UROHEALTH SYSTEMS INC, 10-K/A, 1997-01-09

UROHEALTH SYSTEMS INC
10-K/A, 1997-01-09
PLASTICS PRODUCTS, NEC

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

FORM 10-K/A

(AMENDMENT NO. 1)

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)

[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM JULY 1, 1995 TO MARCH 31, 1996

COMMISSION FILE NUMBER: 1-11150

UROHEALTH SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 98-0122944
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

5 CIVIC PLAZA, SUITE 100, NEWPORT BEACH, CALIFORNIA 92660
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)(ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 668-5858

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None

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

Common Stock

Warrants to Purchase Common Stock

Indicate by check mark whether the Company (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-K 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-K or any amendment to this
Form 10-K. [ ]

As of May 31, 1996, the aggregate market value of the Common Stock held by
non-affiliates of the Registrant was approximately $114,717,302. The number of
shares outstanding of the Registrants's Common Stock as of May 31, 1996 was
14,183,034.

Documents incorporated by reference into Part III: Portions of the
definitive Proxy Statement for the Registrant's 1996 Annual Meeting of
Stockholders are incorporated by reference into Part III hereof.
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<PAGE> 2

PART II

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data of the Company has been
derived from the financial statements of UROHEALTH which have been prepared in
accordance with United States generally accepted accounting principles ("GAAP")
and includes the statements of operations and balance sheet data for Osbon,
Advanced, Dacomed and Allstate which acquisitions were accounted for as
pooling-of-interests transactions. The selected consolidated financial data for
the Company as of March 31, 1996 and for the nine months ended March 31, 1996
and as of June 30, 1995 and for the year ended June 30, 1995 are derived from
the consolidated financial statements of UROHEALTH which have been audited by
Ernst & Young LLP, independent auditors. The selected consolidated financial
data for the year ended June 30, 1994 are derived from the consolidated
financial statements of UROHEALTH which have been audited by Cherry, Bekaert &
Holland LLP, independent auditors. The data should be read in conjunction with
the consolidated financial statements, related notes, and other financial
information included herein. The selected consolidated financial data set forth
below for the years ended June 30, 1992 and 1993 and as of June 30, 1992, 1993
and 1994 are derived from audited financial statements not included herein. The
following data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements of UROHEALTH included elsewhere herein.

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED JUNE 30, MARCH 31,
------------------------------------------ --------------------
1992 1993 1994 1995 1995 1996
------- ------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net sales..................... $26,797 $32,565 $ 37,828 $ 45,453 $ 32,746 $ 39,641
Net loss from operations...... $(3,533) $(9,535) $(19,437) $(17,007) $(14,442) $(16,485)
Net loss...................... $(4,026) $(9,985) $(20,127) $(18,506) $(15,497) $(17,998)
Loss per share................ $ (0.40) $ (0.88) $ (1.77) $ (1.52) $ (1.28) $ (1.50)
</TABLE>

<TABLE>
<CAPTION>
JUNE 30,
---------------------------------------------- MARCH 31,
1992 1993 1994 1995 1996
------- ------- ------- ------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)........ $16,974 $14,330 $ 8,346 $ 4,043 $(3,728)
Total assets..................... $28,177 $28,686 $25,075 $26,174 $27,835
Long-term liabilities, minority
interest in subsidiary and
redeemable preferred stock.... $ 125 $ 1,292 $ 3,386 $ 5,219 $13,771
Common stockholders' equity...... $22,964(1) $20,390 $14,339 $10,538 $(6,190)
</TABLE>

- ---------------
(1) Amount reflects the sale of 1,378,500 Units providing net proceeds to the
Company of approximately $9.7 million.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this item is set forth herein. Such information
is listed under Item 14 of Part IV of this report.

<PAGE> 3

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

The following consolidated financial statements of the Company are included
herein:

<TABLE>
<CAPTION>
PAGE OR
METHOD OF FILING
----------------
<S> <C>
(a)(1) CONSOLIDATED FINANCIAL STATEMENTS
(1) Report of Independent Auditors - Ernst & Young LLP............. F-1
(2) Report of Independent Certified Public Accountants - Cherry,
Bekaert & Holland LLP.......................................... F-2
(3) Report of Independent Auditors - Doane Raymond................. F-3
(4) Independent Auditors' Reports of KPMG Peat Marwick LLP......... F-4
(5) Independent Auditors' Report of Coopers & Lybrand L.L.P........ F-6
(6) Consolidated Balance Sheets at June 30, 1995 and March 31,
1996........................................................... F-7
(7) Consolidated Statements of Operations for the Years Ended June
30, 1994 and 1995 and for the nine months ended March 31,
1996........................................................... F-8
(8) Consolidated Statements of Common Stockholders' Equity for the
Years Ended June 30, 1994 and 1995 and for the nine months
ended March 31, 1996........................................... F-9
(9) Consolidated Statements of Cash Flows for the Years Ended June
30, 1994 and 1995 and for the nine months ended March 31,
1996........................................................... F-10
(10) Notes to the Consolidated Financial Statements................. F-11
(2) FINANCIAL STATEMENT SCHEDULES
Independent Auditors Reports........................................ S-1
Schedule II--Consolidated Valuation Accounts........................ S-3
</TABLE>

All other financial statement schedules have been omitted because they are
inapplicable or the information required thereby is included in the
financial statements.

(3) EXHIBITS

Reference is made to the Exhibit Index immediately preceding the exhibits
hereto for the exhibits included herein.

(b) REPORTS ON FORM 8-K.

No reports on Form 8-K filed by the Company during the last quarter of the
fiscal period ended March 31, 1996.

2
<PAGE> 4

REPORT OF INDEPENDENT AUDITORS

Stockholders and Board of Directors
UroHealth Systems, Inc.

We have audited the accompanying consolidated balance sheets of UroHealth
Systems, Inc. as of March 31, 1996, and June 30, 1995, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the nine months ended March 31, 1996 and the year ended June 30, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based upon
our audits. We did not audit the fiscal 1995 financial statements of Dacomed
Corporation, a wholly-owned subsidiary, which statements reflect total assets
and total revenues constituting 4% and 10% of the related consolidated totals.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to data included in the fiscal
1995 consolidated financial statements for Dacomed Corporation, is based solely
on the report of other auditors.

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 and the report of other auditors provide a reasonable
basis for our opinion.

In our opinion, based upon our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of UroHealth Systems, Inc. at March 31, 1996
and June 30, 1995, and the consolidated results of its operations and its cash
flows for the nine months ended March 31, 1996 and the year ended June 30, 1995
in conformity with generally accepted accounting principles.

/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP

Orange County, California
June 4, 1996

F-1
<PAGE> 5

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Stockholders of

UroHealth Systems, Inc.

We have audited the consolidated statements of operations, common
stockholders' equity, and cash flows of Urohealth Systems, Inc. for the year
ended June 30, 1994 (restated to reflect the acquisitions of Osbon Medical
Systems, Ltd., Dacomed Corporation, Allstate Medical Products, Inc., and
Advanced Surgical Inc., each accounted for as a pooling-of-interests). 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 audit. We did not audit the fiscal 1994 financial statements of Dacomed
Corporation, UroHealth Systems, Inc. (pre-acquisitions), Allstate Medical
Products, Inc., and Advanced Surgical, Inc., (collectively "the Companies")
which statements reflect total net sales (in thousands) of $8,920 (24% of total
net sales), $4,258 (11% of total net sales), $2,215 (6% of total net sales), and
$1,754 (5% of total net sales), respectively, for the year ended June 30, 1994.
Those statements were audited by other auditors, other than the financial
statements of Allstate Medical Products, Inc. which are immaterial and
unaudited, whose reports have been furnished to us, and our opinion, insofar as
it relates to the amounts included for the Companies, is based solely on the
reports of the other auditors.

We conducted our audit 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 audit and the reports of other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audit and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated results of operations and cash flows of
UroHealth Systems, Inc. for the year ended June 30, 1994, in conformity with
generally accepted accounting principles.

/s/ Cherry, Bekaert & Holland, L.L.P.

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

Cherry, Bekaert & Holland, L.L.P.

Augusta, Georgia

January 8, 1997

F-2
<PAGE> 6

REPORT OF INDEPENDENT AUDITORS

To the Directors of
UroHealth Systems, Inc.

We have audited the consolidated statements of operations, stockholders'
equity and cash flows of UroHealth Systems, Inc. for the year ended June 30,
1994 (not included herein) presented under United States generally accepted
accounting principles. 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 audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance 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.

Under date of August 22, 1994, we previously reported, without
qualification, on the consolidated statements of operations, shareholders'
equity and cash flows of the company for the year ended June 30, 1994 presented
in accordance with accounting principles generally accepted in Canada.

In our opinion, the consolidated financial statements referred to in the
first paragraph present fairly, in all material respects, the results of
operations of the company and its cash flows for the year ended June 30, 1994 in
accordance with accounting principles generally accepted in the United States.

/s/ DOANE RAYMOND
--------------------------------------
Chartered Accountants

Toronto, Canada
August 22, 1994

F-3
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INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
Dacomed Corporation:

We have audited the consolidated balance sheet of Dacomed Corporation and
subsidiary as of June 24, 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the fiscal year then ended
(not included separately herein). These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Dacomed
Corporation and subsidiary as of June 24, 1995, and the results of their
operations and their cash flows for the fiscal year then ended, in conformity
with generally accepted accounting principles.

/s/ KPMG PEAT MARWICK LLP
--------------------------------------
KPMG Peat Marwick LLP

Minneapolis, Minnesota
October 10, 1995

F-4
<PAGE> 8

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
Dacomed Corporation:

We have audited the consolidated statements of operations, stockholders'
equity, and cash flows of Dacomed Corporation and subsidiary for the fiscal year
ended October 29, 1994 (not included separately herein). These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.

In our opinion, the 1994 consolidated financial statements referred to
above present fairly, in all material respects, the results of operations and
cash flows of Dacomed Corporation and subsidiary for the fiscal year ended
October 29, 1994, in conformity with generally accepted accounting principles.

/s/ KPMG PEAT MARWICK LLP
--------------------------------------
KPMG Peat Marwick LLP

Minneapolis, Minnesota
December 19, 1994

F-5
<PAGE> 9

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
Advanced Surgical, Inc.:

We have audited the consolidated balance sheet of Advanced Surgical, Inc.
and subsidiary as of December 31, 1994, and the related consolidated statements
of operations, shareholders' equity, and cash flows for the year ended December
31, 1994. 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 audit.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Advanced
Surgical, Inc. and subsidiary as of December 31, 1994, and the results of their
operations and their cash flows for the year ended December 31, 1994, in
conformity with generally accepted accounting principles.

The consolidated financial statements referred to above have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
2 to the consolidated financial statements, the Company has suffered recurring
losses and negative cash flows from operations. The Company anticipates that
losses and negative cash flows from operations will continue and that cash
resources currently available may not be sufficient to sustain operations
through 1995. These factors raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 2. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

/s/ COOPERS & LYBRAND L.L.P.
--------------------------------------
Coopers & Lybrand L.L.P.

Princeton, New Jersey
February 24, 1995

F-6
<PAGE> 10

UROHEALTH SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
UNAUDITED
PRO FORMA
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1996
-------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and equivalents..................................... $ 1,051 $ 1,185 $ 33,695
Short-term investments................................... 1,026 -- --
Receivables, net of allowance for doubtful accounts of
$538
and $1,644 in 1995 and 1996, respectively............. 6,666 7,337 7,337
Note receivable from officer of subsidiary............... 105 -- --
Inventories.............................................. 4,680 5,705 5,705
Prepaids and deposits.................................... 932 1,685 1,685
Deferred debt issuance costs............................. -- 614 4,731
-------- -------- --------
Total current assets....................................... 14,460 16,526 53,153
Property and equipment, net................................ 8,698 8,132 8,132
Patents and intangibles, net of accumulated amortization of
$1,860
and $2,102 in 1995 and 1996, respectively................ 2,334 2,135 2,135
Deposits and other assets.................................. 273 649 649
Goodwill................................................... 409 393 393
-------- -------- --------
$ 26,174 $ 27,835 $ 64,462
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.................... $ 6,670 $ 9,455 $ 9,455
Compensation and employee benefits....................... 1,259 2,045 2,045
Restructuring accrual.................................... 268 1,345 1,345
Revolving lines of credit................................ 1,689 7,123 --
Current portion of notes payable and capital leases...... 531 286 286
-------- -------- --------
Total current liabilities.................................. 10,417 20,254 13,131
Long-term liabilities:
Notes payable............................................ 1,077 6,641 641
Capital leases........................................... 323 211 211
Convertible note......................................... 1,077 1,284 --
Other liabilities........................................ 151 185 185
Restructuring, less current portion...................... 218 823 823
Minority interest in consolidated subsidiary............... 1,230 1,073 1,073
Redeemable convertible preferred stock..................... 1,143 3,554 --
Convertible subordinated debentures........................ -- -- 50,000
Commitments and contingencies
Common stockholders' equity:
Preferred stock, $0.001 par value
Authorized shares -- 5,000,000
Issued and outstanding shares -- none................. -- -- --
Common stock, $0.001 par value
Authorized shares -- 20,000,000
Issued and outstanding shares -- 12,287,000 and
12,460,000, respectively (13,266,000 pro forma)..... 12 12 13
Warrants................................................. 1,402 2,922 4,172
Additional paid-in capital............................... 52,820 55,050 59,887
Foreign currency adjustment.............................. 115 (98) (98)
Deficit.................................................. (43,811) (64,076) (65,576)
-------- -------- --------
Total common stockholders' equity.......................... 10,538 (6,190) (1,602)
-------- -------- --------
$ 26,174 $ 27,835 $ 64,462
======== ======== ========
</TABLE>

See accompanying notes.

F-7
<PAGE> 11

UROHEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
NINE
MONTHS
YEAR ENDED JUNE 30, ENDED
--------------------- MARCH 31,
1994 1995 1996
-------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Net sales.................................................. $ 37,828 $ 45,453 $ 39,641
Cost of sales.............................................. 13,993 16,159 12,896
-------- -------- --------
Gross profit............................................... 23,835 29,294 26,745
Operating expenses:
Selling, general and administrative...................... 32,802 35,145 32,218
Research and development................................. 9,470 8,805 1,324
Restructuring charges.................................... -- 1,200 5,456
Direct acquisition costs................................. -- 851 4,232
Settlement of litigation................................. 1,000 300 --
-------- -------- --------
Total operating expenses................................... 43,272 46,301 43,230
-------- -------- --------
Loss from operations....................................... (19,437) (17,007) (16,485)
Other income (expense):
Minority interest consisting of accrued dividends on
preferred stock of subsidiary......................... (175) (78) (55)
Interest income.......................................... 318 263 23
Interest expense......................................... (267) (303) (1,002)
Other.................................................... -- 5 (48)
-------- -------- --------
Loss before taxes.......................................... (19,561) (17,120) (17,567)
Provision for income taxes................................. 566 1,386 431
-------- -------- --------
Net loss................................................... $(20,127) $(18,506) $(17,998)
======== ======== ========
Net loss per share:
Net loss................................................. $(20,127) $(18,506) $(17,998)
-------- -------- --------
Dividends and accretion on redeemable convertible
preferred stock....................................... -- (45) (579)
-------- -------- --------
Net loss attributable to common stockholders............. $(20,127) $(18,551) $(18,577)
======== ======== ========
Net loss per share....................................... $ (1.77) $ (1.52) $ (1.50)
======== ======== ========
Weighted average number of shares used to compute net loss
per share................................................ 11,384 12,235 12,344
======== ======== ========
</TABLE>

See accompanying notes.

F-8
<PAGE> 12

UROHEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL FOREIGN
------------------ PAID-IN CURRENCY
SHARES AMOUNT WARRANTS CAPITAL DEFICIT TRANSLATION TOTAL
------ -------- -------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1993............. 11,003 $ 34,238 $ -- $ 3,235 $(17,083) $ -- $ 20,390
Redeemable common stock............ -- -- -- (281) -- -- (281)
Stock compensation................. -- -- -- 926 -- -- 926
Exercise of options and warrants... 56 195 -- 1 -- -- 196
Stockholder distribution........... -- -- -- -- (85) -- (85)
Change in valuation of redeemable
common stock.................... -- -- -- -- 281 -- 281
Foreign currency translation....... -- -- -- -- 8 -- 8
Issue of shares subscribed......... 250 598 -- -- -- -- 598
Cancellation of stock options...... -- -- -- (10) -- -- (10)
Exchange of preferred stock of
subsidiary...................... 323 4,453 -- -- -- -- 4,453
Purchase of Laparomed
Corporation..................... 236 6,990 -- -- -- -- 6,990
Net loss........................... -- -- -- -- (20,127) -- (20,127)
Net unrealized gain/loss on
investments..................... -- -- -- -- -- --
Settlement of litigation........... -- -- 1,000 -- -- -- 1,000
------ -------- ------ ------- -------- ----- --------
Balance at June 30, 1994............. 11,868 46,474 1,000 3,871 (37,006) -- 14,339
Exercise of options and warrants... 55 87 -- -- -- -- 87
Issuance of common shares.......... 169 899 -- 95 -- -- 994
Warrants........................... -- -- 402 -- -- -- 402
Exchange of preferred stock of
subsidiary...................... 195 2,720 -- -- -- -- 2,720
Reincorporation in Delaware........ -- (50,168) -- 50,168 -- -- --
Adjustment for pooling of
interest........................ -- -- -- -- 10,432 -- 10,432
Dividends and accretion on
redeemable convertible preferred
stock........................... -- -- -- -- (45) -- (45)
Net loss........................... -- -- -- -- (18,506) -- (18,506)
Foreign currency translation....... -- -- -- -- -- 115 115
------ -------- ------ ------- -------- ----- --------
Balance at June 30, 1995............. 12,287 12 1,402 54,134 (45,125) 115 10,538
Adjustments for pooling of
interests....................... -- -- -- -- (374) -- (374)
Exercise of options and warrants... 170 -- -- 871 -- -- 871
Exchange of preferred stock of
subsidiary...................... 3 -- -- 45 -- -- 45
Dividends and accretion on
redeemable convertible preferred
stock........................... -- -- -- -- (579) -- (579)
Warrants........................... -- -- 1,520 -- -- -- 1,520
Net loss........................... -- -- -- -- (17,998) -- (17,998)
Foreign currency translation....... -- -- -- -- -- (213) (213)
------ -------- ------ ------- -------- ----- --------
Balance at March 31, 1996............ 12,460 $ 12 $2,922 $55,050 $(64,076) $ (98) $ (6,190)
====== ======== ====== ======= ======== ===== ========
</TABLE>

See accompanying notes.

F-9
<PAGE> 13

UROHEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, NINE MONTHS ENDED
--------------------- MARCH 31,
1994 1995 1996
-------- -------- -----------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................................................ $(20,127) $(18,506) $ (17,998)
Noncash items included in net loss:
Depreciation and amortization......................................... 1,612 2,723 1,422
Loss on retirement/write-off of assets................................ 114 26 629
Deferred income taxes................................................. 160 46 (110)
Amortization of deferred loan costs................................... -- -- 637
Settlement of litigation.............................................. 1,000 -- --
Increase in provision for doubtful accounts........................... 322 54 1,106
Stock compensation.................................................... 936 -- --
Other................................................................. 8 147 49
Equity issued for purchased research and development.................. 5,312 5,312 --
Changes in operating assets and liabilities:
Receivables........................................................... (1,472) (1,563) (1,743)
Inventories........................................................... (399) (604) (1,092)
Prepaids and deposits................................................. 110 (261) (1,044)
Note receivable from related party.................................... (40) (60) --
Other................................................................. (64) 469 --
Accounts payable and accrued expenses................................. 659 2,968 2,909
Compensation and employee benefits.................................... (18) 343 729
Accrued dividends on preferred stock of subsidiary.................... 175 132 --
Accrued restructuring charges......................................... -- 486 2,005
Other................................................................. 24 76 --
-------- -------- --------
Net cash used in operating activities................................... (11,688) (8,212) (12,501)
INVESTING ACTIVITIES
Purchase of investments................................................. (2,280) (2,280) --
Purchases of property and equipment, net................................ (1,935) (3,469) (2,596)
Proceeds from disposal of property and equipment........................ (163) 5 788
Cash acquired from acquisition of business.............................. 1,008 -- --
Sale of investments..................................................... 5,972 6,361 1,026
Patents/intangibles..................................................... (398) (315) (43)
Deposits and other assets............................................... 324 1,162 --
Other................................................................... (60) (31) --
-------- -------- --------
Net cash provided by (used in) investing activities..................... 2,468 1,433 (825)
FINANCING ACTIVITIES
Issuance of common shares............................................... 177 748 --
Exercise of employee stock options...................................... 18 1 700
Issuance of preferred stock by subsidiary............................... 6,286 1,831 --
Issuance of redeemable convertible preferred stock...................... -- 1,500 1,830
Issuance of warrants.................................................... -- -- 670
Proceeds from notes payable............................................. 314 738 --
Proceeds from term loan................................................. -- -- 5,579
Proceeds from issuance of convertible debt.............................. -- 1,000 --
Proceeds from revolving lines of credit................................. 11,280 9,278 5,568
Principal payments on notes payable and capital leases.................. (761) (724) (887)
Principal payments on lines of credit................................... (11,021) (9,022) --
Cash paid for shareholder distribution.................................. (85) -- --
-------- -------- --------
Net cash provided by financing activities............................... 6,208 5,350 13,460
-------- -------- --------
Net increase (decrease) in cash......................................... (3,012) (1,429) 134
Cash, beginning of year................................................. 6,798 3,994 1,051
-------- -------- --------
Cash, end of year....................................................... $ 3,786 $ 2,565 1,185
======== ======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES
Equipment acquired under capital leases................................. $ 235 $ 160 --
======== ======== ========
Preferred stock of subsidiary exchanged for common shares of the
Company............................................................... $ 4,452 $ 2,721 45
======== ======== ========
Shares subscribed for in 1992 for which common shares were issued in
1994.................................................................. $ 598 $ -- --
======== ======== ========
Equity issued in acquisition of a business.............................. -- 6,990 --
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest.................................................. $ 57 $ 195 912
======== ======== ========
Cash paid for taxes, net of refunds..................................... $ 5 $ 1,262 1,010
======== ======== ========
</TABLE>

See accompanying notes.

F-10
<PAGE> 14

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION

Description of the Company

UROHEALTH Systems, Inc. (the "Company") is engaged in the manufacture,
marketing and distribution of products used by urologists and gynecologists. The
Company is focused on developing a broad range of products specific to these two
specialities using a direct sales distribution channel.

Basis of Financial Statement Presentation

In 1996, the Company changed its fiscal year end to March 31. Fiscal 1996
is a nine month transition period ended March 31, 1996.

During the nine month period ended March 31, 1995, the Company's results of
operations included: net sales of $32.7 million; gross profits of $21.7 million;
income taxes of $1.0 million; net loss of $15.5 million; and net loss per share
of $1.28.

Financial information for fiscal years 1994 and 1995 has been restated to
reflect mergers with Osbon Medical Systems Ltd., Dacomed Corporation, Advanced
Surgical, Inc. and Allstate Medical Products, Inc. Significant intercompany
accounts and transactions have been eliminated in consolidation and certain
amounts have been reclassified in prior periods to conform to the current period
presentation.

Unaudited Pro Forma Financial Information

The accompanying pro forma balance sheet as of March 31, 1996 has been
prepared assuming the Company completed a private placement of $50.0 million of
convertible subordinated debentures and converted the convertible note and
redeemable convertible preferred stock into common stock as of that date.

The first and second closings of a private placement of $50.0 million,
8.75% convertible debentures were completed on May 13, 1996 and May 20, 1996,
respectively, and upon consummation of the third closing, is estimated to
provide proceeds of approximately $45.0 million, net of debt issuance costs
(Note 7). The Company used $16.5 million of the private placement proceeds to
repay amounts outstanding under a Credit Agreement. As of March 31, 1996,
approximately $13.1 million was outstanding under the Credit Agreement (Note 6).
In connection with the $50.0 million private placement, a break-up fee
consisting of $500,000 cash and 200,000 warrants, was paid to the lender under
the Credit Agreement. The warrants have an exercise price of $9.15 and expire in
May 2001. The break-up fee and unamortized deferred loan costs related to the
Credit Agreement totaling approximately $2.0 million, net of taxes, will be
recorded as an extraordinary expense in fiscal 1997.

Also on May 13, 1996, obligations under the convertible note and redeemable
convertible preferred stock, totalling approximately $8.5 million, were
exchanged for 1,414,827 shares of the Company's common stock, (Note 8). As of
March 31, 1996, approximately $4.8 million was outstanding under these
securities and were convertible into approximately 806,000 shares.

Business Combinations

In December 1995, the Company acquired all of the outstanding common stock
of Osbon Medical Systems, Ltd. (Osbon), a private healthcare company in the
urological products field and Advanced Surgical, Inc. (Advanced), a publicly
held manufacturer and distributor of minimally invasive surgical products and a
proprietary female incontinence product under development. The acquisitions were
completed in two separate transactions both of which have been accounted for as
pooling of interests and accordingly, the accompanying consolidated financial
statements of the Company include the assets, liabilities and operations of
these companies with those of the Company for all periods presented. The Company
issued 5,937,833 shares of its common stock in connection with these
acquisitions.

F-11
<PAGE> 15

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION
(CONTINUED)

In July 1995, the Company acquired all of the outstanding common stock of
Dacomed Corporation (Dacomed), a private healthcare company in the urological
products field and Allstate Medical Products, Inc. (Allstate), a private
manufacturer and distributor of disposable urinary incontinence products. The
acquisitions were completed in two separate transactions both of which have been
accounted for as pooling of interests and accordingly, the accompanying
consolidated financial statements of the Company include the assets, liabilities
and operations of these companies with those of the Company for all periods
presented. The Company issued 1,800,856 shares of its common stock in connection
with these acquisitions.

The results of operations previously reported by Osbon, Advanced, Dacomed
and Allstate included in the accompanying consolidated financial statements are
summarized below (in thousands):

<TABLE>
<CAPTION>
NINE
MONTHS
YEAR ENDED JUNE 30, ENDED
--------------------- MARCH 31,
1994 1995 1996
-------- -------- ---------
<S> <C> <C> <C>
Net sales:
Osbon............................................ $ 20,681 $ 25,767 $ 23,653
Advanced......................................... 1,754 2,231 1,223
Dacomed.......................................... 8,920 9,300 8,017
Allstate......................................... 2,215 2,275 1,798
UroHealth........................................ 4,258 5,880 4,950
-------- -------- --------
Combined................................. $ 37,828 $ 45,453 $ 39,641
======== ======== ========
Net income (loss):
Osbon............................................ $ 813 $ 2,035 $ 528
Advanced......................................... (13,068) (12,283) (2,408)
Dacomed.......................................... (1,389) (692) (1,310)
Allstate......................................... 148 (42) (623)
UroHealth........................................ (6,631) (7,524) (14,185)
-------- -------- --------
Combined................................. $(20,127) $(18,506) $(17,998)
======== ======== ========
</TABLE>

Prior to the December 1995 merger, Osbon prepared its financial statements
on the basis of a September 30 fiscal year and Advanced had a December 31 year
end. The consolidated results of operations for the years ended June 30, 1994
and 1995 include the results of operations of Osbon for the years ended
September 30, 1994 and 1995, respectively. Accordingly, revenues of
approximately $6,809,000 and net income from operations of $373,000 were
included in the consolidated results of operations for both fiscal periods ended
June 30, 1995 and March 31, 1996. The consolidated results of operations for the
years ended June 30, 1994 and 1995 include the results of operations of Advanced
for the year ended December 31, 1994 and for the year ended June 30, 1995,
respectively. Accordingly, revenues of approximately $1,111,000 and net loss
from operations of $10,154,000 for Advanced were included in both the June 30,
1994 and 1995 consolidated results of operations.

Prior to the July 1995 merger, Dacomed and Allstate prepared their
financial statements on the basis of an October 31 and December 31 fiscal year
end, respectively. Revenues of approximately $3,500,000 and net loss from
operations of $315,000 of Dacomed for the period from July 1, 1994 to October
31, 1994 were included in both the June 30, 1994 and 1995 consolidated results
of operations. Revenues of approximately $1,100,000 and net income of $74,000 of
Allstate for the period from July 1, 1994 to December 31, 1994 were included in
both the June 30, 1994 and 1995 consolidated results of operations.

F-12
<PAGE> 16

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION
(CONTINUED)

No adjustments were required to be made to the net assets of the combining
enterprises to conform accounting practices. There was no effect on net income
previously reported. The individual fiscal years of the merged companies were
not changed.

On March 17, 1995, the Company acquired all of the issued and outstanding
stock of UroHealth of Kentucky, Inc. in exchange for an aggregate of 25,000
shares of the Company's common stock and assumption of debt, aggregating
approximately $137,000 to two principal stockholders of UroHealth of Kentucky,
Inc. The acquisition of UroHealth of Kentucky, Inc. has been accounted for by
the purchase method of accounting and, accordingly, the operations are included
in the accompanying consolidated financial statements from the acquisition date.
The excess of cost over fair value of net assets acquired in this transaction
has been allocated to goodwill in the consolidated balance sheet. In addition,
one principal stockholder entered into an employment agreement, two principal
stockholders entered into consulting arrangements with the Company, and all
three principal stockholders are entitled to receive, in the aggregate, fifty
percent of the Company's net profits generated from future incontinence clinics
operated by the Company if employing the UroHealth of Kentucky, Inc. operating
model.

On July 27, 1994 through its Advanced subsidiary, the Company purchased all
of the outstanding capital stock of Laparomed Corporation, a developer,
manufacturer and marketer of single-use instruments for minimally invasive
surgery, primarily laparoscopic procedures used by gynecologists and general
surgeons, in exchange for 236,000 shares of the Company's common stock. The
acquisition has been accounted for by the purchase method of accounting and the
purchase price of $6,990,000 approximates the fair value of the net assets
acquired. The operating results of this acquisition, including purchased
research and development as a result of this acquisition, are included in the
Company's consolidated results of operations from the date of the Laparomed
acquisition. During the fiscal year ended June 30, 1995, the Company incurred
approximately $1,665,000 related to the relocation of Laparomed's operations and
employee termination costs.

2. SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

Revenue from sales of manufactured products is recognized upon shipment to
customers.

Cash and Equivalents

Cash and equivalents include time deposits, certificates of deposit and
other marketable securities with original maturities of three months or less.

Property and Equipment

Property and equipment are recorded at cost, less accumulated depreciation
and amortization. Maintenance and repairs are charged to expense as incurred,
and renewals and betterments are capitalized. Depreciation and amortization are
provided on the straight line method over the assets estimated useful lives.
Estimated useful lives range from five to seven years for office equipment, five
to ten years for equipment and tooling, ten years for molds and three to five
years for vehicles. For leasehold improvements, the useful life is determined to
be the original term of the lease.

Patents, Intangibles and Goodwill

Intangible assets consisting of patents, trademarks and goodwill are
amortized on a straight-line basis over various periods up to twenty years.
Intangible assets are reviewed if the facts and circumstances suggest that they
may be impaired. An intangible asset is deemed to be impaired when the
unamortized balance exceeds the undiscounted estimated future cash flows from
the related assets.

F-13
<PAGE> 17

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Advertising Expense

Advertising and promotion costs are expensed when incurred. Such costs in
fiscal 1994, 1995 and 1996 were $952,000, $1,037,000 and $727,000, respectively.

Research and Development Expense

Research and development expenses are charged against income as incurred.

Warranty and Product Liability Costs

Estimated warranty costs, insurance deductible amounts associated with
product liability claims, and an amount for incurred but not reported product
liability incidents are accrued in the period the products are sold. Actual
costs are charged against the accrual when paid.

Per Share Information

Net loss per share is based on net income attributable to common
stockholders and the weighted average number of shares of common stock
outstanding during the periods presented. Common stock equivalents have not been
included in the calculation as they are anti-dilutive.

Recent Accounting Pronouncements

Effective March 1995, the Financial Accounting Standards Board issued
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long Lived Assets to be Disposed of ("FAS 121), which requires impairment losses
to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than assets' carrying amount. FAS 121 also addresses
the accounting for long-lived assets that are expected to be disposed of. The
Company adopted FAS 121 during the first quarter of fiscal 1996 and, with no
material effect to its financial statement position or results of operations.

In November 1995, the Financial Accounting Standards Board issued Statement
No. 123 Accounting for Stock Based Compensation ("FAS 123"). The Company has
elected to continue accounting for stock options under APB No. 25 Accounting for
Stock Issued to Employees and adopt the pro forma disclosure provisions of FAS
123. The adoption of FAS 123 would not have a material effect on the Company's
financial position or results of operations for the year ended December 31,
1995.

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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

F-14
<PAGE> 18

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. INVESTMENTS

All investments have been classified as available-for-sale, and are carried
at fair value or amortized cost. At June 30, 1995, investments consist of mutual
funds, corporate bonds and certificates of deposits in the amounts of $1.0
million, $20,000 and $6,000, respectively. All debt securities carried as
investments matured in six months or less.

4. PROPERTY AND EQUIPMENT

Property and equipment consists of the following (in thousands):

<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1995 1996
-------- ---------
<S> <C> <C>
Office equipment................................................ $ 4,027 $ 4,560
Equipment and tooling........................................... 5,582 3,920
Molds........................................................... 2,169 2,177
Leasehold improvements.......................................... 462 1,150
Building........................................................ 1,265 1,718
Land............................................................ 247 247
Other........................................................... 484 962
------- -------
14,236 14,734
Accumulated depreciation........................................ 5,538 6,602
------- -------
$ 8,698 $ 8,132
======= =======
Equipment recorded under capital leases included above.......... $ 534 534
Accumulated depreciation thereon................................ 80 124
------- -------
$ 454 $ 410
======= =======
</TABLE>

5. INVENTORIES

Inventories are carried at the lower of cost, determined on the first-in,
first-out basis, or market and consist of the following (in thousands):

<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1995 1996
-------- ---------
<S> <C> <C>
Raw materials and supplies....................................... $1,783 $1,963
Work in progress................................................. 262 318
Finished goods................................................... 2,635 3,424
------ ------
$4,680 $5,705
====== ======
</TABLE>

F-15
<PAGE> 19

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. NOTES PAYABLE AND LINES OF CREDIT

Notes payable consist of the following (dollars in thousands):

<TABLE>
<CAPTION>
MARCH
JUNE 30, 31,
1995 1996
-------- --------
<S> <C> <C>
Term loan under Credit Agreement, repaid May 13, 1996.......... $ -- $6,000
Bank note, interest at prime plus 3%, repaid in November
1995......................................................... 375 --
Bank note, interest at 8.75%, repaid in April 1996............. 338 326
Bank note, interest at 8.75%, repaid in April 1996............. 253 221
Bank note dated December 21, 1992, due in 180 monthly
installments with interest at 8.75% collateralized by a
building..................................................... 180 175
Unsecured bank notes with interest rates of prime plus .5% to
10%, repaid in October 1995.................................. 170 --
Bank note dated April 29, 1994, due in 36 monthly installments
with interest at 8.75%; collateralized by equipment.......... 42 41
Bank note dated February 11, 1994, due in 30 monthly
installments with interest at 8.75%; collateralized by
equipment.................................................... 34 29
Various notes payable with interest from 8.5% to 10%, due dates
through August 1, 1997, secured by equipment................. 43 19
------ ------
1,435 6,811
Less current maturities.............................. 358 170
------ ------
$1,077 $6,641
====== ======
</TABLE>

Revolving lines of credit consist of the following (dollars in thousands):

<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1995 1996
-------- ---------
<S> <C> <C>
Line of credit under Credit Agreement, interest at prime rate
plus 4%, repaid in May 1996.................................... $ -- $5,500
Line of credit with a bank in the lesser of $2,000 or 80% of
subsidiaries' qualifying accounts receivable; interest at the
bank's prime minus .25%; guaranteed by a stockholder of the
company; repaid in May 1996.................................... 986 1,623
Line of credit with interest at the bank's reference rate plus
2.5%; repaid in April 1996..................................... 378 --
Line of credit, interest at bank prime plus 2%, repaid in
November 1995.................................................. 150 --
Line of credit, interest at bank prime plus 2%, repaid in October
1995........................................................... 175 --
------ ------
$1,689 $7,123
====== ======
</TABLE>

In October 1995, the Company refinanced all lines of credit assumed under
the Dacomed and Allstate mergers under a Credit Facility which provided for
borrowings up to $2.6 million under a revolving line of credit and maintained an
existing $375,000 term loan. In connection with the Credit Facility the Company
also granted 50,000 warrants with a five year term and an exercise price of
$10.50.

In November 22, 1995, the Company refinanced the $2.6 million revolving
line of credit and the $375,000 term loan under the Credit Facility, entering
into a $10.0 million Credit Agreement with a new bank. The Credit Agreement
consisted initially of a $6.0 million term loan and a $4.0 million revolving
line of credit. The revolving line of credit under the Credit Agreement was
increased to $5.5 million in March 1996 and to $10.5 million in April 1996.
Interest on all borrowings under the Credit Agreement was at the bank's prime
rate plus 4.0% (plus 2.0% in the event of default). The Credit Agreement was
repaid with proceeds from the sale of convertible subordinated debentures in May
1996.

F-16
<PAGE> 20

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. NOTES PAYABLE AND LINES OF CREDIT (CONTINUED)

In connection with the initial borrowings under the Credit Agreement, the
Company granted a warrant to purchase 366,667 shares of the Company's common
stock at $9.15 per share. The warrant expires on November 22, 2000. In
connection with subsequent increases of amounts available under the line of
credit and significant covenant modifications the Company granted a warrant to
purchase 350,000 shares of the Company's common stock at $9.15 per share. The
warrant expires on April 12, 2001.

7. CONVERTIBLE SUBORDINATED DEBENTURES -- (UNAUDITED)

On May 3, 1996, the Company authorized the issuance of $50.0 million of
8.75% convertible subordinated debentures (the "Debentures") and warrants to
purchase 250,000 shares of the Company's common stock at $13.00. The Debentures
are convertible at any time and are subject to certain registration rights. The
Debentures mature in May 2006 and interest is payable quarterly in arrears. The
warrants expire in five years.

The Debentures are redeemable at the option of the Company after two years,
if the average market price of the Company's common stock is above $22.00 for 60
consecutive days, or after three years without regard to the Company's common
stock price. The redemption price is equal to 105% of the principal amount
decreasing annually to the principal amount in 2004, plus accrued and unpaid
interest.

The Debentures are convertible into common stock at $11.00 per share, are
subordinate to all future senior borrowings and will have voting rights on all
matters on an "as converted" basis. The holders of the
Debentures must approve any dividend, payment or other distribution to
stockholders, as well as any redemption of shares of common stock, options or
warrants of the Company or any subsidiary other than the preferred stock issued
by Urohealth-California.

8. CONVERTIBLE NOTE AND REDEEMABLE CONVERTIBLE PREFERRED STOCK

In connection with the private placement of convertible subordinated
debentures, the holder of the Company's convertible note and the redeemable
convertible preferred stock exchanged these securities, plus accrued interest,
for 358,617 and 1,056,210 shares of the Company's common stock, respectively.
The exchange price was $6.00 per share. As a result of the conversion, deferred
debt issuance costs totalling approximately $0.9 million were charged to
additional paid-in capital. Warrants previously granted to the holder to
purchase 800,000 shares of the Company's common stock at $6.88 remain
outstanding and expire in 2000 and a warrant to purchase 250,000 shares of the
Company's common stock at $10.00 per share which expires in 2000 was issued to
the holder in connection with the conversion and modification of certain other
rights.

9. CAPITAL AND OPERATING LEASES

The Company has various capital equipment leases and operating lease
agreements for office and production facilities. The Company is required to pay
maintenance and property taxes attributable to the facilities. Rent expense
under all operating leases was approximately $1.0 million, $1.1 million and
$625,000 in 1994, 1995 and 1996, respectively.

F-17
<PAGE> 21

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. CAPITAL AND OPERATING LEASES (CONTINUED)

Future minimum lease payments at March 31, 1996 are shown in the following
table:

<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
(IN THOUSANDS)
<S> <C> <C>
Years ending March 31:
1997............................................................ $150 $ 925
1998............................................................ 140 733
1999............................................................ 66 738
2000............................................................ 36 461
2001............................................................ -- 442
thereafter...................................................... 1 368
---- ------
Net minimum lease payments........................................ 393 $3,667
======
Less imputed interest............................................. 66
----
Present value of net minimum lease payments....................... 327
Less current portion.............................................. 116
----
Long-term portion................................................. $211
====
</TABLE>

10. RESTRUCTURING CHARGES

During the year ended June 30, 1995, the Company hired a new senior
management team which adopted and implemented a restructuring plan (the Plan)
under which it has refocused the Company's strategic direction. Under the Plan,
the Company terminated or amended certain distribution, consulting and
employment agreements. Accordingly, the consolidated statement of operations
reflects a charge of $1,200,000 ($.06 per common share) to terminate or
restructure these agreements under the Plan. The components of the restructuring
charges include a provision to discontinue the distribution of the
Adzorbstar(TM) product line of $360,000, termination agreements which include
indemnification costs of former employees for legal fees associated with an SEC
investigation of $250,000, termination of certain other consulting and
distributor agreements of $50,000, and the amendment and settlement of certain
claims under the employment agreement with the former Chief Executive Officer of
$540,000. All significant restructuring charges were paid in cash during the
1995 calendar year. Through March 31, 1996, cash payments have reduced the
components of the restructuring accrual to $328,000 primarily relating to the
settlement of certain claims with the former Chief Executive Officer.

In December 1995, the Company implemented a restructuring plan to
consolidate redundant facilities and reduce personnel resulting from the mergers
with Dacomed Corporation, Osbon Medical Systems, Ltd. and Advanced Surgical,
Inc. Under the plan the Company has eliminated approximately 70 manufacturing,
engineering and administrative personnel and closed all operations at two
acquired facilities. The estimated cost associated with each component of this
restructuring plan and the cash and non-cash charges incurred during fiscal 1996
are summarized in the table below. Non-cash charges consist of the write-down of
existing assets to their estimated net realizable value. Reclassifications
during the period relate to decreases in severence amounts payable to officer's
of acquired companies, offset by increases in estimates for facility closure
costs including loss on sale of discontinued product lines and closure costs
related to international operations of acquired companies. The remaining
restructuring accrual at March 31, 1996 relates primarily to terminated employee
severance and facility lease obligations, which are expected to be paid in cash.
Although subject to future adjustment, management of the Company believes that
restructuring reserves as of March 31, 1996 are adequate to complete the
restructuring.

F-18
<PAGE> 22

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. RESTRUCTURING CHARGES (CONTINUED)

<TABLE>
<CAPTION>
BEGINNING BALANCE AT
RESTRUCTURING NON-CASH CASH MARCH 31,
ACCRUAL CHARGES CHARGES RECLASSIFICATIONS 1996
-------------- --------- -------- ------------------ -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Personnel reduction
costs.................... $2,620 $ -- $1,171 $(730) $ 719
Facility reduction costs... 2,836 1,187 1,258 730 $1,121
------ ------ ------ ----- ------
$5,456 $1,187 $2,429 $ -- $1,840
====== ====== ====== ===== ======
</TABLE>

11. MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY

In September and October 1993, the Company, and its subsidiary, Urohealth,
Inc. (California) ("Urohealth-California"), completed two private placements for
430,000 units at a subscription price of $10.00 per unit for gross proceeds of
$4,300,000. The net proceeds to Urohealth-California were $3,820,000. In the
first private placement, each unit consisted of two shares of Series A
Convertible Preferred Stock of Urohealth-California ("Urohealth-California
Series A Preferred Stock") and one warrant to purchase one third of a share of
common stock of the Company at an exercise price of $5.00 per preferred share.
In the second private placement, each unit consisted of two shares of Junior
Convertible Preferred Stock of Urohealth-California ("Urohealth-California
Junior Preferred Stock") and one warrant to purchase one third of a share of
common stock of the Company at an exercise price of $5.00 per share. The
Urohealth-California Series A Preferred Stock and Urohealth-California Junior
Preferred Stock are hereinafter collectively referred to as the
"Urohealth-California Preferred Stock." Each share of the Urohealth-California
Preferred Stock has a liquidation preference of $5.00 per preferred share,
together with all accrued but unpaid dividends. Cumulative dividends of 7% per
annum accrue on the Urohealth-California Preferred Stock, payable when and if
declared by the Board of Directors of the Company out of legally available
funds, prior to any dividend on the Company's common stock. Unless exchanged or
converted prior to redemption, each share of the Urohealth-California Preferred
Stock is redeemable by the Company upon 30 days' notice, by payment of $5.00 per
preferred share together with any accrued but unpaid dividends and prior to
October 31, 2001, and a designated redemption premium. The Board of Directors of
the Company, subsequent to year end, has authorized the redemption of all
outstanding Urohealth-California Series A Preferred Stock. The terms of the
warrants included in the units are identical to the terms of the warrants issued
as part of the units sold in the public offering in March 1992 (Note 15).

In May 1994, the Company and Urohealth-California completed an additional
private placement for 178,180 units at a subscription price of $15.50 per unit
for gross proceeds of $2,762,000. The net proceeds to Urohealth-California were
$2,466,000. In fiscal 1995, the Company accepted subscriptions for 130,000 units
(representing 390,000 shares of Urohealth-California Subordinate Preferred
Stock, and 390,000 warrants of the Company) at $15.50 per unit for total
proceeds of $2,015,000. The net proceeds to Urohealth-California was $1,831,000.
Each unit consisted of three shares of Subordinate Convertible Preferred Stock
of Urohealth-California (the "Urohealth-California Subordinate Preferred Stock")
and three warrants identical to the warrants issued as part of the units sold in
the public offering in March 1992 (Note 15). All outstanding shares of
Urohealth-California Subordinate Preferred Stock were exchanged for 177,000
shares of the Company's common stock in fiscal 1995.

F-19
<PAGE> 23

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY (CONTINUED)

Minority interest reflected in the consolidated balance sheets consists of
(dollars in thousands):

<TABLE>
<CAPTION>
JUNE 30, 1995 MARCH 31, 1996
-------------------- --------------------
SHARES AMOUNT SHARES AMOUNT
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Davstar Series A Preferred Stock:
Outstanding at beginning of year........... 267,000 $ 1,186 213,000 $ 944
Issued during year......................... -- -- -- --
Exchanged during year...................... (54,000) (242) (10,000) (45)
-------- ------- -------- -------
Outstanding at end of year................. 213,000 944 203,000 899
Davstar Subordinate Preferred Stock:
Outstanding at beginning of year........... 140,568 648 -- --
Issued during year......................... 390,000 1,831 -- --
Exchanged during year...................... (530,568) (2,479) -- --
-------- ------- -------- -------
Outstanding at end of year................. -- -- -- --
-------- ------- -------- -------
Outstanding at June 30, 1995................. 213,000 $ 944 203,000 $ 899
======== ======= ======== =======
</TABLE>

The redemption value at March 31, 1996 of the outstanding 203,000 Davstar
preferred stock is $1,239,750.

12. RELATED PARTY TRANSACTIONS

Corporations related through common ownership provide advertising,
publishing management and computer services to the Company. Such services
totaled $1,035,000, $1,977,000 and $1,359,000 for the fiscal periods ended June
30, 1994 and 1995 and March 31, 1996, respectively. At June 30, 1994 and 1995
and March 31, 1996, amounts owed to these related corporations totaled $127,000,
$28,000 and $53,000, respectively. These services are in all cases competitively
priced and of comparable value to services that would have been received from a
third party.

The Company leases certain of its office facilities from a party related to
certain shareholders; rental expense under the lease is approximately $17,000
per month and the lease expires in 2003.

13. CAPITAL STOCK

Subsequent to March 31, 1996 the Board of Directors approved an increase in
the number of common shares authorized to be issued from 20.0 million shares to
50.0 million shares, which increase is subject to stockholder approval.

Each outstanding share of the Company's common stock carries a stock
purchase right. Under certain circumstances, each right may be exercised to
purchase one-hundredth of a share of the Company's Series B Preferred Stock for
$200. Under certain circumstances, following the acquisition of 20% or more of
the Company's outstanding common stock by an acquiring person, as defined in the
Preferred Share Purchase Rights Plan (Note 16), each right (other than rights
held by an acquiring person) may be exercised to purchase common stock of the
Company or a successor company with a market value of twice the $200 exercise
price. The rights, which are redeemable by the Company at $.01 per right, expire
June 30, 2003.

The Series B Preferred Stock is issuable in series holding rights and
restrictions as designated by the directors before issue. In June 1993, the
directors designated a series of 250,000 Series A Preferred Stock. Subsequent to
March 31, 1996, the Board of Directors created Series C Preferred Stock of the
Company having the rights, preferences and privileges designated by the
directors. The Series C Preferred Stock will be

F-20
<PAGE> 24

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. CAPITAL STOCK (CONTINUED)

exchanged for convertible subordinated debentures (Note 7) upon approval by
stockholders of voting rights for the convertible subordinated debentures.
Except as described above, no other series of preference shares has been
designated.

In December 1994, the Company completed a private placement of 121,667
common shares for net proceeds of $618,000. At March 31, 1996, the number of
common shares potentially issuable in relation to outstanding stock options,
warrants, the convertible note, redeemable convertible preferred stock and
conversion of preferred stock of Urohealth-California and the Company was
7,925,669 shares, subject to increase under anti-dilution provisions.

14. STOCK OPTION PLANS

In March 1986, the Company established a stock option plan (the "1986
Plan"), which provides for the granting of common stock options to directors,
officers and key employees of the Company and its subsidiaries. The 1986 Plan
was amended in March 1988. Under the 1986 Plan, common stock options for up to
10% of the number of common shares of the Company outstanding from time to time
may be granted, provided that options in favor of any one individual may not
exceed 5% of the issued and outstanding common shares. However, the total number
of common shares under the 1986 Plan and any other option plan maintained by the
Company may not exceed 10% of the common shares of the Company outstanding from
time to time.

The exercise price of all stock options granted under the 1986 Plan must be
at least equal to the fair market value of such shares on the date of grant, and
the maximum term of each option may not exceed five years.

In October 1992, the Company adopted the 1992 Employee Stock Option Plan
(the "1992 Plan"), which provides for the granting of both incentive and
nonstatutory common stock options (as defined) to officers and employees of the
Company and its subsidiaries. Under the 1992 Plan, up to 366,667 options may be
granted; however, the total number of common shares under the 1992 Plan and any
other option plan maintained by the Company may not exceed 10% of the number of
common shares of the Company outstanding from time to time. The 1992 Plan
received stockholder approval at the Company's annual meeting held in December
1992.

The exercise price of all options granted under the 1992 Plan is to be
determined by the Board; however, in the case of incentive stock options, the
exercise price must be at least equal to the fair market value of such shares on
the date of grant, and the maximum term of each option may not exceed ten years.

In October 1994, the Company established a stock option plan (the "1994
Plan") which provides for the granting of both incentive and nonstatutory common
stock options to employees, consultants and independent contractors of the
Company and its affiliates. The 1994 Plan, as amended, authorizes the issuance
of up to the greater of 2,333,333 shares of common stock or 20% of the Company's
outstanding shares in the form of stock options, stock grants, rights to
purchase restricted stock and stock appreciation rights.

The exercise price for any incentive stock option granted under the 1994
Plan shall not be less than the fair market value of the stock on the date of
the grant. However, no incentive option may be granted to a person who, at the
time of grant, owns stock constituting more than 10% of the total combined
voting power of all classes of the Company's stock, unless the exercise price is
at least 110% of the fair market value of the stock on the option grant date.
The exercise price for any nonstatutory stock option granted under the 1994 Plan
may not be less than 85% of the fair market value of the stock on the date the
option is granted; provided, however, that the exercise price of options granted
to covered employees shall not be less than 100% of the fair market value on the
date of the grant.

The term of an incentive stock option granted under the 1994 Plan shall not
exceed ten years; provided that the term of any option granted to a 10%
stockholder shall not exceed five years.

F-21
<PAGE> 25

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. STOCK OPTION PLANS (CONTINUED)

Pursuant to the merger agreement with Dacomed, the Company assumed the
obligation to Dacomed employees for stock options granted under the Dacomed 1989
Stock Option Plan (the "Dacomed Plan"). The Dacomed Plan provides for granting
of both incentive and non-statutory stock options at the fair market value of
such shares at the date granted and the option term may not exceed ten years.

Pursuant to the merger agreement with Advanced, the Company assumed the
obligation to Advanced employees for stock options granted under Advanced's 1992
stock option plan for employees and consultants (the "Advanced Plan"); there are
reserved for issuance 289,300 common shares of the Company. The Advanced Plan
provides for the granting of incentive and non-qualified stock options. The
exercise price of options under this plan may not be less than 85% of the fair
market value of the shares at the time of grant. Options may be exercised for
not more than ten years from the date of grant and vest at various rates.
Options under the 1986 Plan, the 1992 Plan, the 1994 Plan, the Dacomed Plan and
the Advanced Plan expire at various dates through 2005.

The following table summarizes the activity under the 1986 Plan, the 1992
Plan, the 1994 Plan, the Dacomed Plan and the Advanced Plan for the year ended
June 30, 1995 and for the nine months ended March 31, 1996.

<TABLE>
<CAPTION>
NUMBER OF SHARES
-----------------------
JUNE 30, MARCH 31,
1995 1996
--------- ---------
<S> <C> <C>
Outstanding at beginning of year.............................. 458,483 1,526,658
Granted....................................................... 1,141,789 2,682,499
Exercised (1995 -- $1.50 per share,
1996 -- $2.25 to $12.125 per share)......................... (30,360) (159,805)
Expired or cancelled.......................................... (43,254) (38,798)
--------- ---------
Outstanding at end of year.................................... 1,526,658 4,010,554
========= =========
Exercisable at end of year (1995 and 1996 -- $1.86 to
$58.48 per share)........................................... 761,732 969,360
========= =========
</TABLE>

Option Agreements

In November 1992, the Company adopted the Non-Employee Directors Stock
Option Plan (the "Directors Plan"). Under the terms of the Directors Plan, up to
200,000 options may be granted. The Directors Plan received stockholder approval
at the Company's annual meeting held December 1992. The term of each option is
five years, and an option first becomes exercisable one year after the date of
the grant. Under the Plan, each person serving as a director of the Company who,
during the previous fiscal year, has attended 75% of the total number of
meetings of the Board and committees of the Board on which he or she served, and
who is not employed by the Company, will automatically be granted 7,500 options.
At March 31, 1996, 60,000 options were outstanding under the Directors Plan.

In December 1992, the Company adopted a Stock Appreciation Rights Plan (the
"SAR Plan"), which provides for granting of Stock Appreciation Rights ("SARs")
to officers and significant employees of the Company and its subsidiaries. Under
the SAR Plan, up to 500,000 SAR's may be granted and the SAR holder may elect to
receive cash, common stock or a combination of cash and common stock upon
exercise of a SAR. During 1995, of the 300,000 outstanding SAR's, 150,000 SAR's
were cancelled and 150,000 SAR's were converted to options to purchase the
Company's common stock. None of the remaining 200,000 SAR's were granted, and
the plan was terminated in 1995.

F-22
<PAGE> 26

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. OTHER STOCK OPTIONS AND WARRANTS

The following table indicates the expiration dates, exercise prices per
share and number of non-employee common stock options and warrants outstanding
at June 30, 1995 and March 31, 1996.

<TABLE>
<CAPTION>
NUMBER OF SHARES
-----------------------
JUNE 30, MARCH 31,
1995 1996
--------- ---------
<S> <C> <C>
Warrants issued in conjunction with public offering
in March 1992 expiring in March 1997........................ 499,415 499,415
Warrants issued to underwriters in conjunction with
public offering expiring in March 1997:
110,000 units............................................... 73,333 73,333
110,000 warrants............................................ 36,667 36,667
Warrants issued in conjunction with private placements........ 451,513 451,513
Other non employee stock options and warrants expiring
between November 1993 and May 2005, exercise price 1995 and
1996 $1.86 to $23.625....................................... 1,330,353 1,980,571
--------- ---------
Outstanding at end of year.................................... 2,391,281 3,041,499
========= =========
Exercisable at end of year (1995 and 1996 $1.86 to $23.625 per
share)...................................................... 1,113,809 1,322,367
========= =========
</TABLE>

Each warrant issued in conjunction with the public offering or private
placements in the table above entitles the holder to purchase a one third share
of common stock of the Company at a price of $5.00 until the warrants expire in
March 1997. The number and kind of securities or other property for which the
options are exercisable are subject to adjustments in certain events, such as
mergers, reorganizations or stock splits, to prevent dilution. The Company may
redeem any unexercised outstanding warrants for $0.25 per warrant (upon 30 days'
written notice) at any time at which the closing price for the Company's common
shares, has exceeded $22.50 per share for any period of 30 consecutive trading
days within the 60 trading days preceding the call notice.

16. PREFERRED SHARE PURCHASE RIGHTS PLAN

On December 22, 1992, the Board adopted the Preferred Share Purchase Rights
Plan (the "Rights Plan") which is designed to deter coercive or unfair takeover
tactics, to prevent a person or group from gaining control of the Company
without offering fair value to all stockholders and to deter other abusive
takeover tactics which are not in the best interest of stockholders. In May
1993, the Company executed the Rights Plan with its transfer agent.

Under the terms of the Rights Plan each common share is accompanied by one
right; each right entitles the registered stockholder to purchase from the
Company, one-hundredth of a share of, Series A Junior Participating Preferred
Stock, $0.001 par value, at an exercise price of $200.

The rights only become exercisable ten days after a public announcement
that an acquiring person (as defined in the Rights Plan) has acquired 20% or
more of the outstanding common shares of the Company or a person or group offers
to acquire 35% or more of the outstanding common shares of the Company or ten
days after the Company determines that a person is an Adverse Person (as defined
in the Rights Plan). The Company can redeem the Rights for $.01 per Right at any
time until ten days after the rights become exercisable (the 10-day period can
be extended by the Company). The Rights Plan will expire on June 30, 2003 unless
earlier redeemed by the Company.

F-23
<PAGE> 27

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. PREFERRED SHARE PURCHASE RIGHTS PLAN (CONTINUED)

If, subsequent to the rights becoming exercisable, the Company is acquired
in a merger or other business combination at any time when there is a 20% or
more holder, the rights will then entitle a holder to buy shares of common stock
of the acquiring company with a market value equal to twice the exercise price
of each right. Alternatively, if the 20% holder acquires the Company by means of
a merger in which the Company and its stock survive, or if any person acquires
35% or more of the Company's common stock, each right not owned by a 20% or more
stockholder, will become exercisable for common stock of the Company having a
market value equal to twice the exercise price of the right.

17. SETTLEMENT OF LITIGATION AND WARRANTS TO BE ISSUED

Class action litigation which has been settled, was filed against the
Company and its former management in November 1992, in the United States
District Court in Los Angeles, California alleging federal securities law
claims. The Company negotiated a settlement that was approved by the court in
March, 1995. Under the terms of the settlement, the Company will issue to the
stockholder class and register pursuant to the Securities Act 260,163 warrants
to purchase Common Stock identical to the Company's currently outstanding
publicly traded warrants having an exercise price of $15.00 per share and an
expiration date of March 20, 1997. The Company's insurance carrier will make a
cash payment to the stockholder class in the amount of $2.4 million. The
settlement included a release of class claims.

The Securities and Exchange Commission (the "Commission") also instituted
an investigation relating to the above matters. The Commission has approved a
settlement under which the Company neither admits nor denies the findings of the
Commission and under which the Company is the subject of a cease and desist
order. There were no monetary sanctions sought against the Company as a part of
the settlement.

The Company required Advanced as part of the merger agreement to resolve a
class action complaint filed in the United States District Court for the
Southern District of New York which names Advanced as one of the defendants in
the class action lawsuit titled "In re Blech Securities Litigation." In
September 1995, Advanced and the plaintiffs in the litigation, through their
attorneys, reached an agreement in principle for the settlement of the class
action with respect to Advanced, the terms of which are set forth in a
Stipulation of Settlement between such parties (the "Stipulation of
Settlement"). Pursuant to the terms of the Stipulation of Settlement, Advanced
paid $300,000 in settlement of such lawsuit.

F-24
<PAGE> 28

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18. INCOME TAXES

Deferred income taxes reflect the net effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1995 1996
-------- ---------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Federal, state and foreign net operating loss carryovers..... $ 16,785 $19,132
Restructuring and merger costs............................... -- 2,875
Tax credit carryovers........................................ 715 1,072
Inventory reserve............................................ -- 805
Allowance for doubtful accounts.............................. -- 645
Other........................................................ 816 561
Valuation allowance.......................................... (18,157) (23,365)
-------- -------
Total deferred tax assets, net....................... 159 1,725
Deferred tax liabilities:
Book basis of fixed assets in excess of tax basis............ 159 765
State taxes.................................................. -- 960
-------- -------
Total deferred tax liabilities....................... 159 1,725
-------- -------
Total................................................ $ -- $ --
======== =======
</TABLE>

The Company increased its valuation allowance during the period ended March
31, 1996 by $5,208,000 since the realization of tax benefits of operating loss
carryforwards is not assured. Certain reductions in the valuation allowance
totaling approximately $105,000 will be credited to additional paid-in capital.

The components of the provision (benefit) for income taxes are as follows:

<TABLE>
<CAPTION>
JUNE 30, JUNE 30, MARCH 31,
1994 1995 1996
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal.............................................. $451 $1,199 $ 420
Foreign.............................................. -- -- 14
State................................................ 96 137 149
---- ------ -----
Total current................................ 547 1,336 583
Deferred:
Federal.............................................. 16 42 (128)
Foreign.............................................. -- -- --
State................................................ 3 8 (24)
---- ------ -----
Total deferred............................... 19 50 (152)
---- ------ -----
Provision for income taxes............................. $566 $1,386 $ 431
==== ====== =====
</TABLE>

F-25
<PAGE> 29

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18. INCOME TAXES (CONTINUED)

The provision for income taxes at the Company's effective tax rate differed
from the provision for income taxes at the statutory rate as follows:

<TABLE>
<CAPTION>
JUNE 30, JUNE 30, MARCH 31,
1994 1995 1996
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax benefit at the expected statutory rate............ $(6,626) $(5,560) $(5,953)
Increases (decreases) in taxes resulting from:
Valuation allowance................................. 7,094 6,486 5,208
Reverse foreign net operating loss not previously
benefited........................................ -- -- 1,994
State income taxes, net............................. 61 137 69
Other............................................... 37 37 188
Non-deductible goodwill............................. -- 286 --
Establishment of deferred tax assets not previously
benefited........................................ -- -- (1,075)
------- ------- -------
Provision for income taxes.......................... $ 566 $ 1,386 $ 431
======= ======= =======
</TABLE>

The utilization of net operating loss carryovers (NOL's) of the Company is
limited by change in ownership rules under section 382 of the Internal Revenue
Code of 1986. Accordingly, the annual utilization of the Company's NOL's is
limited to a prescribed annual amount equal to 5.75% multiplied by the fair
market value of the Company as of December 29, 1995. Additionally, certain
losses and credits of each individual subsidiary which arose prior to its merger
with the Company can only be used against that subsidiary's future taxable
income.

At March 31, 1996, the Company had net operating loss carryovers for U.S.
federal and state income tax purposes of approximately $42,000,000 and
$30,000,000, respectively, and generally business credit carryovers of
approximately $800,000 and $180,000, respectively. These net operating loss
carryovers and general business credits are available to offset future taxable
income, if any, through the year 2011 and are subject to limitations as well as
separate return limitations for the subsidiaries Urohealth-California, Advanced,
and Laparomed, as described below.

Urohealth-California has a June 30 tax year end. At March 31, 1996,
Urohealth-California had federal and state net operating loss carryovers of
approximately $17,000,000 and $9,000,000, respectively, and general business
credit carryovers of approximately $200,000 and $180,000, respectively,
reflecting the tax return filings through July 24, 1995.

Advanced had a December 31 tax year end prior to its merger with the
Company. As of December 29, 1995, Advanced has federal and state net operating
loss carryovers of approximately $25,000,000 and $21,000,000, respectively and
research and experimental credit carryovers of approximately $600,000.
Advanced's wholly-owned subsidiary, Laparomed, has federal and state net
operating loss carryovers (of approximately $7,000,000 and $3,000,000,
respectively) and research and experimental credits (of approximately $172,000)
included in the amounts above. There is a strong likelihood that a portion of
these attributes will expire before utilization.

On July 24, 1995, the Company redomesticated from Canada to the United
States. As of this date, the Company had loss carryovers for Canadian income tax
purposes of approximately $15,000,000, of which $4,000,000 would expire in
various years through 2003 and $11,000,000 would carryforward indefinitely.
These losses will not be carried forward due to the redomestication. Any
potential Canadian tax liability arising from the redomestication will be offset
against the Company's Canadian loss carryovers. Accordingly, no provision for
any such potential liability has been included in the accompanying consolidated
financial statements.

F-26
<PAGE> 30

UROHEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

19. COMMITMENTS AND CONTINGENCIES

Dacomed is a defendant in approximately five lawsuits seeking damages
against Dacomed in products liability and related theories. Dacomed has also
been notified of certain other products liability claims that may become the
subject of lawsuits in the future. Dacomed is being defended in such lawsuits by
law firms selected by Dacomed's products liability insurer(s).

The Company has employment agreements with 14 officers providing for annual
aggregate salaries of approximately $3.0 million per annum.

The Company has various product licensing arrangements which require the
payment of certain of the licensor's patent costs and royalties on sales of
products which incorporate the licensed technology.

In addition, the Company is involved from time to time in various claims
and legal actions in the ordinary course of business. No provision for any
liability that may result from the ultimate resolution of such matters has been
included in the accompanying consolidated financial statements.

F-27
<PAGE> 31

REPORT OF INDEPENDENT AUDITORS

We have audited the consolidated financial statements of UroHealth Systems,
Inc. as of March 31, 1996 and June 30, 1995, and for the nine months ended March
31, 1996 and the year ended June 30, 1995, and have issued our report thereon
dated June 4, 1996 (included elsewhere in this report). Our audits also included
the financial statement schedule listed in Item 14(a)(2) of this report. These
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. We have not audited the fiscal
1995 financial statements of Dacomed Corporation, a wholly-owned subsidiary,
which statements reflect total assets and total revenues constituting 4% and 10%
of the related consolidated totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to data included in the fiscal 1995 consolidated financial statements
for Dacomed Corporation, is based solely on the report of other auditors.

In our opinion, based on our audits and the report of other auditors, the
financial statement schedule referred to above, when considered in relation to
the basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.

/s/ ERNST & YOUNG LLP

--------------------------------------
ERNST & YOUNG LLP

Orange County, California
June 4, 1996

S-1
<PAGE> 32

REPORT OF INDEPENDENT AUDITORS

We have audited the consolidated statements of operations, common
stockholders' equity, and cash flows of UroHealth Systems, Inc. for the year
ended June 30, 1994, (restated to reflect the acquisitions of Osbon Medical
Systems, Ltd., Dacomed Corporation, Allstate Medical Products, Inc., and
Advanced Surgical Inc., each accounted for as a pooling-of-interest), and have
issued our report thereon dated January 8, 1997 (included elsewhere in this
report). Our audit also included the information for the year ended June 30,
1994 that is included in the financial statement schedule listed in item
14(a)(2) of this report. This statement is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audit. We
did not audit the fiscal 1994 financial statements of Dacomed Corporation,
UroHealth Systems, Inc. (pre-acquisitions), Allstate Medical Products, Inc., and
Advanced Surgical, Inc., (collectively "the Companies") which statements reflect
total net sales (in thousands) of $8,920 (24% of total net sales), $4,258 (11%
of total net sales), $2,215 (6% of total net sales), and $1,754 (5% of total net
sales), respectively, for the year ended June 30, 1994. Those statements were
audited by other auditors, other than the financial statements of Allstate
Medical Products, Inc. which are immaterial and unaudited, whose reports have
been furnished to us, and our opinion, insofar as it relates to the amounts
included for the Companies, is based solely on the reports of the other
auditors.

In our opinion, based on our audit and the reports of other auditors, the
information for the year ended June 30, 1994 that is included in the financial
statement schedule referred to above, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

/s/ Cherry, Bekaert & Holland, L.L.P.

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

CHERRY, BEKAERT & HOLLAND, L.L.P.

Augusta, Georgia

January 8, 1997

S-2
<PAGE> 33

UROHEALTH SYSTEMS, INC.

SCHEDULE II
CONSOLIDATED VALUATION ACCOUNTS

<TABLE>
<CAPTION>
BALANCE AT
BEGINNING BALANCE AT END
DESCRIPTION OF PERIOD ADDITIONS WRITE OFFS OF PERIOD
- ---------------------------------------------- ---------- --------- ---------- --------------
<S> <C> <C> <C> <C>
Nine month period ended March 31, 1996:
Allowance for doubtful accounts.......... $538 $1,106 $ -- $1,644
Reserve for inventory obsolescences...... 241 1,140 -- 1,381
---- ------ ---- ------
Total............................... $779 $2,246 $ -- $3,025
==== ====== ==== ======
Year ended June 30, 1995:
Allowance for doubtful accounts.......... $506 $ 54 $(22) $ 538
Reserve for inventory obsolescences...... -- 272 (31) 241
---- ------ ---- ------
Total............................... $506 $ 326 $(53) $ 779
==== ====== ==== ======
Year ended June 30, 1994:
Allowance for doubtful accounts.......... $167 $ 348 $ (9) $ 506
Reserve for inventory obsolescences...... -- -- -- --
---- ------ ---- ------
Total............................... $167 $ 348 $ (9) $ 506
==== ====== ==== ======
</TABLE>

S-3
<PAGE> 34

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, Registrant has duly caused this Amendment No. 1 on Form 10-K/A to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Newport Beach, State of California, on January 8, 1997.

UROHEALTH SYSTEMS, INC.

By: /s/ CHARLES A. LAVERTY
------------------------------------
Charles A. Laverty
Chairman of the Board and
Chief Executive Officer

II-1
<PAGE> 35

EXHIBIT INDEX

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NO. DESCRIPTION NUMBERED PAGE
- ----------- ----------------------------------------------------------------- -------------
<S> <C> <C>
23.1 Consent of Ernst & Young LLP
23.2 Consent of Cherry, Bekaert & Holland LLP
23.3 Consent of Doane Raymond
23.4 Consent of KPMG Peat Marwick LLP
23.5 Consent of Coopers & Lybrand L.L.P.
</TABLE>

<PAGE> 1

EXHIBIT 23.1

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in Registration Statements
(Form S-8 Nos. 33-59918, 33-59916, 33-59920, 33-91900, 33-92684 and 333- )
pertaining to the Davstar Industries Ltd. Stock Option Plan, 1992 Employee Stock
Option Plan, the Non-Employee Directors Stock Option Plan, the Davstar
Industries, Ltd. 1994 Stock Incentive Plan, Dacomed 1989 Stock Option Plan, 1996
Directors Non-Qualified Stock Incentive Plan, Employee Stock Purchase Plan,
Advanced Surgical 1992 Stock Plan and Employee Reserved Stock Agreements of
UroHealth Systems, Inc. of our reports dated June 4, 1996, with respect to the
consolidated financial statements and schedule of UroHealth Systems, Inc.
included in the Transition Report (Form 10-K/A) for the nine months ended March
31, 1996.

/s/ ERNST & YOUNG LLP

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

Ernst & Young LLP

Orange County, California

January 7, 1997

<PAGE> 1

EXHIBIT 23.2

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-59918, 33-59916, 33-59920, 33-91900, 33-92684 and 333- )
pertaining to the Davstar Industries Ltd. Stock Option Plan, 1992 Employee Stock
Option Plan, the Non-Employee Directors Stock Option Plan, the Davstar
Industries, Ltd. 1994 Stock Incentive Plan, Dacomed 1989 Stock Option Plan, 1996
Directors Non-Qualified Stock Incentive Plan, Employee Stock Purchase Plan,
Advanced Surgical 1992 Stock Plan and Employee Reserved Stock Agreements of
UroHealth Systems, Inc. of our report dated January 8, 1997, with respect to the
financial statements of UroHealth Systems, Inc. for the year ended June 30,
1994, included in its Transition Report (Form 10-K/A) for the nine months ended
March 31, 1996, filed with the Securities and Exchange Commission.

/s/ CHERRY, BEKAERT & HOLLAND,
L.L.P.

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

Cherry, Bekaert & Holland, L.L.P.

Augusta, Georgia

January 8, 1997

<PAGE> 1

EXHIBIT 23.3

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-59918, 33-59916, 33-59920, 33-91900, 33-92684 and 333- )
pertaining to the Davstar Industries Ltd. Stock Option Plan, the 1992 Employee
Stock Option Plan, the Non-Employee Directors Stock Option Plan, the Davstar
Industries Ltd. 1994 Stock Incentive Plan, Dacomed 1989 Stock Option Plan, 1996
Directors Non-Qualified Stock Incentive Plan, Employee Stock Purchase Plan,
Advanced Surgical 1992 Stock Plan and Employee Reserved Stock Agreements of
UroHealth Systems, Inc. of our report dated August 22, 1994, with respect to the
consolidated statements of operations, stockholders' equity and cash flows of
UroHealth Systems, Inc. for the year ended June 30, 1994, included in its
Transition Report (Form 10-K/A) for the nine months ended March 31, 1996, filed
with the Securities and Exchange Commission.

/s/ DOANE RAYMOND

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

Chartered Accountants

Toronto, Canada

January 7, 1997

<PAGE> 1

EXHIBIT 23.4

INDEPENDENT AUDITORS' CONSENT

The Board of Directors

UroHealth Systems, Inc.:

We consent to incorporation by reference in the Transition Report on Form
10-K/A of UroHealth Systems, Inc. of our report dated October 10, 1995, relating
to the consolidated balance sheet of Dacomed Corporation as of June 24, 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the fiscal year then ended, and our report dated December 19,
1994, relating to the consolidated statements of operations, stockholders'
equity and cash flows for Dacomed Corporation for the fiscal year ended October
29, 1994.

/s/ KPMG PEAT MARWICK LLP

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

KPMG Peat Marwick LLP

Minneapolis, Minnesota

January 6, 1997

<PAGE> 1

EXHIBIT 23.5

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-59918, 33-59916, 33-59920, 33-91900, 33-92684 and 333- )
pertaining to the Davstar Industries Ltd. Stock Option Plan, 1992 Employee Stock
Option Plan, the Non-Employee Directors Stock Option Plan, the Davstar
Industries, Ltd. 1994 Stock Incentive Plan, Dacomed 1989 Stock Option Plan, 1996
Directors Non-Qualified Stock Incentive Plan, Employee Stock Purchase Plan,
Advanced Surgical 1992 Stock Plan and Employee Reserved Stock Agreements of
UroHealth Systems, Inc. of our report, which included an explanatory paragraph
related to the Company's ability to continue as a going concern, dated February
24, 1995 on our audit of the consolidated financial statements of Advanced
Surgical, Inc. as of and for the year ended December 31, 1994 of which the
results are included in the June 30, 1994 consolidated results of operations of
UroHealth Systems, Inc. included in the Transition Report on Form 10-K/A for the
nine months ended March 31, 1996.

/s/ COOPERS & LYBRAND L.L.P.

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

Coopers & Lybrand L.L.P.

2400 Eleven Penn Center

Philadelphia, Pennsylvania

January 7, 1997