock at an initial price of $4 per share of Common Stock.  On the date
the Company closed such private placement, December 19, 1997, the closing per
share price of the Company's Common Stock on the NASDAQ SmallCap Market was
$4.063.  The conversion price is subject to downward revision if the Company
sells shares of its Common Stock, or securities convertible into Common Stock,
at a price less than $4 per share of Common Stock, subject to certain allowed
exceptions, during the term of the Debentures.  Accordingly, the conversion
price for the Debentures was reduced to $2 per share of Common Stock in
connection with the August 1998 private placement.  The Debentures are also
subject to a one-time adjustment to the conversion price whereby the price will
be reduced if (i) the Company does not have pre-tax income, excluding
extraordinary gains, of at least $4,400,000 in 1998 and (ii) following the
Company's public release of its 1998 financial results, the then current market
price of Common Stock, as defined in the Debentures, is less than $2 per share.
The Debentures are currently convertible for an aggregate of 1,500,000 shares
of Common Stock; however, since the conversion price is subject to downward
adjustment as described above, and there is no minimum conversion price, the
maximum number of shares of Common Stock which may be issued pursuant to the
Debentures is undeterminable.  The provisions of the Debentures provide that
the holders of the Debentures have an option to redeem the Debentures, in an
amount equal to an 18 percent annual yield on the principal balance, upon the
occurrence of certain events, including the delisting of Common Stock from the
NASDAQ SmallCap Market and certain "change of control" provisions, as defined
in the Debentures, as they relate to the Company.  The Company may redeem the
Debentures at its option subject to certain share price and market activity
levels being obtained.  The Company's right of redemption is subject to the
holder's prior right of conversion of the Debenture.
    

         On February 26, 1996, the Company borrowed $750,000 from a commercial
bank pledging a like amount of short-term investments as collateral.  The loan
proceeds were used to replace more expensive debt, mainly capital equipment
leases, acquired with the acquisition of GME.  On September 3, 1997, the loan
was converted to a line of credit maturing September 1998 whereby all
inventories, accounts receivable and intangibles of the Company are pledged as
collateral.  The line of credit was paid in full in December 1997 with proceeds
from the private placement described above.  There was no outstanding balance
on the line of credit at December 31, 1997.

         Capital expenditures, including purchase business combinations, were
$450,000 during 1997.  The Company anticipates further capital expenditures as
the Company's geographical expansion continues.

         In December 1997, the Company entered into an agreement to acquire
approximately 20 percent of the stock of TFX Holding Co. ("TFX") for
$1,000,000, which was paid in January 1998.  The Company recognized no revenues
or expenses associated with TFX during 1997.

         In December 1997, the Company and Canwell Medical, Inc. formed Canwell
Surgical, Inc. ("Canwell").  Canwell is 50 percent owned by the Company and
Canwell Medical, Inc. and was formed for the purpose of selling minimally
invasive surgical products in China and other Asian countries.  The Company
recognized no revenues or expenses associated with Canwell during 1997.  In
January 1998, the Company loaned $100,000 to Canwell for initial working
capital requirements.  The loan is unsecured and bears interest at 9 percent
with the principal maturing in January 2000.

   
         For the year ended December 31, 1997, operating activities utilized
$2,249,000 of cash primarily from the net loss for the year.  Investment
activities during 1997 provided cash of $1,871,000 primarily from the sale of
investments.  Total cash provided from financing activities for 1997 was
$3,320,000.  The Company sold common stock and convertible debentures during
1997 realizing net proceeds of $4,200,000.  Also, during 1997, the Company
repaid $796,000 of long-term debt.

         For the year ended December 31, 1996, operating activities utilized
$1,938,000 of cash primarily due to the net loss for the year.  Investment
activities during 1996 provided cash of $1,700,000 primarily from the sale of
investments.  The Company borrowed $1,016,000 during 1996 and repaid $714,000
of long-term debt and capital lease obligations which were the primary
components of financing activities which provided cash of $222,000.
    



                                      -24-
<PAGE>   26
         Based upon the current level of operations, the Company believes that
projected cash flow from operations plus the Company's cash from the
realization of its current assets will be adequate to meet its anticipated
requirements for working capital and capital expenditures during 1998.
However, additional capital may be required in order for the Company to take
advantage of any additional attractive acquisition opportunities or to
participate in future alliances or joint ventures.  There can be no assurance
that the Company will not require additional funding or that such additional
funding, if needed, will be available on terms attractive to the Company or at
all.

RESULTS OF OPERATIONS FOR YEAR ENDING DECEMBER 31, 1997

   
         For the year ended December 31, 1997, the Company reported a net loss
of $2,997,000 or $.48 per basic and diluted share.  This compares with a net
loss of $1,958,000, or $.40 per basic and diluted share for the year ended
December 31, 1996.  The increase in the net loss for the year was primarily
caused by costs associated with the Company's acceleration of the geographic
expansion of its business activity and sales force and distribution and sales
support infrastructure and due to expenses incurred during the development of
the Company's own SST brand of trocars and cannulas.  During the year ended
December 31, 1997, the Company's sales force grew in excess of 200% and its
distribution coverage expanded to include 32 states and one Canadian province.
The sales force expansion was necessary to prepare for two major product
introductions the Company has planned for 1998, which significantly increased
selling, general and administrative expenses as discussed below.
    

         In March 1998 the Company launched distribution of the patented
Dexterity(R) Pneumo Sleeve and Dexterity(R) Protractor in the United States.
The Dexterity(R) devices are owned by TFX Holding Company, a business
development subsidiary of Teleflex, Inc. (NYSE:TFX).  The Company owns
approximately 20% of the voting common stock of TFX Holding Company.

         The Pneumo Sleeve is a device that allows the surgeon to insert one
hand into the abdominal cavity while preserving pneumoperitoneum during
laparoscopic surgery.  This new surgical modality, called Hand Assisted
Laparoscopic Surgery (HALS), is a hybrid between open and laparoscopic surgery.
This enabling technology is expected to greatly increase the number of advanced
minimal access surgeries as well as the number of surgeons who perform these
procedures.  The U.S. market potential for the Dexterity(R) Pneumo Sleeve is
estimated at more than 580,000 procedures annually, including digestive tract
surgery, urinary tract surgery, organ transplants, cancer surgery and vascular
surgery.  This translates into an estimated $600 million U.S. market for
Dexterity(R) procedural kits, which include accessory devices such as hand-held
surgical instruments.

         In addition to being used with the Dexterity(R) Pneumo Sleeve, the
Dexterity(R) Protractor is used as a stand- alone product for open surgery,
providing atraumatic retraction and wound protection.  The market potential for
the Dexterity(R) Protractor is estimated at 2.4 million surgical procedures per
year in the United State, representing a dollar market potential in excess of
$200 million.

   
         The Company has the option to acquire the exclusive U.S. distribution
rights to a patented state-of-the-art clip applier which management believes is
superior to currently available clip appliers.  The 5mm clip applier is less
invasive than the 10mm clip appliers which currently dominate the U.S. market.
LifeQuest plans to exercise such option and introduce this product as soon as
the supplier's manufacturing assembly line preparations are complete, which the
Company estimates will be in the fourth quarter of 1998.  Clip appliers are
crucial instruments for surgeons working in the abdomen and chest because they
provide the simplest, quickest and most effective means of occluding structures
such as small blood vessels and ducts, thus decreasing total surgical and
anesthesia time.
    

         The Company believes the potential exists for significant market
penetration by both of these products, and that sales of the Company's existing
product lines should benefit from these product introductions.  The Company
expects that both products shall become integral components of LifeQuest's
Lapro-PAK surgical procedure kits.

   
         Product sales increased 140% in 1997 as compared with 1996.  Product
sales were $13,428,000 for 1997 and $5,595,000 for 1996.  The increase in sales
is due to the acquisition of Val-U-Med, which transaction was recorded using
the purchase method of accounting.  Therefore, the results of operations of
Val-U-Med are included in the Company's consolidated statement of operations
for 1997 but not 1996.

         Gross profit from product sales was $4,727,000 in 1997 versus
$2,099,000 in 1996.  The corresponding gross profit margins were 35% in 1997
and 38% in 1996.  The decrease in margins for 1997 was a result of certain
inventory
    



                                      -25-
<PAGE>   27

   
adjustments relative to discontinued product lines as well as inventory
consumed as demonstration units in the sales function.  On July 18, 1997, the
Company completed its previously announced relocation which combined its
corporate offices, San Antonio warehouse and distribution center, repair and
service center, and manufacturing facility in one new San Antonio location.
The Company believes this move and the related February 1997 move of Val-U-Med
and the Atlanta distribution center into a new larger facility prepares the
Company for continued growth and positions the Company to capture further
operating efficiencies.
    

         Research and development expenses for 1997 were $32,000, as compared
to $398,000 for 1996.  The decrease is due to the Company's decision to
severely curtail research activity and to concentrate its resources on sales
growth through geographical and product line expansion.

   
         In 1997, selling, general and administrative expenses, which consist
primarily of sales commissions, salaries and other costs necessary to support
the Company's infrastructure, increased to $8,188,000 in 1997 from $3,933,000
in 1996.  The increased costs reflect higher sales commissions due to the
inclusion of the Val-U-Med results, increased costs related to developing and
supporting an infrastructure necessary to integrate the Company's acquisitions
during 1996 and 1997 and costs associated with development of a new customized
line of trocars and cannulas.
    

         The minority interest in net loss of consolidated subsidiary reflects
the minority ownership share of ValQuest's operations.

         Investment income represents interest earned on the Company's
short-term investments.  Therefore, investment income declined in 1997 to
$83,000 from $209,000 in 1996, due to a commensurate decline in the level of
short-term investments of the Company from 1997 to 1996.

RESULTS OF OPERATIONS FOR YEAR ENDING DECEMBER 31, 1996

         Net loss for the year ended December 31, 1996 was $1,958,000, a
decrease of 12 percent from the $2,215,000 net loss for the year ended December
31, 1995.  The decline was primarily due to a reduction in expenses and an
increase in gross profit margins as detailed hereinafter.

   
         Gross profit from sales was $2,100,000 in 1996 versus $1,419,000 in
1995.  The corresponding gross profit margins were 37 percent in 1996 and 28
percent in 1995.  The improvement in margins was primarily due to the upgrading
of facilities and increased employee training which both contribute to better
efficiencies.
    

         Research and development expenses decreased 45 percent in 1996 from
1995.  This decline was due to the Company's decision to severely curtail
research activity and to concentrate its resources on sales growth through
geographical and product line expansion.

         Selling, general and administrative expenses, which consist primarily
of sales commissions, salaries and other costs necessary to support the
Company's infrastructure, increased 23 percent to $3,933,000 in 1996 from
$3,191,000 in 1995.  This comparative increase was primarily a result of the
Company's expanded sales force.

         The minority interest in net loss of consolidated subsidiary of
$21,000 in 1996 reflects the minority ownership share of the ValQuest net loss.
This interest in ValQuest net loss was down 85 percent from 1995 which reflects
the smaller loss from ValQuest.

         Investment income represents interest earned on the Company's short
term investments.  Investment income declined from $347,000 in 1995 to $209,000
in 1996 as the level of short term investments declined from year to year.

         Merger and acquisition costs of $254,000 in 1996 include legal,
accounting and testing expenses incurred during the acquisitions of GME, Klein
and Val-U-Med.

INCOME TAX

         As of December 31, 1997, the Company had net operating loss (NOL)
carryforwards of approximately $14,300,000 for federal income tax purposes that
are available to reduce future taxable income and will expire in 2006 through
2012 if not utilized.  For federal income tax purposes, the Company deferred
for future amortization certain



                                      -26-
<PAGE>   28
acquisition and research and development costs in the amount of $2,453,000.
Such costs, which have been expensed for financial reporting purposes, will be
amortized for tax purposes over future years when and if associated commercial
operations commence.  The Company received IRS approval of its request for a
change of tax accounting method to expense research and development costs for
expenditures incurred in 1992 and future years.  The Company also has research
and development credit carryforwards available to offset future income taxes
and expire in 2005 through 2010.

         As there is no assurance of future income, a 100% valuation reserve in
1996 and 1997 has been established against the Company's deferred tax assets.
The Company will continue to evaluate the necessity for such valuation reserve
in the future.

         The Company's ability to use its NOL carryforwards to offset future
taxable income is subject to restrictions enacted in the United States Internal
Revenue Code of 1986, as amended (the "Code").  These restrictions provide for
limitations on the Company's utilization of its NOL carryforwards following
certain ownership changes described in the Code.  As a result of ownership
changes, the Company's existing NOL carryforwards are subject to limitation.
Additionally, because the Code limits the time during which NOL and tax credit
carryforwards may be applied against future taxable income and tax liabilities,
the Company may not be able to take full advantage of its NOL and tax credits
for federal income tax purposes.

YEAR 2000 COMPLIANCE

         The efficient operation of the Company's business is dependent on its
computer software programs and operating systems (collectively, "Programs and
Systems").  These Programs and Systems are used in several key areas of the
Company's business, including information management services and financial
reporting, as well as in various administrative functions.  The Company has
been evaluating its Programs and Systems to identify potential year 2000
compliance problems, as well as manual processes, external interfaces with
customers, and services supplied by vendors to coordinate year 2000 compliance
and conversion.  The year 2000 problem refers to the limitations of the
programming code in certain existing software programs to recognize date
sensitive information for the year 2000 and beyond.  Unless modified prior to
the year 2000, such systems may not properly recognize such information and
could generate erroneous data or cause a system to fail to operate properly.

         Based on current information, the Company expects to attain year 2000
compliance and institute appropriate testing of its modifications and
replacements in a timely fashion and in advance of the year 2000 date change.
It is anticipated that modification or replacement of the Company's Programs
and Systems will be performed in-house by company personnel.  The Company
believes that, with modifications to existing software and conversions to new
software, the year 2000 problem will not pose a significant operational problem
for the Company.  However, because most computer systems are, by their very
nature, interdependent, it is possible that non-compliant third party computers
may not interface properly with the Company's computer systems.  The Company
could be adversely affected by the year 2000 problem if it or unrelated parties
fail to successfully address this issue.  Management of the Company currently
anticipates that the expenses and capital expenditures associated with its year
2000 compliance project will not have a material effect on its financial
position or results of operations.

ITEM 7.          FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements and supplementary data described in Item
13(a) herein are attached hereto.


ITEM 8.        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                     ACCOUNTING AND FINANCIAL DISCLOSURE

         None.



                                      -27-
<PAGE>   29
                                    PART III

ITEM 9.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Information required under this Item will be contained in the
Company's Proxy Statement for 1998 Annual Meeting, which is incorporated herein
by reference.

         See also "Executive Officers of the Registrant" under Part I, Item 1,
herein.


ITEM 10.                    EXECUTIVE COMPENSATION

         Information required under this Item will be contained in the
Company's Proxy Statement for 1998 Annual Meeting, which is incorporated herein
by reference.


ITEM 11.           SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
                            OWNERS AND MANAGEMENT

         Information required under this Item will be contained in the
Company's Proxy Statement for 1998 Annual Meeting, which is incorporated herein
by reference.


ITEM 12.        CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Information required under this Item will be contained in the
Company's Proxy Statement for 1998 Annual Meeting, which is incorporated herein
by reference.


                                      -28-
<PAGE>   30
                                    PART IV

ITEM 13.           EXHIBITS, FINANCIAL STATEMENT SCHEDULES
                           AND REPORTS ON FORM 8-K

(a) 1.  FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                                     Page
                                                                                                                     ----
        <S>                                                                                                           <C>
        Report of Independent Public Accountants  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F-1

        Balance Sheets at December 31, 1996 and 1997  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F-2

        Statements of Operations for the years ended December 31, 1996 and 1997 . . . . . . . . . . . . . . . . . .   F-4

        Statements of Stockholders' Equity for the years ended December 31, 1996 and 1997   . . . . . . . . . . . .   F-5

        Statements of Cash Flows for the years ended December 31, 1996 and 1997   . . . . . . . . . . . . . . . . .   F-6

        Notes to Financial Statements   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F-8
</TABLE>

2.      EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER           IDENTIFICATION OF EXHIBIT
-------          -------------------------
<S>              <C>

2.1              Plan of Merger and Acquisition Agreement dated February 13, 1996, but effective as of January 1, 1996,
                 among LifeQuest Medical, Inc., LifeQuest Endoscopic Technologies, Inc., GM Engineering, Inc., Gregory
                 M. Miles and Susan G. Miles (incorporated by reference herein to Exhibit 2.1 to the Company's Current
                 Report on Form 8-K filed February 27, 1996).

2.2              Plan of Merger and Acquisition Agreement dated November 27, 1996, among LifeQuest Medical, Inc., Klein
                 Medical Acquisition Co., Klein Medical, Inc. and Richard H. Klein (incorporated by reference herein to
                 Exhibit 2.1 to the Company's Current Report on Form 8-K filed December 12, 1996).

2.3              Plan of Merger and Acquisition Agreement dated December 27, 1996, among LifeQuest Medical, Inc., Val-U-
                 Med Acquisition Co., Val-U-Med, Inc. and the Stockholders of Val-U-Med, Inc. (incorporated by reference
                 herein to Exhibit 2.1 to the Company's Current Report on Form 8-K filed January 10, 1997).

2.4              Plan of Merger and Acquisition Agreement dated June 30, 1997, among LifeQuest Medical, Inc., Klein
                 Medical, Inc., Trimedica, Inc., and Mark Lovejoy. (incorporated by reference herein to Exhibit 2.1 to
                 the Company's Quarterly Report on Form 10-QSB for the quarter ending June 30, 1997).

2.5              Plan of Merger and Acquisition Agreement dated September 30, 1997, among LifeQuest Medical, Inc., Val-
                 U-Med, Inc., W. H. Bookwalter & Associates, Inc., and the shareholders of W. H. Bookwalter &
                 Associates, Inc. (incorporated by reference herein to Exhibit 21.1 to the Company's Quarterly Report on
                 Form 10-Q for the quarter ending September 30, 1997).

2.6              Plan of Merger and Acquisition Agreement dated October 7, 1997, among LifeQuest Medical, Inc., Klein
                 Medical, Inc., Mishbucha, Inc. d/b/a Medex Surgical, Inc., Edward Kraus, and Robert Kraus (incorporated
                 by reference herein to Exhibit 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter
                 ending September 30, 1997).
</TABLE>


                                      -29-
<PAGE>   31
<TABLE>
<S>              <C>
2.7*             Plan of Merger and Acquisition Agreement dated December 30, 1997, among LifeQuest Medical, Inc.,
                 LifeQuest Endoscopic Technologies, Inc., Klein Medical, Inc. and Val-U-Med, Inc.

3.1              Certificate of Incorporation of the Registrant (incorporated by reference herein to Exhibit 3.1 to the
                 Company's Registration Statement on Form S-1 filed on August 19,1992, Registration No. 33-49196).

3.2              Bylaws of the Registrant (incorporated by reference herein to Exhibit 3.2 to the Company's Registration
                 Statement on Form S-1 filed on August 19, 1992, Registration No. 33-49196).

4.1*             Convertible Loan Agreement among the Company, Renaissance Capital Growth and Income Fund III, Inc.,
                 Renaissance US Growth and Income Trust PLC and Renaissance Capital Group, Inc. dated December 19, 1997.


10.1             1989 Stock Option Plan of LifeQuest Medical, Inc. (incorporated by reference herein to Exhibit 4.4 to
                 the Company's Registration Statement on Form S-8 filed on October 12, 1993, Registration No. 33-70174).

10.2             Employment Agreement dated February 15, 1992, between LifeQuest Medical, Inc. and Herbert H. Spoon
                 (incorporated by reference herein to Exhibit 10.8 to the Company's Registration Statement on Form S-1
                 filed on August 19, 1992, Registration No. 33-49196).

10.3             Incentive Stock Option Agreement dated January 15, 1990, between LifeQuest Medical, Inc. and Herbert H.
                 Spoon (incorporated herein to Exhibit 10.12 to the Company's Registration Statement on Form S-1 filed
                 on August 19, 1992, Registration No. 33-49196).

10.4             Patent License Agreement dated January 1, 1989, between LifeQuest Medical, Inc. and The Board of
                 Regents of the University of Texas System, as amended by instrument dated November 1, 1989
                 (incorporated herein to Exhibit 10.15 to the Company's Registration Statement on Form S-1 filed on
                 August 19, 1992, Registration No. 33-49196).

10.5             License Agreement dated June 26, 1992, between LifeQuest Medical, Inc. and George C. Kramer, Ph.D.
                 (incorporated herein to Exhibit 10.22 to the Company's Registration Statement on Form S-1 filed on
                 August 19, 1992, Registration No. 33-49196).

10.6             Incentive Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and Herbert H.
                 Spoon (incorporated herein by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K
                 for the fiscal year ended December 31, 1994).

10.7             Incentive Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and Randall K.
                 Boatright (incorporated herein by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-
                 K for the fiscal year ended December 31, 1994).

10.8             Incentive Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and David J.
                 Collette, M.D. (incorporated herein by reference to Exhibit 10.18 to the Company's Annual Report on
                 Form 10-K for the fiscal year ended December 31, 1994).

10.9             1994 Non-Employee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.19 to the
                 Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).

10.10            Non-Qualified Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and Robert
                 B. Johnson (incorporated herein by reference to Exhibit 10.21 to the Company's Annual Report on Form
                 10-K for the fiscal year ended December 31, 1994).

10.11            Non-Qualified Stock Option Agreement dated March 2, 1995, between LifeQuest Medical, Inc. and Jeffrey
                 H. Berg, Ph.D. (incorporated herein by reference to Exhibit 10.22 to the Company's Annual Report on
                 Form 10-K for the fiscal year ended December 31, 1994).
</TABLE>


                                      -30-
<PAGE>   32
<TABLE>
<S>              <C>
10.12            ValQuest Medical, Inc. 1994 Stock Option Plan (incorporated herein by reference to Exhibit 10.23 to the
                 Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).

10.13            Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and Herbert H.
                 Spoon (incorporated herein by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K
                 for the fiscal year ended December 31, 1994).

10.14            Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and Randall K.
                 Boatright (incorporated herein by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-
                 K for the fiscal year ended December 31, 1994).

10.15            Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and David J.
                 Collette, M.D. (incorporated herein by reference to Exhibit 10.26 to the Company's Annual Report on
                 Form 10-K for the fiscal year ended December 31, 1994).

10.16            Non-Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and Robert
                 B. Johnson (incorporated herein by reference to Exhibit 10.29 to the Company's Annual Report on Form
                 10-K for the fiscal year ended December 31, 1994).

10.17            Assignment and License Agreement dated May 11, 1994, between ValQuest Medical, Inc. and Fibotech, Inc.
                 d/b/a Valdor Fiber Optics (incorporated herein by reference to Exhibit 10.30 to the Company's Annual
                 Report on Form 10-K for the fiscal year ended December 31, 1994).

10.18            Employment Agreement dated November 27, 1996, between Klein Medical Acquisition Co. and Richard H.
                 Klein (incorporated by reference herein to Exhibit 10.1 to the Company's Current Report on Form 8-K
                 filed December 12, 1996).

10.19            Non-Qualified Stock Option Agreement dated November 27, 1996, between LifeQuest Medical, Inc. and
                 Richard H. Klein (incorporated by reference herein to Exhibit 10.2 to the Company's Current Report on
                 Form 8-K filed December 12, 1996).

10.20            Employment Agreement dated December 27, 1996, between Val-U-Med Acquisition Co. and K.C. Fadem
                 (incorporated by reference herein to Exhibit 10.1 to the Company's Current Report on Form 8-K filed
                 January 10, 1997).

10.21            Non-Qualified Stock Option Agreement dated December 27, 1996, between LifeQuest Medical, Inc. and K.C.
                 Fadem (incorporated by reference herein to Exhibit 10.2 to the Company's Current Report on Form 8-K
                 filed January 10, 1997).

10.22            Employment Agreement dated December 27, 1996, between Val-U-Med Acquisition Co. and Robert Fadem
                 (incorporated by reference herein to Exhibit 10.3 to the Company's Current Report on Form 8-K filed
                 January 10, 1997).

10.23            Non-Qualified Stock Option Agreement dated December 27, 1996, between LifeQuest Medical, Inc. and
                 Robert Fadem (incorporated by reference herein to Exhibit 10.4 to the Company's Current Report on Form
                 8-K filed January 10, 1997).

10.24            Lease Agreement dated April 28, 1997, between Interpark Jack Limited Partnership and LifeQuest Medical,
                 Inc. (incorporated by reference herein to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
                 for the quarterly period ended June 30, 1997).

10.25            Lease Agreement dated March 1, 1997, between Williams North Fulton Group and the Company (incorporated
                 by reference herein to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly
                 period ended June 30, 1997).
</TABLE>


                                      -31-
<PAGE>   33

   
<TABLE>
<S>              <C>
10.26            Employment Agreement dated September 30, 1997, between William H. Bookwalter and the Company
                 (incorporated by reference herein to Exhibit No. 10.1 to the Company's Quarterly Report on Form 10-Q
                 for the quarterly period ended September 30, 1997).

10.27**          Distribution Agreement dated May 1, 1997 between LifeQuest Medical, Inc. and Origin MedSystems, Inc.

22               Subsidiaries
                                                                                       Name Under Which
                 Name                                      State of Incorporation       Doing Business
                 ----------------------------------------------------------------------------------------
                 <S>                                       <C>                      <C>
                 ValQuest Medical, Inc.                     Nevada                  ValQuest Medical, Inc.

11*              Computation of earnings (loss) per share

23**             Consent of Arthur Andersen LLP

27*              Financial Data Schedule
</TABLE>
    

   
*   Previously filed
**  Filed herewith
    

(b)      REPORTS ON FORM 8-K

         (1)     Form 8-K dated December 27, 1996 and filed January 10, 1997
                 described the merger of Val-U-Med, Inc., a Georgia
                 corporation, with and into Val-U-Med Acquisition Co., a Nevada
                 corporation and newly formed, wholly owned subsidiary of
                 LifeQuest Medical, Inc.

         (2)     Form 8-K/A Amendment No. 1, was filed February 7, 1997, which
                 provided the financial statements, pro forma financial
                 information and exhibits pertaining to the previously
                 announced merger of Klein Medical, Inc., a Texas corporation
                 with and into Klein Medical, Inc., a Nevada corporation and
                 newly formed, wholly owned subsidiary of LifeQuest Medical,
                 Inc.

         (3)     Form 8-K/A, Amendment No. 1, was filed March 12, 1997 which
                 provided the financial statements, pro forma financial
                 information and exhibits pertaining to the previously
                 announced merger of Val-U-Med, Inc., a Georgia corporation
                 with and into Val-U-Med, Inc., a Nevada corporation and newly
                 formed, wholly owned subsidiary of LifeQuest Medical, Inc.



                                      -32-
<PAGE>   34
                                   SIGNATURES

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

   
                                       LIFEQUEST MEDICAL, INC.


November 6, 1998                       By      /s/ Richard A. Woodfield        
                                           -------------------------------------
                                                   Richard A. Woodfield
                                           President and Chief Executive Officer
    

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

   
<TABLE>
<CAPTION>
              SIGNATURE                            TITLE                               DATE
              ---------                            -----                               ----
    <S>                               <C>                                        <C>
    /s/ Richard A. Woodfield          President, Chief Executive                 November 6, 1998
    ---------------------------       Officer and Director (Principal       
        Richard A. Woodfield          Executive Officer)                    
                                                                            
                                                                            
    /s/ Randall K. Boatright          Executive Vice President, Chief            November 6, 1998
    ---------------------------       Financial Officer and Director        
        Randall K. Boatright          (Principal Financial and              
                                      Accounting Officer)                   
                                                                            
                                                                            
      /s/ Robert B. Johnson           Director                                   November 6, 1998
    ---------------------------                                                                   
          Robert B. Johnson                                                 
                                                                            
                                                                            
          /s/ K.C. Fadem              Director                                   November 6, 1998
    ---------------------------                                                                  
              K.C. Fadem                                                     
                                                                            
                                                                            
    /s/ Jeffrey H. Berg, Ph.D.        Director                                   November 6, 1998
    ---------------------------                                                                  
        Jeffrey H. Berg, Ph.D.                                              
                                                                            
                                                                            
       /s/ Richard H. Klein           Director                                   November 6, 1998
    ---------------------------                                                                 
           Richard H. Klein                                                 
                                                                            
                                                                            
       /s/ Robert L. Evans            Director                                   November 6, 1998
   ------------------------------                                                                
           Robert L. Evans                                                  
                                                                            
                                                                            
     /s/ William H. Bookwalter        Director                                   November 6, 1998
   ------------------------------                                                                  
         William H. Bookwalter                                              
</TABLE>
    

   
    


                                      -33-
<PAGE>   35
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Board of Directors and Stockholders of LifeQuest Medical, Inc.:

         We have audited the accompanying consolidated balance sheets of
LifeQuest Medical, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1996 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of LifeQuest Medical,
Inc. and subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.



                                       /S/   ARTHUR ANDERSEN LLP




San Antonio, Texas
March 16, 1998





                                       F-1
<PAGE>   36

                    LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                         December 31,       December 31,
                                 ASSETS                                      1996               1997
                                                                         ------------       ------------
<S>                                                                      <C>                <C>
Current assets:
     Cash and cash equivalents                                           $    294,143       $  3,236,307
     Short-term investments                                                 2,464,743            144,682
     Accounts receivable (net of allowance for doubtful accounts of
         $231,891 in 1996 and $256,362 in 1997)                             1,162,880          2,292,235
     Accounts receivable from related party                                    14,871             17,710
     Interest receivable                                                       60,381              5,318
     Inventories, net                                                       1,628,913          1,745,523
     Prepaid and other assets                                                  74,379            172,209
                                                                         ------------       ------------
                  Total current assets                                      5,700,310          7,613,984
                                                                         ------------       ------------

Property, plant and equipment                                               1,253,277          1,541,376
     Less-Accumulated depreciation                                           (785,897)          (922,437)
                                                                         ------------       ------------
                  Net property, plant and equipment                           467,380            618,939
                                                                         ------------       ------------

Deferred finance charges                                                         --              180,996
                                                                         ------------       ------------

Intangible assets:
     Licensed technology rights                                               441,358            441,358
     Goodwill, net                                                          2,677,142          1,882,839
                                                                         ------------       ------------
                  Total assets                                           $  9,286,190       $ 10,738,116
                                                                         ============       ============
</TABLE>



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



                                       F-2


<PAGE>   37

                    LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                         December 31,           December 31,
                  LIABILITIES AND STOCKHOLDERS' EQUITY                       1996                   1997
                                                                         ------------           ------------

<S>                                                                      <C>                    <C>         
Current liabilities:
     Accounts payable                                                    $  1,689,686           $  2,605,366
     Accrued expenses                                                         998,965                826,695
     Current portion of long-term debt and
         capital lease obligations                                             11,577                  6,838
                                                                         ------------           ------------
     Total current liabilities                                              2,700,228              3,438,899

Long-term debt and capital lease obligations                                  790,991                   --
                                                                         ------------           ------------

Minority interest                                                             120,380                108,802
                                                                         ------------           ------------

Convertible debentures                                                           --                3,000,000
                                                                         ------------           ------------

Commitments and contingencies (Note 9)

Stockholders' equity:
     Preferred stock, $.001 par value; 2,000,000 shares authorized;
         no shares issued and outstanding                                        --                     --
     Common stock, $.001 par value; 10,000,000 shares authorized;
         shares issued and outstanding:  6,134,071
         and 6,653,883 (1997)                                                   6,134                  6,654
     Additional paid-in capital                                            19,989,524             21,576,854
     Deferred compensation                                                       --                  (40,055)
     Accumulated deficit                                                  (14,321,067)           (17,353,038)
                                                                         ------------           ------------

                  Total stockholders' equity                                5,674,591              4,190,415
                                                                         ------------           ------------

                  Total liabilities and stockholders' equity             $  9,286,190           $ 10,738,116
                                                                         ============           ============
</TABLE>




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



                                       F-3

<PAGE>   38

                    LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                            Year Ended December 31,
                                                                       --------------------------------
                                                                            1996               1997
                                                                       ------------       ------------

<S>                                                                    <C>                <C>
Net sales
     Product sales                                                     $  5,594,763       $ 13,427,839
     Commissions earned                                                     241,798            908,989
                                                                       ------------       ------------
                                                                          5,836,561         14,336,828
                                                                       ============       ============
Cost and expenses:
     Cost of sales                                                        3,495,293          8,701,263
     Research and development                                               398,438             32,424
     Selling, general and administrative                                  3,932,545          8,188,384
     Interest                                                                62,598             83,788
     Depreciation and amortization                                          138,907            432,160
                                                                       ------------       ------------

                                                                          8,027,781         17,438,019
                                                                       ------------       ------------

Loss from operations                                                     (2,191,220)        (3,101,191)

Other income:
     Other                                                                    2,608              9,417
     Investment income                                                      209,152             83,069
                                                                       ------------       ------------

Net loss before minority interest                                        (1,979,460)        (3,008,705)

Minority interest in net loss of
     consolidated subsidiary                                                 20,984             11,578
                                                                       ------------       ------------

Net loss                                                               $ (1,958,476)      $ (2,997,127)
                                                                       ============       ============

     Basic and diluted loss per share of common stock                  $       (.40)      $       (.48)
                                                                       ============       ============

Weighted average shares used in computing
     basic and diluted loss per share of common stock                     4,941,771          6,299,592
                                                                       ============       ============
</TABLE>




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



                                       F-4


<PAGE>   39

                   LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                               Common Stock
                                           ---------------------
                                             Shares        $.001       Additional
                                           Issued and       Par          Paid-In        Deferred      Accumulated
                                           Outstanding     Value         Capital     Compensation       Deficit           Total
                                           -----------     -----       ----------    ------------     -----------         -----


<S>                                        <C>          <C>          <C>             <C>             <C>             <C>         
Balances, December 31, 1995                 4,878,451    $   4,879    $ 17,666,587    $    --        $ (12,299,424)   $  5,372,042
   Contribution from stockholder                 --           --            17,500         --                 --            17,500
   Exercise of stock options                   38,370           38          13,402         --                 --            13,440
   Issuance of stock, finder's fee             17,250           17          30,635         --                 --            30,652
   Issuance of stock, Val-U-Med             1,200,000        1,200       2,261,400         --                 --         2,262,600
     acquisition                                                                                       
   Trimedica dividend                            --           --              --           --              (63,167)        (63,167)
   Net loss                                      --           --              --                        (1,958,476)     (1,958,476)
                                           ----------    ---------    ------------    ---------      -------------    ------------
Balances, December 31, 1996                 6,134,071        6,134      19,989,524         --          (14,321,067)      5,674,591
   Exercise of stock options                  121,566          122         131,304         --                 --           131,426
   Trimedica dividend                            --           --              --                           (34,844)        (34,844)
   Revaluation of stock options                  --           --            78,346      (78,346)              --              --
   Compensation expense                          --           --              --         38,291               --            38,291
   Sale of stock to officer                    50,000           50         199,950         --                 --           200,000
   Sale of stock                              250,000          250         999,750         --                 --         1,000,000
   Issuance of stock options to                  --           --           158,611         --                 --           158,611
     Consultant  
   Issuance of stock, Medex Surgical           98,246           98             902         --                 --             1,000
     Acquisition 
   Issuance of stock for services by             --           --            18,467         --                 --            18,467
     acquired entity
   Net loss                                      --           --              --           --           (2,997,127)     (2,997,127)
                                           ----------    ---------    ------------    ---------      -------------    ------------
Balances, December 31, 1997                 6,653,883    $   6,654    $ 21,576,854    $ (40,055)     $ (17,353,038)   $  4,190,415
                                           ==========    =========    ============    =========      =============    ============
</TABLE>




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



                                      F-5
<PAGE>   40

                    LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                                   Year Ended December 31,
                                                                              --------------------------------
                                                                                   1996               1997
                                                                              ------------       ------------ 

<S>                                                                           <C>                <C>
Cash flows from operating activities:
Net loss                                                                      $ (1,958,476)      $ (2,997,127)
Adjustments to reconcile net loss to net cash used in
  operating activities:
         Depreciation and amortization                                             138,907            432,160
         Option expense                                                               --               56,758
         Issuance of stock, finder's fee                                            30,652               --
         Issuance of stock and options to consultants                               17,500             36,005
         Loss on disposal of fixed assets                                            3,198              7,070
         Minority interest in net loss of consolidated subsidiary                  (20,984)           (11,578)
         Changes in operating assets and liabilities
                  (Increase) in accounts receivable, net                          (129,634)          (959,739)
                  Decrease in interest receivable, net                              35,274             55,063
                  (Increase) in inventories                                       (866,215)          (121,408)
                  (Increase) decrease in prepaid and other assets                   (4,581)            24,776
                  (Increase) in accounts receivable from related parties            (5,915)            (2,839)
                  Increase in accounts payable                                     561,591            915,680
                  Increase in accrued expenses                                     261,034            316,567
                                                                              ------------       ------------

Net cash used in operating activities                                           (1,937,649)        (2,248,612)
                                                                              ------------       ------------

Cash flows from investing activities:
     Additions to property, plant, and equipment                                  (252,678)          (378,679)
     Acquisitions, net of cash received                                               --              (70,462)
     Cash paid in connection with Val-U-Med acquisition                           (400,000)              --
     Purchases of investments                                                   (2,464,743)        (2,248,153)
     Sale of investments                                                         4,817,221          4,568,214
                                                                              ------------       ------------

Net cash provided by investing activities                                        1,699,800          1,870,920
                                                                              ------------       ------------

Cash flows from financing activities:
     Additional capital contributed                                                 (2,847)              --
     Proceeds from issuance of notes payable                                     1,016,000               --
     Proceeds from convertible debentures                                             --            3,000,000
     Proceeds from issuance of common stock                                           --            1,200,000
     Payments for deferred finance charges                                            --             (180,996)
     Proceeds from exercise of stock options                                        13,440            131,426
     Payments to stockholder                                                       (27,599)              --
     Dividends paid by acquired entities                                           (63,167)           (34,844)
     Payments on long-term debt and capital lease obligations                     (713,787)          (795,730)
                                                                              ------------       ------------

Net cash provided by financing activities                                          222,040          3,319,856
                                                                              ------------       ------------

Net (decrease) increase in cash and cash equivalents                               (15,809)         2,942,164
Cash and cash equivalents, beginning of year                                       309,952            294,143
                                                                              ------------       ------------
Cash and cash equivalents, end of year                                        $    294,143       $  3,236,307
                                                                              ============       ============
</TABLE>




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



                                       F-6

<PAGE>   41

                    LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - ORGANIZATION AND DESCRIPTION OF LIFEQUEST AND RISK FACTORS

         LifeQuest Medical, Inc., a Delaware corporation ("LifeQuest" or the
"Company"), was incorporated on December 23, 1988 and commenced operations on
January 1, 1989. LifeQuest is engaged in the development and commercialization
of proprietary and non-proprietary medical devices. In 1994, LifeQuest and
Valdor Fiber Optics formed ValQuest Medical, Inc., a Nevada corporation
("ValQuest"), a corporate joint venture (see Note 5). ValQuest currently
operates as an 82% owned subsidiary of LifeQuest. In December 1996, LifeQuest
completed the merger of Val-U-Med, Inc., a Georgia corporation ("VMI") with and
into Val-U-Med, Inc., a Nevada corporation ("Val-U-Med") and wholly owned
subsidiary of LifeQuest. Val-U-Med merger was accounted for as a purchase
transaction. The accounts of Val-U-Med have been included since acquisition
date. In February 1996, LifeQuest completed the merger of GM Engineering, Inc.,
a California corporation ("GME") with and into LifeQuest Endoscopic
Technologies, Inc., a Nevada corporation ("LQET") and wholly owned subsidiary of
LifeQuest. In November 1996, LifeQuest completed the merger of Klein Medical,
Inc., a Texas corporation ("KMI") with and into Klein Medical, Inc., a Nevada
corporation ("Klein") and wholly owned subsidiary of LifeQuest. In June 1997,
LifeQuest completed the merger of Trimedica, Inc., a Colorado corporation
("Trimedica") with and into Klein. In September 1997, LifeQuest completed the
merger of Mishbucha, Inc., a Texas corporation d/b/a Medex Surgical ("Medex
Surgical") with and into Klein. In September 1997, LifeQuest completed the
merger of W. H. Bookwalter and Associates, Inc., a Vermont corporation
("Bookwalter") with and into Val-U-Med. The LQET, Klein, Trimedica, Medex
Surgical, and Bookwalter mergers were accounted for as pooling-of-interest
business combinations. See Note 6 for further description of the Company's
recent acquisitions. The consolidated financial statements for 1996 have been
restated to include the accounts of Trimedica, Medex Surgical, and Bookwalter.
The accompanying consolidated financial statements include the accounts of
LifeQuest and subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

         Since its inception, The Company has incurred cumulative net losses of
approximately $17,400,000. During the years ended December 31, 1996 and 1997 the
Company incurred net losses of approximately $2,000,000 and $3,000,000
respectively. The Company's cumulative losses have been funded primarily through
the Company's initial public offering of common stock, private sales of common
stock, cash proceeds from the exercise of stock options, debt financing and the
sale of convertible debentures. As discussed in Note 11, the Company has
obtained a waiver for certain affirmative financial covenant requirements
associated with its convertible debentures for the quarters ending March 31 and
June 30, 1998. The Company has also taken steps to improve its 1998 operating
results which include anticipated improvements relating to the Company's recent
acquisitions described in Note 6 and the anticipated launch of new products. The
Company's management believes that it is likely the Company's operating results
for 1998 will significantly improve over 1997 and will generate sufficient
working capital along with available cash and available borrowings under the
Company's line of credit, to sustain its operations throughout the year.
However, there are no assurances that the Company can achieve such operating
improvements. If the Company is unable to significantly improve operations, the
Company will require additional capital infusions or debt financing to maintain
continuing operations. There are no assurances that any additional capital
infusions or debt financing would be available to the Company.

         The medical devices industry in which the Company competes is highly
competitive and dominated by a relatively small number of competitors with
financial and other resources much greater than those possessed by the Company.
The Company's ability to achieve increases in sales or to sustain current sales
levels depends in part on the ability and willingness of the Company's suppliers
to provide products to the Company. Furthermore, while the Company has written
distribution agreements with many of its suppliers, these agreements in certain
instances provide for non-exclusive distribution rights and often include
territorial restrictions that limit the geographical area in which the Company
is permitted to distribute the products. The agreements are also generally
short-term, are subject to periodic renewal and often contain provisions
permitting termination by either party without cause upon relatively short
notice. These, and other factors which are beyond the control of the Company,
provide no assurances that the Company will be able to successfully compete in
the medical devices market and the failure to do so would have a material
adverse effect on the Company's business, financial condition, and results of
operations.



                                       F-7


<PAGE>   42

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

         Product sales are recognized upon the shipment of products to the
customer. Commissions earned are recognized when customer orders are placed with
product suppliers. Customers may return products in the event of product defect
or inaccurate order fulfillment. The Company maintains an allowance for sales
returns based upon an historical analysis of returns.

Inventory

         Inventory consists of raw materials, work-in-process, and finished
goods which are stated at the lower of cost (determined on a first-in, first-out
basis) or market.

Research and Development

         Research and development costs are expensed as incurred.

Fixed Assets and Depreciation

         Fixed assets are recorded at cost less accumulated depreciation.
Depreciation is provided utilizing the straight-line method over the estimated
useful lives of the respective assets (3 - 7 years).

Additions and improvements that extend the useful life of the asset are
capitalized. Repairs and maintenance are charged to expense as incurred. Upon
sales or retirement of property and equipment, the related cost and accumulated
depreciation are eliminated from the accounts and the resulting gain or loss is
recorded.

Licensed Technology Rights

         Licensed technology rights will be amortized upon the commencement of
ValQuest's planned principle operations. The carrying value of the licensed
technology is periodically reviewed by the Company with impairments being
recognized when the expected future operating cash flows derived from such
licensed technology rights is less than their carrying value.

Net Loss Per Share

         Net loss per share has been computed using the weighted average number
of shares of common stock outstanding during the year. Stock options are
excluded from the computation as their effect is antidilutive.

Use of Estimates

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

Statements of Cash Flows

         The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents.

         During 1996 and 1997, the Company had cash payments for interest of
$62,598 and $83,788, respectively. During 1997, the Company had a cash payment
for income taxes of $70,462 relating to a preacquisition liability of an
acquired entity. The Company had no cash payments for income taxes during 1996.

         The following provides supplemental disclosure of noncash investing and
financing activities during 1996 and 1997:

<TABLE>
<CAPTION>
                                                                      1996                1997
                                                                  -----------          ---------

<S>                                                               <C>                  <C>      
Assets acquired in connection with acquisitions                   $ 3,588,104          $ 121,973
Liabilities assumed in connection with acquisitions               $   925,504          $ 121,973
Common stock issued in connection with acquisitions               $ 2,262,600          $    --
</TABLE>



                                      F-8
<PAGE>   43

         During 1997, the Company determined that approximately $700,000 of
accrued liabilities that had been recorded in connection with the Val-U-Med
acquisition (see Note 6) were not required. Accordingly, the liabilities and
goodwill were reduced by a corresponding amount during 1997.

         See Note 6 for a description of shares of the Company's common stock
issued in connection with mergers and acquisitions.

Impact of Recently Issued Accounting Standards

         In February 1997, Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings per Share" ("SFAS 128"), was issued. SFAS 128 specifies the
computation, presentation and disclosure requirements for earnings per share
(EPS) for entities with publicly held common stock or potential common stock.
SFAS 128 supercedes Accounting Principles Board Opinion No. 15 and replaces the
presentation of Primary EPS with Basic EPS and requires dual presentation of
Basic and Diluted EPS on the face of the statements of operations. Basic EPS
excludes dilution and is computed by dividing income (loss) available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company. SFAS 128 is effective for financial statements
issued after December 15, 1997, and accordingly, the accompanying consolidated
financial statements reflect the adoption of SFAS 128. As the Company had a net
loss for the years ended December 31, 1996 and 1997, Diluted EPS equals Basic
EPS as potentially dilutive common stock equivalents are antidilutive in loss
periods. Prior period EPS date has been restated as required by SFAS 128.

Reclassifications

Certain prior period amounts have been reclassified to conform with the 1997
presentation.


NOTE 3 - CONCENTRATION OF RISK:

Credit Risk

         The Company's accounts receivable are from various hospitals, clinics
and practicing surgeons. Concentration of credit risk with respect to trade
receivables is limited due to the large number of customers comprising the
Company's customer base. Ongoing credit evaluations of customers' financial
condition are performed and, generally, no collateral is required. The Company
maintains reserves for potential credit losses and such losses have not exceeded
management's expectations.

Customers

         The Company had one customer that accounted for 14 percent of
consolidated sales for the year ended December 31, 1996. No single customer
accounted for more than 10 percent of consolidated sales during the year ended
December 31, 1997.

Suppliers

         The Company had two suppliers that accounted for 22 percent and 21
percent of purchases for the year ended December 31, 1996. The Company had one
supplier that accounted for 52 percent of purchases for the year ended December
31, 1997.


NOTE 4 - INVENTORIES

         Inventories at December 31 are summarized as follows:

<TABLE>
<CAPTION>
                                                      1996                    1997
                                                  -----------             -----------
<S>                                              <C>                      <C>
         Raw materials                            $    66,979             $   328,375
         Work-in-process                              128,774                  18,557
         Finished goods                             1,463,160               1,579,551
         Allowances                                   (30,000)               (180,960)
                                                  -----------             -----------
                                                  $ 1,628,913             $ 1,745,523
                                                  ===========             ===========
</TABLE>



                                      F-9
<PAGE>   44

NOTE 5 - CORPORATE JOINT VENTURES AND INVESTMENTS

         In May 1994, LifeQuest and Valdor Fiber Optics ("Valdor") of San Jose,
California, formed ValQuest, a corporate joint venture. In accordance with the
terms of the joint venture agreement, Valdor transferred to ValQuest the
exclusive worldwide rights to develop, manufacture, and market all present and
future medical applications of Valdor's patented fiber optic connector
technology. LifeQuest paid $100,000 to Valdor in consideration for the transfer
of these rights to ValQuest. Valdor contributed such rights, which had an
initial value of $327,273 in the consolidated financial statements, to ValQuest
in exchange for a 45% interest in ValQuest. LifeQuest contributed $400,000 to be
used as working capital in exchange for a 55% interest in ValQuest. At December
31, 1997, purchases of additional ValQuest stock had increased LifeQuest's
ownership interest to 82%.

         In December 1997, the Company entered into an agreement to acquire
approximately 20 percent of the stock of TFX Holding Co. ("TFX") for $1,000,000.
TFX, an affiliate of Teleflex, Inc., is a newly formed entity and the Company
plans to begin distribution of TFX's minimally invasive surgical devices, the
Dexterity--Trademark--Pneumo Sleeve and Dexterity--Trademark--Protractor. The
Company recognized no revenues or expenses associated with TFX operations during
1997.

         In December 1997, the Company and Canwell Medical, Inc. formed Canwell
Surgical, Inc. ("Canwell"). Canwell is 50 percent owned by the Company and
Canwell Medical, Inc. and was formed for the purpose of selling minimally
invasive surgical products in China and other Asian countries. The Company
recognized no revenues or expenses associated with Canwell operations during
1997.


NOTE 6 - ACQUISITIONS

The following describes acquisitions by the Company during the years ended
December 31, 1996 and December 31, 1997:

G.M. Engineering, Inc.

         In February 1996, GME was merged with and into LQET, a subsidiary of
LifeQuest. The merger was accomplished through exchanging all of the outstanding
common stock of GME for 350,000 shares of LifeQuest restricted common stock. The
transaction was recorded using the pooling-of-interest method of accounting.

Klein Medical, Inc.

         In November 1996, KMI was merged with and into Klein, a subsidiary of
LifeQuest. The merger was accomplished through exchanging all of the outstanding
common stock of KMI for 600,000 shares of LifeQuest restricted common stock. The
transaction was recorded using the pooling-of-interest method of accounting.

         The Klein merger agreement also provides a compensation agreement with
the former stockholder of KMI to act as chief executive officer and president of
the surviving corporation, Klein, through December 31, 1999. The agreement
provides for base compensation of $125,000 per year, additional performance
based compensation and participation in all employee benefits provided by
LifeQuest. LifeQuest issued 17,250 shares of LifeQuest restricted common stock
to a third party for a finder's fee associated with the transaction. In
addition, LifeQuest and the former stockholder have entered into a nonqualified
stock option agreement pursuant to which LifeQuest has granted to the former
stockholder nonqualified stock options to buy up to 60,000 shares of LifeQuest
common stock, as specified in the agreement.

Val-U-Med, Inc.

         In December 1996, VMI was merged with and into Val-U-Med, a subsidiary
of LifeQuest. The merger was accomplished through exchanging all of the
outstanding stock of VMI for 1,200,000 shares of LifeQuest restricted common
stock and $400,000. In addition, LifeQuest is obligated to give 57,000 shares of
LifeQuest restricted common stock to a third party for a finder's fee associated
with the transaction. The transaction was recorded using the purchase method of
accounting effective December 27, 1996.

         LifeQuest recorded the assets and liabilities of VMI at fair value as
of the purchase date. The excess of the purchase price over net assets acquired
of approximately $2,100,000 was recorded as goodwill and will be amortized over
10 years.



                                      F-10

<PAGE>   45

         The following table reflects unaudited pro forma combined results of
operations of the Company and VMI on the basis that the acquisition had taken
place at the beginning of the fiscal year ended December 31, 1996:

<TABLE>
<S>                                             <C>
         Net sales                              $ 10,224,886
         Net loss                                 (2,355,787)
         Net loss per common share              $       (.48)
</TABLE>

         The unaudited pro forma combined results of operations are not
necessarily indicative of the actual results that would have occurred had the
acquisition been consummated at the beginning of 1996 nor does such information
purport to project the results of operations for any future period.

         The Val-U-Med merger agreement also provides a compensation agreement
with the former president of VMI to act as president and chief operating officer
of the surviving corporation, Val-U-Med, and as vice president of LifeQuest
through December 31, 1999. Furthermore the agreement provides a compensation
agreement with the former vice president of sales of VMI to act as vice
president of sales of the surviving corporation, Val-U-Med, through December 31,
1999. The agreements provide for base compensations of $100,000 each per year,
additional performance based compensation and participation in all employee
benefits provided by LifeQuest. In addition, LifeQuest and the president and
vice president of sales of Val-U-Med have entered into a nonqualified stock
option agreement pursuant to which LifeQuest has granted to the president and
vice president of sales of Val-U-Med nonqualified stock options to receive up to
60,000 shares each of LifeQuest common stock, as specified in the agreement.

Trimedica, Inc.

         Effective June 1997, Trimedica was acquired by the Company and merged
into Klein. Trimedica was purchased for an aggregate of 57,143 shares of common
stock. The transaction was accounted for using the pooling-of-interest
accounting method, therefore, the assets, liabilities, and operations of
Trimedica prior to the merger are included in the consolidated financial
statements for all periods reported herein. Trimedica business activity will
constitute the new orthopedic sales force of Klein.

         The following table shows the net sales and net income related to
Trimedica through the date of acquisition that have been included in the
consolidated statements of operations:

<TABLE>
<CAPTION>
                                                 Year Ended December 31,
                                                -------------------------
                                                   1996            1997
                                                ---------       ---------

<S>                                             <C>             <C>      
         Net sales                              $ 192,451       $ 148,464
         Net income                             $  61,657          49,230
</TABLE>

Medex Surgical

         Effective September 1997, Medex Surgical was acquired by the Company
and merged into Klein. Medex Surgical was purchased for an aggregate of 98,246
shares of common stock. Medex Surgical was formed during 1997 and the
transaction was accounted for using the pooling-of-interest accounting method,
therefore, the assets, liabilities, and operations of Medex Surgical prior to
the merger are included in the consolidated financial statements for 1997. Medex
Surgical business activity will allow the Company to further expand its
geographical area.

         The following table shows the net sales and net loss related to Medex
Surgical through the date of acquisition that have been included in the
consolidated statements of operations for the fiscal year ended December 31,
1997:

<TABLE>
<S>                                             <C>
         Net sales                              $ 58,579
         Net loss                               $ (5,757)
</TABLE>


W. H. Bookwalter and Associates, Inc.

         Effective September 1997, Bookwalter was acquired by the Company and
merged into Val-U-Med. Bookwalter was purchased for an aggregate of 466,473
shares of common stock. The transaction was accounted for using the
pooling-of-interest accounting method, therefore, the assets, liabilities, and
operations of Bookwalter prior to the merger are included in the consolidated
financial statements for all periods reported herein. Bookwalter business
activity will provide the Company with distribution coverage in the northeastern
region of the United States.



                                      F-11

<PAGE>   46

         The following table shows the net sales and net loss related to
Bookwalter through the date of acquisition that have been included in the
consolidated statements of operations:


<TABLE>
<CAPTION>
                                                  Year Ended December 31,
                                                --------------------------
                                                    1996           1997
                                                -----------    -----------

<S>                                             <C>            <C>        
         Net sales                              $ 2,005,040    $ 1,790,572
         Net loss                               $   (41,750)   $   (89,839)
</TABLE>

         The following table reconciles the net sales and net income (loss)
included in the 1996 operating results as previously reported, to the restated
amounts resulting from pooling-of-interest business combinations.

<TABLE>
<CAPTION>
                                          Net Sales      Net Income (Loss)
                                          ---------      -----------------

<S>                                      <C>              <C>          
As reported in the 1996 10-KSB           $ 3,639,070      $ (1,978,383)
Trimedica                                    192,451            61,657
Bookwalter                                 2,005,040           (41,750)
                                         -----------      ------------
As reported in the 1997 10-KSB           $ 5,836,561      $ (1,958,476)
                                         ===========      ============
</TABLE>


NOTE 7 - FEDERAL INCOME TAXES

         As of December 31, 1997, the Company had net operating loss (NOL)
carryforwards of approximately $14,300,000 for federal income tax purposes that
are available to reduce future taxable income and will expire in 2006 through
2012 if not utilized. For federal income tax purposes, the Company deferred for
future amortization certain acquisition and research and development costs in
the amount of $2,453,000. Such costs, which have been expensed for financial
reporting purposes, will be amortized for tax purposes over future years when
associated commercial operations commence. The Company received IRS approval of
its request for a change of tax accounting method to expense research and
development costs for expenditures incurred in 1992 and future years. The
Company also has research and development credit carryforwards available to
offset future income taxes and expire in 2005 through 2010.

         The tax effect of significant temporary differences representing income
tax assets (liabilities) at December 31, 1996, and 1997, are as follows:

<TABLE>
<CAPTION>
                                                                         1996               1997
                                                                     -----------       -----------

<S>                                                                  <C>               <C>        
     Capitalized research and development and acquisition costs      $   735,000       $   735,000
     Depreciation                                                         15,000             5,000
     Accruals                                                             20,000            59,000
     Reserves not deductible for tax                                      94,000           149,000
     Other                                                                34,000              --
     Research and development credit carryforwards                       552,000           552,000
     Tax loss carryforwards                                            4,021,000         4,871,000
                                                                     -----------       -----------

     Net deferred tax assets                                           5,471,000         6,371,000
     Deferred tax valuation reserve                                   (5,471,000)       (6,371,000)
                                                                     -----------       -----------

     Net deferred tax assets                                         $      --         $      --
                                                                     ===========       ===========
</TABLE>

         As there is no assurance of future income, a 100% valuation reserve in
1996 and 1997 has been established against the Company's deferred tax assets.
The Company will continue to evaluate the necessity for such valuation reserve
in the future.

         The Company's ability to use its NOL carryforwards to offset future
taxable income is subject to restrictions enacted in the United States Internal
Revenue Code of 1986 as amended (the "Code"). These restrictions provide for
limitations on the Company's utilization of its NOL carryforwards following
certain ownership changes described in the Code. As a result of ownership
changes, the Company's existing NOL carryforwards are subject to limitation.
Additionally, because United States tax laws limit the time during which NOL and
tax credit carryforwards may be applied against future taxable income and tax
liabilities, the Company may not be able to take full advantage of its NOL and
tax credits for federal income tax purposes.



                                      F-12


<PAGE>   47



NOTE 8 -  SHORT-TERM INVESTMENTS

         Short-term investments consist solely of debt securities issued by the
United States Treasury. The Company intends to hold these securities to maturity
and believes it has the ability to do so. Therefore, these securities are
reported at amortized cost. A portion of the investments is pledged as
collateral (see Note 10). The following table summarizes short-term investments
held by the Company at December 31, 1996, and 1997:

<TABLE>
<CAPTION>
                                                                                             Gross            Gross
                                                          Amortized       Fair Market      Unrealized       Unrealized
                                                            Cost              Value       Holding Gains   Holding Losses
                                                            ----              -----       -------------   --------------

<S>                                                       <C>             <C>               <C>          <C>
December 31, 1996:
     Debt securities issued by the U.S. Treasury          $ 2,464,743     $ 2,522,766       $ 58,033            --

December 31, 1997:
     Debt securities issued by the U.S. Treasury          $   144,682     $   149,816       $ 5,134             --
</TABLE>


NOTE 9 - LEASE OBLIGATIONS, COMMITMENTS AND CONTINGENCIES

Operating Leases

         The Company leases office space under non-cancelable operating leases.
Rentals are subject to escalation for increases in property taxes, insurance and
various other expenses. Future minimum rental payments of the Company under
existing and pending operating lease agreements at December 31, 1997, are as
follows:

<TABLE>
<S>                                                                  <C>
                         1998                                            266,832
                         1999                                            278,385
                         2000                                            281,495
                         2001                                            273,024
                         2002                                             71,335
                      Thereafter                                          -
                                                                     -----------
                                                                     $ 1,171,071
                                                                     ===========

</TABLE>


Rent expense totaled approximately $191,123 and $249,482 for the years ended
December 31, 1996, and 1997, respectively.

Employment Agreements

         In connection with certain of the Company's acquisitions, the Company
has entered into various employment agreements that provide for future
compensation as described below:

<TABLE>
<CAPTION>
                       Employee         Annual Compensation              Expires
                       --------         -------------------           --------------

<S>                                          <C>                      <C> 
                           A                 $ 125,000                December 1999
                           B                 $ 100,000                December 1999
                           C                 $ 100,000                December 1999
                           D                 $ 100,000                  June 2000
                           E                 $ 100,000                September 2000
</TABLE>

         In addition, certain of the Company's employees have an opportunity to
earn bonuses based upon the achievement of specified performance criteria of
various Company divisions.



                                      F-13

<PAGE>   48

Contingencies

         The Company is a party to claims and legal proceedings arising in the
ordinary course of business. The Company believes it is unlikely that the final
outcome of any of the claims or proceedings to which the Company is a party
would have a material adverse effect on the Company's financial statements;
however, due to the inherent uncertainty of litigation, the range of possible
loss, if any, cannot be estimated with a reasonable degree of precision and
there can be no assurance that the resolution of any particular claim or
proceeding would not have an adverse effect on the Company's results of
operations for the interim period in which such resolution occurred.


NOTE 10 - DEBT AND CAPITAL LEASE OBLIGATIONS

         The Company had the following current and long-term debt and capital
lease obligations at December 31:

<TABLE>
<CAPTION>
                                                                                         1996                   1997
                                                                                      ----------             ----------
<S>                                                                                  <C>                    <C>  
Secured note payable for a vehicle loan, bearing interest at 8.75 percent, 
     principal and interest due monthly, maturing in 1998                                11,879                 6,838

Line of credit with a financial institution, secured by short-term investments,
     bearing interest at 6.41 percent, interest due monthly with a maturity 
     date of September, 1998                                                            682,500                   --

Unsecured note, bearing interest at a bank's prime rate plus 3.09 (11.34 
     percent at December 31, 1996), interest payable monthly, principal due 
     on demand or, if no demand is made, in monthly installments of
     $1,458 through August 1997                                                          11,577                   --

Note payable to a financial institution, secured by substantially all assets of
     Bookwalter, bearing interest at 10.75 percent, interest due monthly, 
     maturing January 1997                                                               96,612                   --
                                                                                      ---------               -------

             Total long-term debt and capital lease obligations                         802,568                 6,838

Less - Current portion                                                                  108,189                 6,838
                                                                                      ---------               -------

             Long-term debt and capital lease obligations                             $ 694,379               $   --
                                                                                      =========               =======
</TABLE>

         The carrying amount of the debt approximates the fair value of the
debt. This determination is based on management's estimate of the fair value at
which such instruments could be sold or obtained in a third-party transaction.

         At December 31, 1997 the Company had a line of credit with a financial
institution which provides the Company with the ability to borrow up to
$750,000. Interest is due monthly at a rate equal to the institution's prime
rate, plus 1.5 percent. The line of credit expires in September 1998. At
December 31, 1997, no amounts were outstanding under the line of credit.



                                      F-14

<PAGE>   49

NOTE 11 -- CONVERTIBLE DEBENTURES

         In December 1997, the Company sold 250,000 shares of its common stock
to affiliates of Renaissance Capital Group, Inc. (Renaissance) in a private
placement for proceeds of $1,000,000 and placed $3,000,000 in 9 percent
Convertible Debentures (Debentures) with Renaissance. The Debentures require
monthly payments of interest beginning in February 1998 and, unless sooner paid,
redeemed or converted, require monthly principal payments commencing in December
2000 of $10 per $1000 of the then remaining principal amount. The remaining
principal balance will mature in December 2004. The Debenture agreement contains
various affirmative and negative covenant requirements and the maintenance of
certain financial ratios and the Debentures are secured by substantially all
assets of the Company. At December 31, 1997, the Company was in compliance with
all of the covenants of the Debentures. The Company has obtained a waiver to
suspend certain affirmative financial covenant requirements for the quarters
ending March 31 and June 30, 1998. The following table shows the principal
maturities of the Debentures as of December 31, 1997:

<TABLE>
<S>                                       <C>
                         1998              $      --
                         1999                     --
                         2000                   30,000
                         2001                  335,000
                         2002                  300,000
                      Thereafter             2,335,000
                                           -----------
                         Total             $ 3,000,000
                                           ===========
</TABLE>

         The holders of the Debentures have the option to convert at any time
all or a portion of the Debentures into shares of the Company's common stock at
a conversion price of $4 per common share. The conversion price is subject to
downward revision if the Company sells shares of its common stock at a price
less than $4 per share, subject to certain allowed exceptions, during the term
of the Debentures. The Debentures are also subject to a one-time adjustment to
the conversion price whereby the price will be reduced if the Company does not
achieve certain financial objectives during 1998 and the current market price,
as defined in the Debenture agreement, following the Company's public release of
its 1998 financial results is less than $4 per share. The provisions of the
Debenture agreement provide that the holders of the Debentures have an option to
redeem the debentures, in an amount equal to an 18 percent annual yield on the
principal balance, upon the occurrence of certain events including delisting of
the Company's common stock and certain "change of control" provisions, as
defined in the Debenture agreement, as they relate to the Company. The Company
may redeem the Debentures at its option subject to certain share price and
market activity levels being obtained. The Company's right of redemption is
subject to the holder's prior right of conversion of the Debenture.


NOTE 12 - STOCK OPTIONS

         In October 1995, SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"), was issued. SFAS 123 defines a fair value based
method of accounting for employee stock options or similar equity instruments
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. Under the fair value based method,
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period of the award, which is usually the
vesting period. However, SFAS 123 also allows entities to continue to measure
compensation costs for employee stock compensation plans using the intrinsic
value method of accounting prescribed by APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). The Company has adopted SFAS 123
effective January 1, 1996, and has elected to remain with the accounting
prescribed by APB 25. The Company has made the required disclosures prescribed
by SFAS 123

         In December 1989, the Company adopted a stock option plan (the "1989
Plan"). Under the 1989 Plan, the Company may grant incentive and non-statutory
stock options to employees, directors and consultants of the Company. The
maximum number of shares available for grant under the 1989 Plan, as amended in
1993, is 685,000. Unexercised options expire ten years from the date of grant.

         In August 1994, ValQuest adopted the 1994 Stock Option Plan (the "1994
Plan"). Under the 1994 Plan, ValQuest may grant incentive and non-statutory
stock options to employees, directors and consultants of ValQuest. The maximum
number of shares of ValQuest common stock available for grant under the 1994
Plan is 250,000. Stock options under the 1989 Plan and the 1994 Plan become
exercisable pursuant to the individual written agreements between the Company
and ValQuest, respectively, and the participants. Unexercised options expire ten
years from the date of grant for the 1994 Plan.



                                      F-15


<PAGE>   50

         In May 1995, the Company adopted the 1995 Non-Employee Director Stock
Option Plan ("NEDSOP"). Under NEDSOP, the Company may grant stock options to
non-employee directors of the Company. The maximum number of shares available
for grant under NEDSOP is 400,000. The NEDSOP options vest in 25 percent
increments on each succeeding anniversary of the grant date, with unexercised
options expiring on the tenth anniversary of the date they vest. Under the three
plans the option exercise price must be equal to at least the stock's market
price on the date of grant.

         Pursuant to certain agreements entered into in May 1990, the Company
granted to three consultants in January 1993, non-qualified stock options to
purchase in the aggregate up to 21,141 shares of common stock at an exercise
price of $.001 per share. The options, which expire in January 2003, were
granted outside any option plan and vested in 1994. Options to purchase 14,094
shares have been exercised to date and 5,285 options are currently exercisable.
Prior to December 31, 1996, the Company has recognized approximately $236,000
(none in the current year) as research and development expense representing the
difference between the exercise price and the fair market value of options that
became exercisable.

         In 1996, the Company granted four employee directors non-qualified
options to purchase in the aggregate up to 380,000 shares of common stock at an
exercise price equal to the stock's market price on the date of grant. The
options were granted outside any option plan, vest over three years based on
continued employment, and expire ten years from grant date. During 1997, one
employee terminated employment with the Company and 185,000 unvested options
were forfeited. There are 60,000 options currently exercisable.

         During 1997, the Company granted certain employees 304,700 options to
purchase shares of common stock at exercise prices ranging from $3.00 to $5.03
per share. The options were granted outside any option plan and vest over time
periods ranging from 3 to 4 years. During 1997, 26,000 of these options were
forfeited by employees upon termination of service. As of December 31, 1997,
there were 278,700 options outstanding under these option grants with none
exercisable.

         Had compensation cost for these plans been determined consistent with
SFAS 123, the Company's net loss and net loss per share (EPS) would have been
reduced to the following pro forma amounts at December 31:

<TABLE>
<CAPTION>
                                                 1996                    1997
                                            -------------           ------------

<S>                                         <C>                     <C>          
         Net Loss:    As Reported           $ (1,958,476)           $ (2,997,127)
                      Pro Forma               (2,118,851)             (3,495,377)

         EPS:         As Reported           $       (.40)           $       (.48)
                      Pro Forma                     (.43)                   (.55)
</TABLE>

         Because the SFAS 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.

         A summary of the status of the Company's stock options at December 31,
1996, and 1997, and changes during the years then ended is presented in the
table and narrative below:

<TABLE>
<CAPTION>
                                                                      1996                           1997
                                                          ---------------------------    ---------------------------
                                                                       Weighted Avg.                  Weighted Avg. 
                                                           Shares      Exercise Price     Shares      Exercise Price
                                                           (000)         Per Share        (000)          Per Share
                                                           -----         ---------        -----          ---------

<S>                                                        <C>          <C>              <C>          <C>   
         Outstanding at beginning of year                     577          $ 1.34           954          $ 1.95
         Granted                                              440            2.67           522            3.85
         Exercised                                            (39)            .35          (122)           1.11
         Forfeited                                            (24)           3.05          (268)           2.56
                                                            -----          ------        ------          ------
         Outstanding at end of year                           954          $ 1.95         1,086          $ 2.81

         Options exercisable at end of year                   436          $  .83           438          $ 1.99

         Weighted average fair value of                                    $ 2.51                        $ 2.94
                  options granted
</TABLE>



                                      F-16


<PAGE>   51



         The following table summarizes the information about options
outstanding at December 31, 1997:

<TABLE>
<CAPTION>
                                              Weighted Avg.
                                                Remaining            Number
          Exercise Prices       Number         Contractual       Exercisable at
             Per Share       Outstanding          Life           Dec. 31, 1997
          ---------------    -----------      -------------      -------------

<S>                           <C>             <C>                    <C>
              $ .001             5,285          5.04 years             5,285 
                                                                             
                .35            168,638          3.57 years           112,254 
                                                                             
                .75             72,000          6.64 years            72,000 
                                                                             
                2.00            20,000          8.67 years            20,000 
                                                                             
                2.25            50,000          7.39 years            50,000 
                                                                             
                2.50            64,165          7.57 years            32,765 
                                                                             
                3.00           288,700          8.99 years            60,000 
                                                                             
                3.13            59,300          9.08 years             2,800 
                                                                             
                3.50             5,500          9.14 years              --   
                                                                             
                4.00            68,580          6.80 years            51,435 
                                                                             
                4.25             5,000          9.87 years              --   
                                                                             
                4.38           209,500          9.68 years            12,500 
                                                                             
                4.63             5,000          9.68 years              --   
                                                                             
                4.75             5,000          9.18 years              --   
                                                                             
                4.875           19,200          9.51 years            19,200 
                                                
                5.03            40,000          9.76 years
                            ----------                              --------

                             1,085,868          7.67 years           438,239
                            ==========                              ========
</TABLE>

         The fair value of each option grant is estimated on the date of grant
using the Black Scholes option pricing model for a stock that does not pay
dividends with the following weighted-average assumptions used for grants in
1996 and 1997, respectively: risk-free interest rates of 6.0 and 6.4 percent;
expected lives of 10 years and expected volatility of 111 and 61 percent.


NOTE 13 - RELATED-PARTY TRANSACTIONS

         The Company made payments to certain stockholders for consulting fees
of approximately $12,000 for the year ended December 31, 1996.

         During 1997, the Company sold 50,000 shares of common stock to its
former President and Chief Executive Officer for $200,000.

NOTE 14 - MARKETING AGREEMENT

         In April 1995, GME entered into an agreement, as amended, whereby a
marketing consultant would provide marketing, distribution and sales consulting
services to GME over the three-year term of the agreement. As compensation for
entering into this contract, a stockholder gave to the consultant shares equal
to 3.75 percent of the outstanding shares of GME stock, which had an estimated
fair market value of $17,500. This stock was subsequently exchanged for the
Company's stock. The consultant also earned commissions based on sales levels as
defined in the agreement. The Company accounted for this transaction as a
contribution of capital and recognized the related expense in 1995.

         During 1996, the Company expensed approximately $35,000 related to this
agreement. The agreement was terminated June 30, 1996.



                                      F-17


<PAGE>   52


NOTE 15 - SUBSEQUENT EVENTS

         Effective January 1, 1998, the Company merged each of its wholly owned
subsidiaries, LQET, Klein, and Val-U-Med into the Company.

         In January 1998, the Company paid $1,000,000 to acquire approximately
20 percent of the stock of TFX.

         In January 1998, the Company loaned $100,000 to Canwell for initial
working capital requirements. The loan is unsecured and bears interest at 9
percent with the principal maturing in January 2000.



                                      F-18
<PAGE>   53
                                EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER           IDENTIFICATION OF EXHIBIT
-------          -------------------------
<S>              <C>

2.1              Plan of Merger and Acquisition Agreement dated February 13, 1996, but effective as of January 1, 1996,
                 among LifeQuest Medical, Inc., LifeQuest Endoscopic Technologies, Inc., GM Engineering, Inc., Gregory
                 M. Miles and Susan G. Miles (incorporated by reference herein to Exhibit 2.1 to the Company's Current
                 Report on Form 8-K filed February 27, 1996).

2.2              Plan of Merger and Acquisition Agreement dated November 27, 1996, among LifeQuest Medical, Inc., Klein
                 Medical Acquisition Co., Klein Medical, Inc. and Richard H. Klein (incorporated by reference herein to
                 Exhibit 2.1 to the Company's Current Report on Form 8-K filed December 12, 1996).

2.3              Plan of Merger and Acquisition Agreement dated December 27, 1996, among LifeQuest Medical, Inc., Val-U-
                 Med Acquisition Co., Val-U-Med, Inc. and the Stockholders of Val-U-Med, Inc. (incorporated by reference
                 herein to Exhibit 2.1 to the Company's Current Report on Form 8-K filed January 10, 1997).

2.4              Plan of Merger and Acquisition Agreement dated June 30, 1997, among LifeQuest Medical, Inc., Klein
                 Medical, Inc., Trimedica, Inc., and Mark Lovejoy. (incorporated by reference herein to Exhibit 2.1 to
                 the Company's Quarterly Report on Form 10-QSB for the quarter ending June 30, 1997).

2.5              Plan of Merger and Acquisition Agreement dated September 30, 1997, among LifeQuest Medical, Inc., Val-
                 U-Med, Inc., W. H. Bookwalter & Associates, Inc., and the shareholders of W. H. Bookwalter &
                 Associates, Inc. (incorporated by reference herein to Exhibit 21.1 to the Company's Quarterly Report on
                 Form 10-Q for the quarter ending September 30, 1997).

2.6              Plan of Merger and Acquisition Agreement dated October 7, 1997, among LifeQuest Medical, Inc., Klein
                 Medical, Inc., Mishbucha, Inc. d/b/a Medex Surgical, Inc., Edward Kraus, and Robert Kraus (incorporated
                 by reference herein to Exhibit 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter
                 ending September 30, 1997).

2.7*             Plan of Merger and Acquisition Agreement dated December 30, 1997, among LifeQuest Medical, Inc.,
                 LifeQuest Endoscopic Technologies, Inc., Klein Medical, Inc. and Val-U-Med, Inc.

3.1              Certificate of Incorporation of the Registrant (incorporated by reference herein to Exhibit 3.1 to the
                 Company's Registration Statement on Form S-1 filed on August 19,1992, Registration No. 33-49196).

3.2              Bylaws of the Registrant (incorporated by reference herein to Exhibit 3.2 to the Company's Registration
                 Statement on Form S-1 filed on August 19, 1992, Registration No. 33-49196).

4.1*             Convertible Loan Agreement among the Company, Renaissance Capital Growth and Income Fund III, Inc.,
                 Renaissance US Growth and Income Trust PLC and Renaissance Capital Group, Inc. dated December 19, 1997.


10.1             1989 Stock Option Plan of LifeQuest Medical, Inc. (incorporated by reference herein to Exhibit 4.4 to
                 the Company's Registration Statement on Form S-8 filed on October 12, 1993, Registration No. 33-70174).

10.2             Employment Agreement dated February 15, 1992, between LifeQuest Medical, Inc. and Herbert H. Spoon
                 (incorporated by reference herein to Exhibit 10.8 to the Company's Registration Statement on Form S-1
                 filed on August 19, 1992, Registration No. 33-49196).

10.3             Incentive Stock Option Agreement dated January 15, 1990, between LifeQuest Medical, Inc. and Herbert H.
                 Spoon (incorporated herein to Exhibit 10.12 to the Company's Registration Statement on Form S-1 filed
                 on August 19, 1992, Registration No. 33-49196).

10.4             Patent License Agreement dated January 1, 1989, between LifeQuest Medical, Inc. and The Board of
                 Regents of the University of Texas System, as amended by instrument dated November 1, 1989
                 (incorporated herein to Exhibit 10.15 to the Company's Registration Statement on Form S-1 filed on
                 August 19, 1992, Registration No. 33-49196).

10.5             License Agreement dated June 26, 1992, between LifeQuest Medical, Inc. and George C. Kramer, Ph.D.
                 (incorporated herein to Exhibit 10.22 to the Company's Registration Statement on Form S-1 filed on
                 August 19, 1992, Registration No. 33-49196).

10.6             Incentive Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and Herbert H.
                 Spoon (incorporated herein by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K
                 for the fiscal year ended December 31, 1994).

10.7             Incentive Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and Randall K.
                 Boatright (incorporated herein by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-
                 K for the fiscal year ended December 31, 1994).

10.8             Incentive Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and David J.
                 Collette, M.D. (incorporated herein by reference to Exhibit 10.18 to the Company's Annual Report on
                 Form 10-K for the fiscal year ended December 31, 1994).

10.9             1994 Non-Employee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.19 to the
                 Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).

10.10            Non-Qualified Stock Option Agreement dated October 17, 1994, between LifeQuest Medical, Inc. and Robert
                 B. Johnson (incorporated herein by reference to Exhibit 10.21 to the Company's Annual Report on Form
                 10-K for the fiscal year ended December 31, 1994).

10.11            Non-Qualified Stock Option Agreement dated March 2, 1995, between LifeQuest Medical, Inc. and Jeffrey
                 H. Berg, Ph.D. (incorporated herein by reference to Exhibit 10.22 to the Company's Annual Report on
                 Form 10-K for the fiscal year ended December 31, 1994).
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<S>              <C>
10.12            ValQuest Medical, Inc. 1994 Stock Option Plan (incorporated herein by reference to Exhibit 10.23 to the
                 Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).

10.13            Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and Herbert H.
                 Spoon (incorporated herein by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K
                 for the fiscal year ended December 31, 1994).

10.14            Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and Randall K.
                 Boatright (incorporated herein by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-
                 K for the fiscal year ended December 31, 1994).

10.15            Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and David J.
                 Collette, M.D. (incorporated herein by reference to Exhibit 10.26 to the Company's Annual Report on
                 Form 10-K for the fiscal year ended December 31, 1994).

10.16            Non-Incentive Stock Option Agreement dated August 19, 1994, between ValQuest Medical, Inc. and Robert
                 B. Johnson (incorporated herein by reference to Exhibit 10.29 to the Company's Annual Report on Form
                 10-K for the fiscal year ended December 31, 1994).

10.17            Assignment and License Agreement dated May 11, 1994, between ValQuest Medical, Inc. and Fibotech, Inc.
                 d/b/a Valdor Fiber Optics (incorporated herein by reference to Exhibit 10.30 to the Company's Annual
                 Report on Form 10-K for the fiscal year ended December 31, 1994).

10.18            Employment Agreement dated November 27, 1996, between Klein Medical Acquisition Co. and Richard H.
                 Klein (incorporated by reference herein to Exhibit 10.1 to the Company's Current Report on Form 8-K
                 filed December 12, 1996).

10.19            Non-Qualified Stock Option Agreement dated November 27, 1996, between LifeQuest Medical, Inc. and
                 Richard H. Klein (incorporated by reference herein to Exhibit 10.2 to the Company's Current Report on
                 Form 8-K filed December 12, 1996).

10.20            Employment Agreement dated December 27, 1996, between Val-U-Med Acquisition Co. and K.C. Fadem
                 (incorporated by reference herein to Exhibit 10.1 to the Company's Current Report on Form 8-K filed
                 January 10, 1997).

10.21            Non-Qualified Stock Option Agreement dated December 27, 1996, between LifeQuest Medical, Inc. and K.C.
                 Fadem (incorporated by reference herein to Exhibit 10.2 to the Company's Current Report on Form 8-K
                 filed January 10, 1997).

10.22            Employment Agreement dated December 27, 1996, between Val-U-Med Acquisition Co. and Robert Fadem
                 (incorporated by reference herein to Exhibit 10.3 to the Company's Current Report on Form 8-K filed
                 January 10, 1997).

10.23            Non-Qualified Stock Option Agreement dated December 27, 1996, between LifeQuest Medical, Inc. and
                 Robert Fadem (incorporated by reference herein to Exhibit 10.4 to the Company's Current Report on Form
                 8-K filed January 10, 1997).

10.24            Lease Agreement dated April 28, 1997, between Interpark Jack Limited Partnership and LifeQuest Medical,
                 Inc. (incorporated by reference herein to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
                 for the quarterly period ended June 30, 1997).

10.25            Lease Agreement dated March 1, 1997, between Williams North Fulton Group and the Company (incorporated
                 by reference herein to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly
                 period ended June 30, 1997).

10.26            Employment Agreement dated September 30, 1997, between William H. Bookwalter and the Company
                 (incorporated by reference herein to Exhibit No. 10.1 to the Company's Quarterly Report on Form 10-Q
                 for the quarterly period ended September 30, 1997).

10.27**          Distribution Agreement dated May 1, 1997 between LifeQuest Medical, Inc. and Origin MedSystems, Inc.

22               Subsidiaries
                                                                                       Name Under Which
                 Name                                      State of Incorporation       Doing Business
                 ----------------------------------------------------------------------------------------
                 ValQuest Medical, Inc.                     Nevada                  ValQuest Medical, Inc.

11*              Computation of earnings (loss) per share

23**             Consent of Arthur Andersen LLP

27*              Financial Data Schedule
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*   Previously filed
**  Filed herewith