<PAGE>   1

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


                                  FORM 10-KSB
  (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

Transitional Small Business Disclosure Format.  YES       NO   X .
                                                    -----   -----
</TABLE>
================================================================================

                                     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").

         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.

         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.




                                      -1-
<PAGE>   3

         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.  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 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.



                                      -2-
<PAGE>   4
         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.  Canwell
plans to maintain offices in Atlanta, Georgia and Toronto, Ontario, Canada.
Canwell plans to establish a distribution network for selling MIS products
within the People's Republic of China and other Asian countries.

         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 its
manufacturing assembly line preparations are complete, which the Company
estimates will be in the second 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 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.




                                      -3-
<PAGE>   5
         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 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 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.



                                      -4-
<PAGE>   6
         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.

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




                                      -5-
<PAGE>   7
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.  Additionally, the Company
plans to continually increase the volume of products which it manufactures and
to continue to be a party to manufacturing agreements with various companies in
the medical instrument industry under which the Company produces selected MIS
products for private labeling.

         The Company also intends to capitalize on its in-house technical
expertise by significantly increasing the size and scope of its service and
repair site.  Management believes that these operations are synergistic with
the Company's distribution business.

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.



                                      -6-
<PAGE>   8
         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 other distributors,
their own dealer networks, or directly to resellers.  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, United Parcel Service delivers the substantial majority of the
Company's products to its customers.  The termination of the Company's
relationship with United Parcel Service, 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, 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.  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.



                                      -7-
<PAGE>   9
         Herbert H. Spoon resigned from his positions as President, Chief
Executive Officer and Director of the Company effective March 9, 1998.  Randall
K. Boatright, Vice President and Chief Financial Officer of the Company since
1992, has been appointed as Interim President and Chief Executive Officer.  A
search committee comprised of certain members of the Company's Board of
Directors has been formed to find a new President and Chief Executive Officer.
The Company anticipates it will find a qualified and suitable President and
Chief Executive Officer, however, there can be no assurance that the Company
will be able to hire or retain such an individual.

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.

         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.  See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

PATENTS, PROPRIETARY INFORMATION AND TRADEMARKS

         The Company holds all rights to medical applications of the patented
Impact Mount(TM) technology owned by ValQuest.

         The Company's success will depend in part on its ability to obtain
patent protection for products and processes, to preserve its trade secrets and
to operate without infringing the proprietary rights of third parties. While the
Company has obtained exclusive rights to certain patents and to various
applications for additional United States and foreign patents covering certain
aspects of its technology, no assurance can be given that any additional patents
will be issued, that the scope of any patent protection will exclude competitors
or that any of the Company's patents will be held valid if subsequently
challenged.  The validity and breadth of claims covered in the medical
technology patents involve complex legal and factual questions and, therefore,
may be highly uncertain.  Whether or not the Company's patents are issued,
others may receive patents which contain claims having a scope that covers
products developed by the Company.

         There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry.  Litigation, which
would result in substantial cost to and diversion of effort by the Company, may
be necessary to enforce patents issued to the Company, to protect trade secrets
or know-how owned by the Company or to defend the Company against claimed
infringement of the rights of others and to determine the scope and validity of
the proprietary rights of others.  Adverse determinations in litigation could
subject the Company to significant liabilities to third parties, could require
the Company to seek licenses from third parties and could prevent the Company
from manufacturing, selling or using its products, any of which could have a
material adverse effect on the Company's business, financial condition or
results of operations.


                                      -8-
<PAGE>   10
         The Company may decide for business reasons to retain certain
knowledge that it considers proprietary as trade secrets.  In that event, or if
patent protection is unattainable, then the Company must rely upon trade
secrets, know-how and continuing technological innovation to maintain its
competitive position.  Employees and consultants of the Company who have access
to proprietary information have signed confidentiality agreements with the
Company.  There can be no assurance that these agreements will provide
meaningful protection for the Company's trade secrets in the event of
unauthorized use or disclosure of such information.  The Company intends to
require any new employees to sign similar confidentiality agreements.

         There can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques, or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its rights to its unpatented trade
secrets.

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.

         Manufacturers of medical devices marketed in the United States are
required to adhere to applicable regulations setting forth detailed 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 and MDR 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 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.

         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.

         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.



                                      -9-
<PAGE>   11
         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.

         International sales of medical devices are subject to the regulatory
agency requirements of each country, and more recently in Europe, the
regulations of the European Economic Community.  The regulatory review process
varies from country to country.  In addition, international sales of medical
devices not cleared by the FDA for distribution in the United States may be
subject to FDA export requirements, which require the Company to document that
the sale of the device is not in violation of that country's medical device
laws.  This documentation is then submitted to the FDA with a request for a
permit for export to that country.  The Company intends to apply for regulatory
approval, import approval and export approval for its products for sales in
countries comprising the major foreign market.

         The Company is also required to register and list its products with
the FDA as a device manufacturer or distributor.  As such, the Company is
subject to inspection on a routine basis for compliance with the FDA's GMP
requirements and other applicable regulations.  Further, the Company is
required to comply with various FDA requirements for labeling.  The Medical
Device Reporting regulation requires that the Company provide information to
the FDA on death or serious injuries alleged to have been associated with the
use of its product, as well as product malfunctions that would likely cause or
contribute to death or serious injury if the malfunction were to recur.
Special reports and routine annual reports are required to be submitted to the
FDA by a company after a PMA for a device has been approved.  These reports
assure that the official FDA file for the PMA is kept current and reflects
actual manufacturing, labeling, marketing, and use practices and experience
once the product is marketed.  In addition, the FDA prohibits an approved
device from being promoted for unapproved applications.

         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

         In the United States, health care providers, such as hospitals and
physicians, that purchase medical devices, such as the Company's products,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or part of the
cost of the



                                      -10-
<PAGE>   12
procedure in which the medical device is being used.  In addition, certain
health care providers are moving toward a managed care system in which such
providers contract to provide comprehensive health care for a fixed cost per
person.  Managed care providers are attempting to control the cost of health
care by authorizing fewer elective surgical procedures.  The Company is unable
to predict what changes will be made in the reimbursement methods utilized by
third- party health care payors.  Furthermore, the Company could be adversely
affected by changes in reimbursement policies of governmental or private health
care payors, particularly to the extent any such changes affect reimbursement
for procedures in which the Company's products are used.  Failure by
physicians, hospitals and other users of products sold by the Company to obtain
sufficient reimbursement from health care payors for procedures in which the
Company's products are used or adverse changes in governmental and private
third-party payors' policies toward reimbursement for such procedures would
have a material adverse effect on the Company's business, financial condition
or results of operations.

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

         Hospitals, medical clinics and physicians' offices that purchase
medical devices generally rely on third-party payors, such as Medicare,
Medicaid and private health insurance plans, to pay for some or all of the
costs of the screening, diagnostic and therapeutic procedures performed with
these devices.  Whether a particular procedure qualifies for third-party
reimbursement depends upon such factors as the safety and effectiveness of the
procedure; and reimbursement may be denied if the medical device is
experimental or was used for a non-approved indication.  The Company believes
that third-party reimbursement will be available for most procedures using its
products.

         In April 1983, Congress enacted the Social Security Act Amendments of
1983 which mandated a system of Medicare reimbursement for in-patient hospital
services based primarily upon diagnostic- related groups known as "DRGs."
Under this system, hospitals are generally paid only a fixed amount per patient
plus additional amounts for certain specific hospital costs.  The amount
payable under DRGs for a particular patient depends on many factors, including
the principal diagnosis of the patient, but it usually does not depend upon the
hospital's actual current cost of treating the patient.  The prospective
payment system and other cost control measures adopted by third-party payors in
recent years, including reductions in Medicare payments for hospital outpatient
services and capital costs, have had and may continue to have significant
effect on the purchasing practices of many providers, generally causing them to
be more selective in the purchase of medical devices.

         Third-party payors use a variety of mechanisms to determine
reimbursement fees for surgical procedures.  In some cases, reimbursement
amounts are based on the provider's costs associated with the procedure,
including materials costs.  In such a situation, the cost of a device used in
the procedure would likely be covered by the reimbursement payment.

         While third-party payors generally make their own decisions regarding
which items and services to cover, Medicaid and other third-party payors often
apply standards similar to Medicare's in determining whether to provide
coverage for a particular medical procedure.  The Medicare statute prohibits
payment for any items or services that are not reasonable and necessary for the
diagnosis or treatment of illness or injury or to improve the functioning of a
malformed body member, and the Health Care Financing Administration ("HCFA"),
an agency within the Federal Department of Health and Human Services
responsible for administering the Medicare program, has interpreted this
provision to prohibit Medicare coverage of procedures or devices that, among
other things, are determined to be medically unnecessary, inappropriate, not
cost-effective, unsafe, ineffective, experimental or used for non-approved
indication.  For medical devices, FDA clearance for marketing is required but
is not determinative of whether those prerequisites for Medicare coverage have
been met.  In particular, although the FDA may grant approval to market a
medical device, the HCFA, a state health care agency or a third-party payor
could independently determine not to approve coverage for the use of a
particular medical device.



                                      -11-
<PAGE>   13
         While a limited number of national coverage decisions are made by
HCFA, in general, the determination of whether a procedure or device satisfies
these standards is made by the Medicare carrier or intermediary which processes
claims for reimbursement within that carrier's or intermediary's jurisdiction.

         The unavailability of third-party coverage or the inadequacy of the
reimbursement for medical procedures using the Company's products, including
any future product that the Company may develop or acquire, would adversely
affect the Company's business, financial condition and results of operations.
Moreover, the Company is unable to predict what additional legislation or
regulation, if any, may be enacted or adopted in the future relating to the
Company's business or the health care industry, including third-party coverage
and reimbursement, or what effect any such legislation or regulation may have
on the Company.

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 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 business exposes it to potential product liability risks
which are inherent in the design, manufacture and marketing of medical devices.
The Company has not experienced any product liability claims to date.  The
Company currently maintains product liability insurance coverage in the
aggregate annual amount of $2,000,000.  There can be no assurance that product
liability claims will not exceed such insurance coverage limits, which could
have a material adverse effect on the Company.  Product liability claims or
product recalls in the future, regardless of their ultimate outcome, could have
a material adverse effect on the Company's business and reputation and on its
ability to attract and retain customers for its products.

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.

         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 progress of the Company's product development programs; the
receipt of, and the time required to obtain, regulatory clearances and
approvals; the resources required to protect the Company's intellectual
property; 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



                                      -12-
<PAGE>   14
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.  Any additional equity financings may be dilutive to
stockholders, and debt financing, 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.  Although many of the acquired companies 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 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 addition, the issuance of stock in connection with acquisitions 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.  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



                                      -13-
<PAGE>   15
"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 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.

         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.

         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.



                                      -14-
<PAGE>   16
         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 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.

         AUTHORIZATION OF PREFERRED 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.
Accordingly, the Board of Directors is empowered, without stockholder approval,
to issue preferred stock with dividend, liquidation, conversion, voting or
other rights that could adversely affect the voting power or other rights of
the holders of the Common Stock.  In the event of issuance, the preferred stock
could be used, under certain circumstances, as a method of discouraging,
delaying or preventing a change in control of the Company.  Although the
Company has no present intention to issue any additional shares of its
preferred stock, 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 certain of the
Company's loan agreements restrict the payment of dividends.

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.



                                      -15-
<PAGE>   17
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>
 Randall K. Boatright                49      Interim President and Chief Executive              1992
                                             Officer, Chief 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.



                                      -16-
<PAGE>   18
                                    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
 -------------              ----                  ---
 <S>                       <C>                  <C>
 Fiscal 1997:
 -----------

 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.




                                      -17-
<PAGE>   19
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.  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 will allow the Company to further expand its geographical 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 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.



                                      -18-
<PAGE>   20
         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.

         Pursuant to the terms of the private placement, the Company issued to
two affiliates of Renaissance an aggregate of (i) 250,000 shares of Common
Stock at a per share purchase price of $4.00, and (ii) 9% convertible
debentures in an aggregate amount of $3,000,000.  The debentures mature in
December 2004 and are convertible at any time prior to maturity into shares of
Common Stock at a conversion price not to exceed $4.00.  Unless the debentures
are earlier converted, the Company shall make interest payments on the
debentures for three years, and then payments of principal and interest until
maturity.

         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.

         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



                                      -19-
<PAGE>   21
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
its manufacturing assembly line preparations are complete, which the Company
estimates will be in the second 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 was due
to continued sales growth throughout the Company and the inclusion in 1997 of
companies acquired by the Company in 1997 and 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
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




                                      -20-
<PAGE>   22
due to the growth in Company sales, 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 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



                                      -21-
<PAGE>   23
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.



                                      -22-
<PAGE>   24
                                    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.



                                      -23-
<PAGE>   25
                                    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).

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.
</TABLE>





                                      -24-
<PAGE>   26
<TABLE>
<S>              <C>
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>





                                      -25-
<PAGE>   27
<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>





                                      -26-
<PAGE>   28
<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).

11*              Computation of earnings (loss) per share

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

23*              Consent of Arthur Andersen LLP

27*              Financial Data Schedule
</TABLE>

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

*   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.




                                      -27-
<PAGE>   29
                                   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.


March 27, 1998                     By  /s/ Randall K. Boatright
                                      ------------------------------------------
                                           Randall K. Boatright
                                   Interim 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/ Randall K. Boatright          Interim President and Chief                    March 27, 1998
  ---------------------------------   Executive Officer, Chief
        Randall K. Boatright          Financial Officer and Director
                                      (Principal Executive Officer
                                      and Principal Financial and
                                      Accounting Officer)

    /s/ Robert B. Johnson             Director                                       March 27, 1998
  ---------------------------------
        Robert B. Johnson


      /s/ K.C. Fadem                  Director                                       March 27, 1998
    -----------------------------
          K.C. Fadem


    /s/ Jeffrey H. Berg, Ph.D.        Director                                       March 27, 1998
  ---------------------------------
        Jeffrey H. Berg, Ph.D.


    /s/ Richard H. Klein              Director                                       March 27, 1998
  ---------------------------------
        Richard H. Klein


      /s/ Robert L. Evans             Director                                       March 27, 1998
  ---------------------------------
          Robert L. Evans


     /s/ William H. Bookwalter        Director                                       March 27, 1998
   --------------------------------
         William J. Bookwalter
</TABLE>




                                      -28-
<PAGE>   30
                    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>   31
                    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>   32
                    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 (1996)
         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>   33
                    LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

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

<S>                                                                                    <C>              <C>
Retail value of product and commission sales                                            $  6,885,650     $  17,903,295
                                                                                        ============     =============

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>   34
                    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>
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>   35
                    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>   36
                    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>   37
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

    Operating revenues are recognized upon the shipment of products to the
customer.

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>   38
         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>   39
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(R) Pneumo Sleeve and Dexterity(R) 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>   40
         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>   41
         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>   42
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>   43
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>   44
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 convenant 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>   45
         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>                    <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>   46
         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>   47
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>   48
                                 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).
</TABLE>





<PAGE>   49
<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).

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).

11*              Computation of earnings (loss) per share

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

23*              Consent of Arthur Andersen LLP

27*              Financial Data Schedule
</TABLE>

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

*   Filed herewith