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

                                   FORM 10-Q
                                        

                                  (Mark One)

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
  FOR THE QUARTER ENDED SEPTEMBER 30, 1998

                                       or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
  For the transition period from _______________ to _______________

                        COMMISSION FILE NUMBER:  0-27600
                                        
                          OPTICAL SENSORS INCORPORATED
             (Exact name of registrant as specified in its charter)

             DELAWARE                                     41-1643592
   (State of other jurisdiction of                     (I.R.S. Employer
   incorporation or organization)                      Identification No.)


7615 GOLDEN TRIANGLE DRIVE, SUITE A, MINNEAPOLIS, MINNESOTA    55344-3733
     (Address of principal executive offices)                  (Zip Code)

       Registrant's telephone number, including area code  (612) 944-5857
                                        

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.   [X] Yes   [ ] No

  AS OF NOVEMBER 10, 1998, THE REGISTRANT HAD 8,825,824 SHARES OF COMMON STOCK
                                  OUTSTANDING.
<PAGE>
 
                                     INDEX


                          OPTICAL SENSORS INCORPORATED



PART I.  FINANCIAL INFORMATION

      ITEM 1.  FINANCIAL STATEMENTS (UNAUDITED)

       Balance Sheets  September 30, 1998 and December 31, 1997

       Statements of Operations--Three months ended September 30, 1998 and 1997.
                                 Nine months ended September 30, 1998 and 1997.

       Statements of Cash Flows--Nine months ended September 30, 1998 and 1997.

       Notes to Financial Statements

      ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
               RESULTS OF OPERATIONS


PART II.  OTHER INFORMATION

      Item 6.  Exhibits and Reports on Form 8-K

                                       1
<PAGE>
 
                          Optical Sensors Incorporated

                                 Balance Sheets

<TABLE>
<CAPTION>
                                                                     SEPTEMBER 30,       DECEMBER 31, 
                                                                         1998               1997
                                                                  -----------------------------------
                                                                     (Unaudited)            (Note)
<S>                                                               <C>                 <C>
ASSETS                                                            
Current assets:                                                   
 Cash and cash equivalents                                           $10,764,994          $17,101,130
 Accounts receivable                                                     211,285               27,100
 Inventory                                                             1,884,917            2,017,497
 Prepaid expenses and other current assets                               125,035               70,491
                                                                  -----------------------------------
                                                                  
Total current assets                                                  12,986,231           19,216,218
                                                                  
Property and equipment:                                           
 Leased equipment                                                        989,772              679,892
 Research and development equipment                                      733,742              594,542
 Leasehold improvements                                                  334,037              259,172
 Furniture and equipment                                                 145,473              109,214
 Marketing equipment                                                   1,004,840              986,483
 Production equipment                                                    454,275              259,363
                                                                  -----------------------------------
                                                                  
                                                                       3,662,139            2,888,666
 Less accumulated depreciation                                        (1,616,858)            (974,887)
                                                                  -----------------------------------
                                                                  
                                                                       2,045,281            1,913,779
Other assets:                                                     
 Patents                                                                 498,921              434,752
 Other assets                                                             23,975               60,785
                                                                  -----------------------------------
                                                                  
                                                                         522,896              495,537
Total assets                                                         $15,554,408          $21,625,534
                                                                  ===================================
                                                                  
LIABILITIES AND SHAREHOLDERS' EQUITY                              
Current liabilities:                                              
 Accounts payable                                                   $    268,232         $    437,039
 Employee compensation                                                   638,636              404,513
 Other liabilities and accrued expenses                                    8,630                2,154
 Obligations under capital lease, current portion                        229,292              152,756
                                                                  ----------------------------------- 
Total current liabilities                                              1,144,790              996,462
                                                                  
Obligations under capital lease, less current portion                    557,303              472,206
                                                                  
SHAREHOLDERS' EQUITY                                              
Convertible Preferred Stock, par value $.01                       
 per share:                                                       
  Authorized shares--5,000,000                                    
Common Stock, par value $.01 per share:                           
 Authorized shares--30,000,000                                    
 Issued and outstanding shares 1998--8,821,436 and                
  1997--8,400,554                                                          88,220                84,006
Additional paid-in capital                                             69,304,550            67,088,370
Deficit accumulated                                                   (55,443,303)          (46,548,720)
Deferred compensation                                                     (97,152)             (221,790)
Note receivable from officer                                                    -              (245,000)
                                                                  -------------------------------------
                                                                  
Total shareholders' equity                                             13,852,315            20,156,866
                                                                  -------------------------------------
Total liabilities and shareholders' equity                           $ 15,554,408          $ 21,625,534
                                                                  =====================================
</TABLE>

Note:  The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

See accompanying notes.

                                       2
<PAGE>
 
                          Optical Sensors Incorporated

                            Statements of Operations
                                  (Unaudited)



<TABLE>
<CAPTION>
 
 
                                                        THREE MONTHS ENDED          NINE MONTHS ENDED
                                                           SEPTEMBER 30                SEPTEMBER 30
                                                        1998          1997          1998          1997
 
<S>                                                 <C>           <C>           <C>           <C>
Net sales                                           $   319,505   $    23,840   $   798,698   $   104,406
Cost of goods sold                                      827,156       928,901     2,296,076     1,850,523
                                                  -------------------------------------------------------
Gross margin                                           (507,651)     (905,061)   (1,497,378)   (1,746,117)
Operating expenses:
 Research and development expenses                    1,051,614     1,066,785     3,097,109     4,023,963
 Selling, general and administrative expenses         1,704,799     1,342,886     4,808,471     4,166,085
Operating loss                                       (3,264,064)   (3,314,732)   (9,402,958)   (9,936,165)
 
Interest expense                                        (24,405)       (5,565)      (70,906)       (5,565)
Interest income                                         167,430       292,411       601,179     1,001,775
Other  income (expense)                                  (4,148)       (7,519)      (21,898)      (43,501)
                                                  -------------------------------------------------------
 
 
Net loss                                            $(3,125,187)  $(3,035,405)  $(8,894,583)  $(8,983,456)
 
Net loss per common share:
Basic and diluted                                         $(.35)        $(.36)       $(1.01)       $(1.07)
 
Shares used in calculation of net loss per share      8,858,515     8,382,297     8,817,727     8,369,151
</TABLE>


See accompanying notes.

                                       3
<PAGE>
 
                          Optical Sensors Incorporated

                            Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
 
                                                                           NINE MONTHS ENDED
                                                                   SEPTEMBER 30,       SEPTEMBER 30,
                                                                        1998                1997
                                                               ---------------------------------------
<S>                                                              <C>                 <C>
 
Operating activities
Net loss                                                               $(8,894,583)       $ (8,983,456)
Adjustments to reconcile net loss to net cash used in
 operating activities:
  Writedown of inventories                                                       -             500,000
  Depreciation and amortization                                            767,878             325,210
  Deferred compensation amortization                                       124,638             244,486
  Amortization of warrants in connection with debt and lease
   financings                                                               13,135              13,574
 
  Changes in operating assets and liabilities:
      Receivables                                                         (184,185)             41,502
      Inventories                                                           52,688          (1,326,953)
      Prepaid expenses                                                     (54,544)            (53,863)
      Accounts payable and accrued expenses                                 71,791            (511,424)
                                                               ---------------------------------------
 
Net cash used in operating activities                                   (8,103,182)         (9,750,924)
 
INVESTING ACTIVITIES
Purchases of property and equipment                                       (780,539)         (1,017,510)
Other                                                                      (66,309)           (101,295)
                                                               ---------------------------------------
 
Net cash used in investing activities                                     (846,848)         (1,118,805)
 
FINANCING ACTIVITIES
Proceeds from note receivable-officer                                      245,000                   -
Net proceeds from issuance of Common Stock                               2,207,261              67,474
Proceeds (payments) on long-term debt and lease obligations                161,633             241,886
                                                               ---------------------------------------
Net cash provided by financing activities                                2,613,894             309,360
                                                               ---------------------------------------
 
Increase (decrease) in cash and cash equivalents                        (6,336,136)        (10,560,369)
Cash and cash equivalents at beginning of period                        17,101,130          30,134,800
                                                               ---------------------------------------
Cash and cash equivalents at end of period                             $10,764,994        $ 19,574,431
                                                               =======================================
</TABLE>
See accompanying notes.

                                       4
<PAGE>
 
                          OPTICAL SENSORS INCORPORATED

                         NOTES TO FINANCIAL STATEMENTS
                                  (UNAUDITED)

                               SEPTEMBER 30, 1998

Note A - Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X.  Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.  In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and nine month periods ended September
30, 1998 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1998.  For further information, refer to the
financial statements and footnotes thereto included in the Optical Sensors
Incorporated 1997 Annual Report to Shareholders incorporated by reference into
the Annual Report on Form 10-K for the year ended December 31, 1997.

NOTE B - NET LOSS PER SHARE

Basic and diluted net loss  per common share is  computed  using the  weighted
average  number of common shares outstanding during the period.  Options and
warrants were outstanding during the quarter ended September 30, 1998 and 1997,
but were not included in the computation of diluted net loss per common share
because the effect would be antidilutive.  All earnings per share amounts for
all periods have been presented, and where necessary, restated to conform to the
Statement 128 requirements.

                                       5
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

OVERVIEW

Optical Sensors Incorporated (the "Company") has developed the SensiCath system,
a patient-connected, on-demand arterial blood gas ("ABG") monitoring system,
which provides precise and accurate ABG results within 60 seconds without
exposure to potentially infectious blood or depleting the patient's blood supply
(the "SensiCath System").  ABG tests measure oxygen ("O2"), carbon dioxide
("CO2") and acid-base ("pH") in a sample of blood taken from a patient's artery.
These tests, which are among the most frequently ordered and most urgently
needed tests for critically ill and unstable patients, are the foremost
indicators of the body's ability to absorb and use oxygen.  Results of ABG tests
provide a basis for medical treatment and intervention and are required to
accurately regulate the patient's respiratory support system.  The Company
believes that the SensiCath System is the first ABG analyzer to be integrated
into both an arterial pressure monitoring line and a critical care patient
monitoring system.  The SensiCath System utilizes a disposable, fiberoptic
sensor device (the "SensiCath Sensor") connected to a small modular instrument
(the "ABG Module") that is part of the Company's OpticalCAM instrumentation
("OpticalCAM").  The SensiCath System is able to either stand alone or interface
with various monitoring platforms, including monitoring systems produced and
installed by Marquette Medical Systems, Inc., SpaceLabs Medical, Inc., and the
Hewlett-Packard Company.  These three producers account for approximately 80% of
the installed base of critical care monitoring instrumentation in the United
States.

In January 1998, the Company entered into an agreement with Instrumentation
Laboratory Company ("IL") for worldwide distribution of the Company's SensiCath
Sensors and OpticalCAM instrumentation.  In April 1998, IL announced the U.S.
introduction of the GEM SensiCath and GEM OpticalCAM, new members of the IL GEM
family of hospital point-of-care diagnostic products.

In July, 1998 the Company entered into an agreement with the Institute for
Critical Care Medicine ("ICCM") providing the Company with the rights to
commercialize a new application of its sensor technology ("CapnoProbeTM") for
the non-invasive measurement of carbon dioxide in the tissue of  ill or injured
patients to aid in the diagnosis and monitoring of shock.  The CapnoProbe SLTM,
the first prodouct in the line that the Company plans to commercialize, is a
handheld, lightweight device with a probe that can be slipped under the tongue
like a thermometer.  In less than 60 seconds, it noninvasively measures the
tissue CO2 of the mucous membrane in the mouth - a sensitive measure that can
indicate ealry clinical shock, even when traditional vital signs may still
appear realtively normal, as in compensated shock cases.  The Company expects to
begin clinical evaluations of prototype products before the end of 1998.

In October, 1998 the Company implemented a strategic plan to focus its corporate
resources on the development and commercialization of the CapnoProbe product.
The plan resulted in reducing staff by approximately 20 percent through layoffs
and attrition and implementing other expense management measures. The
restructuring and expense management measures affected all areas of the Company.
The Company expects to begin receiving  the full benefit of the restructuring in
the first

                                       6
<PAGE>
 
quarter of 1999. The Company currently plans to direct all of the cost savings
to development of the CapnoProbe.

RESULTS OF OPERATIONS

Net sales in the third quarter of 1998 increased $295,665 or 1,240% from $23,840
in the third quarter in 1997 to $319,505 in the third quarter of 1998.  Net
sales for the nine month period ended September 30, 1998 increased $694,292 or
665% from $104,406 for the nine month period ended September 30, 1997.  Sales
for the three and nine month periods ended September 30, 1998 were insignificant
due to a product recall that the Company initiated in May 1997 because of an
interference problem with a certain portion of the critical care patient
population.  In December 1997, the Company introduced an enhanced version of its
SensiCath Sensor that solved the interference problems, accounting for the
increase in sales in 1998.  The Company does not believe that the product recall
will have a material impact on future results.  Sales of SensiCath Sensors
accounted for approximately 17% of the total sales for the third quarter of 1998
while OpticalCAM instrumentation accounted for the balance. For the third
quarter of 1998, approximately 90% of  Sensor sales and 98% of the OpticalCAM
instrumentation sales were made to the Company's distributor for resale to
customers with the remainder purchased for sales demonstration purposes.

Costs of products sold in the third quarter of 1998 decreased $101,745 or 11% to
$827,156 from $928,901 in the third quarter in 1997. Costs of products sold for
the nine months ended September 30, 1998 increased $445,553 or 24% to $2,296,076
from $1,850,523 for the nine months ended September 30, 1997. The decrease for
the quarter is due to a $500,000 write-down in the third quarter of 1997 of
OpticalCAM inventories to the lower of cost or market.  After adjusting for this
write-down, the increase for the nine months ended September 30, 1998 is due
primarily to the increased sales levels. Under the agreement between the Company
and IL, the Company has agreed to sell OpticalCAM instrumentation to IL at the
lower of the Company's direct cost of manufacturing or previously scheduled
amounts.  Accordingly, the Company does not expect to generate any gross margin
from the sale of OpticalCAM instrumentation in future periods.  Because
instrument sales are sold at amounts close to cost, gross margins in future
periods will be affected by the mix of sensor and instrumentation sales.  The
Company expects an improving relationship between sales and cost of product sold
once sales volumes for sensors begin to increase.  The Company believes it has
the capacity to increase production levels to approximately 50,000 sensors per
year without materially increasing manufacturing infrastructure costs.

Research and development costs for the third quarter of 1998 declined $15,171 or
1% to $1,051,614 from $1,066,785 in the third quarter of 1997.  Research and
development costs for the nine months ended September 30, 1998 declined $926,854
or 23% to $3,097,109 from $4,023,963 for the nine months ended September 30,
1997.  Research and development expenses in the nine month period ended
September 30, 1997 included approximately $417,000 for outside development of
the OpticalCAM and a $500,000 payment to Marquette Medical Systems, Inc. under a
previously disclosed technology purchase agreement.   These expenses, which did
not recur in 1998, accounted for the majority of the decrease for the nine
months ended September 30, 1998. Overall, the Company expects research and 
development expenses to increase by approximately $300,000 in the fourth
quarter due to development efforts related to the CapnoProbe. In addition, the
Company

                                       7
<PAGE>
 
may become obligated to make a $500,000 payment to Marquette Medical Systems,
Inc. under a previously disclosed technology purchase agreement, assuming
Marquette sells a specified number of ABG Modules.

Selling, general and administrative expenses in the third quarter of 1998
increased $361,913 or 27% to $1,704,799 from $1,342,886 in the third quarter of
1997. Selling, general and administrative expenses for the nine months ended
September 30, 1998 increased $642,386 or 15% to $4,808,471 from $4,166,085 for
the nine months ended September 30, 1997.  The increase for the three and nine
month periods are primarily due to a higher level of selling activity, compared
to 1997.   The majority of selling activities continued to be directed towards
the market launch of the enhanced SensiCath. Additionally, selling expenses
increased as the Company has began market research related to the CapnoProbe
currently under development. The Company expects to operate through the balance
of 1998 with slightly higher selling, general and administrative expenses from
the current level due to market research activities related to the CapnoProbe.

Net interest income in the third quarter of 1998 decreased $124,981 to $167,430
from $292,411 in the third quarter of 1997. Net interest income for the nine
month period ended September 30, 1998 decreased $400,596 to $601,179 from
$1,001,775 for the nine month period ended 1997. The decrease in net interest
income in the three and nine month periods ending September 30, 1998 is due
primarily to declining cash balances of proceeds from the Company's initial
public offering, which was completed in the first quarter of 1996.  The Company
expects interest income to continue to decline in future periods as it uses cash
for operations.

Since its inception, the Company has experienced significant operating losses.
The Company incurred a net loss of $3,125,187 for the quarter ended September
30, 1998, compared to a net loss of $3,035,405 for the quarter ended September
30, 1997. As of September 30, 1998, the Company had an accumulated deficit of
$55,443,301. The Company anticipates that its operating losses will continue for
the foreseeable future because it plans to expend substantial resources in
funding sales and marketing activities, commercial manufacturing, and research
and development.  Except for historical information contained herein, the
disclosures in this report are forward looking statements.  See "Certain
Important Factors".


LIQUIDITY AND CAPITAL RESOURCES

To date, the Company has financed its operations primarily through the sale of
equity securities.  From inception through December 31, 1995, the Company raised
net proceeds of $30,400,000 from private equity financings and stock option
exercises.  In the second quarter of 1996, the Company completed an initial
public offering of 2,875,000 shares of Common Stock.  The net proceeds to the
Company from the public offering were approximately $33,916,000. In January
1998, the Company sold 441,203 shares of Common Stock to IL, which represented
4.99% of the Company's outstanding Common Stock following completion of the
transaction, at a price of $5.00 per share (which is equal to the closing market
price on the day before signing of the agreement). for a total price of
$2,206,015.  The proceeds from the sales of stock has been used to fund costs of
producing

                                       8
<PAGE>
 
products and operating expenses described above and capital expenditures
described below.  The Company's Common Stock is quoted on the Nasdaq National
Market under the symbol "OPSI."

The Company's cash and cash equivalents were $10,764,994 and $17,101,130 at
September 30, 1998 and December 31, 1997, respectively. The Company incurred
cash expenditures for the nine months ended September 30, 1998 of $8,103,181 for
operations and $780,539 for capital expenditures.  The capital equipment
expenditures were principally for the acquisition of manufacturing, research and
development and marketing promotional equipment.  A substantial portion of the
inventory level at September 30, 1998 consisted of key components, OpticalCAM
monitors and ABG Modules for which the Company relies on sole suppliers.

As of September 30, 1998, the Company had no material commitments outstanding
for tooling and equipment. The Company has contracts for minimum purchase
quantities of OpticalCAM monitors and ABG Modules and other sole source
inventory items.

SensiCath(R) and OpticalCAM(TM) are trademarks of Optical Sensors Incorporated.
GEM(R) is a trademark of Instrumentation Laboratory Company.

YEAR 2000 SOFTWARE PERFORMANCE EXPOSURE

The Company has determined that the software embedded in the ABG Modules is Year
2000 compliant and that its major internal information technology systems are
Year 2000 compliant.  The Company has numerous ancillary software programs which
are in the process of being evaluated and tested for Year 2000 compliance.  The
Company expects to complete this process and to have taken any corrective
actions by mid 1999.  Should any of these programs require replacement, the
Company anticipates that the total cost will not exceed $100,000. The Company
does not believe this amount nor any impact on ongoing information technology
projects will have any material affect on its ongoing operations. The Company
has initiated discussions with its significant suppliers, large customers and
financial institutions to ensure that those parties have appropriate plans to
remediate Year 2000 issues where their systems interface with the Company's
systems or otherwise impact its operations.  The Company is assessing the extent
to which its operations are vulnerable should those organizations fail to
properly remediate their computer systems.  For those vendors that have not yet
certified  Year 2000 compliance and which are sole suppliers of critical product
components, the Company plans to have sufficient inventories on hand at the end
of 1999 to support its needs for at least six months. For the Company's
exclusive distributer, the Company has the ability to ship product directly to
the end customer and to invoice and collect receivables should it be necessary
to do so.  The Company's Year 2000 initiative is being managed by an internal
staff and is scheduled to be completed in early 1999.  While the Company
believes its planning efforts are adequate to address its Year 2000 concerns,
there can be no assurance that the systems of other companies which may impact
the Company's operations will be converted on a timely basis and will not have a
material effect on the Company.  The cost of the Year 2000 initiatives is not
expected to be material to the Company's results of operations or financial
position.


CERTAIN IMPORTANT FACTORS

                                       9
<PAGE>
 
There are several important factors that could cause the Company's actual
results to differ materially from those anticipated by the Company or which are
reflected in any forward-looking statement of the Company.  These factors, and
their impact on the success of the Company's operations and its ability to
achieve its goals include the following:

-  MARKET ACCEPTANCE OF THE SENSICATH SYSTEM. The Company's future revenues will
   depend on market acceptance of the SensiCath System and the CapnoProbe
   product. The Company will need to demonstrate to health care professionals,
   hospital administrators and third-party payors the accuracy, reliability,
   ease of use, safety and cost effectiveness of these products. In order to use
   these products, hospitals need to acquire the instrumentation, which may
   require capital expenditure approvals by the hospital.

-  DEVELOPMENT AND COMMERCIALIZATION OF CAPNOPROBE. The Company's future success
   will depend, in part, on successful development and commercialization of the
   CapnoProbe product. Although this product is based on the Company's existing
   technology, the Company is in the early stages of developing prototypes and
   completing preliminary animal trials of the CapnoProbe product. Accordingly,
   there can be no assurance that the Company will successfully develop a
   commercial CapnoProbe product.

-  SALES BY INSTRUMENTATION LABORATORY. The Company's near term revenues will
   depend almost exclusively on sales of the Company's products by IL. Although
   IL is required to purchase sufficient quantities of products from the Company
   that will result in pre-established annual minimum revenues to the Company in
   order to maintain exclusivity, there can be no assurance that IL will achieve
   sufficient sales for the Company to substantially increase revenues or
   achieve profitability.

-  MANUFACTURING AND SUPPLY. Although the Company has established and validated
   manufacturing processes, equipment and infrastructure to manufacture sensors
   in volumes that will be necessary to achieve significant revenues, the
   Company has limited experience in producing sensors at these volumes. A
   failure to successfully scale-up manufacturing of sensors could have a
   material adverse effect on the Company. Currently, the Company has only one
   supplier for the ABG Module, the OpticalCAM Monitor and certain other key
   components. Any disruption or delay in the supply of key components or
   instrumentation could have a material adverse effect on the Company.

-  COMPETITION. Competition among companies attempting to provide ABG and other
   critical blood analyte analysis at the point-of-care is intense and
   increasing. There can be no assurance that the Company's competitors will not
   succeed in developing or marketing technologies and products that are more
   effective or less expensive than the Company's products or that would render
   the Company's products obsolete or non-competitive.

-  REGULATORY APPROVALS. The Company's ability to market its current products
   and any products that it may develop in the future requires clearances or
   approvals from the FDA and other governmental agencies, including, in some
   instances, foreign and state agencies. The process for maintaining and
   obtaining necessary regulatory clearances and approvals can be expensive and
   time consuming. There can be no assurance that the Company will be able to
   maintain or obtain necessary regulatory approvals and clearances in the
   future.


PART II.   OTHER INFORMATION

                                       10
<PAGE>
 
ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following exhibit is included herein:
 
     (10.1)  Patent License Agreement, dated July 20, 1998, between the Company
             and the Institute of Critical Care Medicine. (Confidential
             treatment has been requested with respect to designated portions
             contained in this document. Such portions have been omitted and
             filed separately with the Commission pursuant to Rule 24b-2 of the
             Securities Exchange Act of 1934, as amended.)

     (27)    Financial Data Schedule

(b)  Reports on Form 8-K

     None

                                       11
<PAGE>
 
                                   SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                              OPTICAL SENSORS INCORPORATED
 
 
 
Date   November 5, 1998                  -----------------------------------
                                                   /s/ Paulita LaPlante
                                                        President
                                              (Principal Executive Officer)
 
 
Date   November 5, 1998                  -----------------------------------
                                                  /s/ Wesley G. Peterson
                                         Chief Financial Officer, Vice President
                                         of Finance and Administration and 
                                         Secretary (Principal Financial and 
                                         Accounting Officer)




                                       12
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UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                   FORM 10-Q
                                        

                                  (Mark One)

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
  FOR THE QUARTER ENDED SEPTEMBER 30, 1998

                                       or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
  For the transition period from _______________ to _______________

                        COMMISSION FILE NUMBER:  0-27600
                                        
                          OPTICAL SENSORS INCORPORATED
             (Exact name of registrant as specified in its charter)

             DELAWARE                                     41-1643592
   (State of other jurisdiction of                     (I.R.S. Employer
   incorporation or organization)                      Identification No.)

7615 GOLDEN TRIANGLE DRIVE, SUITE A, MINNEAPOLIS, MINNESOTA    55344-3733
     (Address of principal executive offices)                  (Zip Code)

       Registrant's telephone number, including area code  (612) 944-5857
                                        

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.   [X] Yes   [ ] No

  AS OF NOVEMBER 10, 1998, THE REGISTRANT HAD 8,825,824 SHARES OF COMMON STOCK
                                  OUTSTANDING.
INDEX

                          OPTICAL SENSORS INCORPORATED

PART I.  FINANCIAL INFORMATION

      ITEM 1.  FINANCIAL STATEMENTS (UNAUDITED)

       Balance Sheets  September 30, 1998 and December 31, 1997

       Statements of Operations--Three months ended September 30, 1998 and 1997.
                                 Nine months ended September 30, 1998 and 1997.

       Statements of Cash Flows--Nine months ended September 30, 1998 and 1997.

       Notes to Financial Statements

      ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
               RESULTS OF OPERATIONS

PART II.  OTHER INFORMATION

      Item 6.  Exhibits and Reports on Form 8-K

                                       1
Optical Sensors Incorporated

                                 Balance Sheets
SEPTEMBER 30,       DECEMBER 31, 
                                                                         1998               1997
                                                                  -----------------------------------
                                                                     (Unaudited)            (Note)
ASSETS                                                            
Current assets:                                                   
 Cash and cash equivalents                                           $10,764,994          $17,101,130
 Accounts receivable                                                     211,285               27,100
 Inventory                                                             1,884,917            2,017,497
 Prepaid expenses and other current assets                               125,035               70,491
                                                                  -----------------------------------
                                                                  
Total current assets                                                  12,986,231           19,216,218
                                                                  
Property and equipment:                                           
 Leased equipment                                                        989,772              679,892
 Research and development equipment                                      733,742              594,542
 Leasehold improvements                                                  334,037              259,172
 Furniture and equipment                                                 145,473              109,214
 Marketing equipment                                                   1,004,840              986,483
 Production equipment                                                    454,275              259,363
                                                                  -----------------------------------
                                                                  
                                                                       3,662,139            2,888,666
 Less accumulated depreciation                                        (1,616,858)            (974,887)
                                                                  -----------------------------------
                                                                  
                                                                       2,045,281            1,913,779
Other assets:                                                     
 Patents                                                                 498,921              434,752
 Other assets                                                             23,975               60,785
                                                                  -----------------------------------
                                                                  
                                                                         522,896              495,537
Total assets                                                         $15,554,408          $21,625,534
                                                                  ===================================
                                                                  
LIABILITIES AND SHAREHOLDERS' EQUITY                              
Current liabilities:                                              
 Accounts payable                                                   $    268,232         $    437,039
 Employee compensation                                                   638,636              404,513
 Other liabilities and accrued expenses                                    8,630                2,154
 Obligations under capital lease, current portion                        229,292              152,756
                                                                  ----------------------------------- 
Total current liabilities                                              1,144,790              996,462
                                                                  
Obligations under capital lease, less current portion                    557,303              472,206
                                                                  
SHAREHOLDERS' EQUITY                                              
Convertible Preferred Stock, par value $.01                       
 per share:                                                       
  Authorized shares--5,000,000                                    
Common Stock, par value $.01 per share:                           
 Authorized shares--30,000,000                                    
 Issued and outstanding shares 1998--8,821,436 and                
  1997--8,400,554                                                          88,220                84,006
Additional paid-in capital                                             69,304,550            67,088,370
Deficit accumulated                                                   (55,443,303)          (46,548,720)
Deferred compensation                                                     (97,152)             (221,790)
Note receivable from officer                                                    -              (245,000)
                                                                  -------------------------------------
                                                                  
Total shareholders' equity                                             13,852,315            20,156,866
                                                                  -------------------------------------
Total liabilities and shareholders' equity                           $ 15,554,408          $ 21,625,534
                                                                  =====================================
Note:  The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

See accompanying notes.

                                       2
Optical Sensors Incorporated

                            Statements of Operations
                                  (Unaudited)
THREE MONTHS ENDED          NINE MONTHS ENDED
                                                           SEPTEMBER 30                SEPTEMBER 30
                                                        1998          1997          1998          1997
Net sales                                           $   319,505   $    23,840   $   798,698   $   104,406
Cost of goods sold                                      827,156       928,901     2,296,076     1,850,523
                                                  -------------------------------------------------------
Gross margin                                           (507,651)     (905,061)   (1,497,378)   (1,746,117)
Operating expenses:
 Research and development expenses                    1,051,614     1,066,785     3,097,109     4,023,963
 Selling, general and administrative expenses         1,704,799     1,342,886     4,808,471     4,166,085
Operating loss                                       (3,264,064)   (3,314,732)   (9,402,958)   (9,936,165)
 
Interest expense                                        (24,405)       (5,565)      (70,906)       (5,565)
Interest income                                         167,430       292,411       601,179     1,001,775
Other  income (expense)                                  (4,148)       (7,519)      (21,898)      (43,501)
                                                  -------------------------------------------------------
 
 
Net loss                                            $(3,125,187)  $(3,035,405)  $(8,894,583)  $(8,983,456)
 
Net loss per common share:
Basic and diluted                                         $(.35)        $(.36)       $(1.01)       $(1.07)
 
Shares used in calculation of net loss per share      8,858,515     8,382,297     8,817,727     8,369,151
See accompanying notes.

                                       3
Optical Sensors Incorporated

                            Statements of Cash Flows
(Unaudited)
 
                                                                           NINE MONTHS ENDED
                                                                   SEPTEMBER 30,       SEPTEMBER 30,
                                                                        1998                1997
                                                               ---------------------------------------
Operating activities
Net loss                                                               $(8,894,583)       $ (8,983,456)
Adjustments to reconcile net loss to net cash used in
 operating activities:
  Writedown of inventories                                                       -             500,000
  Depreciation and amortization                                            767,878             325,210
  Deferred compensation amortization                                       124,638             244,486
  Amortization of warrants in connection with debt and lease
   financings                                                               13,135              13,574
 
  Changes in operating assets and liabilities:
      Receivables                                                         (184,185)             41,502
      Inventories                                                           52,688          (1,326,953)
      Prepaid expenses                                                     (54,544)            (53,863)
      Accounts payable and accrued expenses                                 71,791            (511,424)
                                                               ---------------------------------------
 
Net cash used in operating activities                                   (8,103,182)         (9,750,924)
 
INVESTING ACTIVITIES
Purchases of property and equipment                                       (780,539)         (1,017,510)
Other                                                                      (66,309)           (101,295)
                                                               ---------------------------------------
 
Net cash used in investing activities                                     (846,848)         (1,118,805)
 
FINANCING ACTIVITIES
Proceeds from note receivable-officer                                      245,000                   -
Net proceeds from issuance of Common Stock                               2,207,261              67,474
Proceeds (payments) on long-term debt and lease obligations                161,633             241,886
                                                               ---------------------------------------
Net cash provided by financing activities                                2,613,894             309,360
                                                               ---------------------------------------
 
Increase (decrease) in cash and cash equivalents                        (6,336,136)        (10,560,369)
Cash and cash equivalents at beginning of period                        17,101,130          30,134,800
                                                               ---------------------------------------
Cash and cash equivalents at end of period                             $10,764,994        $ 19,574,431
                                                               =======================================
See accompanying notes.

                                       4
OPTICAL SENSORS INCORPORATED

                         NOTES TO FINANCIAL STATEMENTS
                                  (UNAUDITED)

                               SEPTEMBER 30, 1998

Note A - Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X.  Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.  In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and nine month periods ended September
30, 1998 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1998.  For further information, refer to the
financial statements and footnotes thereto included in the Optical Sensors
Incorporated 1997 Annual Report to Shareholders incorporated by reference into
the Annual Report on Form 10-K for the year ended December 31, 1997.

NOTE B - NET LOSS PER SHARE

Basic and diluted net loss  per common share is  computed  using the  weighted
average  number of common shares outstanding during the period.  Options and
warrants were outstanding during the quarter ended September 30, 1998 and 1997,
but were not included in the computation of diluted net loss per common share
because the effect would be antidilutive.  All earnings per share amounts for
all periods have been presented, and where necessary, restated to conform to the
Statement 128 requirements.

                                       5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

OVERVIEW

Optical Sensors Incorporated (the "Company") has developed the SensiCath system,
a patient-connected, on-demand arterial blood gas ("ABG") monitoring system,
which provides precise and accurate ABG results within 60 seconds without
exposure to potentially infectious blood or depleting the patient's blood supply
(the "SensiCath System").  ABG tests measure oxygen ("O2"), carbon dioxide
("CO2") and acid-base ("pH") in a sample of blood taken from a patient's artery.
These tests, which are among the most frequently ordered and most urgently
needed tests for critically ill and unstable patients, are the foremost
indicators of the body's ability to absorb and use oxygen.  Results of ABG tests
provide a basis for medical treatment and intervention and are required to
accurately regulate the patient's respiratory support system.  The Company
believes that the SensiCath System is the first ABG analyzer to be integrated
into both an arterial pressure monitoring line and a critical care patient
monitoring system.  The SensiCath System utilizes a disposable, fiberoptic
sensor device (the "SensiCath Sensor") connected to a small modular instrument
(the "ABG Module") that is part of the Company's OpticalCAM instrumentation
("OpticalCAM").  The SensiCath System is able to either stand alone or interface
with various monitoring platforms, including monitoring systems produced and
installed by Marquette Medical Systems, Inc., SpaceLabs Medical, Inc., and the
Hewlett-Packard Company.  These three producers account for approximately 80% of
the installed base of critical care monitoring instrumentation in the United
States.

In January 1998, the Company entered into an agreement with Instrumentation
Laboratory Company ("IL") for worldwide distribution of the Company's SensiCath
Sensors and OpticalCAM instrumentation.  In April 1998, IL announced the U.S.
introduction of the GEM SensiCath and GEM OpticalCAM, new members of the IL GEM
family of hospital point-of-care diagnostic products.

In July, 1998 the Company entered into an agreement with the Institute for
Critical Care Medicine ("ICCM") providing the Company with the rights to
commercialize a new application of its sensor technology ("CapnoProbeTM") for
the non-invasive measurement of carbon dioxide in the tissue of  ill or injured
patients to aid in the diagnosis and monitoring of shock.  The CapnoProbe SLTM,
the first prodouct in the line that the Company plans to commercialize, is a
handheld, lightweight device with a probe that can be slipped under the tongue
like a thermometer.  In less than 60 seconds, it noninvasively measures the
tissue CO2 of the mucous membrane in the mouth - a sensitive measure that can
indicate ealry clinical shock, even when traditional vital signs may still
appear realtively normal, as in compensated shock cases.  The Company expects to
begin clinical evaluations of prototype products before the end of 1998.

In October, 1998 the Company implemented a strategic plan to focus its corporate
resources on the development and commercialization of the CapnoProbe product.
The plan resulted in reducing staff by approximately 20 percent through layoffs
and attrition and implementing other expense management measures. The
restructuring and expense management measures affected all areas of the Company.
The Company expects to begin receiving  the full benefit of the restructuring in
the first

                                       6
quarter of 1999. The Company currently plans to direct all of the cost savings
to development of the CapnoProbe.

RESULTS OF OPERATIONS

Net sales in the third quarter of 1998 increased $295,665 or 1,240% from $23,840
in the third quarter in 1997 to $319,505 in the third quarter of 1998.  Net
sales for the nine month period ended September 30, 1998 increased $694,292 or
665% from $104,406 for the nine month period ended September 30, 1997.  Sales
for the three and nine month periods ended September 30, 1998 were insignificant
due to a product recall that the Company initiated in May 1997 because of an
interference problem with a certain portion of the critical care patient
population.  In December 1997, the Company introduced an enhanced version of its
SensiCath Sensor that solved the interference problems, accounting for the
increase in sales in 1998.  The Company does not believe that the product recall
will have a material impact on future results.  Sales of SensiCath Sensors
accounted for approximately 17% of the total sales for the third quarter of 1998
while OpticalCAM instrumentation accounted for the balance. For the third
quarter of 1998, approximately 90% of  Sensor sales and 98% of the OpticalCAM
instrumentation sales were made to the Company's distributor for resale to
customers with the remainder purchased for sales demonstration purposes.

Costs of products sold in the third quarter of 1998 decreased $101,745 or 11% to
$827,156 from $928,901 in the third quarter in 1997. Costs of products sold for
the nine months ended September 30, 1998 increased $445,553 or 24% to $2,296,076
from $1,850,523 for the nine months ended September 30, 1997. The decrease for
the quarter is due to a $500,000 write-down in the third quarter of 1997 of
OpticalCAM inventories to the lower of cost or market.  After adjusting for this
write-down, the increase for the nine months ended September 30, 1998 is due
primarily to the increased sales levels. Under the agreement between the Company
and IL, the Company has agreed to sell OpticalCAM instrumentation to IL at the
lower of the Company's direct cost of manufacturing or previously scheduled
amounts.  Accordingly, the Company does not expect to generate any gross margin
from the sale of OpticalCAM instrumentation in future periods.  Because
instrument sales are sold at amounts close to cost, gross margins in future
periods will be affected by the mix of sensor and instrumentation sales.  The
Company expects an improving relationship between sales and cost of product sold
once sales volumes for sensors begin to increase.  The Company believes it has
the capacity to increase production levels to approximately 50,000 sensors per
year without materially increasing manufacturing infrastructure costs.

Research and development costs for the third quarter of 1998 declined $15,171 or
1% to $1,051,614 from $1,066,785 in the third quarter of 1997.  Research and
development costs for the nine months ended September 30, 1998 declined $926,854
or 23% to $3,097,109 from $4,023,963 for the nine months ended September 30,
1997.  Research and development expenses in the nine month period ended
September 30, 1997 included approximately $417,000 for outside development of
the OpticalCAM and a $500,000 payment to Marquette Medical Systems, Inc. under a
previously disclosed technology purchase agreement.   These expenses, which did
not recur in 1998, accounted for the majority of the decrease for the nine
months ended September 30, 1998. Overall, the Company expects research and 
development expenses to increase by approximately $300,000 in the fourth
quarter due to development efforts related to the CapnoProbe. In addition, the
Company

                                       7
may become obligated to make a $500,000 payment to Marquette Medical Systems,
Inc. under a previously disclosed technology purchase agreement, assuming
Marquette sells a specified number of ABG Modules.

Selling, general and administrative expenses in the third quarter of 1998
increased $361,913 or 27% to $1,704,799 from $1,342,886 in the third quarter of
1997. Selling, general and administrative expenses for the nine months ended
September 30, 1998 increased $642,386 or 15% to $4,808,471 from $4,166,085 for
the nine months ended September 30, 1997.  The increase for the three and nine
month periods are primarily due to a higher level of selling activity, compared
to 1997.   The majority of selling activities continued to be directed towards
the market launch of the enhanced SensiCath. Additionally, selling expenses
increased as the Company has began market research related to the CapnoProbe
currently under development. The Company expects to operate through the balance
of 1998 with slightly higher selling, general and administrative expenses from
the current level due to market research activities related to the CapnoProbe.

Net interest income in the third quarter of 1998 decreased $124,981 to $167,430
from $292,411 in the third quarter of 1997. Net interest income for the nine
month period ended September 30, 1998 decreased $400,596 to $601,179 from
$1,001,775 for the nine month period ended 1997. The decrease in net interest
income in the three and nine month periods ending September 30, 1998 is due
primarily to declining cash balances of proceeds from the Company's initial
public offering, which was completed in the first quarter of 1996.  The Company
expects interest income to continue to decline in future periods as it uses cash
for operations.

Since its inception, the Company has experienced significant operating losses.
The Company incurred a net loss of $3,125,187 for the quarter ended September
30, 1998, compared to a net loss of $3,035,405 for the quarter ended September
30, 1997. As of September 30, 1998, the Company had an accumulated deficit of
$55,443,301. The Company anticipates that its operating losses will continue for
the foreseeable future because it plans to expend substantial resources in
funding sales and marketing activities, commercial manufacturing, and research
and development.  Except for historical information contained herein, the
disclosures in this report are forward looking statements.  See "Certain
Important Factors".

LIQUIDITY AND CAPITAL RESOURCES

To date, the Company has financed its operations primarily through the sale of
equity securities.  From inception through December 31, 1995, the Company raised
net proceeds of $30,400,000 from private equity financings and stock option
exercises.  In the second quarter of 1996, the Company completed an initial
public offering of 2,875,000 shares of Common Stock.  The net proceeds to the
Company from the public offering were approximately $33,916,000. In January
1998, the Company sold 441,203 shares of Common Stock to IL, which represented
4.99% of the Company's outstanding Common Stock following completion of the
transaction, at a price of $5.00 per share (which is equal to the closing market
price on the day before signing of the agreement). for a total price of
$2,206,015.  The proceeds from the sales of stock has been used to fund costs of
producing

                                       8
products and operating expenses described above and capital expenditures
described below.  The Company's Common Stock is quoted on the Nasdaq National
Market under the symbol "OPSI."

The Company's cash and cash equivalents were $10,764,994 and $17,101,130 at
September 30, 1998 and December 31, 1997, respectively. The Company incurred
cash expenditures for the nine months ended September 30, 1998 of $8,103,181 for
operations and $780,539 for capital expenditures.  The capital equipment
expenditures were principally for the acquisition of manufacturing, research and
development and marketing promotional equipment.  A substantial portion of the
inventory level at September 30, 1998 consisted of key components, OpticalCAM
monitors and ABG Modules for which the Company relies on sole suppliers.

As of September 30, 1998, the Company had no material commitments outstanding
for tooling and equipment. The Company has contracts for minimum purchase
quantities of OpticalCAM monitors and ABG Modules and other sole source
inventory items.

SensiCath(R) and OpticalCAM(TM) are trademarks of Optical Sensors Incorporated.
GEM(R) is a trademark of Instrumentation Laboratory Company.

YEAR 2000 SOFTWARE PERFORMANCE EXPOSURE

The Company has determined that the software embedded in the ABG Modules is Year
2000 compliant and that its major internal information technology systems are
Year 2000 compliant.  The Company has numerous ancillary software programs which
are in the process of being evaluated and tested for Year 2000 compliance.  The
Company expects to complete this process and to have taken any corrective
actions by mid 1999.  Should any of these programs require replacement, the
Company anticipates that the total cost will not exceed $100,000. The Company
does not believe this amount nor any impact on ongoing information technology
projects will have any material affect on its ongoing operations. The Company
has initiated discussions with its significant suppliers, large customers and
financial institutions to ensure that those parties have appropriate plans to
remediate Year 2000 issues where their systems interface with the Company's
systems or otherwise impact its operations.  The Company is assessing the extent
to which its operations are vulnerable should those organizations fail to
properly remediate their computer systems.  For those vendors that have not yet
certified  Year 2000 compliance and which are sole suppliers of critical product
components, the Company plans to have sufficient inventories on hand at the end
of 1999 to support its needs for at least six months. For the Company's
exclusive distributer, the Company has the ability to ship product directly to
the end customer and to invoice and collect receivables should it be necessary
to do so.  The Company's Year 2000 initiative is being managed by an internal
staff and is scheduled to be completed in early 1999.  While the Company
believes its planning efforts are adequate to address its Year 2000 concerns,
there can be no assurance that the systems of other companies which may impact
the Company's operations will be converted on a timely basis and will not have a
material effect on the Company.  The cost of the Year 2000 initiatives is not
expected to be material to the Company's results of operations or financial
position.

CERTAIN IMPORTANT FACTORS

                                       9
There are several important factors that could cause the Company's actual
results to differ materially from those anticipated by the Company or which are
reflected in any forward-looking statement of the Company.  These factors, and
their impact on the success of the Company's operations and its ability to
achieve its goals include the following:

-  MARKET ACCEPTANCE OF THE SENSICATH SYSTEM. The Company's future revenues will
   depend on market acceptance of the SensiCath System and the CapnoProbe
   product. The Company will need to demonstrate to health care professionals,
   hospital administrators and third-party payors the accuracy, reliability,
   ease of use, safety and cost effectiveness of these products. In order to use
   these products, hospitals need to acquire the instrumentation, which may
   require capital expenditure approvals by the hospital.

-  DEVELOPMENT AND COMMERCIALIZATION OF CAPNOPROBE. The Company's future success
   will depend, in part, on successful development and commercialization of the
   CapnoProbe product. Although this product is based on the Company's existing
   technology, the Company is in the early stages of developing prototypes and
   completing preliminary animal trials of the CapnoProbe product. Accordingly,
   there can be no assurance that the Company will successfully develop a
   commercial CapnoProbe product.

-  SALES BY INSTRUMENTATION LABORATORY. The Company's near term revenues will
   depend almost exclusively on sales of the Company's products by IL. Although
   IL is required to purchase sufficient quantities of products from the Company
   that will result in pre-established annual minimum revenues to the Company in
   order to maintain exclusivity, there can be no assurance that IL will achieve
   sufficient sales for the Company to substantially increase revenues or
   achieve profitability.

-  MANUFACTURING AND SUPPLY. Although the Company has established and validated
   manufacturing processes, equipment and infrastructure to manufacture sensors
   in volumes that will be necessary to achieve significant revenues, the
   Company has limited experience in producing sensors at these volumes. A
   failure to successfully scale-up manufacturing of sensors could have a
   material adverse effect on the Company. Currently, the Company has only one
   supplier for the ABG Module, the OpticalCAM Monitor and certain other key
   components. Any disruption or delay in the supply of key components or
   instrumentation could have a material adverse effect on the Company.

-  COMPETITION. Competition among companies attempting to provide ABG and other
   critical blood analyte analysis at the point-of-care is intense and
   increasing. There can be no assurance that the Company's competitors will not
   succeed in developing or marketing technologies and products that are more
   effective or less expensive than the Company's products or that would render
   the Company's products obsolete or non-competitive.

-  REGULATORY APPROVALS. The Company's ability to market its current products
   and any products that it may develop in the future requires clearances or
   approvals from the FDA and other governmental agencies, including, in some
   instances, foreign and state agencies. The process for maintaining and
   obtaining necessary regulatory clearances and approvals can be expensive and
   time consuming. There can be no assurance that the Company will be able to
   maintain or obtain necessary regulatory approvals and clearances in the
   future.

PART II.   OTHER INFORMATION

                                       10
ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following exhibit is included herein:
 
     (10.1)  Patent License Agreement, dated July 20, 1998, between the Company
             and the Institute of Critical Care Medicine. (Confidential
             treatment has been requested with respect to designated portions
             contained in this document. Such portions have been omitted and
             filed separately with the Commission pursuant to Rule 24b-2 of the
             Securities Exchange Act of 1934, as amended.)

     (27)    Financial Data Schedule

(b)  Reports on Form 8-K

     None

                                       11
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                              OPTICAL SENSORS INCORPORATED
 
 
 
Date   November 5, 1998                  -----------------------------------
                                                   /s/ Paulita LaPlante
                                                        President
                                              (Principal Executive Officer)
 
 
Date   November 5, 1998                  -----------------------------------
                                                  /s/ Wesley G. Peterson
                                         Chief Financial Officer, Vice President
                                         of Finance and Administration and 
                                         Secretary (Principal Financial and 
                                         Accounting Officer)

                                       12