XOMED SURGICAL PRODUCTS INC, 424B4, 1998-07-15

XOMED SURGICAL PRODUCTS INC
424B4, 1998-07-15
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS

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FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-53625

1,500,000 SHARES

[XOMED LOGO APPEARS HERE]

Common Stock

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Of the 1,500,000 shares of Common Stock offered hereby, 615,500 shares are
being sold by Xomed Surgical Products, Inc. ("Xomed" or the "Company") and
884,500 shares are being sold by certain stockholders of the Company (the
"Selling Stockholders"). The Company will not receive any of the proceeds from
the sale of shares of Common Stock by the Selling Stockholders.

The Common Stock is quoted on the Nasdaq National Market under the symbol
"XOMD." On July 14, 1998, the last reported sale price for the Common Stock
was $32.00.

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THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 7.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
PRICE UNDERWRITING PROCEEDS PROCEEDS TO
TO DISCOUNTS AND TO SELLING
PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share.................... $30.50 $1.75 $28.75 $28.75
- --------------------------------------------------------------------------------
Total(2)..................... $45,750,000 $2,625,000 $17,695,625 $25,429,375
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
(1) Before deducting expenses of the offering estimated at $600,000, payable
by the Company.
(2) Each of the Company and a Selling Stockholder has granted to the
Underwriters a 30-day option to purchase up to 112,500 additional shares
of Common Stock solely to cover over-allotments, if any. To the extent
that the option is exercised, the Underwriters will offer the additional
shares at the Price to Public shown above. If the option is exercised in
full, the total Price to Public, Underwriting Discounts and Commissions,
Proceeds to Company and Proceeds to Selling Stockholders will be
$52,612,500, $3,018,750, $20,930,000 and $28,663,750, respectively. See
"Underwriting."

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The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject
to the right of the Underwriters to reject any order in whole or in part. It
is expected that delivery of the shares of Common Stock will be made at the
offices of BT Alex. Brown Incorporated, Baltimore, Maryland, on or about July
20, 1998.

BT ALEX. BROWN
ING BARING FURMAN SELZ LLC
PIPER JAFFRAY INC.

THE DATE OF THIS PROSPECTUS IS JULY 14, 1998.

<PAGE>

[ARTWORK]

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SUCH TRANSACTIONS MAY INCLUDE THE PURCHASE OF SHARES OF COMMON STOCK FOLLOWING
THE OFFERING TO COVER A SYNDICATE SHORT POSITION IN THE COMMON STOCK OR
MAINTAIN THE PRICE OF THE COMMON STOCK, AND THE IMPOSITION OF PENALTY BIDS.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND OTHER SELLING
GROUP MEMBERS OR THEIR AFFILIATES MAY ENGAGE IN PASSIVE MARKET MAKING
TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE
WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."

<PAGE>

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus.

THE COMPANY

Xomed is a leading developer, manufacturer and marketer of a broad line of
surgical products for use by ear, nose and throat ("ENT") specialists. The
Company's core ENT products include powered tissue-removal systems and other
microendoscopy instruments, implantable devices, nerve-monitoring systems and
disposable fluid-control products. The Company also offers a line of ophthalmic
and other products. For the year ended December 31, 1997, Xomed derived
approximately 80% of its revenues from disposable or implantable products. The
Company distributes its products worldwide through an 82-person direct-sales
organization in the U.S. and selected other countries and through a network of
over 130 independent distributors. Xomed is the only major manufacturer and
marketer of ENT surgical products with a direct U.S. sales force exclusively
serving ENT specialists. Approximately 30% of the Company's net sales was
derived from international markets for the year ended December 31, 1997.
Approximately 29% of the Company's net sales in 1997 in its core ENT product
line was derived from products introduced within the last three years. With
over 25 years of industry experience, Xomed believes that it has established a
long-standing reputation for innovative, high-quality products and is uniquely
positioned as the only major surgical-products company focused on the ENT
market.

More than an estimated 20,000 ENT specialists practice worldwide, of which
approximately 9,000 practice in the U.S. Diseases and conditions addressed by
ENT specialists affect sizable patient populations and include chronic
sinusitis, chronic infection of the middle ear, tonsils and adenoids, nasal and
laryngeal polyps and facial tumors. Increasingly, ENT surgeons are expanding
their practices to include facial-plastic and reconstructive surgery. The
Company estimates that more than three million ENT procedures were performed in
the U.S. in 1996 and that the U.S. market for surgical instruments, devices and
supplies used by ENT specialists was approximately $180 million in 1996.

The ENT market is in the midst of a conversion from conventional surgical
approaches to less-traumatic approaches that involve the use of advanced
surgical tools, such as powered tissue-removal systems and small-diameter
surgical endoscopes, thereby minimizing patient trauma and reducing procedure
times. Xomed believes that the adoption of these less-traumatic techniques is
being driven by several factors, including economic pressures and patient
demand. Minimally invasive techniques have the potential to increase the number
of ENT procedures that can be performed in lower-cost outpatient or day surgery
settings. Patient demand is likely to increase due to the reduced morbidity and
improved outcomes of these less-invasive ENT procedures. Xomed believes that
the ongoing conversion in the ENT market to less-traumatic approaches is
similar to recent conversions in the general surgery market to less-invasive
techniques and in the orthopaedic surgery market to powered instrumentation
systems.

Xomed's objective is to enhance its leading position in the ENT market and to
enter new markets. The Company's strategy for achieving this objective is to:
(i) increase its penetration of the ENT market; (ii) facilitate ENT market
conversion to less-traumatic approaches; (iii) emphasize product innovation
through internal research and development; (iv) maintain a broad product line
of ENT products with particular emphasis on disposable and implantable
products; (v) expand its global distribution network; and (vi) leverage its
core competencies to enter new markets, including potentially orthopaedics and
plastic and reconstructive surgery.

The Company's principal executive office is located at 6743 Southpoint Drive
North, Jacksonville, Florida 32216, and its telephone number is (904) 296-9600.

3
<PAGE>

RECENT EVENTS

In June 1998, the Company entered into a worldwide distribution and license
agreement with ArthroCare Corporation ("ArthroCare"). The Company and
ArthroCare have signed a binding term sheet with the intention of reaching a
definitive agreement in the near future. ArthroCare has granted an exclusive
five-year license to the Company to distribute products into the ENT market
incorporating ArthroCare's Coblation(TM) technology. Products developed under
the arrangement will be manufactured by ArthroCare and distributed exclusively
through the Company's direct sales force and network of independent
distributors.

RISK FACTORS

The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors."

THE OFFERING

<TABLE>
<C> <S>
Common Stock offered by the Company...................... 615,500 shares
Common Stock offered by the Selling Stockholders......... 884,500 shares
Common Stock to be outstanding after the offering........ 7,961,624 shares(1)
Use of proceeds.......................................... Business development and
expansion, working
capital and other
general corporate
purposes
Nasdaq National Market symbol............................ XOMD
</TABLE>
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(1) Based on 7,346,124 shares of Common Stock outstanding as of July 10, 1998.
Excludes 832,291 shares of Common Stock issuable upon the exercise of
outstanding stock options having a weighted average exercise price of
$17.07 per share. See "Capitalization" and "Principal and Selling
Stockholders."

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Private Securities Litigation Reform Act Safe Harbor Statement. This
Prospectus (including the documents incorporated by reference herein) contains
certain forward-looking statements (as such term is defined in the Private
Securities Litigation Reform Act of 1995) and information relating to the
Company that are based on the beliefs of the management of the Company, as well
as assumptions made by and information currently available to the management of
the Company. When used in this Prospectus, the words "estimate," "project,"
"believe," "anticipate," "intend," "expect" and similar expressions are
intended to identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and are subject to
risks and uncertainties that could cause actual results to differ materially
from those contemplated in such forward-looking statements (including those
discussed under "Risk Factors"). Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof. The Company does not undertake any obligation to publicly release any
revisions to these forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

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Unless the context otherwise requires, references to the "Company" or "Xomed"
include Xomed Surgical Products, Inc. and all of its subsidiaries and their
respective predecessors. Except as otherwise specified, all information in this
Prospectus assumes no exercise of the Underwriters' over-allotment option. See
"Underwriting."

4
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SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED
------------------------------------------ -------------------
MARCH 29, MARCH 28,
1993 1994(1) 1995 1996 1997 1997 1998
------- ------- ------- ------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Sales, net............. $10,071 $42,475 $59,865 $65,664 $77,240 $17,804 $20,682
Gross profit........... 7,195 23,242 36,690 39,738 46,765 10,644 12,619
Selling, general and
administrative........ 6,074 19,126 27,077 26,799 30,334 7,253 8,085
Research and
development........... 311 1,958 2,405 3,659 4,088 1,006 1,170
Amortization of
intangibles(2)........ 394 2,652 2,579 2,421 2,374 615 584
Write-off of acquired
research and
development(3)........ -- -- -- 2,380 -- -- --
Restructuring
charges(4)............ -- -- -- 3,093 -- -- --
Operating income (loss)
from continuing
operations............ 416 (494) 4,629 1,386 9,969 1,770 2,780
Income (loss) from
continuing
operations............ 219 (1,555) 325 (1,167) 6,130 1,087 1,725
Per Share(5):
Income (loss) from con-
tinuing operations
available to common
shareholders--basic... $ 0.75 $ (5.20) $ (3.53) $ 1.14 $ 0.84 $ 0.15 $ 0.23
Income (loss) from con-
tinuing operations
available to common
shareholders--dilut-
ed.................... $ 0.75 $ (5.20) $ (3.53) $ (0.22) $ 0.82 $ 0.15 $ 0.23
OTHER STATISTICAL
DATA(6):
Market Mix (Percent of Sales):
Sinus and rhinology..................... 28.5% 33.9% 37.4% 35.2% 41.0%
Head and neck........................... 23.7 24.5 23.1 20.3 22.0
Otology................................. 20.7 21.1 18.7 21.7 20.0
------- ------- ------- ------- -------
Total core business.................... 72.9% 79.5% 79.2% 77.2% 83.0%
Ophthalmic and other.................... 27.1 20.5 20.8 22.8 17.0
------- ------- ------- ------- -------
Total.................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Geographic Mix (Percent of Sales):
U.S. ................................... 70.6% 68.0% 69.7% 69.1% 70.9%
International........................... 29.4 32.0 30.3 30.9 29.1
------- ------- ------- ------- -------
Total.................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Product-Type Mix (Percent of Sales):
Equipment and instrumentation........... 15.7% 15.5% 20.4% 17.1% 18.5%
Disposables and implantables............ 84.3 84.5 79.6 82.9 81.5
------- ------- ------- ------- -------
Total.................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Core product sales growth(7)............ 10.3% 16.9% 17.2% 8.3% 24.8%
Gross margin(8)......................... 62.8% 60.5% 60.5% 59.8% 61.0%
EBITDA(8)............................... $10,279 $12,090 $14,883 $ 2,997 $ 3,997
EBITDA margin(8)........................ 17.2% 18.4% 19.3% 16.8% 19.3%
CASH FLOW DATA:
Net Cash Provided By (Used In):
Operating Activities.................... $ 6,257 $ 4,844 $ 6,365 $ (80) $ 2,769
Investing Activities.................... (4,019) (112) (2,286) (308) (659)
Financing Activities.................... (2,081) (4,520) (2,996) 444 67
</TABLE>

<TABLE>
<CAPTION>
MARCH 28, 1998
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ACTUAL AS ADJUSTED(9)
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<S> <C> <C>
BALANCE SHEET DATA:
Working capital....... $27,736 $ 44,832
Cost in excess of net
assets acquired,
net.................. 41,901 41,901
Total assets.......... 98,773 115,869
Total shareholders'
equity............... 88,275 105,371
</TABLE>

See accompanying notes on following page.

5
<PAGE>

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(1) Statement of Operations Data includes the results of operations of Xomed-
Treace, Inc. since the date of its acquisition by the Company in April
1994.

(2) Amortization of intangibles includes amortization of foreign distribution
rights of $838,000 and $162,000 for the years ended December 31, 1994 and
1995, respectively.

(3) Research and development acquired in the purchase of TreBay Medical
Corporation ("TreBay"). See Notes to Consolidated Financial Statements--
Note 1.

(4) Restructuring charge related to the combination of certain operations and
termination of employees. See Notes to Consolidated Financial Statements--
Note 7.

(5) Per share earnings--basic for 1994 and 1995 was reduced by accreted
preferred stock dividends of $3.30 and $3.85 per share, respectively, and
increased in 1996 by $1.56 per share related to dividend forgiveness. Per
share earnings--diluted was affected similarly in 1994 and 1995, but not
affected in 1996 due to the dilutive effect of the preferred shares using
the if converted method of calculating per share earnings when preferred
stock is outstanding.

(6) Other Statistical Data has been omitted for the fiscal years ended December
31, 1993 and 1994 because the statement of operations for the Company only
includes the results of operations of Xomed-Treace, Inc. since the date of
its acquisition by the Company in April 1994 and therefore such data for
prior periods is not comparable to subsequent periods.

(7) Core product sales growth for 1995 is computed based on the inclusion of
Xomed-Treace Inc. for a full year in 1994. Xomed-Treace, Inc. was purchased
on April 15, 1994. Core product sales growth was 40.9% without the
inclusion of Xomed-Treace, Inc. prior to the purchase date. Core product
sales growth in 1996 excludes $1,200,000 of sales in 1996 resulting from a
change in distribution arrangements. Including these sales, core product
sales growth would have been 19.6% in 1996.

(8) Gross margin, EBITDA and EBITDA margin for 1995 exclude acquisition cost of
$919,000 related to the write up of inventory associated with the Xomed
Acquisition (as defined). See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Xomed Acquisition."
Including this cost, gross margin, EBITDA and EBITDA margin for 1995 were
61.3%, $9,360,000 and 15.6%, respectively. Gross margin, EBITDA and EBITDA
margin for 1996 exclude one-time charges of $2,380,000 and $3,093,000 for
the write-off of in-process research and development costs and a
restructuring charge, respectively. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Including these
costs, gross margin, EBITDA and EBITDA margin for 1996 were 60.5%,
$6,617,000, and 10.1%, respectively. EBITDA is computed based on statement
of operations data. EBITDA is not a financial measure under U.S. GAAP and
should not be considered an alternative to U.S. measures of net income
(loss) or cash flows.

(9) Adjusted to give effect to the offering and the Company's application of
the net proceeds therefrom. See "Use of Proceeds."

6
<PAGE>

RISK FACTORS

In addition to the other information in this Prospectus, the following
factors should be considered carefully in evaluating an investment in the
shares of Common Stock offered by this Prospectus.

Possible Obsolescence from Rapid Technological Change; Uncertainty as to
Market Acceptance of the Company's Products. The health care industry is
characterized by rapidly changing technology and frequent new product
introductions. The Company believes that its ability to develop and
commercialize new products and enhancements of existing products is critical
to its continued growth and profitability. There can be no assurance that the
Company will continue to be successful in identifying, developing and
marketing new products or enhancing its existing products. The Company's
business will be adversely affected if the Company incurs delays in developing
new products or enhancements or if such products or enhancements do not gain
market acceptance. Market acceptance of the Company's products will be
determined in large part by the Company's ability to demonstrate the surgical
advantages, safety and efficacy, cost effectiveness and performance features
of such products, as well as to train surgeons and other operating staff in
their use. The Company believes that use and acceptance by physicians and
hospitals will be essential for market acceptance of certain of its products,
and there can be no assurance that its products will be used or accepted.
There can be no assurance that those products or technologies developed by
others will not render the Company's products or technologies noncompetitive
or obsolete.

Possible Adverse Effects of Significant Competition. The Company encounters
significant competition in all of the markets in which it participates. Many
of the Company's current and potential competitors have substantially greater
resources, including capital, name recognition, research and development
experience and regulatory, manufacturing and marketing capabilities. Many of
these competitors offer well-established, broad product lines and ancillary
services not offered by the Company. Some of the Company's competitors have
long-term or preferential supply arrangements with hospitals, which may act as
a barrier to market entry. Other large health care companies may enter the
market for the Company's products in the future. Competing companies may
succeed in developing products that are more efficacious or less costly than
any that may be developed and marketed by the Company, and such companies also
may be more successful than the Company in production and marketing. Competing
companies may also exert competitive pricing pressures that may adversely
affect the Company's sales levels and margins. Rapid technological development
by others may result in the Company's products becoming obsolete before the
Company recovers a significant portion of the research, development and
commercialization expenses incurred with respect to those products. There can
be no assurance that the Company will be able to continue to compete
successfully with existing competitors or will be able to compete successfully
with new competitors. See "Business--Competition."

Dependence on Management and Other Key Personnel. The Company's success
depends to a significant extent on the efforts and abilities of its executive
officers. The loss of the services of certain of these individuals or of other
key personnel could have a material adverse effect on the Company. The Company
does not maintain key man life insurance on any of its employees that provide
for the payment of proceeds to the Company. Although the Company has entered
into employment agreements with James T. Treace, its President, Chief
Executive Officer and Chairman, F. Barry Bays, its Senior Vice President,
Operations and Chief Operating Officer, and certain other executive officers
that include non-competition covenants, there can be no assurance that any of
these individuals or any other key employee will not terminate his or her
employment with the Company. The Company believes that its success also will
depend significantly upon its ability to attract, motivate and retain
additional highly skilled managerial, operational, technical and sales and
marketing personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be successful in attracting,
assimilating and retaining the personnel it requires. See "Business--
Employees."

Risks Associated with Newly Established International Sales Operations;
Currency Exchange Risks. Within the past three years, the Company has
established direct sales operations in five countries. The failure of these
new direct sales operations to develop successfully may have a material
adverse effect on the

7
<PAGE>

Company's business, financial condition or results of operations.
International sales (including export sales) accounted for approximately 32%
of the Company's net sales in fiscal 1996 and 30% of net sales in 1997, and
the Company expects that international sales will continue to be a significant
portion of the Company's business. Fluctuations in currency exchange rates, as
well as increases in duty rates and difficulties in obtaining export licenses,
may affect the Company's international business. The Company's establishment
of direct international sales operations further increases its exposure to
fluctuations in currency exchange rates, which may adversely affect reported
sales and earnings, because the sales of these operations are denominated in
local currency and not in U.S. dollars. Although the Company in 1997 began
hedging its intercompany foreign currency receivables to protect against
uncertainty in the level of future exchange rates, there can be no assurance
that such hedging will succeed in protecting against such uncertainty.
International sales in emerging economies are also subject to potential
political and economic instability, regional conflicts, unexpected changes in
regulatory requirements, longer payments cycles, greater difficulty in
receivable collection, potentially adverse tax consequences and trade
restrictions. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

Seasonality and Quarterly Fluctuations. The Company's sales and operating
results have varied, and are expected to continue to vary, significantly from
quarter to quarter as a result of seasonal patterns, the timing of new product
introductions and promotional activities. The Company believes that its
business is seasonal in nature, with the third quarter of each year typically
having the lowest sales and the fourth quarter of each year typically having
the highest sales. Quarterly results of operations for any particular quarter
may not be indicative of results of operations for future periods. There can
be no assurance that future seasonal and quarterly fluctuations will not
adversely affect the Company's business, financial condition and results of
operations.

Uncertainty Relating to Third-Party Reimbursement for Costs of
Products. Demand for the Company's products is likely to depend in part on the
extent to which reimbursement for the cost of such products and the procedures
in which such products are used will be available from government third-party
payors (including the Medicare and Medicaid programs), government health
administration authorities, private health insurers and other organizations.
These third-party payors may deny coverage if they determine that a procedure
was not reasonable or necessary as determined by the payor, was experimental
or was used for an unapproved indication. In addition, certain health care
providers are moving towards a managed care system in which such providers
contract to provide comprehensive health care for a fixed cost per person,
irrespective of the amount of care actually provided. Such providers, in an
effort to control health care costs, are increasingly challenging the prices
charged for medical products and services and, in some instances, have
pressured medical suppliers to lower their prices. Although the Company
believes that the development of procedure-specific instrumentation for use in
less-traumatic procedures may in certain cases reduce overall operating time
and therefore reduce the aggregate cost of those procedures, there can be no
assurance that the development of such products will have this effect or that
third-party payors will reimburse the costs of such instrumentation. In
addition, although the Company does not depend upon reimbursement from third-
party payors with respect to its products used in surgical cosmetic
procedures, there can be no assurance these procedures will not become subject
to third-party reimbursement in the future. Third-party payors have recently
increased their emphasis on managed care, which has led to an increased
emphasis on cost-effective medical devices by health care providers. In
addition, through their purchasing power, these payors often seek discounts,
price reductions or other incentives from medical product suppliers. The
Company is unable to predict what changes will be made in the reimbursement
methods utilized by third-party health care payors. Furthermore, the Company
could be adversely affected by changes in reimbursement policies of
governmental or private health care payors, particularly to the extent any
such changes affect reimbursement for procedures in which the Company's
products are used. If coverage and adequate reimbursement levels are not
provided by government or third-party payors for use of the Company's
products, the Company's business, financial condition and ability to market
its technologies or products will be adversely affected. Reimbursement and
health care payment systems in international markets vary significantly by
country, and include both government-sponsored health care and private
insurance. To the extent that any of the Company's products are not entitled
to reimbursement in an international market, market acceptance
of such products in such international market would be adversely affected. See
"Business--Third-Party Reimbursement."

8
<PAGE>

Uncertainty of Effect of Potential Health Care Reform Measures. Federal,
state and local officials and legislators (and certain foreign government
officials and legislators) have proposed or are reportedly considering
proposing a variety of reforms to the health care systems in the U.S. and
abroad. The Company cannot predict what health care reform legislation, if
any, will be enacted in the U.S. or elsewhere. Significant changes in the
health care system in the U.S. or elsewhere are likely to have a substantial
impact over time on the manner in which the Company conducts its business.
Such changes could have a material adverse effect on the Company's business,
financial condition and results of operations.

Extensive Government Regulation. The Company's products, product development
activities, promotional and marketing activities and manufacturing processes
are subject to extensive and rigorous regulation by the U.S. Food and Drug
Administration (the "FDA") and comparable agencies in foreign countries. In
the U.S., the FDA regulates the interstate commerce of medical devices as well
as the manufacturing, labeling, promotion and recordkeeping procedures for
such devices. In order for the Company to market its products in the U.S., the
Company must obtain marketing clearance from the FDA through what is known as
a 510(k) pre-market notification or obtain approval through a more detailed
application process resulting in what is known as pre-market approval ("PMA").
The process of obtaining marketing clearance for new medical devices from the
FDA can be costly and time consuming, and there can be no assurance that such
clearance will be granted for the Company's future products on a timely basis,
if at all, or that FDA review will not involve delays that will adversely
affect the Company's ability to commercialize additional products or expand
permitted uses of existing products.

Even if regulatory clearance to market a device is obtained from the FDA,
the clearance may entail limitations on the indicated uses of the device. The
clearance can also be withdrawn by the FDA due to the failure to comply with
regulatory standards or the occurrence of unforeseen problems following
initial clearance. The Company may be required to make further filings with
the FDA under certain circumstances such as the addition of new product
claims. The FDA could also limit or prevent the manufacture or distribution of
the Company's products and has the power to seize or require the recall of
such products. The Company has made modifications to its 510(k) cleared
devices which the Company believes do not require submission of new 510(k)s.
There can be no assurance, however, that the FDA will agree with any of the
Company's determinations and will not require the Company to submit new
510(k)s for any of the changes made to the devices and/or to stop marketing
until new 510(k)s are cleared by the FDA.

All of the products currently marketed by the Company either have received
marketing clearance pursuant to 510(k) pre-market notifications or PMA
applications filed by the Company and cleared by the FDA, or are exempt from
obtaining marketing clearance by virtue of their status as pre-amendment
devices (i.e. devices introduced into interstate commerce prior to May 28,
1976). A 510(k) pre-market notification requires the manufacturer of a medical
device to establish that the device is "substantially equivalent" to medical
devices legally marketed in the U.S. For future products, there can be no
assurance that the FDA will concur in the Company's 510(k) request for
clearance or that the FDA will not require the Company to file PMA
applications. The process of obtaining a PMA can be expensive, uncertain and
lengthy, frequently requiring anywhere from one to several years from the date
of submission, if approval is obtained at all. Significant delay or cost in
obtaining, or failure to obtain FDA clearance to market products, or any FDA
limitations on the use of the Company's products, could have a material
adverse effect on the business, financial condition and results of operations
of the Company.

In addition, the FDA's Good Manufacturing Practice ("GMP") regulations, as
set forth in the FDA's Quality System Regulation, must be adhered to with
respect to all of the products manufactured by the Company and its contract
manufacturers. Ongoing compliance with GMP and other applicable regulatory
requirements is monitored through periodic inspection by state and federal
agencies, including the FDA. The FDA may inspect the Company and its
facilities from time to time to determine whether the Company is in compliance
with regulations relating to medical device manufacturing companies, including
regulations concerning manufacturing, testing, quality control, record keeping
and product labeling practices.

FDA regulations depend heavily on administrative interpretation, and there
can be no assurance that future interpretations made by the FDA or other
regulatory bodies, with possible retroactive effect, will not adversely

9
<PAGE>

affect the Company. In addition, changes in the existing regulations or
adoption of new governmental regulations or policies could prevent or delay
regulatory approval of the Company's products.

Failure to comply with applicable regulatory requirements could result in,
among other things, warning letters, fines, injunctions, civil penalties,
recall or seizure of products, total or partial suspension of production,
refusal of the government to grant pre-market clearance or pre-market approval
for devices, withdrawal of approvals and criminal prosecution. Any of the
actions could result in adverse publicity for the Company and could damage the
Company's reputation.

A portion of the Company's revenue is dependent upon sales of its products
outside the U.S. Foreign regulatory bodies have established regulations
governing product standards, packaging requirements, labeling requirements,
import restrictions, tariff regulations, duties and tax requirements. After
June 1998, medical devices may not be sold in European Union ("EU") countries
unless they display the CE mark, an international symbol of adherence to
quality assurance standards and compliance with applicable European medical
device directives. In order to obtain the right to affix the CE mark to its
products, the Company must obtain and maintain certification that its
processes meet European quality standards, including certification that its
design and manufacturing facility complies with ISO 9001 standards. All of the
Company's products marketed in the countries comprising the trading members of
the EU have been CE marked. There can be no assurance that the Company will be
able to obtain CE mark certification for its new products. The inability or
failure of the Company or its international distributors to comply with
varying foreign regulations or the imposition of new regulations could result
in the restriction or, in certain countries, the prohibition of the sale of
the Company's products internationally and thereby adversely affect the
Company's business, financial condition and results of operations. See
"Business--Government Regulation."

The Company also is subject to various federal and state laws pertaining to
health care "fraud and abuse," including anti-kickback laws and false claims
laws. Anti-kickback laws make it illegal to knowingly and willfully offer,
pay, solicit or receive any remuneration (including any kickback, bribe or
rebate) directly or indirectly, overtly or covertly, in cash or in kind in
return for or to induce (a) the referral of an individual for the furnishing
or arranging for the furnishing of any item or service, or (b) the purchasing,
leasing, ordering, or arranging for (or recommending purchasing, leasing, or
ordering of) any good, facility, service, or item. False claims laws prohibit
anyone from knowingly and willfully presenting, or causing to be presented,
claims for payment that contain false or fraudulent information. Violations of
these laws are punishable by criminal and/or civil sanctions including, in
some instances, imprisonment and exclusion from participation in Federal
Health Care Programs, including Medicare and Medicaid. The Company has never
been challenged by a governmental authority under these laws and believes
that, based on this history, its operations are in material compliance with
such laws. However, because of the broad scope of some of these laws, there
can be no assurance that one or more of the Company's practices would not be
challenged by governmental authorities under certain of these laws, that the
Company would not be required to alter its practices as a result, or that the
occurrence of one or more of these events would not result in material adverse
effect on the Company's business, financial condition and results of
operations. See "Government Regulation--Health Care Fraud and Abuse."

Uncertainty Regarding Patents and Proprietary Rights. The Company's success
will depend in part on its ability to develop patentable products, obtain
patent protection for its products both in the U.S. and in other countries and
enforce its patents. The Company's competitive position and business
operations do not materially depend on any expired patents or patents expiring
in the near future. However, the patent positions of medical device companies
are generally uncertain and involve complex legal and factual questions. No
assurance can be given that patents will issue from any patent applications
owned by or licensed to the Company or that, if patents do issue, the claims
allowed will be sufficiently broad to protect the Company's technology. In
addition, no assurance can be given that any issued patents owned by or
licensed to the Company will not be challenged, invalidated or circumvented,
or that the rights granted thereunder will provide competitive advantages to
the Company. The enforceability of patents issued with respect to biomedical
products can be highly uncertain. Federal court decisions establishing legal
standards for determining the validity and scope of patents are in transition.
There can be no assurance that the historical legal standard surrounding
questions of validity and scope

10
<PAGE>

will continue to be applied or that current defenses as to issued patents in
the field will offer protection in the future. The Company also relies on
unpatented trade secrets to protect its proprietary technology, and no
assurance can be given that others will not independently develop or otherwise
acquire substantially equivalent techniques or otherwise gain access to the
Company's proprietary technology or that the Company can ultimately protect
meaningful rights to such unpatented proprietary technology.

The commercial success of the Company will also depend in part on its
neither infringing patents issued to others, nor breaching any licenses upon
which its products might be based. The Company's licenses of patents and
patent applications impose various commercialization, sublicensing, insurance,
royalty and other obligations on the Company. Failure of the Company to comply
with these requirements could result in termination of the licenses or
conversion of the licenses from being exclusive to nonexclusive in nature.

The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights. Litigation, which
would likely result in substantial cost to the Company, may be necessary to
enforce any patents issued or licensed to the Company and/or to determine the
scope and validity of others' proprietary rights. In particular, competitors
of the Company and other third parties hold issued patents and are assumed by
the Company to hold pending patent applications, which may result in claims or
infringement against the Company or other patent litigation. The Company also
may have to participate in interference proceedings declared by the U.S.
Patent and Trademark Office, which could result in substantial cost to the
Company, to determine the priority of inventions. Furthermore, the Company may
have to participate at substantial cost in International Trade Commission
proceedings to abate importation of products which would compete unfairly with
products of the Company.

The Company relies on confidentiality agreements with its collaborators,
employees, advisors, vendors and consultants. There can be no assurance that
these agreements will not be breached, that the Company would have adequate
remedies for any breach or that the Company's trade secrets will not otherwise
become known or be independently developed by competitors. Failure to obtain
or maintain patent and trade secret protection, for any reason, could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business--Patents, Trade Secrets and Proprietary
Rights."

Dependence upon Key Suppliers. Although the Company believes that there are
a number of possible vendors for most of the components and subassemblies
required for its products, certain materials, including thermoplastic
elastomer (TPE)-based materials and certain fluoropolymers used in certain of
its ventilation tubes, currently are obtained from a single source. Although
it is not presently the case, if the supply of materials from a single source
vendor were interrupted, replacement or alternative sources might not be
readily obtainable due to the regulatory requirements that the Company certify
as to the quality and suitability of the new or alternate material. In
addition, a new or supplemental filing with the FDA would be required to be
approved prior to the Company's marketing a product containing new material.
This approval process may take a substantial period of time, and there is no
assurance that the Company would be able to identify, certify or obtain the
necessary regulatory approval for the new material to be used in the Company's
products. In addition, certain suppliers could terminate or limit the sales of
certain materials to the Company for use in medical devices in an attempt to
limit their potential exposure to product liability claims. See "Business--
Suppliers."

Product Liability Risk; Limited Insurance Coverage. The manufacture and sale
of medical instrumentation entail significant risk of product liability claims
in the event that the use of such instrumentation is alleged to have resulted
in adverse effects on a patient. The Company has taken and will continue to
take what it believes are appropriate precautions, including maintaining
general liability and commercial liability insurance policies which include
coverage for product liability claims. There can be no assurance that the
Company's existing insurance coverage limits are adequate to protect the
Company from any liabilities it might incur in connection with the sale of its
products. In addition, the Company may require, or desire to obtain, increased
product liability coverage in the future. Product liability insurance is
expensive and in the future may not be available on acceptable terms, if at
all. A successful product liability claim or series of claims brought against
the Company in excess of its insurance coverage could have a material adverse
effect on the Company's business, financial

11
<PAGE>

condition and results of operations. Additionally, it is possible that adverse
product liability actions could negatively affect the Company's ability to
obtain and maintain regulatory approval for its products, as well as damage
the Company's reputation in any or all of the markets in which it
participates. See "Business--Product Liability and Insurance."

Environmental Matters. The past and present business operations of the
Company and the past and present ownership and operations of real property by
the Company are subject to extensive and changing federal, state, and local
environmental laws and regulations. The Company believes it is in material
compliance with all such applicable laws and regulations. The Company cannot
predict what environmental legislation or regulations will be enacted in the
future, how existing or future laws or regulations will be administered or
interpreted or what environmental conditions may be found to exist. Compliance
with more stringent laws or regulations or stricter interpretations of
existing laws may require additional expenditures by the Company, some of
which may be material.

Influence by Existing Stockholders. Following the consummation of this
offering, Warburg, Pincus Investors, L.P. ("WP Investors") will beneficially
own approximately 31.4% of the outstanding shares of Common Stock. A
stockholders agreement among the Company, WP Investors and certain other
stockholders provides that WP Investors has the right to designate specified
numbers of persons to the Company's Board of Directors so long as WP Investors
maintains specified levels of ownership of the outstanding Common Stock. WP
Investors currently has the right under the stockholders agreement to
designate three persons to be appointed or nominated to the Company's Board of
Directors. Following the consummation of this offering, WP Investors will have
the right under the stockholders agreement to designate two such persons. Such
share ownership and minority representation on the Company's Board of
Directors may confer upon WP Investors significant influence over the affairs
and actions of the Company. See "Principal and Selling Stockholders."

Shares Eligible for Future Sale. No prediction can be made as to the effect,
if any, that future sales of Common Stock, or the availability of Common Stock
for future sale, will have on the market price of the Common Stock prevailing
from time to time. Public or private sales of substantial amounts of the
Common Stock following this offering, or the perception that such sales could
occur, could adversely affect the market price of the Common Stock as well as
the ability of the Company to raise additional capital in the public equity
markets at a desirable time and price. Upon completion of this offering, the
Company expects to have 7,961,624 shares of Common Stock outstanding, assuming
no exercise of the Underwriters' over-allotment option. The 1,500,000 shares
of Common Stock sold in this offering will be freely tradeable without
restriction under the Securities Act of 1933, as amended (the "Securities
Act"), except for any such shares which may be acquired by an "affiliate" of
the Company as that term is defined in Rule 144 under the Securities Act,
which shares will be subject to the resale limitations of Rule 144. After this
offering, holders of 2,892,686 shares of Common Stock will have certain rights
with respect to the registration of such shares under the Securities Act. See
"Description of Capital Stock--Registration Rights." The Company may also
provide for the registration of shares currently held or acquired in the
future by employees pursuant to compensation arrangements, thereby permitting
such shares to be sold in the public market from time to time.

Anti-takeover Considerations. The Company's Restated Certificate of
Incorporation authorizes the issuance of Preferred Stock without stockholder
approval upon such terms as the Board of Directors may determine. The issuance
of Preferred Stock could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from acquiring or
making a proposal to acquire, a majority of the outstanding stock of the
Company and could adversely affect the prevailing market price of the Common
Stock. The rights of the holders of Common Stock will be subject to, and may
be adversely affected by, the rights of the holders of Preferred Stock that
may be issued in the future. The Company has no present plans to issue any
shares of Preferred Stock. In addition, the Company is subject to the
provisions of Section 203 of the Delaware General Corporation Law, which could
prohibit or delay a merger, takeover or other change in control of the Company
and therefore discourage attempts to acquire the Company. See "Description of
Capital Stock."

Absence of Dividends on the Common Stock. The Company does not anticipate
paying cash dividends on the Common Stock in the foreseeable future. See
"Dividend Policy."

12
<PAGE>

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 615,500 shares of
Common Stock offered by the Company are estimated to be approximately $17.1
million ($20.3 million if the Underwriters' over-allotment option is exercised
in full), after deducting estimated underwriting discounts and expenses. The
Company intends to use the net proceeds for business development and
expansion, working capital and other general corporate purposes. A portion of
the net proceeds may also be used for the acquisition of businesses, products
and technologies that are complementary to those of the Company. Although it
evaluates potential acquisitions from time to time, the Company has no
agreement, agreement in principle, understanding or arrangement with any
person to acquire or effect any material acquisition. Pending such uses, the
Company intends to invest the net proceeds in short-term, investment-grade,
interest-bearing securities.

The Company will not receive any proceeds from the sale of the 884,500
shares of Common Stock by the Selling Stockholders. See "Principal and Selling
Stockholders."

DIVIDEND POLICY

The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain any earnings to fund its business and therefore
does not anticipate paying cash dividends in the foreseeable future. In
addition, the Company's existing credit agreement restricts the Company's
ability to pay dividends to its stockholders, and it is anticipated that
future financing agreements will contain similar restrictions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

PRICE RANGE OF COMMON STOCK

The Common Stock is quoted on the Nasdaq National Market under the symbol
"XOMD." The Common Stock began trading on October 11, 1996. The following
tables sets forth, for the periods indicated, the high and low intra-day sale
prices of the Common Stock as reported by the Nasdaq National Market.

<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
YEAR ENDED DECEMBER 31, 1996
Fourth Quarter.................................................... $27.25 $18.00
YEAR ENDED DECEMBER 31, 1997
First Quarter..................................................... 20.00 11.75
Second Quarter.................................................... 20.13 15.25
Third Quarter..................................................... 24.63 18.63
Fourth Quarter.................................................... 24.00 19.75
YEAR ENDED DECEMBER 31, 1998
First Quarter..................................................... 29.38 21.00
Second Quarter.................................................... 33.25 26.00
Third Quarter (through July 14, 1998)............................. 33.63 31.00
</TABLE>

On July 14, 1998, the last reported sale price was $32.00 per share. As of
July 14, 1998, there were approximately 60 record holders of the Common Stock.
The Company has approximately 600 beneficial holders of the Common Stock.

13
<PAGE>

CAPITALIZATION

The following table sets forth as of March 28, 1998: (i) the capitalization
of the Company; and (ii) the capitalization of the Company as adjusted for the
sale by the Company of the 615,500 shares of Common Stock offered hereby.

<TABLE>
<CAPTION>
MARCH 28, 1998
-----------------------
AS
ACTUAL ADJUSTED
---------- -----------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Long-term debt:
Revolving credit facility........................... $ -- $ --
Shareholders' equity:
Common Stock, $0.01 par value, 30,000,000 shares
authorized; 7,342,524 shares issued and outstanding
actual, 7,958,024 shares issued and outstanding as
adjusted (1)....................................... 73 79
Non-Voting Common Stock, $0.01 par value, 4,000,000
shares authorized; no shares issued and outstanding
actual and as adjusted (2)......................... -- --
Accumulated deficit................................. (1,734) (1,734)
Additional paid-in capital.......................... 90,331 107,421
Cumulative translation adjustments.................. (142) (142)
Deferred stock compensation......................... (253) (253)
---------- -----------
Total shareholders' equity........................ 88,275 105,371
---------- -----------
Total capitalization............................ $ 88,275 $ 105,371
========== ===========
</TABLE>
- --------
(1) Excludes 832,291 shares of Common Stock issuable upon the exercise of
outstanding stock options having a weighted average exercise price of
$17.07 per share.
(2) On May 27, 1998, the Company eliminated the Non-Voting Common Stock from
the Company's authorized capital stock.

14
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The following table summarizes certain selected consolidated financial data,
which should be read in conjunction with the Company's Consolidated Financial
Statements and Notes thereto included elsewhere herein and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
Company, prior to April 15, 1994, consisted solely of Merocel Corporation. The
selected consolidated financial data for all years presented has been derived
from the Company's audited financial statements, which have been audited by
Ernst & Young LLP, the Company's independent auditors. The selected financial
data presented below as of and for the three months ended March 29, 1997 and
March 28, 1998 has been derived from the Company's unaudited financial
statements. In the opinion of management, the unaudited financial statements
have been prepared on the same basis as the audited financial statements and
include all adjustments, consisting of normal recurring adjustments, necessary
for a fair presentation of the financial condition and results of operations
as of such dates and for such periods.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED
------------------------------------------- -------------------
MARCH 29, MARCH 28,
1993 1994(1) 1995 1996 1997 1997 1998
------- ------- ------- ------- ------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Sales, net............. $10,071 $42,475 $59,865 $65,664 $77,240 $17,804 $20,682
Cost of sales.......... 2,876 15,350 22,256 25,926 30,475 7,160 8,063
Amortization of
acquisition costs
allocated to
inventory............. -- 3,883 919 -- -- -- --
------- ------- ------- ------- ------- ------- -------
Gross profit........... 7,195 23,242 36,690 39,738 46,765 10,644 12,619
Operating expenses:
Selling, general and
administrative........ 6,074 19,126 27,077 26,799 30,334 7,253 8,085
Research and
development........... 311 1,958 2,405 3,659 4,088 1,006 1,170
Amortization of
intangibles(2)........ 394 2,652 2,579 2,421 2,374 615 584
Write-off of acquired
research and
development(3)........ -- -- -- 2,380 -- -- --
Restructuring
charges(4)............ -- -- -- 3,093 -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating
expenses............. 6,779 23,736 32,061 38,352 36,796 8,874 9,839
------- ------- ------- ------- ------- ------- -------
Operating income (loss)
from continuing
operations............ 416 (494) 4,629 1,386 9,969 1,770 2,780
Interest income
(expense), net........ (102) (2,148) (3,063) (2,205) (104) (54) 30
Other income, net...... 26 313 114 525 234 92 40
------- ------- ------- ------- ------- ------- -------
Income (loss) from
continuing operations
before income tax
expense (benefit)..... 340 (2,329) 1,680 (294) 10,099 1,808 2,850
Income tax expense
(benefit)............. 121 (774) 1,355 873 3,969 721 1,125
------- ------- ------- ------- ------- ------- -------
Income (loss) from
continuing
operations............ $ 219 $(1,555) $ 325 $(1,167) $ 6,130 $ 1,087 $ 1,725
======= ======= ======= ======= ======= ======= =======
PER SHARE(5):
Income (loss) from
continuing operations
available to common
shareholders--basic... $ 0.75 $ (5.20) $ (3.53) $ 1.14 $ 0.84 $ 0.15 $ 0.23
======= ======= ======= ======= ======= ======= =======
Income (loss) from
continuing operations
available to common
shareholders--
diluted............... $ 0.75 $ (5.20) $ (3.53) $ (0.22) $ 0.82 $ 0.15 $ 0.23
======= ======= ======= ======= ======= ======= =======
Weighted average common
shares outstanding--
basic................. 291 818 1,009 2,755 7,323 7,289 7,342
======= ======= ======= ======= ======= ======= =======
Weighted average common
shares outstanding--
diluted............... 291 818 1,009 5,201 7,512 7,438 7,632
======= ======= ======= ======= ======= ======= =======
</TABLE>

15
<PAGE>

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------- MARCH 29, MARCH 28,
1993 1994 1995 1996 1997 1997 1998
------- ------- -------- ------- ------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........ $ 3,126 $12,744 $ 12,234 $18,460 $26,106 $20,562 $27,736
Cost in excess of net
assets acquired, net.. -- 54,300 46,381 44,389 42,399 43,892 41,901
Total assets........... 9,484 95,720 93,123 94,056 95,727 93,966 98,773
Long-term debt
including redeemable
preferred stock....... 11,308 89,985 90,488 3,563 -- 2,975 --
Total shareholders'
equity (deficit)...... (3,091) (7,336) (13,058) 79,567 86,509 81,843 88,275
</TABLE>
- --------
(1) Statement of Operations Data includes the results of operations of Xomed-
Treace, Inc. since the date of its acquisition by the Company in April
1994.
(2) Amortization of intangibles included in total operating expenses includes
amortization of foreign distribution rights of $838,000 and $162,000 for
the years ended December 31, 1994 and 1995, respectively.
(3) Research and development acquired in the purchase of TreBay. See Notes to
Consolidated Financial Statements--Note 1.
(4) Restructuring charge related to the combination of certain operations and
termination of employees. See Notes to Consolidated Financial Statements--
Note 7.
(5) Per share earnings--basic for 1994 and 1995 was reduced by accreted
preferred stock dividends of $3.30 and $3.85 per share, respectively, and
increased in 1996 by $1.56 per share related to dividend forgiveness. Per
share earnings--diluted was affected similarly in 1994 and 1995, but not
affected in 1996 due to the dilutive effect of the preferred shares using
the if converted method of calculating per share earnings when preferred
stock is outstanding.

16
<PAGE>

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

This Prospectus contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such differences include, but are not limited to, those discussed in "Risk
Factors."

OVERVIEW

The Company is a leading developer, manufacturer and marketer of a broad
line of surgical products for use by ENT specialists. The Company's broad line
of products includes, in its core ENT market, powered tissue-removal systems
and other microendoscopy instruments, implantable devices, nerve monitoring
systems and disposable fluid-control products. The Company also offers a line
of ophthalmic and other products. The Company distributes its products
worldwide through an 82-person direct sales organization in the U.S. and
selected other countries and through a network of over 130 independent
distributors.

BACKGROUND

The business of Xomed, Inc. was established in 1970 to manufacture and
distribute ventilation tube implants for the middle ear. In 1979, the business
was acquired by Bristol-Myers Squibb Company ("Bristol-Myers Squibb"). In
1989, Bristol-Myers Squibb acquired Treace Medical, Inc. and merged the two
companies together forming Xomed-Treace, Inc. On April 15, 1994, Bristol-Myers
Squibb sold Xomed-Treace, Inc. to the Company for a purchase price of
approximately $81.0 million (the "Xomed Acquisition"). The Company is a
Delaware corporation formerly known as Merocel/Xomed Holdings, Inc., which was
organized for the purpose of acquiring all of the outstanding stock of Merocel
Corporation ("Merocel"), Xomed-Treace, Inc. and Xomed-Treace, P.R. Inc.
(collectively, "Xomed-Treace"). Merocel, which was formed in 1970,
manufactures and markets a line of disposable fluid-control products primarily
used in sinus surgery and rhinology. The Company, prior to April 15, 1994,
consisted solely of Merocel.

In July 1995, the Company sold its surgical drapes segment to an unrelated
party and simultaneously acquired from this party several otology product
lines. In April 1996, the Company acquired TreBay, a microendoscopy products
company. The senior management of TreBay, including James T. Treace, F. Barry
Bays and Thomas E. Timbie, assumed senior management positions at the Company
at the time of the Company's acquisition of TreBay.

XOMED ACQUISITION

The Xomed Acquisition was accounted for under the purchase method of
accounting. Accordingly, the purchase price of approximately $81.0 million was
allocated to the assets acquired and liabilities assumed based upon their
respective fair values at the date of acquisition. The excess of the purchase
price over the fair market value of the net assets at the date of acquisition
of approximately $56.0 million was allocated to goodwill. Of this amount,
$49.9 million related to continuing operations and $6.1 million related to the
surgical drapes segment which was sold in July 1995 and has been presented as
discontinued operations. As a result, amortization of intangibles (over a 25-
year life) has been significantly increased. Further, the value of inventory
of continuing operations was increased by $4.8 million and was charged to cost
of goods sold for the 1994 period following the Xomed Acquisition ($3.9
million) and the first quarter of 1995 ($0.9 million) (the "Inventory
Valuation Adjustment"). These costs reduced gross profit in these periods.
Other intangible assets relating to foreign distribution rights were valued in
connection with the Xomed Acquisition and, as a result, amortization of
intangibles was increased by $0.8 million for the 1994 period following the
Xomed Acquisition and $0.2 million for the first quarter of 1995 (the
"International Distribution Rights Amortization"). In addition, interest
expense increased due to the increased borrowings to finance the Xomed
Acquisition.

The Xomed Acquisition and the Company's initial working capital were funded
primarily through the issuance of $43.5 million of preferred stock and from
the incurrence of approximately $45.9 million in long-term

17
<PAGE>

debt. In connection with the Xomed Acquisition, management implemented a
restructuring plan for Xomed-Treace that included closing certain
manufacturing operations in Puerto Rico and eliminating certain overhead in
other facilities.

CHANGE IN DISTRIBUTION CHANNELS

On January 1, 1996, the Company effected two changes in its product
distribution to focus the Company's resources on its core product lines of
sinus and rhinology, head and neck and otology. The first involved changing
from distributing its ophthalmic product line through its direct sales force
to distributing this line through an independent dealer network. The Company
effected this change to enable the Company's direct sales force to focus
exclusively on ENT products. As a result of this change, the Company's net
sales were approximately $2.1 million lower in 1996 than they would have been
if the ophthalmic product line had continued to be distributed through the
Company's direct sales force.

The second change involved moving the distribution of the Company's Merocel
fluid-control products from an independent dealer network to the Company's
U.S. direct sales force. The Company effected this change so that its entire
portfolio of ENT products could be distributed through a single distribution
channel focused exclusively on ENT products. As a result of this change, the
Company's net sales were approximately $1.2 million higher in 1996 than they
would have been if the Merocel product line had continued to be distributed
through independent dealers.

ACQUISITION OF TREBAY

The Company's acquisition of TreBay in April 1996 was accounted for under
the purchase method of accounting. Accordingly, the purchase price of
approximately $6.6 million was allocated to the individual assets acquired and
liabilities assumed, based upon their respective fair values at the date of
acquisition. The transaction resulted in cost in excess of net assets acquired
of $4.4 million, of which $2.4 million was allocated to in-process research
and development and charged to expense in the second quarter of 1996. The in-
process research and development was valued based upon an independent
valuation utilizing management's projections of cash flows and cost to achieve
technological feasibility of the products. The products acquired from TreBay
have either achieved technological feasibility or are no longer under
development and, therefore, no additional costs are required to achieve
technological feasibility.

RESTRUCTURING CHARGES

During the second quarter of 1996, the Company's new management team
initiated cost savings programs that resulted in the reduction of 50 employees
at the Company's three domestic locations. The reductions included 20
managerial and administrative employees at the Company's Mystic, Connecticut
manufacturing facility, 17 managerial and administrative employees at the
Company's Jacksonville, Florida headquarters and 13 managerial and production
employees at the Company's St. Louis, Missouri manufacturing facility that was
closed in December 1996. The restructuring eliminated redundant overhead at
the sites, and the Company expects these actions to yield cost savings
primarily in general and administrative expense. The Company incurred a
restructuring charge of approximately $3.1 million during the second quarter
of 1996 primarily to reflect the cost of the severance payments to terminated
employees. Most of the affected employees were terminated in the second
quarter of 1996 with severance beginning at that time. The Company had
completed its cost-saving programs as of December 31, 1997. See Notes to
Consolidated Financial Statements--Note 7.

INITIAL PUBLIC OFFERING

In October 1996, the Company completed its initial public stock offering,
raising proceeds of approximately $54.0 million through the sale of 2,875,000
shares of Common Stock. The net proceeds from the initial public offering were
used to repay the Company's term loan totaling $20.8 million including
interest, repay $8.2 million under its revolving line of credit and redeem
$25.0 million of its Redeemable Preferred Stock.

18
<PAGE>

OTHER RECENT EVENTS

In June 1998, the Company entered into a worldwide distribution and license
arrangement with ArthroCare Corporation ("ArthroCare"). The Company and
ArthroCare have signed a binding term sheet with the intention of reaching a
definitive agreement in the near future. ArthroCare has granted an exclusive
worldwide five-year license to the Company to distribute products into the ENT
market incorporating ArthroCare's Coblation(TM) technology. Coblation(TM) uses
radiofrequency (RF) energy to remove or shrink tissue through a cooler process
that is less traumatic than that of traditional electrosurgery or lasers. The
system consists of a controller which regulates the energy being delivered to
the surgical instrument and a variety of procedure specific disposable wands.
Under the agreed terms, the Company will work with ArthroCare to develop
products using this technology for application in sinus surgery, sleep apnea,
snoring relief, wrinkle removal and a less painful tonsillectomy procedure.
Products developed under the arrangement will be manufactured by ArthroCare
and distributed exclusively through the Company's direct sales force and
network of independent distributors. In December 1997, the Company introduced
the XPS 2000 StraightShot(R) micro resector system which includes enhancements
from the original XPS StraightShot system. In October 1997, the Company became
the exclusive distributor of articulating hand-held instruments (the Navigator
line) and micro resector blades for the ENT market and all areas of the
orthopaedic market except spine. The Company also entered into a distribution
agreement with the manufacturer of the Navigator granting that company
exclusive distribution rights for the Company's XPS StraightShot micro
resector system into the spine market. In July and August of 1997, the Company
introduced a number of new procedure specific curved micro resector blades
including the RAD 40 curved sinus blade, the RADenoid curved adenoid blade and
the RAD airway laryngeal blade. In December 1996, the Company appointed
Kobayashi Japan as its exclusive distributor of its full line of products
within Japan. In February 1997, the Company introduced the XPS StraightShot
micro resector system used in endoscopic sinus procedures.

SEASONALITY

The Company's sales and operating results have varied, and are expected to
continue to vary significantly from quarter to quarter as a result of seasonal
patterns. The Company believes that its business is seasonal in nature, with
the third quarter of each year typically having the lowest sales and the
fourth quarter of each year typically having the highest sales. There can be
no assurance that future seasonal fluctuations will not adversely affect the
Company's business, financial condition and results of operations.

FOREIGN CURRENCY EXPOSURE

For a discussion of the Company's foreign currency exchange rate risk and
the use of foreign currency forward exchange contracts to mitigate such
exposure, see Notes to Consolidated Financial Statements--Note 6.

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated certain items of
the Company's statements of operations as a percentage of the Company's net
sales:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31, THREE MONTHS ENDED
------------------- -------------------
MARCH 29, MARCH 28,
1995 1996 1997 1997 1998
----- ----- ----- --------- ---------
<S> <C> <C> <C> <C> <C>
Net sales........................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales....................... 38.7 39.5 39.5 40.2 39.0
Gross profit........................ 61.3 60.5 60.5 59.8 61.0
Selling, general and
administrative..................... 45.2 40.8 39.3 40.7 39.1
Amortization of intangibles......... 4.3 3.7 3.1 3.5 2.8
Research and development............ 4.0 5.6 5.3 5.7 5.7
Operating income from continuing
operations......................... 7.7 2.1 12.9 9.9 13.4
Income (loss) from continuing
operations......................... 0.5 (1.8) 7.9 6.1 8.3
</TABLE>

19
<PAGE>

SALES COMPOSITION

SALES BY MARKET

The Company derives sales from various markets within the ENT industry.
Sinus and rhinology, head and neck and otology are the three core markets in
which the Company operates. In addition to products for these markets, the
Company has other product offerings, including a line of ophthalmic products,
which the Company converted in January 1996 from distributing through its
direct sales force to distributing through independent dealers. The following
table summarizes the Company's worldwide product line sales during the periods
indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED
---------------------------- -------------------
MARCH 29, MARCH 28,
1995 1996 1997 1997 1998
-------- -------- -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
SALES:
Sinus and rhinology........ $ 17,038 $ 22,247 $ 28,848 $ 6,270 $ 8,481
Head and neck.............. 14,187 16,114 17,847 3,619 4,552
Otology.................... 12,406 13,841 14,465 3,862 4,132
-------- -------- -------- ------- -------
Total core business...... 43,631 52,202 61,160 13,751 17,165
Ophthalmic and other....... 16,234 13,462 16,080 4,053 3,517
-------- -------- -------- ------- -------
Total.................... $ 59,865 $ 65,664 $ 77,240 $17,804 $20,682
======== ======== ======== ======= =======
PERCENTAGE OF SALES:
Sinus and rhinology........ 28.5% 33.9% 37.4% 35.2% 41.0%
Head and neck.............. 23.7 24.5 23.1 20.3 22.0
Otology.................... 20.7 21.1 18.7 21.7 20.0
-------- -------- -------- ------- -------
Total core business...... 72.9% 79.5% 79.2% 77.2% 83.0%
Ophthalmic and other....... 27.1 20.5 20.8 22.8 17.0
-------- -------- -------- ------- -------
Total.................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
</TABLE>

20
<PAGE>

SALES BY GEOGRAPHIC MARKET

The Company distributes its products worldwide through an 82-person direct
sales force in the U.S. and selected other countries and through a network of
over 130 independent distributors. The Company's core ENT products are sold in
the U.S. on a direct sales basis only.

Approximately 29.4%, 32.0% and 30.3% of the Company's net sales in 1995,
1996 and 1997, respectively, were made outside the U.S. through direct
operations in the United Kingdom, Canada, France, Germany and Australia, as
well as through over 100 independent international distributors, many of whom
distribute the Company's products exclusively. The portion of sales made
outside the U.S. in 1997 and in the first quarter of 1998 was lower than in
1996 primarily due to international markets only having six months of sales
from the Company's new XPS system compared with the twelve months in the U.S.
(due to a later international introduction date) as well as to the unfavorable
effects of foreign currency rate comparisons in international markets in 1997
(due to the fact that the foreign currencies were weaker against the U.S.
dollar in 1997 than in 1996). The following table summarizes the Company's
U.S. and international sales for the periods indicated:

For additional information concerning the Company's sales by geographic
market, see Notes to Consolidated Financial Statements--Note 17.

SALES BY PRODUCT TYPE

The Company places particular emphasis on disposable products and
implantable devices. One of the Company's principal goals is to continue to
develop additional disposable products for use with its instrumentation
systems. The portion of sales from disposable and implantable products was
lower in 1997 than 1996 primarily due to the introduction of new orthopaedic
instrument sales in 1997 and the initial introduction of the XPS system. The
XPS system initially generated equipment sales followed by on-going disposable
revenues in later periods. The following table summarizes the Company's sales
of equipment and instrumentation products as well as disposable and
implantable products for the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED
---------------------------- -------------------
MARCH 29, MARCH 28,
1995 1996 1997 1997 1998
-------- -------- -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
SALES:
Equipment
and instrumentation
products................. $ 9,396 $ 10,178 $ 15,768 $ 3,052 $ 3,833
Disposable and implantable
products................. 50,469 55,486 61,472 14,752 16,849
-------- -------- -------- ------- -------
Total................... $ 59,865 $ 65,664 $ 77,240 $17,804 $20,682
======== ======== ======== ======= =======
PERCENTAGE OF SALES:
Equipment and
instrumentation
products................. 15.7% 15.5% 20.4% 17.1% 18.5%
Disposable and implantable
products................. 84.3 84.5 79.6 82.9 81.5
-------- -------- -------- ------- -------
Total................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
</TABLE>

21
<PAGE>

THREE MONTHS ENDED MARCH 28, 1998 COMPARED TO THREE MONTHS ENDED MARCH 29,
1997

Net Sales. Net sales increased 16.2% to $20.7 million in the first three
months of 1998 from $17.8 million in the comparable period in 1997. In the
core business of sinus and rhinology, head and neck and otology, sales
increased 24.8% over the prior comparable period. The increase in core
business sales was primarily the result of sales generated from several new
products introduced principally over the last 15 months, including within
sinus and rhinology, the XPS tissue removal system and within head and neck,
the NIM-2(R) XL nerve monitoring system and the Company's Powerforma surgical
drill system. Sinus and rhinology and head and neck sales were up 35.3% and
25.8%, respectively, in the first quarter of 1998 over the prior comparable
period. Sales in the ophthalmic and other category decreased 13.2% primarily
due to an approximate $500,000 decrease in sales of orthopaedic instruments in
the first quarter of 1998 over the prior comparable period which included a
large initial stocking order to an OEM distributor. Sales of these orthopaedic
instruments to this distributor are expected to resume during the second half
of 1998. Domestic sales in the core businesses of sinus and rhinology, head
and neck and otology increased 27.6% and international sales in such core
businesses increased 18.5% in the first three months of 1998 over the prior
comparable period. Total international sales increased 9.7% for the quarter or
14.2% excluding the unfavorable effects of foreign currency comparisons (due
to the fact that the foreign currencies were weaker against the U.S. dollar in
1997 than in 1996). The Company experienced reduced sales during the quarter
in the Asia/Pacific region where sales decreased 21.1% from the prior year's
first quarter primarily due to adverse economic conditions. Strong product
sales, however, were reported in several European countries including the U.K.
and Germany where sales increased 45.1% and 70.1%, respectively, for the
quarter. International sales represented 29.1% of total sales for the first
three months of 1998 compared to 30.9% in the comparable period of 1997.

Cost of Sales and Gross Profit. Cost of sales increased 12.6% to $8.1
million, or 39.0% of sales in the first three months of 1998 from $7.2
million, or 40.2% of sales in the first three months of 1997. The decrease in
cost of goods sold as a percent of sales is primarily due to the decrease in
sales of lower margin products, such as the orthopaedic instrument line, and
partially due to a lower per unit cost that resulted from manufacturing costs
being spread over a higher volume of production. Gross profit as a percent of
sales increased to 61.0% in the first three months of 1998 from 59.8% in the
prior comparable period.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 11.5% or $832,000 in the first three months
of 1998 from the comparable period in 1997. The increase in total selling,
general and administrative expenses is primarily due to variable selling and
marketing costs, which comprised approximately $700,000 of the increase. As a
percent of sales, selling, general and administrative expenses decreased to
39.1% of sales for the first three months of 1998 from 40.7% in the comparable
period of 1997.

Research and Development. Research and development expenses increased 16.3%
to $1.2 million in the first three months of 1998 from $1.0 million in the
comparable period of 1997, and as a percent of sales was 5.7% for the 1998 and
1997 periods.

Amortization. Amortization expense in the first three months of 1998 and
1997 related principally to approximately $49.9 million of goodwill related to
continuing operations generated from the Xomed Acquisition in April 1994,
which is being amortized over 25 years.

Interest and Other. Interest income (expense), net in the first quarter of
1998 reflected income of $30,000 as compared to expense of $54,000 in the
comparable quarter of 1997 due to having an average invested amount of
approximately $3.0 million in the first quarter of 1998 as compared to
borrowing levels of approximately $3.0 million in the first quarter of 1997.
Other income was $40,000 for the first three months of 1998 compared to
$92,000 for the comparable period of 1997. Prior year other income included
income received from a third party related to a non-compete agreement
violation.

Income Taxes. The Company's effective tax rate was 39.5% for the first three
months of 1998 and 39.9% for the prior comparable period.

22
<PAGE>

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

Net Sales. Net sales increased 17.6% to $77.2 million in 1997 from $65.7
million in 1996. When compared to the comparable quarters in 1996, the Company
generated sales growth in 1997 of 9.2% in the first quarter, 15.4% in the
second quarter, 17.7% in the third quarter and 27.9% in the fourth quarter.
The improvement in sales growth in each successive quarter of 1997 relates
principally to accelerating growth in the Company's sinus and rhinology
product lines as a result of the introduction of its XPS StraightShot system
and an overall improvement in the Company's international business in the
third and fourth quarters due to recent new product introductions and
improving availability of funding in certain international health care systems
in which the Company competes. In the core businesses of sinus and rhinology,
head and neck and otology, sales increased 17.2% in 1997 over 1996, which
resulted in these product lines representing 79.2% of the Company's revenue in
1997 as compared to 79.5% in 1996. Total domestic sales increased 20.5% in
1997 compared with 1996, and international sales increased 11.5% in 1997
compared with 1996. Excluding the unfavorable effects of foreign currency
comparisons (due to the fact that the foreign currencies were weaker against
the U.S. dollar in 1997 than in 1996), international sales in 1997 increased
15.0% from 1996.

Cost of Sales. Cost of sales increased 17.5% to $30.5 million in 1997 from
$25.9 million in 1996. As a percent of sales, cost of sales was 39.5% in 1997
and 1996. Similarly, gross profit was 60.5% for both 1997 and 1996. The margin
in 1997 was adversely affected by higher volumes of lower margin products,
including the orthopaedic instrument line, which was offset by higher margins
in its sinus and rhinology business attributable to new product introduction.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 13.2% to $30.3 million from $26.8 million in
1996. For 1997, as a percent of sales, selling, general and administrative
expenses were 39.3%, as compared to 40.8% in 1996. This decrease, as a percent
of sales, is due to increasing sales and the leveraging of general and
administrative expenses.

Research and Development. Research and development expenses increased 11.7%
to $4.1 million in 1997 from $3.7 million in 1996 but decreased as a percent
of sales to 5.3% in 1997 from 5.6% during 1996. Major new product spending in
1997 related to straight and curved cutter blades, enhancements to the XPS
micro resector system and the introduction of the XPS 2000 StraightShot(R)
micro resector system in December 1997, as well as other projects.

Amortization. Amortization expense in 1997 and 1996 related principally to
approximately $49.9 million of goodwill related to continuing operations
generated from the Xomed Acquisition in April 1994, which is being amortized
over 25 years.

Operating Income. Operating income for 1997 was $10.0 million compared to
$1.4 million for 1996. After adding back restructuring and write-off charges,
which occurred only in 1996, operating income for 1996 was $6.9 million. For
1997, operating income, as a percent of sales, was 12.9% compared to 10.4% for
1996. This increase as a percent of sales related to fixed amortization
expense and semi-fixed expenses within the general and administrative
category.

Interest and Other. Interest expense decreased 88.3% to $280,000 for 1997
from $2.4 million in 1996 due to lower average debt levels during 1997. Other
income, net was $234,000 for 1997 compared to $525,000 in 1996. This decrease
of $291,000 related principally to the expiration of a royalty agreement in
late 1996.

Income Taxes. The Company's effective tax rate for 1997 was 39.3% and the
Company had tax expense of $873,000 on a loss of $294,000 for the year ended
December 31, 1996. The Company incurred tax expense instead of tax benefit on
the loss in 1996 due principally to the lack of a tax benefit related to the
write-off of in-process research and development costs, described above.

23
<PAGE>

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

Net Sales. Net sales increased 9.7% to $65.7 million in 1996 from $59.9
million in 1995. In the core businesses of sinus and rhinology, head and neck
and otology, sales increased 19.6% in 1996 over 1995, which resulted in these
product lines representing 79.5% of the Company's revenue in 1996 as compared
to 72.9% in 1995. The increase in sales was principally the result of several
new products introduced late in 1995 and in 1996 including the Company's
Wizard and Wizard Plus(R) powered tissue-removal systems, the BOSS line of ENT
hand instruments, the Activent anti-microbial vent tube line, an otology
implant line acquired in the third quarter of 1995 and a line of facial
implant products. In addition, several existing product lines showed strong
sales growth over the prior period including the Merocel fluid-control
products and nerve monitoring systems. The increase in Merocel products sales
was due partly to price increases resulting from moving the distribution of
these products, effective on January 1, 1996, from an independent dealer
network to the Company's U.S. direct sales force. Sales in this line would
have been approximately $1.2 million lower in 1996 without this distribution
channel change. Sales were adversely affected, however, by a change in the
distribution system for the Company's ophthalmic product line. On January 1,
1996, the Company commenced distribution of its ophthalmic line through an
independent dealer network, with the Company selling to dealers at wholesale
prices. During 1995, these products were distributed through the Company's
direct sales force at retail pricing. This change was made to better focus the
direct sales force on the ENT market. Although unit volume in the ophthalmic
business grew approximately 7% during the year, net sales decreased
approximately $2.1 million in 1996 as a result of the price differential from
changing the distribution channel. Associated ophthalmic operating expenses
also declined. Sales also increased in several other product lines due to
increased penetration of international markets through recently established
direct sales sites. International sales increased 19.3% during the period and
represented 32.0% of the Company's revenue in 1996 compared to 29.4% in 1995.

Cost of Sales and Gross Profit. Cost of sales increased 11.9% to $25.9
million in 1996 from $23.2 million in 1995. As a percent of sales, cost of
sales increased to 39.5% in 1996 from 38.7% in 1995. In accounting for the
Xomed Acquisition, the Company effected the Inventory Valuation Adjustment in
which a portion of the excess cost of the acquisition over book value of the
net assets acquired was allocated to inventory. This allocation resulted in an
increase in inventory value of $5.3 million, of which $4.8 million was
allocated to the inventory of continuing operations. The inventory valued on
this basis was charged to cost of sales on a FIFO basis as it was sold,
increasing cost of sales in 1995 by $0.9 million. No such adjustment affected
1996. Without this charge, cost of sales would have increased 16.5% to $25.9
million in 1996 from $22.3 million in the prior comparable period, and cost of
sales as a percent of sales would have increased to 39.5% in 1996 from 37.2%
in the prior comparable period. This increase was primarily due to the change
in the distribution method described above for the ophthalmic line, which
resulted in lower average selling prices. This increase was partially offset
by the change in the distribution of the Merocel product line, which resulted
in a higher average selling price. Gross profit as a percent of sales
decreased to 60.5% in 1996 from 61.3% in 1995. Without the effects of the
Inventory Valuation Adjustment discussed above, gross profit as a percent of
sales would have decreased to 60.5% in 1996 from 62.8% in the prior comparable
period for the reasons discussed above.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased 1.0% to $26.8 million in 1996 from $27.1
million in 1995. This decrease was primarily due to cost savings realized as a
result of the previously discussed restructuring actions. See "--Overview."
These savings were partially offset by commissions on a larger sales base, an
increase in the average commission rate, the operating expenses of a new
direct sales subsidiary in Germany, which began operations in the first
quarter of 1996, and promotional expenses related to the Company's line of
sinus endoscopy systems. As a percent of sales, selling, general and
administrative expenses decreased to 40.8% in 1996 from 45.2% in 1995.

Research and Development. Research and development expenses increased 52.1%
to $3.7 million in 1996 from $2.4 million in 1995 and increased as a percent
of sales to 5.6% from 4.0% during the prior comparable period. This increase
is primarily the result of project expenses related to the development of the
new XPS powered tissue-removal system and the Powerforma drill system.
Although it has in the past relied in part on strategic acquisitions and
licensing of third-party technology to develop its broad line of ENT products,
the

24
<PAGE>

Company believes it has a strong base of proprietary engineering,
manufacturing and bio-material capabilities upon which to build its future
research and development efforts.

Amortization. Amortization expense in 1996 and 1995 related principally to
approximately $49.9 million of goodwill related to continuing operations
generated from the Xomed Acquisition in April 1994, which is being amortized
over 25 years.

Write-off of Acquired Research and Development. The TreBay acquisition was
accounted for under the purchase method of accounting. Accordingly, the
purchase price of approximately $6.6 million was allocated to the individual
TreBay assets acquired and liabilities assumed based upon their respective
fair values at the date of acquisition. The transaction resulted in cost in
excess of net assets acquired of approximately $4.4 million, of which $2.4
million was allocated to in-process research and development and charged to
expense in the second quarter of 1996.

Restructuring Charges. As noted previously under "--Overview," the Company
initiated cost savings programs and recorded a restructuring charge of
approximately $3.1 million during the second quarter of 1996 primarily to
reflect the cost of the severance payments to terminated employees.

Interest and Other. Interest expense decreased to $2.4 million in 1996 from
$3.1 million in 1995. Interest expense related principally to the Company's
secured term loan (the "Term Loan") borrowings, which were repaid in October
1996 from the net proceeds of the Company's initial public offering, and the
Company's secured revolving credit facility (the "Revolving Credit Facility")
as described below in "--Liquidity and Capital Resources." Other income of
$525,000 in 1996 was $411,000 higher than in 1995 related principally to
royalty income on a product licensed to a third party.

Income Taxes. The Company's tax expense of $873,000 on a $294,000 loss for
the year ended December 31, 1996 varies from an effective tax rate of
approximately 40% due to the lack of tax benefit related to the write-off of
in-process research and development costs, described above. Tax expense for
the comparable period of 1995 was $1.4 million on income of $1.7 million for
an effective tax rate of 80.7%. The tax rate for 1995 was higher than 40% due
to losses recorded on a less than 80% owned subsidiary and losses incurred in
foreign subsidiaries for which a valuation account was provided on the
potential carry forward benefit.

LIQUIDITY AND CAPITAL RESOURCES

The Company historically has financed its operations (including capital
expenditures) through cash flows from operations. Since the Xomed Acquisition
in April 1994, which was financed in part by the incurrence of $45.9 million
of debt under the Term Loan and the Revolving Credit Facility, all cash flow
generated from operations has been applied to repay the outstanding principal
on the Term Loan or the Revolving Credit Facility. In October 1996, the
Company completed its initial public offering, the net proceeds of which were
used to repay the entire Term Loan and the majority of debt outstanding under
the Revolving Credit Facility. During 1997, the Company paid the remaining
portion of the Revolving Credit Facility and long-term capital lease
obligation totaling $3.6 million at December 31, 1996. Consequently, interest
expense has been substantially reduced.

During the three months ended March 28, 1998, the Company generated cash of
$2.8 million in operating activities as compared with a use of $80,000 from
operating activities in the comparable period of 1997. In the first three
months of 1998, cash generated from inventory, accounts receivable and
accounts payable was approximately $100,000 compared to a use of $2.1 million
within these accounts in the comparable period of 1997. Increases in inventory
and accounts receivable due to growth in sales were offset by increases in
accounts payable and accrued expenses due to the timing of payments. The
Company expects that in the future, the growth in these operating assets will
outpace the growth in current liabilities and will create a demand on cash
within these accounts.

25
<PAGE>

Cash used in investing activities was $0.7 million in the first three months
of 1998 as compared to cash used in investing activities of $0.3 million in
the prior comparable period. Capital expenditures were $659,000 and $448,000
in the first three months of 1998 and 1997, respectively.

The Company expects to spend approximately $7.0 million in 1998 on capital
acquisitions, related principally to its corporate headquarters expansion. The
corporate headquarters expansion will enable the Company to consolidate leased
warehouse and office space in Jacksonville, and provide additional office and
manufacturing space. See "Business--Properties." The Company expects to fund
this level of expenditure with cash from operations.

Cash provided by financing activities was $67,000 in the first three months
of 1998 as compared with $444,000 in the comparable period of 1997. These
amounts relate principally to the exercise of stock options.

For the year ended December 31, 1997, the Company generated cash of $6.4
million from operating activities as compared with $4.8 million cash generated
in the prior year. In 1997, the Company had a net use of cash of approximately
$6.6 million within inventory, accounts receivable and accounts payable as
compared to a net use of cash within these components of operations (after
excluding a $1.7 million non-recurring account receivable from one customer)
of approximately $3.0 million in 1996. Accounts payable and accrued expenses
comprised a significant amount of this use of cash during 1997, due to a
$900,000 decrease from December 31, 1996, related principally to payments of
amounts related to the Company's initial public offering. The balance of the
use of cash within these working capital accounts stems from the Company's
growth in sales and related increase in accounts receivable and inventories.
In addition, payments related to the $3.1 million restructuring charge
recorded during the second quarter of 1996 lowered cash flow from operations
in 1997 by $1.2 million, which was offset by a reduction of deferred tax
assets.

Cash used in investing activities was $2.3 million in 1997 as compared to
cash used of $2.1 million (after eliminating the effects of cash acquired in a
business combination) in the prior year. Capital expenditures were $2.4
million in 1997 and 1996. Included in capital expenditures for 1997 was a
significant upgrade of the Company's computer system totaling approximately
$400,000. This purchase did not produce an increase over 1996 purchases due to
the purchase of capital assets in 1996 for the start-up of the Company's
subsidiary in Germany.

Cash used in financing activities was $3.0 million in 1997 as compared with
$4.5 million in 1996. The Company received cash from the exercise of stock
options of $655,000 in 1997 and reduced its long-term debt during 1997 by
approximately $3.6 million. In the first nine months of 1996, the Company made
payments under the then outstanding Term Loan and its capital lease obligation
of $4.1 million, and borrowed a net $1.4 million from its line of credit. In
the fourth quarter of 1996, the Company completed its initial public offering
and repaid the Term Loan and the majority of the debt outstanding under the
Revolving Credit Facility.

In the fourth quarter of 1997, the Company began hedging its intercompany
foreign currency receivables. See Notes to Consolidated Financial Statements--
Note 6.

In May 1997, the Company amended and restated the Revolving Credit Facility
to provide that the Company may borrow up to $25.0 million for working capital
needs and potential acquisitions. See Notes to Consolidated Financial
Statements--Note 8.

Based on the Company's ability to generate cash flow from operations and
with the availability of borrowing under its Revolving Credit Facility, the
Company believes that it will be able to finance its working capital and
expansion needs for the next 24 months.

YEAR 2000 ISSUE

The Company has assessed and continues to assess the impact of the Year 2000
issue on its operations, including the development and implementation of
project plans and cost estimates required to make its

26
<PAGE>

information systems infrastructure Year 2000 compliant. The Company's focus on
this issue is to ensure there is no adverse effect on business operations and
that transactions with customers, suppliers, and financial institutions are
fully supported. Additionally, the Company has initiated communications with
significant suppliers, customers and other third parties to determine their
Year 2000 readiness. Furthermore, the Company has initiated a formal program
to advise customers of the Year 2000 issue; however, the Company believes it
has no material exposure to contingencies related to the Year 2000 issue for
the products it has sold. While the Company has taken these steps, there can
be no certainty that the systems and products of other companies on which the
Company relies will not have a material adverse effect on the Company's
operations. Based on existing information, the Company believes the
anticipated spending to become Year 2000 compliant will not have a material
adverse effect on the Company's financial condition, cash flows or results of
operations.

27
<PAGE>

BUSINESS

OVERVIEW

Xomed is a leading developer, manufacturer and marketer of a broad line of
surgical products for use by ENT specialists. The Company's core ENT products
include powered tissue-removal systems and other microendoscopy instruments,
implantable devices, nerve monitoring systems and disposable fluid-control
products. The Company also offers a line of ophthalmic and other products. For
the year ended December 31, 1997, Xomed derived approximately 80% of its
revenues from disposable or implantable products. The Company distributes its
products worldwide through an 82-person direct sales organization in the U.S.
and selected other countries and through a network of over 130 independent
distributors. Xomed is the only major manufacturer and marketer of ENT
surgical products with a direct U.S. sales force exclusively serving ENT
specialists. Approximately 30% of the Company's net sales was derived from
international markets for the year ended December 31, 1997. Approximately 29%
of the Company's net sales in 1997 in its core ENT product line was derived
from products introduced within the last three years. With over 25 years of
industry experience, Xomed believes that it has established a long-standing
reputation for innovative, high-quality products and is uniquely positioned as
the only major surgical products company focused on the ENT market.

The ENT market is in the midst of a conversion from conventional surgical
approaches to less-traumatic approaches that involve the use of advanced
surgical tools, such as powered tissue-removal systems and small-diameter
surgical endoscopes, thereby minimizing patient trauma and reducing procedure
times. Xomed believes that the adoption of these less-traumatic techniques is
being driven by several factors, including economic pressures and patient
demand. Minimally invasive techniques have the potential to increase the
number of ENT procedures that can be performed in lower-cost outpatient or day
surgery settings. Patient demand is likely to increase due to the reduced
morbidity and improved outcomes of these less invasive ENT procedures. Xomed
believes that the conversion in the ENT market to less-traumatic approaches
will be similar to recent conversions in the general surgery market to less
invasive techniques and in the orthopaedic surgery market to powered
instrumentation systems.

INDUSTRY BACKGROUND

More than an estimated 20,000 ENT specialists, also known as
otorhinolaryngologists, currently practice in the U.S., Canada, Western
Europe, Japan, Australia, South America and the Middle East (collectively,
"worldwide"), with approximately 9,000 of those specialists practicing in the
U.S. ENT practitioners specialize in the diagnosis and treatment of diseases
and conditions affecting the ear, nose and throat. ENT surgeons are also
typically experts in tumor-related diseases of the head and neck.
Increasingly, ENT surgeons are expanding their practices to include facial
plastic and reconstructive surgery. Of the estimated 9,000 ENT specialists in
the U.S., approximately 3,300 currently practice facial plastic and
reconstructive surgery.

Diseases and conditions addressed by ENT specialists affect sizable patient
populations. The Company estimates that ENT surgeons performed over three
million procedures in the U.S. in 1996. The following chart summarizes common
conditions currently treated by ENT surgeons and the Company's estimates of
the number of procedures performed in the U.S. in 1996.

28
<PAGE>

<TABLE>
<CAPTION>
NUMBER OF
ENT PROCEDURES IN
SUBSPECIALTY INDICATION/CONDITION PROCEDURE U.S. IN 1996
- ------------ -------------------- --------- -------------
<S> <C> <C> <C>
Sinus and Chronic sinusitis (sinus Sinus surgeries 406,000
rhinology inflammation)
(nose)
Cosmetic reconstruction, Septoplasty/rhinoplasty 154,000
trauma or congenital
defects
Head and Chronic infection of tonsils Tonsillectomy/adenoidectomy 736,000
neck or adenoids
Vocal cord polyps or lesions Surgical removal 80,000
Acoustic neuromas or mastoid Skull-base surgery 135,000
infection
Facial cosmetic augmentation Face lifts/facial 73,000
sculpting/brow lifts
Chronic snoring or sleep Uvulopharyngoplasty 95,000
disorders
Otology Acute otitis media (middle Myringotomy with vent tubes 1,216,000
(ear) ear infection)
Conductive hearing loss Middle ear reconstruction 155,000
and other middle ear
procedures
</TABLE>

MARKET OPPORTUNITY

ENT procedures currently pose the following challenges:

(i) in many of these procedures, the target tissue is adjacent to critical
anatomy, including the brain, sensory centers and facial motor nerves,
limiting the surgeon's maneuverability and requiring very small,
precise movements;

(ii) the anatomy in the region generally contains many blood vessels,
leading to significant blood loss during surgery that may obscure the
surgeon's vision, as well as increase patient complications, or
morbidity;

(iii) the affected areas are often very small in size and require the
surgeon to perform microsurgery through the use of magnifying devices
such as small-diameter surgical endoscopes ("microendoscopy"); and

(iv) the affected areas are often behind significant bony structures,
including the skull, the penetration of which can entail significant
patient trauma and lengthy procedure times.

Conventional hand-held surgical instruments typically used during ENT
procedures do not provide the surgeon with sufficient power or precision to
minimize trauma and blood loss during the procedure and can contribute to
unnecessary pain, swelling and scarring following the procedure. In addition,
the need to repeatedly remove and reinsert conventional hand-held
instrumentation from the surgical site during procedures can increase patient
trauma and operating time. The Company believes that the limitations of
conventional hand-held surgical instruments create a significant opportunity
for the development of instruments designed for specific ENT procedures,
including powered tissue-removal instrumentation and visualization products,
that will make these procedures easier and faster to perform and less
traumatic to the patient.

The Company believes that the following factors will drive growth in the
market for surgical instruments, devices and supplies for ENT surgeons:

Advancements in Procedure-Specific Instrumentation. The Company believes
that the introduction of new tools and instrumentation is enabling ENT
surgeons to better address the current challenges of ENT procedures. For
example, powered cutting devices adapted for use in particular surgical
procedures allow surgeons to cut and extract tissue and penetrate bone with
more speed, control and precision than conventional hand-held instruments,
thereby minimizing patient trauma and reducing procedure times. The blades for
these newly

29
<PAGE>

developed powered cutting devices are disposable, and thus sales of these
blades represent a significant portion of the market growth of these devices.
By providing ENT surgeons with greater access to difficult-to-reach surgical
sites and reducing trauma to the patient, new procedure-specific instruments
potentially will increase the total number of procedures performed.

Clinical and Cost Benefits for Patient, Surgeon and Payor. The Company
believes that the adoption of less-traumatic ENT procedures is being driven,
in part, by economic pressures. Due to the reduced patient morbidity
associated with less-traumatic techniques, certain procedures previously
performed in hospitals and requiring longer stays can now be performed in
lower-cost outpatient or day surgery settings. In addition, powered tissue-
removal instrumentation allows for reduced operating times.

Demand from Significant Patient Populations. Sizable patient populations
suffer from conditions which can be treated by ENT surgical procedures. As
less-traumatic instrumentation and techniques become available, the portion of
these patients who will elect to undergo these procedures is likely to
increase. In particular, patient demand for endoscopic sinus surgery as well
as facial plastic surgery will, in the Company's view, increase as the pain
and morbidity associated with these procedures decrease due to better
instrumentation and techniques.

Ease of Market Conversion. The Company believes that ENT surgeons are
readily adopting new devices and instrumentation designed to meet the
challenges of specific surgical procedures because of the advantages they
offer over conventional instrumentation. The Company further believes that
physicians require minimal additional training (usually two to three days) to
use these instruments. In addition to its functional advantages, powered
instrumentation should, in the Company's view, be attractive to ENT surgeons
because it requires only a relatively modest (approximately $10,000) capital
investment.

STRATEGY

Xomed's objective is to enhance its leading position in the ENT market and
to enter new markets. The Company's strategy for achieving this objective is
to:

Increase its Penetration of the ENT Market. The Company believes that, as
the only major provider of surgical products with a direct sales force
exclusively serving the ENT surgeon, it is well positioned to participate in
any growth in the ENT surgical market. The Company intends to continue to
develop and maintain close relationships with ENT specialists from whom it has
gained significant brand recognition and loyalty. The Company believes that it
presently sells products to substantially all of the ENT specialists in the
U.S. Accordingly, the Company believes that a significant opportunity exists
to leverage these relationships with new and existing products and therefore
increase penetration of its existing customer base.

Facilitate ENT Market Conversion to Less-Traumatic Approaches. The ENT
market is in the midst of a conversion to less-traumatic approaches that is
similar to recent conversions in the general surgery market to less invasive
techniques and in the orthopaedic surgery market to powered instrumentation
systems. The Company intends to facilitate conversion of high-volume ENT
procedures to less-traumatic techniques. The procedures targeted by the
Company include sinus surgery, the removal of adenoids, laryngeal procedures,
face and brow lifts and facial sculpting. As part of facilitating this
conversion, the Company is continuing its collaborative efforts with leading
ENT surgeons to create products that allow physicians to re-engineer standard
operating procedures to reduce patient trauma and operating time. The Company
believes that the continued advance in powered tissue-removal instrumentation
systems for use in ENT procedures will play a central role in this conversion
and accordingly will continue in its efforts to develop and introduce such
powered instrumentation.

Emphasize Product Innovation through Internal Research and Development. The
Company plans to develop new proprietary products and product enhancements
primarily through internal research and

30
<PAGE>

development efforts. The Company will invest significantly in research and
development in an effort to introduce technological advancements in the ENT
market.

Maintain a Broad Line of ENT Products with Particular Emphasis on Disposable
and Implantable Products. The Company seeks to maintain a broad product line
that addresses all of the surgical needs of ENT specialists. The Company's
current product line consists of approximately 4,000 stock keeping units
(SKUs), including equipment, disposable products and implantable devices. The
Company places particular emphasis on disposable products and implantable
devices, which represented approximately 80% of the Company's sales in 1997.
One of the Company's principal goals is to continue to develop additional
disposable products for use with its instrumentation systems.

Expand its Global Distribution Network. The Company believes that
significant growth opportunities exist through the expansion of its global
distribution network. The Company distributes its products worldwide through
an 82-person direct sales force in the U.S. and selected other countries and
through a network of over 130 independent distributors. The Company's core ENT
products are sold in the U.S. only on a direct sales basis. Approximately 30%
of its net sales in 1997 was made outside the U.S. through direct operations
in the United Kingdom, Canada, France, Germany and Australia, as well as
through over 100 independent international distributors, many of whom
distribute the Company's products exclusively.

Leverage its Core Competencies to Enter New Markets. The Company intends to
enter new medical and surgical products markets through acquisition and new
product development. The Company believes that it can leverage its core
competencies, including the ability to develop rapidly innovative new
products, expertise in commercializing clinical knowledge, relationships with
leading physicians and managerial expertise, beyond the ENT market to enter
new markets on a selective basis. Potential areas for new market entry and
expansion include orthopaedics, plastic and reconstructive surgery and
ophthalmology.

MAJOR ENT SUBSPECIALTIES

The three major ENT subspecialties within the ENT market are sinus and
rhinology, head and neck and otology. The following table sets forth the
Company's estimate of sales in the overall U.S. ENT market in 1996 for
surgical instruments and related products used in procedures within each of
these subspecialties:

<TABLE>
<CAPTION>
1996 U.S. SALES OF
SURGICAL PRODUCTS
ENT SUBSPECIALTY USED IN SUBSPECIALTY
- ---------------- --------------------
<S> <C>
Sinus and rhinology........................................ $65 million
Head and neck.............................................. $81 million
Otology.................................................... $33 million
</TABLE>

SINUS AND RHINOLOGY

The majority of surgical procedures within the sinus and rhinology
subspecialty addresses disease and inflammation of the sinuses, due to
enlarged tissue, deviated septum, infection, trauma or allergies.

Endoscopic Sinus Surgery. Large numbers of the U.S. population suffer from
chronic sinusitis. Although sinus medications provide temporary relief from
symptoms, they may not resolve the underlying cause of the disease or
inflammation and surgery is frequently required. ENT specialists utilize
several methods of treatment, including medication and surgical intervention,
to provide patients with symptomatic relief of sinus disease. In traditional
sinus surgical procedures, surgeons remove the affected tissue or obstruction,
such as a polyp, through the use of forceps. However, with traditional
surgical instruments, ENT surgeons may have limited ability to visualize and
gain access to the deeper sinus cavities through the natural sinus passageways
and may also experience significant difficulty gaining the control needed to
remove the tissue effectively. These limitations

31
<PAGE>

can result in uneven cutting and tearing, which in turn cause trauma to the
surrounding tissue. In some cases, bony structures and tissue obstruct the
nasal passageway, further complicating the procedure.

Although a less-traumatic method for performing sinus surgery with powered
tissue-removal instrumentation was introduced in 1993, much of the
instrumentation used at the time was originally designed for arthroscopic
procedures (less invasive knee surgery). Since this instrumentation was not
designed specifically for sinus surgery, its use for these procedures was
cumbersome and prone to clogging. Overall operating time of procedures
performed with this method can be reduced by approximately 25% from that of
traditional surgical methods due to the greater ease of accessing structures,
the improved visualization at the site and the quicker removal of tissue with
powered instrumentation.

Rhinoplasty and Septoplasty. Rhinoplasty involves the surgical
reconstruction of the nose to treat bone defects or trauma or to improve the
appearance of the nose cosmetically. ENT surgeons generally use either a bone
shaver or a rasp to shape or reduce the targeted area or a chisel to cut the
bone. The use of a shaver or rasp results in significant post-operative
swelling and the use of a chisel carries with it a significant risk of error.
Septoplasty, the surgical correction of a defect, disease or trauma to the
septum, is often done in conjunction with sinus surgery or rhinoplasty.

HEAD AND NECK

The head and neck subspecialty encompasses a wide range of procedures,
including laryngeal (throat) surgery, skull-base surgery, facial tumor removal
and facial plastic surgery.

Laryngeal Surgery. Throat-based procedures include the removal of the
tonsils (tonsillectomy) and adenoids (adenoidectomy), the removal of lesions,
polyps and tumors on the throat or vocal cords and the surgical reduction of
the uvula (the flap of tissue at the back of the throat and the soft palate).

Tonsillectomies and adenoidectomies are performed to treat chronic
inflammation and soreness. In traditional tonsillectomies, surgeons use either
forceps or snares to grasp and pull the tonsils out, or alternatively they cut
away the tonsils with an electrocautery device. The use of these instruments
can cause swelling, pain and post-operative bleeding. For adenoidectomies,
surgeons traditionally utilize a curette, a small hand instrument, to scrape
out the inflamed tissue. Due to the limited precision of a curette in removing
this tissue, adenoidectomies involve many of the same problems experienced in
tonsillectomies.

Lesions, polyps or tumors on the throat or vocal cords are presently removed
using either hand instrumentation, an electrocautery device or a laser. The
use of hand instrumentation, electrocautery devices or lasers may result in
damage to the surrounding tissue. In addition, lasers and electrocautery
devices can destroy the affected tissue and thus prevent the subsequent
pathological testing of a tissue sample.

Uvulopharyngoplasty is a procedure for surgical reduction of the uvula and
the soft palate in the throat to reduce snoring and breathing interruptions
(sleep apnea). The use of electocautery devices or lasers to perform this
procedure is associated with swelling and pain.

Skull-base Surgery. Skull-base surgery includes those procedures in which
the affected anatomy, generally a tumor, is located within or near the skull.
A common skull-base procedure is the removal of an acoustic neuroma, a benign
tumor located on the cranial nerve adjacent to the inner ear. The symptoms of
this condition include hearing loss, ringing in the ears, loss of balance,
pain and headaches. Surgical removal is the only treatment alternative for
persons with an acoustic neuroma; however, the traditional procedure involves
drilling through the dense bone behind the ear to access the nerve, a
procedure that generally takes between six to eight hours to perform and
frequently results in a residual hearing loss.

Facial Tumor Removal. ENT surgeons perform numerous procedures in order to
remove facial tumors from the head and neck area. Surgical resections in this
area are particularly critical procedures to perform because of the numerous
motor nerve branches within the surgical area. Due to the potential
complications from

32
<PAGE>

severing a nerve, the identification and monitoring of nerves during most
facial tumor procedures are becoming a standard of care. These surgeries
frequently require laser incisions in cosmetically important areas and post-
operative cosmetic and functional defects are common.

Facial Plastic Surgery. Approximately one-third of ENT surgeons in the U.S.
currently perform facial plastic procedures. The number of elective procedures
for cosmetic purposes is likely to increase in conjunction with the general
aging demographic trend of the U.S. The procedures covered in this area
include: placement of facial implants to correct defects or augment features
in the face; correction and smoothing of wrinkles; facial lifts, which involve
stretching the muscles and skin of the face; and facial sculpting, which
involves the removal of fat around the neck.

Other common facial plastic surgical procedures include face and brow lifts.
During these procedures, the surgeon peels the skin at the hairline, pulls the
facial muscles and skin taut and then stitches the long incision made at the
hairline. In addition to the post-operative swelling and bruising from the
procedure, the patient is left with a relatively large scar at the hairline
from the long incision needed to access the entire facial region. During
facial sculpting, the surgeon removes fat away from the neck area using a
suction cannula, a device which evacuates fat from the facial tissue. As a
result of the aggressive way in which the suction cannula evacuates the fat
from the neck area, the patient experiences significant swelling and bruising
following the surgical procedure.

OTOLOGY

Common otology procedures include myringotomies (which generally involve the
insertion of ventilation tubes in the middle ear) and stapedectomies (the
replacement of middle ear bones with middle ear prosthetic implants).

Ventilation tubes are used to treat chronic middle ear infection. Their
placement is one of the most common surgical procedures performed in children,
with over one million of these procedures performed in 1996 in the U.S.
Conductive hearing loss is caused by damage to the ossicular bone chain in the
middle ear from disease, trauma or aging. The replacement of diseased bones of
the middle ear with specially designed implants is the preferred method to
restore hearing to these patients, and nearly 60,000 reconstructive middle ear
procedures are performed in the U.S. each year. Re-engineering in the design
and material of the prostheses has, in recent years, improved surgeon
technique and patient hearing outcomes.

PRODUCTS

The Company designs, develops, manufactures, and markets surgical
instruments and related disposables and accessories for use by ENT surgeons.
The Company believes its broad product lines focused on ENT procedures allow
it to be a complete provider to its ENT customer base. The Company also
designs, develops and manufactures surgical products for use during ophthalmic
and orthopaedic procedures. Set forth below is a description of the Company's
products by related subspecialty:

SINUS AND RHINOLOGY

Approximately 28%, 34% and 37% of the Company's net sales in 1995, 1996 and
1997, respectively, were derived from a broad line of powered tissue-removal
instrumentation systems, visualization products, fluid-control products and
hand instruments designed for microendoscopic sinus surgery. The Company has
devoted a significant portion of its investment in research and development to
the development of procedure-specific products to capitalize on and facilitate
the conversion to microendoscopic sinus surgery.

Powered Tissue-Removal Instrumentation Systems. To date, the most
significant product innovation facilitating the conversion of sinus procedures
to less-traumatic techniques has come from the introduction of powered
instrumentation designed for ENT procedures. In 1995, the Company introduced
the first powered micro resector product designed exclusively for use in ENT
procedures. These products cut soft tissue and bone through a unique
oscillating blade design powered by a small, lightweight, surgical handpiece.
In the first quarter of 1997,

33
<PAGE>

the Company introduced its XPS powered tissue-removal system and in the fourth
quarter of 1997 introduced the enhanced XPS 2000 StraightShot(R) system. This
new ENT specific system, which employs straight and curved disposable blades
and burs, offers the ENT surgeon significantly increased power with limited
blade clogging. The XPS system accounted for 54% of Xomed's domestic core
business sales growth in 1997 and the Company had over 800 units in place
worldwide at the end of 1997. On average, each unit in the U.S. currently
generates approximately $10,000 in annual blade revenues.

Visualization Products. The Company produces and distributes a competitive
line of visualization endoscopic equipment designed for use in less-traumatic
sinus, head and neck and otology surgery. These products include the Sharpsite
rigid endoscopes and EndoScrub(R) endoscope lens cleaning system. The
EndoScrub(R) endoscope lens cleaning system, which was introduced in 1992 and
is exclusive to the Company, allows the ENT surgeon to clean a scope lens
during surgical procedures without the need to remove and reposition the scope
repeatedly.

Merocel Fluid-Control Products. The Company maintains a strong franchise
with its proprietary disposable fluid-control products (surgical sponges),
developed with proprietary polymer technology to control blood loss and
simultaneously minimize adhesions at the surgical site. Under its Merocel
brand name, the Company markets its fluid-control products in a broad array of
sizes and shapes, designed primarily for use in sinus and rhinology
procedures.

Hand Instrumentation. In February 1996, the Company became the exclusive
distributor for BOSS Instruments, Ltd. in the U.S. ENT market, and as a result
now provides a complete line of sinus surgery hand instrumentation. Over 400
patterns have been developed to provide surgeons with an ergonomic design and
performance that afford surgeons precision during surgical procedures. In
October 1997, the Company became the exclusive distributor of articulating
instruments and micro resector blades for the ENT market and all areas of the
orthopaedic market except spine.

Rhinology Products. The Company's products for use during surgical repair of
the nose include internal and external nasal splints, nasal catheters, airway
and irrigation catheters and powered sinus burs.

HEAD AND NECK

Approximately 24%, 25% and 23% of the Company's net sales in 1995, 1996 and
1997, respectively, were derived from products and devices related to the head
and neck anatomy. The Company has a strong brand franchise in this product
subspecialty with its nerve monitoring systems, powered systems and facial
plastic implant products. Head and neck surgical techniques are being
developed which use the more precise tissue removal of powered instrumentation
systems, similar to those being used in sinus surgery, to lessen trauma and
bleeding. The Company believes there is significant opportunity to capitalize
on and facilitate the conversion of this subspecialty to these new techniques.

Powered Tissue-Removal Instrumentation Systems. In mid-1997, the Company
introduced several procedure specific blades to address perceived market
opportunities for the conversion of certain head and neck procedures to
powered instrumentation, thereby further leveraging the Company's installed
base of XPS StraightShot systems. Specifically, the Company has introduced
cutter blades for use in facial sculpting procedures where facial fatty tissue
is removed for cosmetic and other reasons; adenoidectomy blades for more
complete and less-traumatic removal of adenoids; and laryngeal blades for the
removal of polyps, lesions and tumors located on the vocal cords. The Company
believes that the market opportunity for conversion of these procedures to
powered technology is at least as significant as the powered sinus conversion
opportunity.

Powered Drill Systems. Head and neck surgery requires precision, high-
powered drilling to access tumors or tissue behind bone structures. The
Company manufactures and markets a line of electric and air powered drilling
systems for such procedures, including the Powerforma electric drill system
introduced in the fourth quarter of 1996, which consists of a power console,
surgical handpiece and disposable and reusable cutting burrs.

34
<PAGE>

This new system provides the ENT surgeon with significantly increased cutting
speed and precision that will reduce the time necessary to complete these head
and neck surgical procedures.

Nerve Monitoring Systems. The Company's NIM-2(R) XL nerve monitor products,
which were first introduced in February 1995, identify and monitor crucial
motor nerve branches during various head and neck procedures. The
identification of nerves during many head and neck procedures is becoming a
standard of care because the inadvertent cutting of any branches of these
nerves could result in facial paralysis. The NIM-2(R) XL provides surgeons
with visual and audio indicators through a system which includes a battery-
powered electromyographic (EMG) monitor, disposable electrodes and nerve
stimulators.

Facial Plastics Products. Increasingly, ENT surgeons are performing more
facial plastic procedures, including face and brow lifts, facial sculpting and
cosmetic facial implants. The Company provides a broad array of products and
devices for the facial plastic market. The Company is a worldwide distributor
for Implantech Associates, Inc. in the ENT market, and thereby provides a
broad line of facial plastic implants, including implants to augment the chin,
nose and cheek.

Hand Instrumentation. As the exclusive distributor for BOSS Instruments,
Ltd. in the U.S. ENT market, the Company provides a broad line of hand
instrumentation for facial plastic surgery. These products are designed to
increase surgeon precision and reduce patient swelling and recovery time.

Specialty Products. The Company's Laser-Shield II(R) is a laser resistant
endotracheal tube used in throat-related surgery performed with lasers. The
Company believes that the Laser-Shield II(R) is safer and more reliable than
current alternatives.

OTOLOGY

Approximately 21%, 21% and 19% of the Company's net sales in 1995, 1996 and
1997, respectively, were derived from otology products. The Company possesses
a strong franchise and significant market share in this segment of the ENT
market. The Company's otology products include ventilation tubes, middle ear
implants and instrumentation used to repair conductive hearing loss and
correct other problems associated with the ear. The Company believes that the
conversion of ENT procedures to less-traumatic techniques is more likely to
have a significant effect on the sinus and rhinology and head and neck
subspecialties than on the otology subspecialty.

Ventilation Tubes. Vent tubes are small tubes surgically implanted into the
eardrum to provide ventilation to the middle ear. Vent tubes are primarily
used in younger children with severe middle ear infection. The Company markets
a full line of vent tubes, including its proprietary Activent anti-microbial
tube.

Middle Ear Implants. The Company develops and markets middle ear prostheses
used to reconstruct any or all of the three bones of the middle ear, primarily
in cases of otosclerosis and chronic middle ear infection. These permanent
implants are made of stainless steel, porous polyethylene, hydroxyapatite and
other biocompatible materials.

Microsurgical Instruments. The Company sells a broad line of microsurgical
hand-held instruments such as otoscopes, vent tube inserters, disposable
blades, proprietary suction irrigators and specialized instruments to insert
and implant middle ear prostheses.

Specialty Products. The Company's specialty otology products include
absorbent dressings, ear plugs, ear protectors, disposable kits for ear
surgery and other disposable surgical instruments. The Company also produces
and markets the Skeeter(R) otologic drill system, which is designed for middle
ear procedures.

OPHTHALMIC AND OTHER

Approximately 27% of the Company's net sales in 1995 and 21% of its net
sales in 1996 and 1997 were derived from ophthalmic and other products, with
substantially all of such sales from ophthalmic products. The

35
<PAGE>

Company develops and manufactures instruments and disposable products for use
during various ophthalmic procedures. The Company markets these products under
the Solan trademark through distributors specializing in the ophthalmic
products market. These instruments include forceps, needle holders, hooks,
probes and scissors. The Company's disposable products relating to ophthalmic
surgery and procedures are micro knives, cannulae, trephines, blades, sponges,
cauteries, penlights and other miscellaneous products and kits. The Company's
Solan division has a management team dedicated to managing the marketing of
its ophthalmic products. In connection with its acquisition of TreBay in April
1996, the Company acquired certain devices and disposable products for use
during orthopaedic surgery which the Company markets through distributors
under the TreBay name. The sales of orthopaedic products totaled 0% and 9% of
the ophthalmic and other category for 1996 and 1997, respectively.

SALES AND MARKETING

The Company has an established worldwide distribution system with an ENT-
focused, 82-person direct sales force, over 130 distributor alliances and
independent distributors for select product specialties and geographic
markets.

The Company sells to substantially all of the approximately 9,000 ENT
specialists in the U.S. through its direct sales force. The Company is the
only major manufacturer and marketer of ENT surgical products with a direct
sales force exclusively serving ENT specialists. The Company's 56-person U.S.
sales force focuses its efforts on developing and maintaining business
relationships with ENT specialists and those surgeons at leading academic
institutions who are considered to be influential in the ENT field. The
ability of the Company to build and maintain these relationships within the
medical community provides a powerful base for the distribution network and
what the Company believes to be a significant competitive advantage,
especially in the area of product development. The Company's direct U.S. sales
representatives are compensated exclusively through sales commissions. The
Company's thirteen marketing personnel specialize according to subspecialty
within the ENT market as well as by category of product.

In the international market, the Company sells its products through a 26-
person direct sales force and through over 100 distributors. The Company
maintains a direct sales presence in Canada, the United Kingdom, France,
Australia and Germany. The Company sells its products to other countries in
Europe, Asia Pacific, Africa, Central and South America using distribution
partners. The Company believes it has experienced significant international
sales gains as a result of creating in certain markets a dedicated sales force
focused exclusively on selling its products.

The Company has an exclusive arrangement with the International Center for
Otologic Training (ICOT), an organization affiliated with the Georgia Ear
Institute in Savannah, Georgia. The charter of ICOT is to train
internationally based ENT surgeons, many from developing countries, in new and
advanced ENT surgical techniques. The Company provides financial support and
equipment to ICOT in connection with the training of these surgeons. As a
result of this relationship with the Company, the Company believes that these
physicians and their affiliated hospitals will be more inclined to purchase
the Company's products upon returning to their respective countries.

The Company utilizes specialty distributors to market its non-ENT products
in the U.S. The Company's Solan ophthalmic products are marketed in the U.S.
through a network of dealers specializing in ophthalmic product sales. Outside
of the U.S., the Solan ophthalmic product line is typically marketed through
the same direct and independent distributor system as the Company's ENT
product lines. The TreBay brand of orthopaedic hip revision instruments is
marketed in the U.S. through an exclusive arrangement with a major orthopaedic
company.

The Company seeks to maintain inventory levels that provide its customers
with a high standard of service. In addition, the Company may build
inventories in advance of new product launches to support sales as well as

36
<PAGE>

to provide its sales force with product samples. The Company generally allows
its customers to return products for any reason within 45 days of shipment.

PRODUCT DEVELOPMENT

In each of the last four years, new products have accounted for an
increasing percentage of the Company's total sales. In 1995, 1996 and 1997,
products introduced within the last three years of the relevant fiscal year
represented approximately 14%, 23%, and 29% of the Company's core ENT sales,
respectively. The Company believes that it has a strong base of proprietary
engineering, manufacturing and biomaterials capabilities. The Company also
believes it has expertise in the core research and development areas relevant
to the production of new ENT surgical products. Primarily through internal
research and development efforts, the Company plans to continue to develop new
proprietary products, often in collaboration with leading ENT surgeons, that
allow surgeons to perform their procedures in a less-traumatic manner with
more precision, less surgical time and greater simplicity. The Company
believes that the strong network it has built through its marketing focus on
ENT specialists gives it a competitive advantage. The Company also may
evaluate strategic acquisitions and licensing of third-party technology to
further expand and enhance its product line.

The Company has entered into royalty agreements or, in certain cases,
consulting agreements, with more than 30 ENT specialists as part of its
product development activities. The royalty agreements generally provide that
the specialist is entitled to a percentage of the revenues generated from the
Company's sales of products developed by the Company in collaboration with the
specialist. In addition, the royalty agreements generally provide that all
products developed in collaboration between the specialist and the Company
will be the exclusive property of the Company, subject to the specialist's
right to receive royalties. The Company is not obligated to make material
payments under any of the royalty or consulting agreements.

The Company employs mechanical, electrical, materials and polymer engineers
to develop the various products offered or contemplated by the Company. The
Company's research and development department has a broad range of electro-
mechanical skills to address its variety of hand instruments, implants,
electrical powered systems, polymer products and disposable products.
Currently, the Company's research and development department consists of 13
engineers experienced in various technical specialties relevant to the
Company's core products.

The research and development engineers work closely with leading surgeons in
assessing new surgical procedures for opportunities to develop products that
will complement current products and new "state of the art" devices that fit
within the overall Company's business strategy. During 1995, 1996 and 1997,
the Company spent $2.4 million, $3.7 million, and $4.1 million, respectively,
in connection with research and development activities. The Company expects to
spend approximately $4.8 million in 1998 for research and development.

The Company also is pursuing research and development projects that target
markets outside of ENT. The Company currently has active projects to develop
products for the plastic and reconstructive surgery market, the arthroscopy
market and the spinal surgery market.

SUPPLIERS

Although most of the purchased components utilized by the Company in
manufacturing are available from more than one vendor, certain materials,
including TPE-based materials and certain fluoropolymers used in its
ventilation tubes, are only supplied by a single vendor. Daikin America, Inc.
supplies the Company with the TPE-based materials and is not obligated to
supply the materials to the Company for any fixed period of time. Although it
is not presently the case, if the supply of materials from such a single
source vendor were interrupted in the future, replacement or alternative
sources may not be readily obtainable due to the regulatory requirements that
the Company certify as to the quality and suitability of the new or alternate
material. In addition, a new or supplemental filing with the FDA would be
required to be approved prior to the Company's marketing a product containing
new material. This approval process may take a substantial period of time and
there is no assurance that the Company would be able to identify, certify or
obtain the necessary regulatory approval for the new

37
<PAGE>

material to be used in the Company's products. In addition, certain suppliers
could terminate or limit the sales of certain materials to the Company for use
in medical devices in an attempt to limit their potential exposure to product
liability claims.

COMPETITION

The markets served by the Company are highly competitive. The Company
believes that the primary competitive factors affecting its business are the
reliability, cost-effectiveness, ease of use, safety and effectiveness of its
products and surgeon and purchaser familiarity with its instrumentation. For
certain of the Company's potential products, an important factor in
competition may be the timing of market introduction of its or its
competitors' products. Accordingly, the relative speed with which the Company
can develop products, complete approval or clearance processes and supply
commercial quantities of the products to the market are also important
competitive factors. The Company believes that its ability to compete
successfully in the ENT markets will depend on its ability to maintain market
share of its core product base and to facilitate the conversion of traditional
surgical procedures to microendoscopy surgical techniques using innovative
technology developed by the Company. See "Risk Factors--Possible Adverse
Effects of Significant Competition."

The Company competes with Smith & Nephew ENT (a division of Smith & Nephew
plc formerly known as Richards Medical Company) in substantially all of the
Company's ENT product lines. Stryker Corporation, Smith & Nephew Endoscopy (a
division of Smith & Nephew plc) and Linvatec Corporation (a division of Conmed
Corporation) offer endoscopic equipment and sinus power systems that compete
with those of the Company. A number of other medical products companies offer
products which compete directly with certain products or product lines
marketed by the Company. Many of the Company's competitors and potential
competitors have substantially greater capital resources than the Company.
Some of the Company's competitors may have long term or preferential supply
arrangements with hospitals. Such arrangements may act as a barrier to market
entry by the Company.

GOVERNMENT REGULATION

FDA. The Company's products, product development activities, promotional and
marketing activities and manufacturing processes are subject to extensive and
rigorous regulation by the FDA and comparable agencies in foreign countries.
In the U.S., the FDA regulates the interstate commerce of medical devices as
well as manufacturing, labeling, promotion and recordkeeping procedures for
such devices. For purposes of these regulations, the Company's products are
generally treated as medical "devices." In order for the Company to market its
products in the U.S., the Company must obtain marketing clearance from the FDA
through what is known as a 510(k) pre-market notification or obtain approval
through a more detailed application process resulting in what is known as PMA.
The process of obtaining marketing clearance for new medical devices from the
FDA can be costly and time-consuming. There can be no assurance that such
clearance will be granted for the Company's products that are under
development or future products on a timely basis, if at all, or that FDA
review will not involve delays that will adversely affect the Company's
ability to commercialize additional products or expand permitted uses of
existing products.

A manufacturer may seek FDA clearance to distribute a new medical device by
filing a 510(k) pre-market notification. A 510(k) pre-market notification
requires the manufacturer of a medical device to establish that the device is
"substantially equivalent" to medical devices legally marketed in the U.S. The
510(k) pre-market notification must be accompanied by appropriate information
or data establishing the claim of substantial equivalence, which, depending on
the type of product, may require animal or human clinical data. If this
substantial equivalence is established to the satisfaction of the FDA, the
manufacturer will receive FDA clearance for marketing of the medical device.
If the manufacturer cannot establish substantial equivalence or if the FDA
determines that a device requires a more rigorous review, the FDA will require
that the manufacturer submit a PMA application prior to obtaining approval to
market the device in the U.S. The PMA process requires laboratory and animal
studies, the submission to the FDA of a request for permission to clinically
evaluate the medical device in humans under an Investigational Device
Exemption ("IDE"), the conduct of human studies meeting the requirements of
the institutional review board of the study institution, the written informed
consent

38
<PAGE>

of all participating patients, the submission of a PMA application, the review
of the human studies by an FDA-selected scientific advisory panel and final
review (including manufacturing facilities review) and approval by the FDA.
This process is expensive and time-consuming, generally taking more than a
year and often substantially longer.

All of the Company's currently marketed products either have received FDA
marketing clearance pursuant to 510(k) pre-market notifications or PMA
applications filed by the Company and cleared by the FDA, or are exempt from
obtaining marketing clearance by virtue of their status as pre-amendment
devices (i.e. devices introduced into interstate commerce prior to May 28,
1976). Although the Company anticipates that, at least in the near term, its
products will be evaluated under the 510(k) pre-market notification process,
there can be no assurance that the Company's current or future products may
not be subjected to the PMA process or that the Company's current or future
products in development will receive FDA marketing clearance.

Even if regulatory clearance to market a device is obtained from the FDA,
this clearance may entail limitations on the indicated uses of the device.
Marketing clearance can also be withdrawn by the FDA due to the failure to
comply with regulatory standards or the occurrence of unforeseen problems
following initial clearance. The Company may be required to make further
filings with the FDA under certain circumstances such as the addition of new
product claims. The Company has made modifications to its cleared products,
which the Company believes do not require submission of new 510(k) notices.
There can be no assurance, however, that the FDA would agree with any of the
Company's determinations and not require the Company to submit new 510(k)
notices for any of the changes made to its products and/or to stop marketing
until new 510(k)s are cleared by the FDA.

The Company is also required to register with the FDA as a medical device
manufacturer. As such, the Company's manufacturing facilities are subject to
inspection on a routine basis for compliance with GMP. These regulations
require that the Company manufacture its products and maintain its documents
in a prescribed manner with respect to manufacturing, testing and quality
control activities. As a medical device manufacturer, the Company is further
required to comply with FDA requirements regarding the reporting of
allegations of death or serious injury associated with the use of its medical
devices, as well as product malfunctions that would likely cause or contribute
to death or serious injury if the malfunctions were to recur. Other FDA
requirements govern product labeling and prohibit a manufacturer from
marketing an approved device for unapproved applications. If the FDA believes
that a manufacturer is not in compliance with the law, it can institute
proceedings to detain or seize products, issue a recall, enjoin future
violations and assess civil and criminal penalties against the manufacturer,
its officers and employees.

Health Care "Fraud and Abuse." The Company is subject to various federal and
state laws pertaining to health care "fraud and abuse," including anti-
kickback laws and false claims laws. Violations of these laws are punishable
by criminal and/or civil sanctions, including, in some instances, imprisonment
and exclusion from participation in Federal Health Care Programs, such as
Medicare and Medicaid. The Company has never been challenged by a governmental
authority under these laws and believes that, based on this history, its
operations are in material compliance with such laws. However, because of the
broad scope of some of these laws, there can be no assurance that one or more
of the Company's practices would not be challenged by governmental authorities
under certain of these laws, that the Company would not be required to alter
its practices as a result, or that the occurrence of one or more of these
events would not result in material adverse effect on the Company's business,
financial condition and results of operations.

The Federal Health Care Programs Anti-Kickback Statute (section 1128B(b) of
the Social Security Act) prohibits persons or entities from, among other
things, knowingly and willfully offering, paying, soliciting or

39
<PAGE>

receiving any remuneration (including any kickback, bribe or rebate) directly
or indirectly, overtly or covertly, in cash or in kind in return for or to
induce (a) the referral of an individual for the furnishing or arranging for
the furnishing of any item or service for which payment may be made in whole
or in part under a Federal Health Care Program or a state health care program,
such as Medicare and Medicaid, or (b) the purchasing, leasing, ordering, or
arranging for (or recommending purchasing, leasing, or ordering of) any good,
facility, service, or item, for which payment may be made in whole or in part
under a Federal Health Care Program or a state health care program. The
statute is broad in scope and has been interpreted by federal courts and
administrative tribunals to apply if even "one purpose" (as opposed to the
primary or sole purpose) of an arrangement is to induce the referral of
business. The statute contains certain exceptions, and federal regulations
have created certain "safe harbors," which identify specific payment practices
that might otherwise fall within the broad language of the statutory
prohibition, but that are not considered unlawful remuneration under the
statute. Each safe harbor contains a number of requirements that must be met
in order for the safe harbor to apply. Payment practices that do not satisfy
all of the requirements of an applicable safe harbor do not necessarily
violate the Federal Health Care Programs Anti-kickback Statute, although such
practices may be subject to scrutiny by enforcement officials. Several states
also have anti-kickback laws that vary in scope and may apply regardless of
whether a Federal Health Care Program is involved.

The Company has various financial relationships with customers, including
ENT specialists and hospitals, which may implicate federal and state anti-
kickback laws. For example, the Company may offer certain customers various
types of discounts on the purchase of its products. The Company believes that
such discount arrangements are in material compliance with the applicable
discounts statutory exception and regulatory safe harbor, however there can be
no assurance in this regard. The Company also has entered into royalty and
consulting agreements with ENT specialists who may purchase, or recommend the
purchase of, the Company's products. Some of these agreements may not satisfy
all elements of the federal safe harbor for personal service arrangements, and
thus they could be subject to scrutiny and challenge under federal or state
anti-kickback laws. A finding that the Company's practices violate these laws,
or even a challenge to the Company's practices in these areas, could have a
material adverse effect on the Company's business, financial condition and
results of operations.

The Company also is subject to federal and state laws prohibiting
individuals or entities from knowingly and willfully presenting, or causing to
be presented, false reimbursement claims to third-party payors (including
Medicare and Medicaid). Although the Company does not submit reimbursement
claims to third party payors, it may provide advice to customers on billing
and coding for the Company's products. Although the Company endeavors to
ensure that any advice provided with respect to billing and coding complies
with applicable laws, if such advice leads to the submission of a false claim
by a customer, the Company could face liability under one or more of these
laws for causing the false claim to be submitted. The Company has never been
challenged under any false claims laws with respect to billing and coding
advice it has provided to customers, however a finding that its practices
violate these laws, or even a challenge to its practices in this area, could
have a material adverse effect on its business, financial condition and
results of operations.

Other Legislation. The Company is also subject to numerous federal, state
and local laws relating to such matters as safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
disposal of hazardous or potentially hazardous substances. There can be no
assurance that the Company will not be required to incur significant costs to
comply with such laws and regulations in the future or that such laws or
regulations will not have a material adverse effect upon the Company's ability
to do business.

The Company may become subject to future legislation and regulations
concerning the manufacture and marketing of medical devices. This could
increase the cost and time necessary to begin marketing new products and could
affect the Company in other respects not presently foreseeable. The Company
cannot predict the effect of possible future legislation and regulations.

Sales of medical devices outside the U.S. are subject to foreign regulatory
requirements that vary widely from country to country. These laws and
regulations range from simple product registration requirements in some

40
<PAGE>

countries to complex clearance and production controls in others. As a result,
the processes and time periods required to obtain foreign marketing approval
may be longer or shorter than that necessary to obtain FDA approval. These
differences may affect the efficiency and timeliness of international market
introduction of the Company's products, and there can be no assurance that the
Company will be able to obtain regulatory approvals or clearances for its
products in foreign countries.

For countries in the EU, in January 1995, CE mark certification procedures
became available for medical devices, the successful completion of which would
allow certified devices to be placed on the market in all EU countries. In
order to obtain the right to affix the CE mark to its products, medical device
companies must obtain certification that its processes meet European quality
standards, including certification that its design and manufacturing facility
complies with ISO 9001 standards. All of the Company's products marketed in
the countries comprising the trading members of the EU have been CE marked.
After June 1998, medical devices may not be sold in EU countries unless they
display the CE mark. The Company successfully obtained certification under the
ISO 9001 standards in November 1995. In addition, international sales of
medical devices manufactured in the U.S. but not approved by the FDA for
distribution in the U.S. are subject to FDA export requirements. Under these
requirements, the Company must assure that the product is not in conflict with
the laws of the country for which it is intended for export, in addition to
complying with the other requirements of Sections 801(e) and/or 802 of the
United States Food, Drug and Cosmetic Act.

THIRD-PARTY REIMBURSEMENT

In the U.S., health care providers that purchase medical devices generally
rely on third-party payors, such as Medicare, Medicaid, private health
insurance plans and health maintenance organizations, to reimburse all or a
portion of the cost of the devices. The Medicare program is funded and
administered by the Health Care Financing Administration ("HCFA"), while the
Medicaid program is jointly funded by HCFA and the states, which administer
the program under general federal oversight. The Company believes its current
products and the procedures in which such products are used are generally
eligible for coverage under these third-party reimbursement programs. The
Company also believes that the products it is developing and the procedures in
which such products will be used will be eligible for third-party
reimbursement. The competitive position of certain of the Company's products
will be partially dependent upon the extent of coverage and adequate
reimbursement for such products and for the procedures in which such products
are used.

The federal government and certain state governments are currently
considering a number of proposals to reform the Medicare and Medicaid health
care reimbursement system. The Company is unable to evaluate what legislation
may be drafted and whether or when any such legislation will be enacted and
implemented. Certain of the proposals, if adopted, could have an adverse
effect on the Company's business, financial condition and results of
operations.

During the past several years, the major third-party payors have
substantially revised their reimbursement methodologies in an attempt to
contain their health care reimbursement costs. Medicare reimbursement for
inpatient hospital services is based on a fixed amount per admission based on
the patient's specific diagnosis. As a result, any illness to be treated or
procedure to be performed will be reimbursed only at a prescribed rate set by
the government that is known in advance to the health care provider. If the
treatment costs less, the provider is still reimbursed for the entire fixed
amount; if it costs more, the provider cannot bill the patient for the
difference. No separate payment is made in most cases for products such as the
Company's instrumentation when they are furnished or used in connection with
inpatient care. Many private third-party payors and some state Medicaid
programs have also adopted similar prospective payment systems.

Third-party payors have recently increased their emphasis on managed care,
which has led to an increased emphasis on cost-effective medical devices by
health care providers. In addition, through their purchasing power, these
payors often seek discounts, price reductions or other incentives from medical
product suppliers.

The Company intends to seek international reimbursement approvals for its
products, although there can be no assurance that such approvals will be
obtained in a timely manner or at all. Reimbursement and health care

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<PAGE>

payment systems in international markets vary significantly by country and
include both government-sponsored health care and private insurance. To the
extent that any of the Company's products are not entitled to reimbursement in
any international market, market acceptance of such products in such
international market would be adversely affected.

PATENTS, TRADE SECRETS AND PROPRIETARY RIGHTS

Proprietary protection for the Company's products and know-how is important
to the Company's business. Thus, the Company's policy is to prosecute and
enforce its patents and proprietary technology. The Company intends to
continue to file patent applications to protect technology, inventions and
improvements that are considered important to the development of its business.
The Company also relies upon trade secrets, know-how, continuing technological
innovation and licensing opportunities to develop and maintain its competitive
position.

As of July 13, 1998, the Company held 57 U.S. patents and 11 foreign
patents, and had filed 29 additional U.S. patent applications and 4 patent
applications in certain major industrial countries. The Company is also
licensed under 9 patents owned by third parties.

The patent positions of medical device companies, including the Company, are
generally uncertain and involve complex legal and factual questions.
Consequently, even though the Company currently is pursuing its patent
applications with the U.S. Patent and Trademark Office and certain foreign
patent authorities, the Company does not know whether any of its remaining
applications will result in the issuance of any patents or, if any patents are
issued, whether they will provide significant proprietary protection or will
be circumvented or invalidated. Patent applications in the U.S. are maintained
in secrecy until patents issue, and because publication of discoveries in the
scientific or patent literature tend to lag behind actual discoveries by
several months there may be material patents or publications of which the
Company is not aware. Thus, the Company cannot be certain that it was the
first creator of inventions claimed by pending patent applications or that it
was the first to file patent applications for such inventions.

The medical device industry is characterized by frequent and substantial
intellectual property litigation, particularly with respect to newly developed
technology. Intellectual property litigation is complex and expensive, and the
outcome of such litigation is difficult to predict. Any future litigation,
regardless of the outcome, is likely to result in substantial expense to the
Company and significant diversion of the efforts of the Company's technical
and management personnel. An adverse determination in any such proceeding
could subject the Company to significant liabilities to third parties, require
disputed rights to be licensed from such parties if licenses to such rights
could be obtained, and/or require the Company to cease using such technology.
There can be no assurance that if such licenses were obtainable, they would be
obtainable at costs reasonable to the Company. If forced to cease using such
technology, there can be no assurance that the Company would be able to
develop or obtain alternate technology. Additionally, if third-party patents
containing claims affecting the Company's technology are issued and such
claims are determined to be valid, there can be no assurance that the Company
would be able to obtain licenses to such patents at costs reasonable to the
Company, if at all, or be able to develop or obtain alternative technology.
Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent the Company
from manufacturing, using or selling certain of its products, which could have
a material adverse effect on the Company's business, financial condition and
results of operations.

The Company's practice is to require its employees, consultants, outside
collaborators and researchers and other advisors to execute confidentiality
agreements upon the commencement of employment or consulting relationships
with the Company. These agreements provide that all confidential information
developed or made known to the individual during the course of the
individual's relationship with the Company is to be kept confidential and not
disclosed to third parties, subject to a right to publish certain information
in the scientific literature in certain circumstances and subject to other
specific exceptions. In the case of employees, the agreements provide that all
inventions conceived by the individual shall be the exclusive property of the

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<PAGE>

Company. There can be no assurance, however, that these agreements will
provide meaningful protection for the Company's trade secrets or adequate
remedies in the event of unauthorized use or disclosure of such information.

PRODUCT LIABILITY AND INSURANCE

The business of the Company entails the risk of product liability claims and
any such claims could have an adverse impact on the Company. The Company has
taken and will continue to take what it believes are appropriate precautions,
including maintaining general liability and commercial liability insurance
policies which include adequate coverage for product liability claims. These
policies currently provide $25 million in aggregate coverage. The Company
evaluates its insurance requirements on an ongoing basis to enable it to
maintain adequate levels of coverage. There can be no assurance that product
liability claims will not exceed such insurance coverage limits or that such
insurance will be available on commercially reasonable terms or at all. The
Company currently is involved in certain legal proceedings involving product
liability claims. Based on information presently available to the Company, the
Company believes that it has adequate legal defenses or insurance coverage for
these actions, and that the ultimate outcome of these actions will not have a
material adverse effect on the Company.

ENVIRONMENTAL MATTERS

The past and present business operations of the Company and the past and
present ownership and operations of real property by the Company are subject
to extensive and changing federal, state, and local environmental laws and
regulations. The Company believes it is in material compliance with all such
applicable laws and regulations. The Company cannot predict what environmental
legislation or regulations will be enacted in the future, how existing or
future laws or regulations will be administered or interpreted or what
environmental conditions may be found to exist. Compliance with more stringent
laws or regulations or stricter interpretations of existing laws may require
additional expenditures by the Company, some of which may be material.

PROPERTIES

The Company owns its 52,000 square-foot corporate headquarters and
manufacturing facility and leases a 36,863 square-foot warehouse and
distribution facility in Jacksonville, Florida. At its Jacksonville corporate
headquarters and manufacturing facility, which has 30,000 square feet
dedicated to manufacturing, the Company produces all of the products that it
manufactures other than fluid-control products. The Company has numerous
manufacturing capabilities at the Jacksonville facility, including: injection
molding; insert molding; CNC machining; CAD/CAM; form, fill and seal; ETO
sterilization utilizing a Joslyn reclamation system; specialty surgical
instrument manufacturing; tool design and manufacturing; design and production
of manufacturing equipment; electronics assembly; bar code technology; and
automated storage systems. The Company has begun construction of additional
office and warehouse space at its corporate headquarters. The construction
will take place in three phases with the last phase expected to be completed
in 1999. The operations housed in the leased facility will be moved to the
newly constructed building.

The Company also owns a 34,000 square-foot manufacturing facility and a
6,300 square-foot distribution facility in Mystic, Connecticut. The Company's
Merocel product line of fluid-control products is manufactured at the Mystic
facility.

Currently, the Company operates two manufacturing shifts at both of its
manufacturing facilities and has the ability to increase production levels of
its current product line without expanding its facilities. The Company
believes that the properties, in conjunction with the planned expansion, are
adequate to serve the Company's business operations for the foreseeable
future.

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<PAGE>

EMPLOYEES

As of June 26, 1998, the Company had 618 full-time employees and 7 temporary
employees, including 265 in production, 106 in professional and technical
positions, 72 in administration and 182 in sales and marketing. The Company
believes that its future success will depend in large part upon the continued
service of its senior management personnel, most of whom joined the Company in
April 1996, and upon the Company's continuing ability to attract and retain
highly qualified managerial, operational, technical and sales and marketing
personnel. Competition for highly qualified personnel is intense and there can
be no assurance that the Company will be able to retain its key personnel or
that it will be able to attract and retain additional qualified personnel in
the future. The Company has not experienced any work stoppage and considers
its relations with its employees to be satisfactory.

LITIGATION

The Company is currently involved in certain legal proceedings incidental to
the normal conduct of its business. The Company does not believe that any
liabilities relating to the legal proceedings to which it is a party are
likely to be, individually or in the aggregate, material to its consolidated
financial condition or results of operations.

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<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information with respect to the
executive officers and directors of the Company as of July 14, 1998:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
James T. Treace............. 52 President, Chief Executive Officer and
Chairman of the Board of Directors
F. Barry Bays............... 51 Senior Vice President, Operations and Chief
Operating Officer
Thomas E. Timbie............ 40 Vice President, Finance, Chief Financial
Officer and Secretary
John R. Treace.............. 53 Vice President, U.S. Sales
R. Glen Coleman............. 43 Vice President, Marketing
Guy K. Williamson........... 43 Vice President, International; President,
Xomed International, Inc.
Fred B. Dinger, III......... 37 Vice President, Research and Development
Dan H. Treace............... 49 Vice President, Regulatory Affairs and
Quality Assurance
Mark J. Fletcher............ 42 Vice President; President of Solan Ophthalmic
Products
Gerard J. Bussell........... 49 Vice President, Operations
Richard B. Emmitt (1)(2).... 53 Director
William R. Miller (1)....... 70 Director
Rodman W. Moorhead, III..... 54 Director
James E. Thomas (2)......... 38 Director
Elizabeth H. Weatherman 38 Director
(1)(2).....................
</TABLE>
- --------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.

James T. Treace has been President, Chief Executive Officer and Chairman of
the Board of Directors of the Company since April 1996. From 1993 until its
acquisition by the Company in April 1996, Mr. Treace served as President,
Chairman of the Board of Directors and Chief Executive Officer of TreBay, an
ENT and orthopaedic product company founded in 1993 by Mr. Treace and Mr. F.
Barry Bays. From 1990 to 1993, Mr. Treace served as President of Linvatec
Corporation ("Linvatec"), a minimally invasive orthopaedic medical device
company formerly known as Concept, Inc. ("Concept"), which became a wholly
owned subsidiary of Bristol-Myers Squibb in 1990. Mr. Treace served as
President and Chief Executive Officer of Concept from 1981 until its
acquisition by Bristol-Myers Squibb in 1990. Mr. Treace is the brother of John
R. Treace and Dan H. Treace.

F. Barry Bays has been Senior Vice President, Operations and Chief Operating
Officer of the Company since April 1996. From 1993 to April 1996, Mr. Bays
served as Vice President and Chief Operating Officer and a Director of TreBay.
From 1990 to 1993, Mr. Bays served as Executive Vice President and Chief
Operating Officer of Linvatec. From 1981 to 1990, Mr. Bays served as Executive
Vice President and Chief Operating Officer of Concept.

Thomas E. Timbie has been Vice President, Finance and Chief Financial
Officer of the Company since April 1996. From 1994 to April 1996, Mr. Timbie
served as Vice President and Chief Financial Officer of TreBay. From 1990 to
1994, Mr. Timbie held financial management positions at Linvatec, including
Senior Director, Working Capital from 1992 to 1994 and Assistant Controller
from 1990 to 1992. From 1987 to 1990, Mr. Timbie served as Director, Financial
Accounting and Reporting of Concept.

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<PAGE>

John R. Treace has been Vice President, U.S. Sales of the Company since
April 1996. From 1995 to April 1996, Mr. Treace served as Vice President,
Sales and Marketing of TreBay. From 1966 to 1994, Mr. Treace served in a
variety of positions at Richards Medical Company. His positions at Richards
Medical Company included Product Manager, Director of Marketing and Sales,
Group Vice President of Marketing and Sales and Sales Distributor. Mr. Treace
is the brother of James T. Treace and Dan H. Treace.

R. Glen Coleman has been Vice President, Marketing of the Company since
August 1996. From January 1983 to August 1996, Mr. Coleman held several
management positions at Linvatec, including Vice President, Global Marketing
from June 1996 to July 1996, Vice President, Sales from October 1993 to June
1996, Vice President and General Manager of its Concept Division from May 1991
to October 1993 and Vice President, Research and Development.

Guy K. Williamson has been Vice President, International of the Company and
President, Xomed International, Inc. since July 1996. From January 1988 to
June 1996, Mr. Williamson held various positions within the Bristol-Myers
Squibb Medical Device Group, including Vice President, Zimmer International
from January 1994 to June 1996, General Manager, China and Hong Kong from
February 1992 to December 1993, Vice President, Marketing and International
Administration, Linvatec from January 1988 to January 1992, and General
Manager Canada of Edward Weck Inc., a surgical products manufacturer, from
1980 to 1988.

Fred B. Dinger, III has been Vice President, Research and Development of the
Company since May 1996. From 1992 to 1996, Mr. Dinger held several positions
with Linvatec, including Vice President, Research and Development from 1994 to
1996, Director, New Product Development from 1993 to 1994 and Manager, Power
Systems Development from 1992 to 1993. From 1984 to 1992, Mr. Dinger was
Engineering Section Supervisor at Honeywell Incorporated.

Dan H. Treace has been Vice President, Regulatory Affairs and Quality
Assurance of the Company since May 1996. From 1994 to April 1996, Mr. Treace
served as Vice President and Quality Manager of TreBay. From 1989 to 1994, Mr.
Treace served as Vice President, Technical Affairs of Xomed-Treace, which was
acquired by the Company in 1994. From 1982 to 1989, Mr. Treace was President
of Treace Medical, Inc., a microsurgical ENT medical device company that he
founded in 1982 and that was acquired by Bristol-Myers Squibb in 1989 and
merged with the business of Xomed, Inc. to form Xomed-Treace, Inc. Mr. Treace
is the brother of James T. Treace and John R. Treace.

Mark J. Fletcher has been Vice President of the Company and President of
Solan Ophthalmic Products since July 1996. From April 1996 to July 1996, Mr.
Fletcher served as Vice President, U.S. Marketing of the Company and from 1994
to April 1996, he served as Vice President, Sales and Marketing of the
Company. From 1988 to 1994, Mr. Fletcher held several senior management
positions with Stryker Corporation, a medical device company, including
Executive Vice President, Sales and Marketing from 1993 to 1994.

Gerard J. Bussell has been Vice President of Operations of the Company since
March 1996 and from 1993 to March 1996 was Director of Manufacturing
Operations and Director of Manufacturing of the Company. Prior to joining the
Company, Mr. Bussell served in senior management positions from 1979 to 1993
with Allergan, Inc., an ophthalmic products company, including Senior
Director, Worldwide Materials, and Managing Director.

Richard B. Emmitt has served as a Director of the Company since April 1994
and from December 1990 to 1994 was a Director of Merocel, which became a
subsidiary of the Company in 1994. Mr. Emmitt has been a Managing Director of
The Vertical Group, Inc., an investment firm, since February 1989.

William R. Miller has served as a Director of the Company since April 1994
and from 1991 to 1994 was a Director of Merocel. In January 1991, Mr. Miller
retired as Vice Chairman of the Board of Directors of Bristol-Myers Squibb.
From 1985 to January 1991, Mr. Miller was a Director of Bristol-Myers Squibb.
Mr. Miller is a Director of Isis Pharmaceuticals, Inc., ImClone Systems, Inc.,
Transkaryotic Therapies, Inc. and Westvaco Corporation. He is Chairman of the
Board of Vion Pharmaceuticals, Inc. and SIBIA Neurosciences, Inc. He is

46
<PAGE>

Vice Chairman of the Board of Trustees of the Cold Spring Harbor Laboratory
and is a past Chairman of the Board of the Pharmaceutical Manufacturers
Association. Mr. Miller is also a Trustee of the Manhattan School of Music,
the Metropolitan Opera Association and the Opera Orchestra of New York, a
Member of Oxford University Chancellor's Court of Benefactors, Honorary Fellow
of St. Edmund Hall and Chairman of the English-Speaking Union of the United
States.

Rodman W. Moorhead, III has served as a Director of the Company since 1994
and was a director of Merocel from 1990 to 1994. Mr. Moorhead has been
employed since 1973 by E.M. Warburg, Pincus & Co., LLC and its predecessor
entities ("EMW LLC"), where he currently serves as Senior Managing Director.
He is a director of Coventry Corporation, NeXstar Pharmaceuticals, Inc. and
Transkaryotic Therapies, and is a trustee of ElderTrust, a healthcare REIT.
Mr. Moorhead is a trustee of The Taft School and a member of the Overseers'
Committee on University Resources, Harvard College.

James E. Thomas has served as a Director of the Company since April 1994.
Since 1989, he has been with EMW LLC, where he currently serves as a Managing
Director. Mr. Thomas is also a Director of Anergen, Inc., Celtrix
Pharmaceuticals, Inc., Menley & James Laboratories, Inc., Oxford
GlycoSciences, plc., Transkaryotic Therapies, Inc. and several privately held
companies.

Elizabeth H. Weatherman has served as a Director of the Company since April
1994 and was a Director of Merocel from December 1990 until 1994. Since 1988,
she has been with EMW LLC, where she currently serves as a Managing Director.
Ms. Weatherman is also a Director of Uroquest Medical Corporation and several
privately held health care companies.

Each director serves until the expiration of his term and thereafter until
his successor is duly elected and qualified. A stockholders agreement among
the Company, WP Investors and certain other stockholders provides that WP
Investors has the right to designate specified numbers of persons to the
Company's Board of Directors so long as WP Investors maintains specified
levels of ownership of the outstanding Common Stock. WP Investors currently
has the right under the stockholders agreement to designate three persons to
be appointed or nominated to the Company's Board of Directors. Following the
consummation of this offering, WP Investors will have the right under the
stockholders agreement to designate two such persons. Executive officers of
the Company are elected annually by the Board of Directors and serve at its
discretion or until their successors are duly elected and qualified.

47
<PAGE>

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information with regard to the
beneficial ownership of the Common Stock as of July 10, 1998, and as adjusted
to reflect the sale of the shares of Common Stock being offered hereby, by:
(i) each person known by the Company to own beneficially more than 5% of the
outstanding shares of Common Stock; (ii) each director of the Company; (iii)
its Chief Executive Officer and certain other executive officers; (iv) all
current directors and executive officers of the Company as a group; and (v)
each Selling Stockholder. Except as otherwise noted, the named beneficial
holder has sole voting and investment power.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE OFFERING OWNED AFTER OFFERING
----------------------------- NUMBER OF --------------------
NAME AND ADDRESSES OF SHARES
BENEFICIAL HOLDERS NUMBER(1) PERCENT(2) BEING OFFERED NUMBER(1) PERCENT(2)
--------------------- ------------- ----------- ------------- --------- ----------
<S> <C> <C> <C> <C> <C>
5% Stockholders:
Warburg, Pincus
Investors, L.P. (3)... 3,296,393 44.9% 800,000 2,496,393 31.4%
466 Lexington Avenue
New York, NY 10017
Wellington Management
Company LLP (4)....... 717,300 9.8% -- 717,300 9.0%
75 State Street
Boston, MA 02109
Stein Roe & Farnham
Incorporated (5)...... 500,600 6.8% -- 500,600 6.3%
One South Wacker Drive
Chicago, IL 60606
HL Investment Advisors,
Inc. (6).............. 417,500 5.7% -- 417,500 5.2%
200 Hopmeadow St.
Simsbury, CT 06070
Directors and executive
officers:
James T. Treace........ 195,168(7) 2.6% 55,000 140,168 1.8%
F. Barry Bays.......... 116,134(8) 1.6% 23,500 92,634 1.2%
R. Glen Coleman........ 16,250(9) * -- 16,250 *
Thomas E. Timbie....... 31,799(10) * 6,000 25,799 *
John R. Treace......... 29,477(11) * -- 29,477 *
Guy K. Williamson...... 17,250(12) * -- 17,250 *
Richard B. Emmitt...... 205,054(13) 2.8% -- 205,054 2.6%
William R. Miller...... 6,750(14) * -- 6,750 *
Rodman W. Moorhead,
III................... 3,296,393(15) 44.9% 800,000 2,496,393 31.4%
James E. Thomas........ 3,296,393(15) 44.9% 800,000 2,496,393 31.4%
Elizabeth H.
Weatherman............ 3,296,393(15) 44.9% 800,000 2,496,393 31.4%
All current directors
and executive officers
as a group (15
persons) (16)......... 3,979,554 52.7% 884,500 3,095,054 37.9%
</TABLE>

- -------
* Less than 1%.
(1) Except as otherwise indicated, the persons in this table have sole voting
and investment power with respect to all shares of Common Stock shown as
beneficially owned by them, subject to community property laws where
applicable and subject to the information contained in the footnotes to
this table. Amounts shown for each stockholder include all shares of
Common Stock subject to stock options exercisable within 60 days of July
10, 1998. Shares not outstanding but deemed beneficially owned by virtue
of the right of a person or group to acquire them within 60 days are
treated as outstanding only for purposes of determining the number of and
percent owned by such person or group.
(2) Based on 7,346,124 shares of Common Stock outstanding as of July 10, 1998
and 7,961,624 shares after this offering.
(3) The sole general partner of WP Investors is Warburg, Pincus & Co., a New
York general partnership ("WP"). EMW LLC, a New York limited liability
company, manages WP Investors. The members of EMW LLC are substantially
the same as the partners of WP. Lionel I. Pincus is the managing partner
of WP and the managing member of EMW LLC and may be deemed

48
<PAGE>

to control both WP and EMW LLC. WP, as the sole general partner of WP
Investors, has a 20% interest in the profits of WP Investors. Messrs.
Moorhead and Thomas and Ms. Weatherman are each a director of the Company,
a Managing Director and member of EMW LLC and a general partner of WP. As
such, Messrs. Moorhead and Thomas and Ms. Weatherman may be deemed to have
an indirect pecuniary interest (within the meaning of Rule 16a-1 under the
Securities Exchange Act of 1934 (the "Exchange Act")) in an indeterminate
portion of the shares beneficially owned by WP Investors and WP. WP
Investors has granted to the Underwriters a 30-day option to purchase up
to 112,500 additional shares of Common Stock solely to cover over-
allotments, if any. If the Underwriters' over-allotment option is
exercised in full, WP Investors will beneficially own 2,383,893 shares of
Common Stock, or 29.5% of the outstanding shares, after this offering.
(4) As reflected as beneficially owned at December 31, 1997 in a Statement on
Schedule 13G under the Exchange Act filed with the Securities and
Exchange Commission (the "Commission") on February 9, 1998.
(5) As reflected as beneficially owned at December 31, 1997 in a Statement on
Schedule 13G under the Exchange Act filed with the Commission on February
11, 1998.
(6) As reflected as beneficially owned at December 31, 1997 in a Statement on
Schedule 13G under the Exchange Act filed with the Commission on February
12, 1998.
(7) Includes 46,167 shares of Common Stock which may be acquired pursuant to
stock options exercisable within 60 days of July 10, 1998. Excludes
111,167 shares of Common Stock which may be acquired pursuant to stock
options that are not exercisable within 60 days of July 10, 1998. Mr.
Treace has pledged 101,460 shares of Common Stock to WP Investors to
secure repayment of a loan used to purchase such shares. As of July 13,
1998, a total balance of $1,277,374 was outstanding under the loan, which
bears interest at an annual rate of 7% and matures on April 16, 2001. The
net proceeds of the sale of Common Stock by Mr. Treace in this offering
will be used to repay the loan.
(8) Includes 30,167 shares of Common Stock which may be acquired pursuant to
stock options exercisable within 60 days of July 10, 1998. Excludes
72,667 shares of Common Stock which may be acquired pursuant to stock
options that are not exercisable within 60 days of July 10, 1998. Mr.
Bays has pledged 58,414 shares of Common Stock to WP Investors to secure
repayment of a loan used to purchase such shares. As of July 13, 1998, a
total balance of $655,775 was outstanding under the loan, which bears
interest at an annual rate of 7% and matures on April 16, 2001. The net
proceeds of the sale of Common Stock by Mr. Bays in this offering will be
used to repay the loan.
(9) Shares of Common Stock which may be acquired pursuant to stock options
exercisable within 60 days of July 10, 1998. Excludes 46,250 shares of
Common Stock which may be acquired pursuant to stock options that are not
exercisable within 60 days of July 10, 1998.
(10) Includes 19,500 shares of Common Stock which may be acquired within 60
days of July 10, 1998. Excludes 35,500 shares of Common Stock which may
be acquired pursuant to stock options that are not exercisable within 60
days of July 10, 1998. Mr. Timbie has pledged 12,299 shares of Common
Stock to WP Investors to secure repayment of a loan used to purchase such
shares. As of July 13, 1998, a total balance of $154,096 was outstanding
under the loan, which bears interest at an annual rate of 7% and matures
on April 16, 2001. The net proceeds of the sale of Common Stock by Mr.
Timbie in this offering will be used to repay the loan.
(11) Includes 19,500 shares of Common Stock which may be acquired pursuant to
stock options exercisable within 60 days of July 10, 1998. Excludes
35,500 shares of Common Stock which may be acquired pursuant to stock
options that are not exercisable within 60 days of July 10, 1998.
(12) Includes 16,250 shares of Common Stock which may be acquired pursuant to
stock options exercisable within 60 days of July 10, 1998. Excludes
35,500 shares of Common Stock which may be acquired pursuant to stock
options that are not exercisable within 60 days of July 10, 1998.
(13) As of December 31, 1997, (i) Vertical Fund Associates, L.P. ("Vertical
Fund") is the direct owner of 166,554 shares of Common Stock and (ii)
Vertical Life Sciences, L.P. ("Vertical Life") is the direct owner of
38,500 shares of Common Stock. The sole general partner of each of
Vertical Fund and Vertical Life is The Vertical Group, L.P. ("VG"). Mr.
Emmitt, a Director of the Company, is a general partner of VG. As such,
Mr. Emmitt may be deemed to have an indirect pecuniary interest (within
the meaning of Rule 16a-1 under the Exchange Act) in an indeterminate
portion of the securities of the Company beneficially owned by VG,
Vertical Fund and Vertical Life. Mr. Emmitt disclaims beneficial
ownership of these securities within the meaning of Rule 13d-3 under the
Exchange Act, except to the extent of his indirect pecuniary interest.
(14) Includes 1,250 shares of Common Stock which may be acquired pursuant to
stock options exercisable within 60 days of July 10, 1998.
(15) All of the shares of Common Stock indicated as owned by Messrs. Moorhead
and Thomas and Ms. Weatherman are owned directly by WP Investors and are
included because of Messrs. Moorhead and Thomas' and Ms. Weatherman's
affiliation with WP Investors. Messrs. Moorhead and Thomas and Ms.
Weatherman disclaim beneficial ownership of these shares within the
meaning of Rule 13d-3 under the Exchange Act, except to the extent of
their indirect pecuniary interest.
(16) Includes an aggregate of 207,334 shares of Common Stock which may be
acquired within 60 days of July 10, 1998.

49
<PAGE>

DESCRIPTION OF CAPITAL STOCK

GENERAL

The authorized capital stock of the Company consists of: (i) 30,000,000
shares of Common Stock, par value $0.01 per share; and (ii) 1,000,000 shares
of Preferred Stock, par value $0.01 per share. As of July 10, 1998, there were
7,346,124 shares of Common Stock outstanding held of record by approximately
60 persons, and no shares of Preferred Stock outstanding.

COMMON STOCK

Holders of Common Stock are entitled to one vote per share in all matters to
be voted on by the stockholders of the Company and do not have cumulative
voting rights. Subject to preferences that may be applicable to any Preferred
Stock outstanding at the time, holders of Common Stock are entitled to receive
ratably such dividends, if any, as may be declared from time to time by the
Board of Directors out of funds legally available therefor. In the event of a
liquidation, dissolution or winding up of the Company, holders of Common Stock
are entitled to share ratably in all assets remaining after payment of the
Company's liabilities and the liquidation preference, if any, of any
outstanding Preferred Stock. Holders of shares of Common Stock have no
preemptive, subscription, redemption or conversion rights. There are no
redemption or sinking fund provisions applicable to the Common Stock. All of
the outstanding shares of Common Stock are, and the shares offered by the
Company in this offering will be, when issued and paid for, fully paid and
non-assessable. The rights, preferences and privileges of holders of Common
Stock are, subject to, and may be adversely affected by, the rights of the
holders of shares of any series of Preferred Stock which the Company may
designate and issue in the future. See "Dividend Policy."

PREFERRED STOCK

The Board of Directors has the authority, without any further vote or action
by the stockholders, to provide for the issuance of up to 1,000,000 shares of
Preferred Stock from time to time in one or more series with such
designations, rights, preferences and limitations as the Board of Directors
may determine, including the consideration received therefor. The Board also
will have the authority to determine the number of shares comprising each
series, dividend rates, redemption provisions, liquidation preferences,
sinking fund provisions, conversion rights and voting rights without approval
by the holders of Common Stock. Although it is not possible to state the
effect that any issuance of Preferred Stock might have on the rights of
holders of Common Stock, the issuance of Preferred Stock may have one or more
of the following effects: (i) to restrict Common Stock dividends if Preferred
Stock dividends have not been paid; (ii) to dilute the voting power and equity
interest of holders of Common Stock to the extent that any Preferred Stock
series has voting rights or is convertible into Common Stock; or (iii) to
prevent current holders of Common Stock from participating in the Company's
assets upon liquidation until any liquidation preferences granted to holders
of Preferred Stock are satisfied. In addition, the issuance of Preferred Stock
may, under certain circumstances, have the effect of discouraging a change in
control of the Company by, for example, granting voting rights to holders of
Preferred Stock that require approval by the separate vote of the holders of
Preferred Stock for any amendment to the Restated Certificate or any
reorganization, consolidation, merger or other similar transaction involving
the Company. As a result, the issuance of such Preferred Stock may discourage
bids for the Common Stock at a premium over the market price therefor, and
could have a materially adverse effect on the market value of the Common
Stock. See "Risk Factors--Anti-takeover Considerations."

REGISTRATION RIGHTS

In connection both with the formation of the Company and its acquisition of
TreBay, the Company granted certain rights with respect to the registration of
shares of Common Stock held by certain stockholders (the "Investors")
(collectively, the "Registrable Securities"). Based on a review of the
Company's stock records, upon completion of this offering there will be
2,892,686 Registrable Securities outstanding. Such registration rights also
extend to any capital stock of the Company issued as a dividend or other
distribution with respect to,

50
<PAGE>

or in exchange for or in replacement of, the shares of Common Stock referred
to above and any additional shares of Common Stock which any of the Investors
may hereafter acquire. Certain of the Investors hold options to purchase an
aggregate of 443,166 shares of Common Stock. The shares obtained upon the
exercise of such options also will be Registrable Securities. A holder or
holders of the Registrable Securities (each a "Holder") who: (i) prior to this
offering, are a Holder or Holders of more than 50% of the then outstanding
Registrable Securities; or (ii) following this offering, are a Holder or
Holders of more than 20% of the then outstanding Registrable Securities (each,
an "Initiating Holder") are entitled to request that the Company file a
registration statement under the Securities Act covering the sale of some or
all of the Registrable Securities owned by such holders, subject to certain
conditions. The Company is required to effect no more than two such
registrations (three if the prior two registrations did not include WP
Investors as an Initiating Holder). The Company is not required to include
Registrable Securities in a registration statement if: (i) the Company either
receives an opinion of counsel that the disposition of such Registrable
Securities does not require registration under the Securities Act; or (ii) the
Registrable Securities can be sold during a single three-month period pursuant
to Rule 144 (without giving effect to the provisions of Rule 144(k)). The
Company is not required to effect any such registration if the anticipated
aggregate public offering price of the shares of Common Stock proposed to be
registered is less than $5.0 million. If officers or directors of the Company
holding other securities of the Company shall request inclusion in any such
registration, or if holders of securities of the Company other than
Registrable Securities who are entitled, by contract with the Company or
otherwise, to have securities included in such a registration (the "Other
Stockholders") request such inclusion, the Holders shall offer to include the
securities of such officers, directors and Other Stockholders in any
underwriting involved in such registration, provided, among other conditions,
that the underwriter representative of any such offering has the right,
subject to certain conditions, to limit the number of Registrable Securities
included in the registration. In addition, in the event that the Company
proposes to register any of its securities under the Securities Act (other
than registrations relating solely to employee benefit plans or pursuant to
Rule 145 or on a form which does not permit secondary sales or does not
include substantially the same information as would be required to be included
in a registration statement covering the sale of Registrable Securities),
either for its own account or for the account of other security holders or
holders exercising their respective demand registration rights, holders of
Registrable Securities may require the Company to include all or a portion of
their Registrable Securities in the registration and in any underwriting
involved therein, provided, among other conditions, that the underwriter
representative of any such offering has the right, subject to certain
conditions, to limit the number of Registrable Securities included in the
registration. Further, since the Company is qualified to use Form S-3 to
register securities under the Securities Act, the holders of Registrable
Securities have the right to request three registrations on Form S-3 to
register all or a portion of such shares under the Securities Act, subject to
certain conditions. In general, the Company will bear all fees, costs and
expenses of such registrations (other than underwriting discounts and selling
commissions applicable to sales of the Registrable Securities and all fees and
disbursements of counsel for each of the Holders).

LIMITATIONS ON DIRECTORS' LIABILITY

The Restated Certificate and Restated By-laws limit the liability of
directors and officers to the maximum extent permitted by Delaware law.
Delaware law provides that directors of a corporation will not be personally
liable for monetary damages for breach of their fiduciary duties as directors,
including gross negligence, except liability for: (i) breach of the directors'
and officers' duty of loyalty; (ii) acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of the law; (iii)
the unlawful payment of a dividend or unlawful stock purchase or redemption;
and (iv) any transaction from which the director or officer derives an
improper personal benefit. Delaware law does not permit a corporation to
eliminate a director's or an officer's duty of care, and this provision of the
Restated Certificate has no effect on the availability of equitable remedies,
such as injunction or rescission, based upon a director's breach of the duty
of care.

These provisions will not limit liability under state or federal securities
laws. The Company believes that these provisions will assist the Company in
attracting and retaining qualified individuals to serve as directors.

51
<PAGE>

POSSIBLE ISSUANCES OF PREFERRED STOCK

The Company has amended its Restated Certificate to authorize the issuance
of Preferred Stock without stockholder approval and upon such terms as the
Board of Directors may determine. This amendment could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from acquiring or making a proposal to acquire, a majority of the
outstanding stock of the Company. The rights of the holders of Common Stock
will be subject to, and may be adversely affected by, the rights of holders of
Preferred Stock that may be issued in the future. The Company has no present
plans to issue any shares of Preferred Stock. See "--Preferred Stock" and
"Risk Factors--Anti-takeover Considerations."

SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW

The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law ("Section 203"). Under Section 203, certain "business
combinations" between a Delaware corporation whose stock generally is publicly
traded or held of record by more than 2,000 stockholders and an "interested
stockholder" are prohibited for a three-year period following the date that
such a stockholder became an interested stockholder, unless: (i) the
corporation has elected in its original certificate of incorporation not to be
governed by Section 203 (the Company did not make such an election); (ii) the
business combination was approved by the Board of Directors of the corporation
before the other party to the business combination became an interested
stockholder; (iii) upon consummation of the transaction that made it an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the commencement of the
transaction (excluding voting stock owned by directors who are also officers
or held in employee benefit plans in which the employees do not have a
confidential right to tender or vote stock held by the plan); or (iv) the
business combination was approved by the Board of Directors of the corporation
and ratified by two-thirds of the voting stock which the interested
stockholder did not own. The three-year prohibition also does not apply to
certain business combinations proposed by an interested stockholder following
the announcement or notification of certain extraordinary transactions
involving the corporation and a person who had not been an interested
stockholder during the previous three years or who became an interested
stockholder with the approval of the majority of the corporation's directors.
The term "business combination" is defined generally to include mergers or
consolidations between a Delaware corporation and an interested stockholder,
transactions with an interested stockholder involving the assets or stock of
the corporation or its majority-owned subsidiaries and transactions which
increase an interested stockholder's percentage ownership of stock. The term
"interested stockholder" is defined generally as a stockholder who, together
with affiliates and associates, owns (or, within three years prior, did own)
15% or more of a Delaware corporation's voting stock. Section 203 could
prohibit or delay a merger, takeover or other change in control of the Company
and therefore could discourage attempts to acquire the Company.

TRANSFER AGENT AND REGISTRAR

The Transfer Agent and Registrar of the Company's Common Stock is First
Union National Bank.

52
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, the Company expects to have 7,961,624
shares of Common Stock outstanding, assuming no exercise of the Underwriters'
over-allotment option. The 1,500,000 shares of Common Stock sold in this
offering will be freely tradeable without restriction under the Securities
Act, except for any such shares which may be acquired by an "affiliate" of the
Company (an "Affiliate") as that term is defined in Rule 144 under the
Securities Act, which shares will be subject to the resale limitations of Rule
144.

Based on a review of the Company's stock records, upon completion of this
offering an aggregate of approximately 2,900,000 shares of Common Stock held
by existing stockholders will be "restricted securities" (as that phrase is
defined in Rule 144) and may not be resold in the absence of registration
under the Securities Act or pursuant to exemptions from such registration,
including among others, the exemption provided by Rule 144 under the
Securities Act.

In general, under Rule 144 as currently in effect, if a period of at least
one year has elapsed since the later of the date the "restricted securities"
were acquired from the Company and the date they were acquired from an
Affiliate, then the holder of such restricted securities (including an
Affiliate) is entitled to sell a number of shares within any three-month
period that does not exceed the greater of 1% of the then outstanding shares
of the Common Stock (approximately 80,000 shares immediately after this
offering) or the average weekly reported volume of trading of the Common Stock
on the Nasdaq National Market during the four calendar weeks preceding such
sale. The holder may only sell such shares through unsolicited brokers'
transactions. Sales under Rule 144 are also subject to certain requirements
pertaining to the manner of such sales, notices of such sales and the
availability of current public information concerning the Company. Affiliates
may sell shares not constituting restricted shares in accordance with the
foregoing volume limitations and other requirements but without regard to the
one-year holding period. Under Rule 144(k), if a period of at least two years
has elapsed between the later of the date restricted securities were acquired
from the Company and the date they were acquired from an Affiliate, as
applicable, a holder of such restricted securities who is not an Affiliate at
the time of the sale and has not been an Affiliate for at least three months
prior to the sale would be entitled to sell the shares immediately without
regard to the volume limitations and other conditions described above.

Any employee of the Company who purchased his or her shares of Common Stock
pursuant to a written compensation plan or contract may be entitled to rely on
the resale provisions of Rule 701 under the Securities Act, which permits
nonaffiliates to sell their Rule 701 shares without having to comply with the
current public information, holding period, volume limitation or notice
provision of Rule 144 and permits affiliates to sell their Rule 701 shares
without having to comply with Rule 144's holding period restrictions.

53
<PAGE>

UNDERWRITING

Subject to the terms and conditions contained in the Underwriting Agreement,
the Underwriters named below (the "Underwriters"), through their
Representatives, BT Alex. Brown Incorporated, ING Baring Furman Selz LLC and
Piper Jaffray Inc., have severally agreed to purchase from the Company and the
Selling Stockholders the following respective numbers of shares of Common
Stock at the public offering price less the underwriting discounts and
commissions set forth on the cover page of this Prospectus:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
BT Alex. Brown Incorporated.......................................... 660,000
ING Baring Furman Selz LLC........................................... 330,000
Piper Jaffray Inc. .................................................. 330,000
CIBC Oppenheimer Corp................................................ 60,000
Sterne, Agee & Leach, Inc............................................ 60,000
Wheat First Union.................................................... 60,000
---------
Total............................................................ 1,500,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all shares of the Common Stock offered hereby if any of such shares
are purchased.

The Company and the Selling Stockholders have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock to the public at the public offering price set forth on the cover page
of this Prospectus and to certain dealers at such price less a concession not
in excess of $1.05 per share. The Underwriters may allow, and such dealers may
reallow, a concession not in excess of $.10 per share to certain other
dealers. After commencement of the offering, the offering price and other
selling terms may be changed by the Representatives.

Each of the Company and WP Investors has granted to the Underwriters an
option, exercisable not later than 30 days after the date of this Prospectus,
to purchase up to 112,500 additional shares of Common Stock, at the public
offering price less the underwriting discounts and commissions set forth on
the cover page of this Prospectus. To the extent that the Underwriters
exercise such option, each of the Underwriters will have a firm commitment to
purchase approximately the same percentage thereof that the number of shares
of Common Stock purchased by each of them shown in the above table bears to
1,500,000, and the Company and WP Investors will be obligated, pursuant to the
option, to sell such shares to the Underwriters. The Underwriters may exercise
such option only to cover over-allotments made in connection with the sale of
the Common Stock offered hereby. If purchased, the Underwriters will offer
such additional shares on the same terms as those on which the 1,500,000
shares are being offered.

The Company has agreed to indemnify the Underwriters and certain controlling
persons against certain liabilities, including liabilities under the
Securities Act.

In connection with this offering, certain Underwriters and selling group
members (if any) who are qualifying registered market makers on the Nasdaq
National Market may engage in passive market making transactions in the Common
Stock on the Nasdaq National Market immediately prior to the commencement of
sales in accordance with Rule 103 of Regulation M under the Exchange Act,
during the qualifying period which is two business days before commencement of
sales in this offering. The passive market making transactions must comply
with applicable price and volume limits and be identified as such. In general,
a passive market maker may display its bid at a price not in excess of the
highest independent bid for the security; if all independent bids are lowered
below the passive market maker's bid, however, such bid must then be lowered
when certain purchase limits are exceeded. Net purchases by a passive market
maker on each day are generally limited to 30.0% of the passive market maker's
average daily trading volume in the Common Stock during a prior period and
must be discontinued when such limit is reached. Passive market making may
stabilize the market price of the Common Stock at a level above that which
might otherwise prevail, and, if commenced, may be discontinued at any time.

54
<PAGE>

The Representatives have advised the Company that, pursuant to Regulation M
under the Exchange Act, certain persons participating in the offering may
engage in transactions, including stabilizing bids, syndicate covering
transactions or the imposition of penalty bids which may have the effect of
stabilizing or maintaining the market price of the Common Stock at a level
above that which might otherwise prevail in the open market. A "stabilizing
bid" is a bid for or the purchase of Common Stock on behalf of the
Underwriters for the purchase of fixing or maintaining the price of the Common
Stock. A "syndicate covering transaction" is the bid for or the purchase of
the Common Stock on behalf of the Underwriters to reduce a short position
incurred by the Underwriters in connection with the offering. A "penalty bid"
is an arrangement permitting, the Representatives to reclaim the selling
concession otherwise accruing to an Underwriter or syndicate member in
connection with the offering if the Common Stock originally sold by such
Underwriter or syndicate member is purchased by the Representatives in a
syndicate covering transaction and has therefore not been effectively placed
by such Underwriter or syndicate member. The Representatives have advised the
Company that such transactions may be effected on the Nasdaq National Market
or otherwise and, if commenced, may be discontinued at any time.

Subject to certain exceptions, the Company has agreed not to offer, sell,
sell short or otherwise dispose of any shares of Common Stock for a period of
90 days from the date of this Prospectus without the prior consent of BT Alex.
Brown Incorporated. In addition, directors, executive officers and certain
stockholders of the Company, who will beneficially own upon the completion of
this offering an aggregate of 3,029,775 shares of Common Stock including
options representing the right to purchase 149,084 shares of Common Stock,
have agreed not to offer, sell, sell short or otherwise dispose of any such
shares of Common Stock beneficially owned by them or any shares issuable upon
exercise of stock options for a period of 90 days from the date of this
Prospectus without the prior written consent of BT Alex. Brown Incorporated.

The Representatives of the Underwriters have advised the Company that the
Underwriters do not intend to confirm sales to any account over which they
exercise discretionary authority.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Willkie Farr & Gallagher, New York, New York. Certain legal matters
relating to this offering will be passed upon for the Underwriters by Hogan &
Hartson L.L.P., Baltimore, Maryland.

EXPERTS

The consolidated financial statements as of December 31, 1997 and 1996 and
for each of the three years in the period ended December 31, 1997 of the
Company appearing in this Prospectus and Registration Statement and
incorporated by reference elsewhere herein have been audited by Ernst & Young
LLP, independent auditors, as set forth in their reports appearing herein and
incorporated by reference elsewhere in the registration statement and are
included in reliance upon such reports given upon the authority of such firm
as experts in accounting and auditing.

55
<PAGE>

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Exchange Act
and in accordance therewith files reports, proxy statements, and other
information with the Commission. Reports, proxy statements and other
information filed by the Company with the Commission can be inspected and
copied at 450 Fifth Street, NW, Washington, D.C. 20549, and at the following
regional offices of the Commission: 7 World Trade Center, Suite 1300, New
York, New York 10048, and 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. Copies of such material can also be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, NW, Washington, D.C.
20549, at prescribed rates. The Commission also maintains a World Wide Web
site (http://www.sec.gov) containing these reports, proxy statements and other
information. The Common Stock is listed on the Nasdaq National Market, and
these records and other information can also be inspected at the offices of
the National Association of Securities Dealers, Inc, Nasdaq Reports Section,
1735 K Street, N.W., Washington, D.C. 20006.

The Company has filed with the Commission a Registration Statement on Form
S-3 (together with all exhibits and amendments, the "Registration Statement")
under the Securities Act with respect to the Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto, certain
portions of which are omitted as permitted by the rules and regulations of the
Commission. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to the Registration Statement,
including the exhibits and schedules thereto. The Registration Statement may
be inspected, without charge, at the Commission's principal office at 450
Fifth Street, NW, Washington, D.C. 20549, and also at the regional offices of
the Commission listed above. Copies of such material may also be obtained from
the Commission upon the payment of prescribed rates. The Registration
Statement may also be accessed from the Commission's World Wide Web site
listed above.

Statements contained in the Prospectus as to any contracts, agreements or
other documents filed as an exhibit to the Registration Statement are not
necessarily complete, and in each instance reference is hereby made to the
copy of such contract, agreement or other document filed as an exhibit to the
Registration Statement for a full statement of the provisions thereof, and
each such statement in the Prospectus is qualified in all respects by such
reference.

The Company distributes to its stockholders annual reports containing
audited financial statements for each fiscal year of the Company.

56
<PAGE>

INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

The following documents have been filed by the Company with the Commission
pursuant to the Exchange Act and are hereby incorporated by reference into
this Prospectus:

(a) the Company's Annual Report on Form 10-K for the year ended December
31, 1997, as amended;

(b) the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 28, 1998;

(d) the description of the Common Stock contained in the Company's
Registration Statement on Form 8-A filed under the Exchange Act and
any amendments or reports filed for the purpose of updating such
description.

All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Prospectus and prior to the
termination of the offering of the Common Stock offered hereby shall be deemed
to be incorporated by reference in this Prospectus and to be a part hereof
from the date of filing such documents.

Any statement contained herein or in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained
herein or in any other subsequently filed document which also is or is deemed
to be incorporated by reference herein modifies or supersedes such statement.
Any such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of this Prospectus.

The Company will provide without charge to each person, including any
beneficial owner, to whom a copy of this Prospectus has been delivered, upon
the written or oral request of any such person, a copy of any or all of the
documents incorporated by reference in this Prospectus (other than exhibits
and schedules thereto, unless such exhibits or schedules are specifically
incorporated by reference into the information that this Prospectus
incorporates). Written or oral requests for copies of these documents should
be directed to Xomed Surgical Products, Inc., 6743 Southpoint Drive North,
Jacksonville, Florida 32216, Attention: Secretary.

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

Xomed(R), EndoScrub(R), NIM-2(R), NIM-2(R) XL, Laser-Shield II(R),
Skeeter(R), Merocel(R), TreBay(R), Powerforma(R), Activent(R), XPS 2000
StraightShot(R) and Solan(R) are registered trademarks of the Company. Rad 40,
RADenoid and Navigator are trademarks of the Company. This Prospectus also
includes trademarks of companies other than the Company.

57
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C>
Report of Independent Auditors.......................................... F-2
Consolidated Balance Sheets at December 31, 1997 and 1996, and March 28,
1998 (Unaudited)....................................................... F-3
Consolidated Statements of Operations for each of the three years in the
period ended
December 31, 1997 and the three months ended March 28, 1998 (Unaudited)
and March 29, 1997 (Unaudited)......................................... F-4
Consolidated Statements of Changes in Shareholders' Equity for each of
the three years in the period ended December 31, 1997.................. F-5
Consolidated Statements of Cash Flows for each of the three years in the
period ended
December 31, 1997 and the three months ended March 28, 1998 (Unaudited)
and March 29, 1997 (Unaudited)......................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
</TABLE>

F-1
<PAGE>

REPORT OF INDEPENDENT AUDITORS

Board of Directors
Xomed Surgical Products, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Xomed
Surgical Products, Inc. and Subsidiaries (the Company) as of December 31, 1997
and 1996, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Xomed Surgical Products, Inc. and Subsidiaries at December 31, 1997 and
1996, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.

Ernst & Young LLP

February 16, 1998
Jacksonville, Florida

F-2
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 28, ----------------
1998 1997 1996
----------- ------- -------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents...................... $ 3,889 $ 1,712 $ 629
Accounts receivable, less allowance for
doubtful accounts of $735 and $400 at December
31, 1997 and 1996, respectively............... 14,337 13,277 9,935
Other receivables.............................. 520 620 1,056
Inventories.................................... 16,498 16,238 14,675
Prepaid expenses and other assets.............. 876 1,083 1,070
Deferred income taxes.......................... 1,404 1,404 1,721
------- ------- -------
Total current assets......................... 37,524 34,334 29,086
Notes receivable from officers................... 826 724 724
Property, plant and equipment, net............... 15,433 15,403 15,377
Cost in excess of net assets acquired, net....... 41,901 42,399 44,389
Other assets..................................... 3,089 2,867 3,444
Deferred income taxes............................ -- -- 1,036
------- ------- -------
Total assets................................. $98,773 $95,727 $94,056
======= ======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................... $ 4,774 $ 3,493 $ 4,370
Accrued expenses............................... 3,507 2,403 3,287
Accrued payroll and commissions................ 1,507 2,332 1,726
Accrued restructuring costs.................... -- -- 1,155
Current portion of long-term debt and capital
lease obligations............................. -- -- 88
------- ------- -------
Total current liabilities.................... 9,788 8,228 10,626
Deferred credits................................. 710 990 300
Long-term debt and capital lease obligations,
less current portion............................ -- -- 3,563
Redeemable preferred stock:
Several series; $1.00 par value, 6,300,000
shares authorized,
-0- shares issued and outstanding............. -- -- --
Shareholders' equity:
Common stock:
Common Stock, voting, $.01 par value;
30,000,000 shares authorized, 7,342,524
shares issued and outstanding................ 73 73 73
Common Stock, non-voting, $.01 par value;
4,000,000 shares authorized, -0- shares
issued and outstanding....................... -- -- --
Accumulated deficit............................ (1,734) (3,459) (9,589)
Additional paid-in capital..................... 90,331 90,264 89,475
Cumulative translation adjustments............. (142) (88) --
Deferred stock compensation.................... (253) (281) (392)
------- ------- -------
Total shareholders' equity................... 88,275 86,509 79,567
------- ------- -------
Total liabilities and shareholders' equity... $98,773 $95,727 $94,056
======= ======= =======
</TABLE>

See accompanying notes.

F-3
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------
YEARS ENDED DECEMBER 31,
MARCH 28, MARCH 29, ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales, net................... $20,682 $17,804 $ 77,240 $ 65,664 $ 59,865
Cost of sales................ 8,063 7,160 30,475 25,926 23,175
------- ------- -------- -------- --------
Gross profit................. 12,619 10,644 46,765 39,738 36,690
Operating expenses:
Selling, general and
administrative............ 8,085 7,253 30,334 26,799 27,077
Research and development... 1,170 1,006 4,088 3,659 2,405
Amortization of
intangibles............... 584 615 2,374 2,421 2,579
Write-off of acquired
research and development.. -- -- -- 2,380 --
Restructuring charges...... -- -- -- 3,093 --
------- ------- -------- -------- --------
Total operating
expenses................ 9,839 8,874 36,796 38,352 32,061
------- ------- -------- -------- --------
Operating income from
continuing operations....... 2,780 1,770 9,969 1,386 4,629
Interest income.............. 55 42 176 194 55
Interest expense............. (25) (96) (280) (2,399) (3,118)
Other income, net............ 40 92 234 525 114
------- ------- -------- -------- --------
Income (loss) from continuing
operations before income tax
expense..................... 2,850 1,808 10,099 (294) 1,680
Income tax expense........... 1,125 721 3,969 873 1,355
------- ------- -------- -------- --------
Income (loss) from continuing
operations.................. 1,725 1,087 6,130 (1,167) 325
Discontinued operations:
Income from operations of
discontinued surgical
drapes segment (less
applicable income tax
expense of $203 for the
period ended December 31,
1995)..................... -- -- -- -- 306
Loss on disposal of
surgical drapes segment
(less applicable income
tax benefit of $1,386).... -- -- -- -- (2,485)
------- ------- -------- -------- --------
Net income (loss)............ $ 1,725 $ 1,087 $ 6,130 $ (1,167) $ (1,854)
======= ======= ======== ======== ========
Per share:
Income (loss) from
continuing operations
available to common
shareholders.............. $ 0.23 $ 0.15 $ 0.84 $ 1.14 $ (3.53)
======= ======= ======== ======== ========
Net income (loss) available
to common shareholders.... $ 0.23 $ 0.15 $ 0.84 $ 1.14 $ (5.69)
======= ======= ======== ======== ========
Income (loss) from
continuing operations
available to common
shareholders--assuming
dilution.................. $ 0.23 $ 0.15 $ 0.82 $ (0.22) $ (3.53)
======= ======= ======== ======== ========
Net income (loss) available
to common shareholders--
assuming dilution......... $ 0.23 $ 0.15 $ 0.82 $ (0.22) $ (5.69)
======= ======= ======== ======== ========
Weighted average common
shares outstanding.......... 7,342 7,289 7,323 2,755 1,009
======= ======= ======== ======== ========
Weighted average common
shares outstanding--
diluted..................... 7,632 7,438 7,512 5,201 1,009
======= ======= ======== ======== ========
</TABLE>

See accompanying notes.

F-4
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
NON-VOTING
COMMON STOCK COMMON STOCK SHAREHOLDERS' ADDITIONAL CUMULATIVE
---------------- ---------------- ACCUMULATED NOTE PAID-IN UNEARNED TRANSLATION
SHARES AMOUNT SHARES AMOUNT DEFICIT RECEIVABLE CAPITAL COMPENSATION ADJUSTMENTS TOTAL
--------- ------ -------- ------ ----------- ------------- ---------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT
DECEMBER 31,
1994........... 573,120 $ 6 426,777 $ 4 $ (6,997) $(349) $ -- $ -- $-- $ (7,336)
Net loss........ -- -- -- -- (1,854) -- -- -- -- (1,854)
Stock options
exercised...... 19,000 -- -- -- -- -- 22 -- -- 22
Accretion of
cumulative
preferred stock
dividends...... -- -- -- -- (3,868) -- (22) -- -- (3,890)
--------- --- -------- ---- -------- ----- ------- ----- ---- --------
BALANCE AT
DECEMBER 31,
1995........... 592,120 6 426,777 4 (12,719) (349) -- -- -- (13,058)
Net loss........ -- -- -- -- (1,167) -- -- -- -- (1,167)
Accretion of
cumulative
preferred stock
dividends...... -- -- -- -- (3,262) -- -- -- -- (3,262)
Forgiveness of
cumulative
preferred stock
dividends...... -- -- -- -- 7,559 -- -- -- -- 7,559
Stock options
exercised...... 104,600 1 -- -- -- -- 188 -- -- 189
Shareholders
stock
returned....... -- -- -- -- -- 162 -- -- -- 162
Acquisition of
minority
interest in
subsidiary..... 8,000 -- -- -- -- -- 180 -- -- 180
Stock
compensation,
net of tax..... -- -- -- -- -- -- 596 (392) -- 204
Proceeds from
initial public
stock
offering....... 2,875,000 29 -- -- -- -- 53,976 -- -- 54,005
Conversion of
preferred stock
to common
stock.......... 3,255,052 33 -- -- -- 187 34,535 -- -- 34,755
Conversion of
non-voting
common stock to
voting common
stock.......... 426,777 4 (426,777) (4) -- -- -- -- -- --
--------- --- -------- ---- -------- ----- ------- ----- ---- --------
BALANCE AT
DECEMBER 31,
1996........... 7,261,549 73 -- -- (9,589) -- 89,475 (392) -- 79,567
Net income...... -- -- -- -- 6,130 -- -- -- -- 6,130
Stock options
exercised...... 74,100 -- -- -- -- -- 655 -- -- 655
Net tax benefits
from stock
options........ -- -- -- -- -- -- 134 -- -- 134
Amortization of
unearned
compensation... -- -- -- -- -- -- -- 111 -- 111
Translation
adjustments.... -- -- -- -- -- -- -- -- (88) (88)
--------- --- -------- ---- -------- ----- ------- ----- ---- --------
BALANCE AT
DECEMBER 31,
1997........... 7,335,649 $73 -- $-- $ (3,459) $ -- $90,264 $(281) $(88) $ 86,509
========= === ======== ==== ======== ===== ======= ===== ==== ========
</TABLE>

See accompanying notes.

F-5
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
THREE MONTHS ENDED YEARS ENDED DECEMBER 31,
------------------- ----------------------------
MARCH 28, MARCH 29,
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)............ $1,725 $1,087 $ 6,130 $ (1,167) $ (1,854)
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depreciation............... 612 511 2,340 2,285 2,038
Amortization............... 628 688 2,776 2,564 2,702
Loss on disposal of
property and equipment.... 18 -- 60 301 4,963
Translation adjustments.... (54) -- 288 41 (67)
Write-off of acquired
research and development.. -- -- -- 2,380 --
Changes in operating assets
and liabilities net of
effects of purchased
business
(Increase) decrease in
accounts and other
receivables, net........ (931) (912) (3,282) 2,456 (3,161)
(Increase) decrease in
inventories, net........ (260) (15) (1,563) (2,530) 535
Decrease (increase) in
deferred income taxes... (372) -- 2,002 266 (494)
Increase (decrease) in
other assets............ (157) (254) (251) (141) 130
Increase (decrease) in
accounts payable and
accrued expenses........ 1,560 (571) (980) (1,099) 2,510
Decrease in accrued
restructuring costs..... -- (614) (1,155) (512) (1,045)
------ ------ -------- -------- --------
Net cash provided by (used
in) operating activities.... 2,769 (80) 6,365 4,844 6,257
INVESTING ACTIVITIES
Purchases of property and
equipment................... (659) (448) (2,426) (2,379) (2,969)
Loans to officers............ -- -- -- 353 --
Proceeds from certificates of
deposit..................... -- 140 140 721 338
Purchase of other assets..... -- -- -- (807) (1,388)
Purchases of businesses
(including cash received)... -- -- -- 2,000 --
------ ------ -------- -------- --------
Net cash used in investing
activities.................. (659) (308) (2,286) (112) (4,019)
FINANCING ACTIVITIES
Proceeds from revolving line
of credit................... -- 5,336 12,302 29,416 28,810
Payments on revolving line of
credit...................... -- (5,509) (15,450) (37,034) (24,986)
Payments on term notes
payable and capital lease... -- (21) (503) (26,096) (5,927)
Exercise of stock options.... 67 638 655 189 --
Issuance of stock............ -- -- -- 54,005 22
Repurchases of redeemable
preferred stock............. -- -- -- (25,000) --
------ ------ -------- -------- --------
Net cash provided by (used
in) financing activities.... 67 444 (2,996) (4,520) (2,081)
------ ------ -------- -------- --------
Net increase in cash and cash
equivalents................. 2,177 56 1,083 212 157
Cash and cash equivalents at
beginning of period......... 1,712 629 629 417 260
------ ------ -------- -------- --------
Cash and cash equivalents at
end of period............... $3,889 $ 685 $ 1,712 $ 629 $ 417
====== ====== ======== ======== ========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
Cash paid during the period
for:
Interest................. $ 11 $ 52 $ 282 $ 2,499 $ 3,118
====== ====== ======== ======== ========
Income taxes............. $ 437 $ 38 $ 1,529 $ 579 $ 228
====== ====== ======== ======== ========
Increase (decrease) in
preferred stock
attributable to accretion
or forgiveness of
cumulative preferred stock
dividends:
Series A................. $ -- $ -- $ -- $ (141) $ 209
Series B................. -- -- -- (1,473) 1,223
Series C................. -- -- -- (2,684) 2,458
------ ------ -------- -------- --------
$ -- $ -- $ -- $ (4,298) $ 3,890
====== ====== ======== ======== ========
Non-Cash financing and
investing activities:
Note receivable accepted
in exchange for surgical
drapes segment assets... $ -- $ -- $ -- $ -- $ 1,125
====== ====== ======== ======== ========
Purchase of business with
preferred stock, net of
cash received........... $ -- $ -- $ -- $ 4,583 $ --
====== ====== ======== ======== ========
Conversion of preferred
stock to common......... $ -- $ -- $ -- $ 34,755 $ --
====== ====== ======== ======== ========
</TABLE>

See accompanying notes.

F-6
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

1. ORGANIZATION

Xomed Surgical Products, Inc. (the Company), a Delaware corporation was
organized on April 5, 1994 for the purpose of acquiring on April 15, 1994, all
of the outstanding stock of Xomed-Treace, Inc. and Xomed-Treace, P.R. Inc.
(collectively, Xomed, Inc.) and Merocel Corporation (Merocel). The Company had
no operations or material assets prior to this transaction. As the owners of
the Company were also owners of Merocel, these transactions have been
accounted for as if Xomed, Inc. were acquired by Merocel. Therefore, the
assets and liabilities of Merocel were not revalued and are presented in the
accompanying balance sheet at historical cost.

Xomed is a leading developer, manufacturer and marketer of a broad line of
surgical products for use by ear, nose and throat (ENT) specialists. The
Company's broad line of products, includes in its core ENT market, powered
tissue-removal systems and other microendoscopy instruments, implantable
devices, nerve monitoring systems and disposable fluid-control products. The
Company also offers a line of ophthalmic and other products. The Company sells
its products worldwide utilizing a sales force domestically and third party
distributors and wholly owned subsidiaries internationally. Trade credit is
extended based on consideration of the financial capabilities of the customer
and letters of credit are obtained in certain situations. Concentrations of
credit risk with respect to the Company's extending of trade credit, which
generally is not collateralized, is limited due to the large number of
customers and their dispersion across different geographic areas.

On April 16, 1996, the Company acquired TreBay Medical Corporation (TreBay)
which was involved in the development of ENT surgical specialty products. The
acquisition, which was accomplished through the issuance of preferred stock,
was accounted for under the purchase method of accounting and accordingly, the
results of operations have been included in the Company's consolidated
financial statements since the date of acquisition. The purchase price of
approximately $6,600 was allocated to the individual assets acquired and
liabilities assumed based upon their respective fair values at the date of
acquisition. The transaction resulted in cost in excess of net assets acquired
of approximately $4,400, of which $2,400 was allocated to in-process research
and development and was subsequently written off. The executive management of
TreBay replaced former management of the Company (see Note 7). The acquisition
was funded through the issuance of approximately $2,800 of redeemable
preferred stock and $3,700 of convertible preferred stock.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements of the Company include the accounts of
Merocel and subsidiary, TreBay, and Xomed, Inc. and subsidiaries. Significant
intercompany transactions and balances between entities have been eliminated.

Cash and Cash Equivalents

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

Inventory Valuation

Inventories are generally stated at average cost on a first-in, first-out
valuation basis not in excess of market. Market for raw materials is based on
replacement costs and for work-in-process and finished goods on net realizable
value.

F-7
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Expenditures for
maintenance and repairs are charged to expense as incurred. Additions,
improvements and major replacements are capitalized. The costs and accumulated
depreciation related to assets sold or retired are removed from the accounts
and any gain or loss is credited or charged to income. Depreciation is
computed using the straight-line method based on the estimated useful lives of
the related asset categories as follows--building and building improvements 27
to 35 years and machinery and equipment including assets under capital leases
three to 15 years.

Income Taxes

The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standard No. 109, "Accounting for Income Taxes," which
requires the use of the liability method of accounting for deferred income
taxes.

Revenue Recognition

The Company recognizes revenue when inventory is shipped to the customer.

Amortization

Amortization of cost in excess of assets acquired is amortized over 25
years. Accumulated amortization totaled $7,680 and $5,689 as of December 31,
1997 and 1996, respectively. Amortization of other intangibles is amortized
straight-line over the life of the related agreement ranging from four to 15
years.

The recoverability of goodwill is periodically assessed by the Company at
the product line level. Cash flows and profitability of each product line as
well as changes in the operations of businesses acquired are reviewed to
determine if impairment exists. If this review indicates that goodwill will
not be recoverable, the Company's carrying value of the goodwill is reduced by
the estimated shortfall of discounted cash flows.

In July 1995, the Company disposed of its surgical drapes segment, and
included a reduction of goodwill totaling $5,805 in the loss on disposal of
discontinued operations.

Research and Development

Expenditures related to research and development of new products and
processes, including research related to product alternatives, are expensed as
incurred.

Translation Adjustments

Prior to the fourth quarter of 1997, translation gains and losses of foreign
currencies related to foreign operations are included in income from
operations and totaled $341 (loss), $41 (loss) and $67 (gain) for the ten
months ended October 31, 1997, and years ended December 31, 1996 and 1995,
respectively. The financial results of these foreign operations were
translated using a combination of current and historical rates. Subsequent to
October 1997, translation gains and losses are included as a component of
shareholder's equity, assets and liabilities of the foreign operations are
translated at current rates, and revenues and expenses are translated at
average rates during the period. This change resulted from a change in the
designation of the functional currency from the U.S. dollar to the foreign
currency due to decreased dependence of the foreign operations on their parent
for financing, marketing and distribution activities.

F-8
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Stock Compensation

The Company follows the intrinsic value method of accounting for stock based
compensation prescribed in Accounting Principles Board Opinion No. 25--
Accounting for Stock Issued to Employees. Accordingly, stock compensation
expense is measured as the excess if any, of the quoted market price of the
Company's stock at the date of grant over the exercise price.

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.

Earnings Per Share

In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings Per Share. Statement 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share exclude any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share are very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate restated, to conform to the Statement 128
requirements.

Comprehensive Income

The Financial Accounting Standards Board has issued Statement No. 130,
Reporting Comprehensive Income effective for fiscal years beginning after
December 15, 1997. The Standard requires companies to report another measure
of operations called Comprehensive Income. This measure, in addition to "net
income" includes as income or loss, the following items, which if present are
included in the equity section of the Balance Sheet: 1) unrealized gains and
losses on certain investments in debt and equity securities; 2) foreign
currency translation; and 3) minimum pension liability adjustments. The
following table depicts comprehensive income for the three months ended:

<TABLE>
<CAPTION>
MARCH 28, MARCH 31,
1998 1997
--------- ---------
<S> <C> <C>
Net income............................................. $1,725 $1,087
Foreign currency translation adjustments............... (54) --
------ ------
Comprehensive income................................... $1,671 $1,087
====== ======
</TABLE>

Reclassifications

Certain prior year amounts in the consolidated financial statements have
been reclassified to conform to the current year presentation.

F-9
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

3. DISCONTINUED OPERATIONS

During mid 1995, the Company approved a plan to dispose of and finalized an
agreement for the disposal of all operating assets, inventory, patents and
license agreements of its surgical drapes segment in exchange for cash, notes
receivable, inventory and fixed assets related to several otology product
lines of a nonrelated entity. Management decided the surgical drapes were not
part of the Company's core business and disposed of this product line in
exchange for the head and neck product line of another entity which is more
compatible with the Company's other products. There was no intent to dispose
of the surgical drapes segment at the time of the Xomed-Treace acquisition.
The operating results of the otology product lines were not significant to the
Company's overall results of operations during 1995.

Certain financial information related to the surgical drapes product line,
which was acquired from Xomed-Treace on April 15, 1994, is as follows:

<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Sales................................................. $ -- $ -- $5,385
====== ====== ======
Pre-tax income........................................ $ -- $ -- $ 509
====== ====== ======
Income tax expense.................................... $ -- $ -- $ 203
====== ====== ======
Net income............................................ $ -- $ -- $ 306
====== ====== ======
</TABLE>

The surgical drapes business accounts consisted principally of inventory,
fixed assets and related goodwill aggregating approximately $7,100 on the date
of disposition. Interest expense attributed to the drapes business was $56 for
1995. The Company realized a net loss of $2,485, after income tax benefits of
$1,386, on this transaction and has restated its financial statements for the
discontinued operations. The loss on disposal was computed as the difference
between the carrying value of the surgical drapes segment assets disposed of
and the estimated fair value of the assets received related to the otology
product lines. There were no significant intangibles such as customer lists or
patents acquired in connection with the otology product lines, nor was any
work force transferred. The components of the loss on disposal in 1995 are as
follows:

<TABLE>
<S> <C>
Cash and notes receivable acquired................................ $ 2,250
Less: Transaction fees............................................ (316)
Goodwill related to the surgical drapes segment................. (5,805)
-------
Pre-tax loss...................................................... (3,871)
Tax benefit....................................................... 1,386
-------
Net loss on disposition........................................... $(2,485)
=======
</TABLE>

The inventory and fixed assets of the otology product lines acquired were
recorded at fair values of $1,170 and $154, respectively, which approximated
the aggregate carrying value of assets disposed of related to the surgical
drapes business.

Included in other receivables and other assets as of December 31, 1996 are
notes receivable of $375 and $375, respectively, related to this transaction.
As part of the transaction both parties agreed to manufacture their existing
products through the end of 1995 and supply those products to the other party
at cost.

F-10
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

4. INVENTORIES

Inventories are summarized as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 28, ----------------
1998 1997 1996
----------- ------- -------
(UNAUDITED)
<S> <C> <C> <C>
Finished goods............................... $10,185 $10,224 $ 7,654
Work in process.............................. 1,928 1,447 2,006
Raw materials and packaging.................. 6,612 6,584 6,066
Reserve for obsolescence..................... (2,227) (2,017) (1,051)
------- ------- -------
$16,498 $16,238 $14,675
======= ======= =======
</TABLE>

Reserves for obsolescence were increased by $1,213, $1,209, and $1,067 for
1997, 1996, and 1995, respectively. Reserve reductions from inventory written
off were $247, $559 and $1,006 for 1997, 1996 and 1995, respectively. The
reserve for obsolescence was $401 and $340 as of December 31, 1995 and
December 31, 1994, respectively.

5. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment, at cost, less allowances for depreciation, is
as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1996
------- -------
<S> <C> <C>
Land and land improvements............................... $ 1,413 $ 1,413
Building and building improvements....................... 6,564 6,360
Machinery and equipment.................................. 14,959 13,317
------- -------
22,936 21,090
Allowances for depreciation.............................. (8,734) (6,685)
------- -------
14,202 14,405
Capital projects in process.............................. 1,201 972
------- -------
$15,403 $15,377
======= =======
</TABLE>

Depreciation expense, including expense on assets under capital lease
obligations, is approximately $2,340, $2,285,and $2,038 for the years ended
December 31, 1997, 1996 and 1995, respectively.

6. FINANCIAL INSTRUMENTS

The Company enters into foreign currency forward exchange contracts to hedge
intercompany trade accounts receivable from its foreign subsidiaries. The
Company's forward exchange contracts do not subject the Company to risk from
exchange rate movements because gains and losses on such contracts offset
gains and losses on the trade accounts receivable being hedged. If the
counterparties to the forward exchange contracts do not fulfill their
obligations to deliver the contracted currencies, the Company could be at risk
for any currency exchange rate movements.

For intercompany receivables, the contracts require the Company to sell
foreign currencies, Australian Dollar, Canadian Dollar, British Pound, French
Franc and the German Duetschmark, in exchange for the U.S. Dollar. At December
31, 1997, the Company held $7,000 in foreign currency forward exchange
contracts, which

F-11
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

mature, in early 1998. These contracts are marked to market each month. The
resulting gains or losses are reflected in income and are generally offset by
gains or losses on the exposures being hedged.

7. ACCRUED RESTRUCTURING COSTS

Incident to the acquisition of Xomed-Treace in April 1994, the Company
initiated a plan to restructure certain of its operations and established a
reserve of $3,258 as part of the cost of the acquired business associated
primarily with closing a plant facility and significantly reducing the
Company's work force. At December 31, 1996, there was no remaining accrued
restructuring costs.

In conjunction with the purchase of TreBay, the Company recorded an accrual
totaling $647 related to severance and relocation costs ($598) and lease
termination costs ($49). All employees of TreBay were terminated, except the
officers and two other individuals who relocated to Jacksonville, Florida, the
corporate headquarters of the Company. For the period from the acquisition
date through December 31, 1996, $250 was paid related to termination and
relocation benefits, $49 was paid related to lease termination costs and $162
was paid related to other acquisition cost. During 1997 the Company utilized
the remaining reserve as follows: $82 was paid related to termination and
relocation, $61 was paid related to lease termination, and $43 related to
other exit costs.

Simultaneous with the purchase of TreBay and a plan by new management to
combine certain operations, (see Note 1), the Company recorded a restructuring
accrual of $3,100 which was comprised of $2,500 of termination benefits and
$600 of other exit costs. The reductions included 20 management and
administrative employees the Company's Mystic, Connecticut manufacturing
facility, 17 management and administrative employees at the Company's
Jacksonville, Florida headquarters, 13 management and production employees at
the Company's St. Louis, Missouri manufacturing facility and 2 management
level employees internationally. For the period from the accrual date through
the end of 1996, the Company had paid out termination benefits totaling $2,000
and paid approximately $100 related to other exit costs. As of December 31,
1996, the Mystic, Connecticut facility maintained only manufacturing
operations, and in December 1996, the St. Louis facility was closed. During
1997 the Company utilized the remaining reserve as follows: paid termination
benefits of $500, wrote off property related to the St. Louis facility closure
of approximately $300, paid other exit costs of $100 and reversed the
remaining reserve approximately $100 against selling general and
administrative expenses.

8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

The Company was obligated under long-term debt and capital lease obligations
as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1997 1996
-------------
<S> <C> <C>
Revolving line-of-credit agreement with interest payable
monthly and all outstanding principal due May 5, 2000;
interest at LIBOR (5.72% at December 31, 1997) Plus 1.5%
or at the lender's base rate (8.5% at December 31,
1997).................................................... $ -- $ 3,148
Note payable under capital lease obligation to vendor in
quarterly principal and interest installments of $36
through October 1, 1997 and a final payment of $415 on
January 1, 1998. The note was paid off early in December
1997. The note carried interest at 10.8%................. -- 503
----- -------
-- 3,651
Less current portion...................................... -- 88
----- -------
$ -- $ 3,563
===== =======
</TABLE>

F-12
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

In May 1997, the Company entered into an Amended and Restated Credit
Agreement (the Credit Agreement) with the bank. Under the terms of the Credit
Agreement, the Company may borrow under a line-of-credit up to a maximum
capacity of $25,000 to be used for working capital and operating needs and
acquisitions. The amount available to the Company at any given time is based
upon various percentages of the Company's outstanding inventories and accounts
receivable and certain other assets. Availability at December 31, 1997 was
approximately $21,000. Any principal amounts outstanding on the line-of-credit
in excess of the borrowing base must be repaid by the Company. In any event,
all outstanding principal on the line-of-credit is due and payable on May 5,
2000. The Company pays a quarterly commitment fee which varies from .25% to
.125% per annum on the average daily unused balance on the line-of-credit
during the preceding calendar quarter.

The line-of-credit is collateralized by the receivables and inventory of the
Company and certain land and buildings at the Mystic, Connecticut facility
with a net book value of $34,506. The debt agreement has restrictions
regarding payment of dividends, incurrence of additional debt and requires
compliance with various financial covenants.

9. SHAREHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK

In October 1996, in conjunction with the Company's initial public offering
of stock, all Series A and B Convertible Preferred shares were converted to
Common Stock, approximately 80% of the Series C Redeemable Preferred Stock was
redeemed for cash and the balance was converted to Common Stock and the Non-
Voting Common Stock was converted to Common Stock.

In September 1996, the Company authorized 1,000,000 shares of a new issue of
preferred stock. The stock is undesignated as to its rights, preferences and
limitations which the Board of Directors is authorized to set at a future date
prior to issuance.

During the year ended December 31, 1995, the Company issued 19,000 shares of
Common Stock under the employee stock incentive plan. The stock was issued at
option prices of between $1.00 to $2.00 per share and resulted in $22 of
additional paid-in capital.

Common Stock

Each share of Common Stock and Non-Voting Common Stock (collectively Common
Equity) entitles its holder to receive dividends as declared by the Company's
Board of Directors, subject to the preferences and other rights of the Series
A, Series B and Series C Redeemable Preferred Stock. Each share of Non-Voting
Common Stock is convertible into one share of Common Stock at the election of
the shareholder.

During 1996, the Company amended and restated its Restated Certificate of
Incorporation to, among other things, (i) change the designation of its Class
A Common Stock to "Common Stock," (ii) change the designation of its Class B
Common Stock to "Non-Voting Common Stock," (iii) increase the number of
authorized shares of Common Stock to 30,000,000 and (iv) authorize a class of
undesignated Preferred Stock, par value $.01 per share.

Redeemable Preferred Stock

Each share of Series A (1.2 million shares authorized) and Series B (3.5
million shares authorized) Convertible Preferred Stock (collectively
Convertible Preferred Stock) entitles its holder to receive an annual
cumulative cash dividend at the rate of six percent per annum, payable on a
quarterly basis. At the election of the Board of Directors, dividends may be
paid in shares of Series A or Series B Convertible Preferred Stock,

F-13
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

9. SHAREHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK (CONTINUED)
respectively, in lieu of cash. Dividends are cumulative and must be paid prior
to any dividends being paid on the Common Equity. The Company at its option,
with the majority consent of the holders of the Convertible Preferred Stock,
may redeem any or all of the outstanding shares of the Convertible Preferred
Stock at a price of $9.58 per share, plus accrued dividends. The Series A
Convertible Preferred Stock is voted along with the Common Equity on an as
converted basis, whereas the Series B has no voting rights.

In any event, any outstanding shares of the Convertible Preferred Stock at
April 15, 2001 are required to be redeemed on that date by the Company at
$9.58 per share, plus accrued dividends. Each share of Convertible Preferred
Stock, at the election of the holder, may be converted for one share of like
Common Equity (the conversion rate being subject to adjustment from time-to-
time).

Each share of Series C Redeemable Preferred Stock (Series C Preferred Stock)
(600,000 shares authorized) entitles its holder to receive an annual
cumulative cash dividend at the rate of nine percent per annum, payable on a
quarterly basis. At the election of the Board of Directors, dividends may be
paid in shares of Series C

Preferred Stock in lieu of cash. Dividends are cumulative and must be paid
prior to any dividends being paid on the Common Equity. The Company at its
option, with the majority consent of the holders of the Series C Preferred
Stock, may redeem any or all of the outstanding shares of the Series C
Preferred Stock at a price of $100.00 per share, plus accrued dividends.

In any event, any outstanding shares of the Series C Preferred Stock at
April 15, 2001 are required to be redeemed on that date by the Company at
$100.00 per share, plus accrued dividends.

In April 1996, the Company acquired all of the outstanding stock of TreBay
in exchange for 390,000 shares of Series A convertible preferred stock and
28,470 shares of Series C redeemable preferred stock.

The following table presents changes in redeemable preferred stock:

<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
----------------- -------------------- ------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
-------- ------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1994................... 364,215 $ 3,632 2,127,838 $ 21,251 273,063 $ 28,996
Accretion of dividends.. -- 209 -- 1,223 -- 2,458
-------- ------- ---------- -------- -------- --------
Balance at December 31,
1995................... 364,215 3,841 2,127,838 22,474 273,063 31,454
Accretion of dividends.. -- 263 -- 922 -- 2,077
Forgiveness of
dividends.............. -- (404) -- (2,395) -- (4,761)
Shareholders stock
returned............... (9,563) (91) -- -- (2,074) (208)
Issuance of shares for
TreBay Medical......... 390,000 3,736 -- -- 28,470 2,847
Redemption of preferred
stock.................. -- -- -- -- (235,327) (25,000)
Conversion of preferred
stock to common Stock.. (744,652) (7,345) (2,127,838) (21,001) (64,132) (6,409)
-------- ------- ---------- -------- -------- --------
Balance at December 31,
1996................... -- $ -- -- $ -- -- $ --
======== ======= ========== ======== ======== ========
</TABLE>

10. RETIREMENT BENEFITS

Retirement benefits are provided to all eligible employees through the
participation in defined contribution plans maintained by the Company which
comply with the provisions of Section 401(k) of the Internal Revenue

F-14
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

10. RETIREMENT BENEFITS (CONTINUED)
Code (the "Savings Plans"). The provisions of the Savings Plans differ with
respect to employee contributions, employer matching percentages and profit
sharing depending on the country in which the employees work. Expense recorded
by the Company for the various plans for the years ended December 31, 1997,
1996 and 1995 was approximately $481, $510, and $520, respectively.

11. EMPLOYEE STOCK INCENTIVES

The Company has reserved an aggregate of 1,078,000 shares of its Common
Stock for grant or sale to key employees of the Company. As of December 31,
1997 and 1996, 295,534 and 184,534 options, respectively, were available for
additional grants. These shares may be issued in such amounts and in such a
manner (including stock options, restricted stock grants, stock bonuses, or
other stock incentive programs) as determined by the Company's Board of
Directors from time-to-time. In general, the options are granted at exercise
prices equal to the fair market value of common stock on the date of grant,
have a life of 10 years and provide for vesting over a four year period. Total
stock based compensation cost recognized in the Statement of Operations for
the years ended December 31, 1997, 1996 and 1995 was $111, $54 and $0,
respectively. During 1996, the Company granted 139,500 options with exercise
prices below the then estimated fair market values. These options have a
weighted average exercise price of $10.65 and weighted average fair value of
$5.69. The exercise price for options outstanding at the end of 1997 ranged
from $2.00 to $15.06. The following table summarizes option activity, which
may be exercised at various dates through January 2007:

<TABLE>
<CAPTION>
1997 1996
WEIGHTED WEIGHTED
1997 AVERAGE 1996 AVERAGE 1995
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS
------------- -------------- ------------ -------------- -----------
<S> <C> <C> <C> <C> <C>
Beginning of the period
options outstanding.... 468,866 $8.99 251,350 $5.67 257,100
Options granted......... 202,000 15.77 421,666 9.15 8,000
Options exercised....... (74,100) 8.34 (104,600) 1.81 (6,750)
Options canceled........ (13,000) 12.14 (99,550) 8.87 (7,000)
------------- ------------ -----------
End of period options
outstanding............ 583,766 11.99 468,866 8.99 251,350
============= ============ ===========
Options granted range of
option prices.......... $15.06-$20.38 $9.36-$10.65 $9.58
============= ============ ===========
Options exercised range
of option prices....... $ 1.00-$10.65 $ 1.00-$9.58 $1.00-$2.00
============= ============ ===========
Options exercisable at
end of year............ 160,391 $9.70 121,514 $8.91 132,242
============= ============ ===========
</TABLE>

The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized for stock
options issued with exercise prices equal to the fair value of the common
stock on the date of grant. Statement No. 123 requires the determination of
fair value of all options utilizing stock option valuation models. In
management's opinion, existing stock option valuation models do not provide a
reliable single measure of the fair value of employee stock options that have
vesting provisions and are not transferable. In providing the pro forma
disclosures below, the Company used the Black-Scholes option pricing model
with the following weighted average assumptions: 1) an expected volatility
factor for the Company's stock of .31; 2) a risk-free interest rate of 6.5%;
3) an expected life of options of 3 years; and 4) no dividend payments. The
weighted-average grant

F-15
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

11. EMPLOYEE STOCK INCENTIVES (CONTINUED)

date fair value of options granted in 1997 and 1996 was $4.59 and $4.01,
respectively. Had compensation cost for the Company's stock option plan been
determined based on the fair value at the grant date for awards consistent
with the provisions of SFAS No. 123, the Company's net income (loss) from
continuing operations available to common shareholders would be as follows:

<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -------
<S> <C> <C> <C>
Net income (loss)--as reported..................... $6,130 $3,130 $(5,744)
Net income (loss)--adjusted........................ $5,908 $2,997 $(5,745)
Net income (loss) per share--as reported........... $ 0.84 $ 1.14 $ (5.69)
Net income (loss) per share--adjusted.............. $ 0.81 $ 1.09 $ (5.69)
</TABLE>

12. EARNINGS PER SHARE

The following table sets forth the computation of shares for purposes of the
earnings per share calculation (in thousands):

<TABLE>
<CAPTION>
MARCH 28, MARCH 29,
1998 1997 1997 1996 1995
--------- --------- ----- ----- -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Weighted average shares
outstanding...................... 7,342 7,289 7,323 2,755 1,009
Net effect of dilutive securities:
Stock options................... 290 149 189 107 --
Convertible preferred stock..... -- -- -- 2,339 --
----- ----- ----- ----- -----
Totals............................ 7,632 7,438 7,512 5,201 1,009
===== ===== ===== ===== =====
</TABLE>

Income from continuing operations and net income for 1996 for purposes of
computing earnings per share-basic include net forgiveness of dividends of
$4,297 and in 1995, a deduction related to preferred stock dividends of
$3,890.

13. INCOME TAXES

The provision for income taxes (benefit) from continuing operations consists
of the following:

<TABLE>
<CAPTION>
1997 1996 1995
------ ----- ------
<S> <C> <C> <C>
Current:
Domestic:
Federal........................................... $1,801 $ 496 $ 206
State............................................. 360 206 33
Foreign............................................. 65 -- --
------ ----- ------
2,226 702 239
Deferred:
Domestic............................................ 1,527 540 1,116
Foreign............................................. 216 (369) --
------ ----- ------
$3,969 $ 873 $1,355
====== ===== ======
</TABLE>

During 1997 and 1996, the Company's tax liability was decreased $134 and
$150, respectively, and additional paid-in capital increased due to the early
disposition of stock by a stock option holder. During 1997, the Company
utilized approximately $650 of operating loss carryforwards thereby reducing
its current liability.

F-16
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

13. INCOME TAXES (CONTINUED)

Income tax expense (benefit) from continuing operations reconciled to the
amount computed at statutory rates is as follows:

<TABLE>
<CAPTION>
1997 1996 1995
------ ----- ------
<S> <C> <C> <C>
Federal tax (benefit) at statutory rate............ $3,434 $(103) $ 588
Purchased in-process research and development...... -- 833 --
State income taxes (net of federal income tax
effect)........................................... 442 92 136
Increase in valuation allowance on foreign losses.. 156 -- 387
Tax benefits related to export sales............... (209) -- --
Loss from unconsolidated subsidiary for tax
purposes.......................................... -- -- 192
Other, net......................................... 146 51 52
------ ----- ------
$3,969 $ 873 $1,355
====== ===== ======
</TABLE>

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

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1996
------- -------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards....................... $ 1,505 $ 1,131
Losses from foreign operations......................... 1,008 1,068
Patents and other intangibles.......................... 511 553
Inventory.............................................. 997 728
Non-deductible accrued expenses........................ 583 420
AMT credit............................................. 44 333
Severance accruals..................................... 27 566
------- -------
4,675 4,799
Valuation allowance.................................... (741) (585)
------- -------
3,934 4,214
------- -------
Deferred income tax liabilities:
Amortization of goodwill............................... (2,118) (570)
Depreciation........................................... (712) (562)
Purchased research and development..................... (215) (298)
Deductible prepaid expenses............................ -- (27)
------- -------
(3,045) (1,457)
------- -------
$ 889 $ 2,757
======= =======
</TABLE>

The valuation allowance at December 31, 1997 and 1996 relates to certain
losses from foreign operations incurred prior to 1996 which management
believes the ultimate realization of the related tax benefits is not more
likely than not at the present time. This allowance was increased $156 and $6
for 1997 and 1996, respectively, for losses of these foreign operations.
Foreign losses totaling approximately $2,300 can be carried forward for
periods ranging from five years to indefinitely. Undistributed earnings
reinvested indefinitely in foreign subsidiaries as working capital and plant
and equipment aggregated $77. Domestic loss carryforwards total $4,071 and
expire in 2009 through 2011.

F-17
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

14. RELATED PARTY TRANSACTIONS

At December 31, 1997 and 1996, the Company had outstanding a note receivable
totaling $724 from an officer, which is collateralized by 44,460 shares of the
Company's common stock, bears interest at 10%, becomes a demand note on
November 7, 2000 and, in any event, is payable in full by November 7, 2002.

In connection with the acquisition of TreBay Medical Corporation in April
1996, a significant shareholder of the Company made loans to three officers to
acquire the Company's stock. At December 31, 1996, the aggregate principal
value of notes payable to the shareholder from the officers was $1,900. The
notes are secured by a total of 172,173 shares of the Company's common stock,
bear interest at 7% and become payable in full on April 16, 2001. The officers
are obligated to apply 50% of the after-tax amount of any Company bonuses to
unpaid interest and principal.

15. LEASE COMMITMENTS

The Company was committed under noncancelable operating leases with terms in
excess of one year involving certain property and equipment. Rental expense on
all rental agreements totaled $706, $790, and $417 for the years ended
December 31, 1997, 1996 and 1995, respectively. In general, the Company has
options to renew its leases for varying periods of time. Annual minimum rental
commitments under these leases are as follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1998.............................................................. $ 602
1999.............................................................. 204
2000.............................................................. 158
2001.............................................................. 127
2002 and thereafter............................................... 124
------
$1,215
======
</TABLE>

16. CONTINGENCIES

The Company is subject to various claims and legal proceedings covering a
wide range of matters that arise in the ordinary course of its business
activities, including product liability claims. Management believes that any
liability that may ultimately result from the resolution of these matters will
not have a material adverse effect on the financial condition or results of
operations of the Company.

The Internal Revenue Service is currently examining tax returns for years
1994 through 1996. Management believes the ultimate resolution of this
examination will not result in a material adverse effect to the Company's
financial position or results of operations.

F-18
<PAGE>

XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

17. SEGMENT INFORMATION

The Company's subsidiaries operate distribution facilities in a number of
foreign countries. Currently, international subsidiaries are present in
Canada, Australia, United Kingdom, France and Germany. These subsidiaries
represent approximately 15% of 1997 total sales of the Company, with France
representing the largest portion of this with 4% of total sales. Inter-area
sales are not significant to the total sales of any one geographic area.

<TABLE>
<CAPTION>
INFORMATION ABOUT THE COMPANY'S OPERATIONS
IN DIFFERENT GEOGRAPHIC AREAS
--------------------------------------------------
INCOME (LOSS)
FROM CONTINUING
OPERATIONS
BEFORE IDENTIFIABLE
SALES INCOME TAXES ASSETS
-------------- ------------------ ---------------
<S> <C> <C> <C>
1997:
United States......... $ 65,958 $ 10,124 $ 89,553
International
Operations........... 11,282 (25) 6,174
-------------- -------------- --------------
Consolidated.......... $ 77,240 $ 10,099 $ 95,727
============== ============== ==============
1996:
United States......... $ 55,034 $ 628 $ 88,788
International
Operations........... 10,630 (922) 5,268
-------------- -------------- --------------
Consolidated.......... $ 65,664 $ (294) $ 94,056
============== ============== ==============
1995:
United States......... $ 51,644 $ 2,801 $ 87,873
International
Operations........... 8,221 (1,121) 5,250
-------------- -------------- --------------
Consolidated.......... $ 59,865 $ 1,680 $ 93,123
============== ============== ==============
</TABLE>

The Company had export sales of $12,200, $10,400 and $9,400 in 1997, 1996
and 1995, respectively, representing 16%, 16% and 16% of total sales,
respectively.

F-19
<PAGE>

[ARTWORK]
<PAGE>

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NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PRO-
SPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER
TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEI-
THER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.

-----------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Use of Proceeds.......................................................... 13
Dividend Policy.......................................................... 13
Price Range of Common Stock.............................................. 13
Capitalization........................................................... 14
Selected Consolidated Financial Data..................................... 15
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 17
Business................................................................. 28
Management............................................................... 45
Principal and Selling Stockholders....................................... 48
Description of Capital Stock............................................. 50
Shares Eligible for Future Sale.......................................... 53
Underwriting............................................................. 54
Legal Matters............................................................ 55
Experts.................................................................. 55
Available Information.................................................... 56
Incorporation of Certain Documents by Reference.......................... 57
Index to Financial Statements............................................ F-1
</TABLE>

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1,500,000 Shares

LOGO

Common Stock

-----------

PROSPECTUS

-----------

BT ALEX. BROWN

ING BARING FURMAN SELZ LLC

PIPER JAFFRAY INC.

July 14, 1998

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