BIO VASCULAR INC, S-3, 1995-08-29

BIO VASCULAR INC
S-3, 1995-08-29
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS

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<PAGE>
As filed with the Securities and Exchange Commission on August 29, 1995.
Registration No. 33-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
_______________

FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
_______________

BIO-VASCULAR, INC.
(Exact name of Registrant as specified in its charter)
MINNESOTA
(State or other jurisdiction of incorporation or organization)
41-1526554
(I.R.S. Employer Identification No.)

2575 UNIVERSITY AVENUE
ST. PAUL, MINNESOTA 55114-1024
(612) 603-3700
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
_______________
M. KAREN GILLES
2575 UNIVERSITY AVENUE
ST. PAUL, MINNESOTA 55114-1024
(612) 603-3700
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
_________________________
Copies to:
Bruce A. Machmeier, Esq. David B. Miller, Esq.
Oppenheimer Wolff & Donnelly Faegre & Benson P.L.L.P.
3400 Plaza VII 2200 Norwest Center
45 South Seventh Street 90 South Seventh Street
Minneapolis, Minnesota 55402 Minneapolis, Minnesota 55402
(612) 344-9300 (612) 336-3000
__________________________

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
_________________________

If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, check the following
box. [_]

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

<TABLE>
<CAPTION>
============================================================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED(1) PER SHARE(2) PRICE(2) FEE
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------
Common Stock, $.01
par value.................... 1,725,000 $14.125 $24,365,625 $8,405
============================================================================================================
</TABLE>

(1) Includes Underwriter's over-allotment option to purchase up to 225,000
shares.
(2) Estimated solely for the purpose of calculating the amount of the
registration fee pursuant to Rule 457(c) under the Securities Act of 1933,
based upon the average between the high and low reported bid quotations of
the Registrant's Common Stock on the national over-the-counter market on
August 23, 1995, as reported by the Nasdaq SmallCap Market.

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.
================================================================================
<PAGE>

Subject to Completion, Dated August 29, 1995
PROSPECTUS
dated , 1995
1,500,000 SHARES

[BIO-VASCULAR LOGO]

COMMON STOCK

All of the 1,500,000 shares of Common Stock offered hereby are being sold by
Bio-Vascular, Inc. (the "Company").

The Common Stock of the Company is quoted on the Nasdaq SmallCap Market under
the symbol "BVAS." On August __, 1995, the closing bid price of the Common
Stock as reported by the Nasdaq SmallCap Market was $_______. See "Price Range
of Common Stock." The Company has applied for quotation of its Common Stock on
the Nasdaq National Market upon completion of this Offering.

SEE "RISK FACTORS" ON PAGE 5 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.

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 TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
- -------------------------------------------------------------
PER SHARE......... $ $ $
- -------------------------------------------------------------
TOTAL(3).......... $ $ $
=============================================================
</TABLE>
(1) The Company has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the Securities Act of 1933. The
Company has also agreed to sell to the Underwriter, for nominal
consideration, warrants to purchase up to 86,250 shares of Common Stock.
See "Underwriting."

(2) Before deducting offering expenses payable by the Company estimated at
$300,000.

(3) The Company has granted to the Underwriter a 30-day option to purchase up
to 225,000 additional shares of Common Stock solely to cover over-
allotments, if any, at the Price to Public shown above less the
Underwriting Discount. If the Underwriter exercises this option in full,
the total Price to Public, Underwriting Discount and Proceeds to Company
will be $ , $ and $ , respectively. See
"Underwriting."

The shares of Common Stock are offered by the Underwriter subject to prior sale
when, as and if delivered to and accepted by the Underwriter and subject to its
right to reject orders in whole or in part. It is expected that delivery of the
certificates representing the shares of Common Stock will be made at the offices
of Piper Jaffray Inc. in Minneapolis, Minnesota on or about ,
1995.

PIPER JAFFRAY INC.

+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
<PAGE>

Bio-Vascular Logo

Bio-Vascular, Inc. develops, manufactures and markets proprietary specialty
medical products for use in thoracic, cardiac, neuro and vascular surgery. The
Company also has a medical imaging software business which develops, markets and
supports software products for interactive visualization and analysis of
three-dimensional image data.

-------------------------------
The Tissue-Guard product line
includes various configurations
of processed bovine pericardium
used in a wide variety of
[picture of Tissue-Guard] surgical procedures designed to
reinforce, reconstruct and repair
tissue and prevent leaks of air,
blood and other body fluids.

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

[picture of Reapproximation] [picture of Peri-Strips
on Stapler]

- ------------------------------ ---------------------------------
Peri-Strips are designed to be applied using
surgical staplers to strengthen staple lines and
reapproximate around staples to prevent air leakage
in lung volume reduction surgery.
------------------------------

[picture of 3-D volume rendered image.]

------------------------------
The Company has developed VoxelView, high-speed volume
imaging software, which provides complete and accurate
three-dimensional volume rendering of data.

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER AND CERTAIN SELLING GROUP
MEMBERS (IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE
COMPANY'S COMMON STOCK ON NASDAQ IN ACCORDANCE WITH RULE 10B-6A UNDER THE
SECURITIES EXCHANGE ACT OF 1934. SEE "UNDERWRITING."

_________________

Tissue-Guard(TM), Peri-Strips(R), Dura-Guard(TM), Vascu-Guard(R), Supple
Peri-Guard(TM), Peri-Guard(R), Biograft(R), Flo-Rester(R), Bio-Vascular
Probe(TM), VoxelView(R), VoxelGeo(R), VoxelMath(TM) and Voxel Animator(TM) are
trademarks of the Company.

2
<PAGE>

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by and should be read in
conjunction with the more detailed information and consolidated financial
statements and notes thereto appearing elsewhere or incorporated by reference in
this Prospectus. Unless otherwise indicated, all information in this Prospectus
assumes no exercise of the Underwriter's over-allotment option.

THE COMPANY

Bio-Vascular, Inc. (the "Company") develops, manufactures and markets
proprietary specialty medical products for use in thoracic, cardiac, neuro and
vascular surgery (the "Surgical Business"). The Company's products include the
Tissue-Guard product line and the Biograft peripheral vascular graft. The
Tissue-Guard product line includes various configurations of bovine pericardium
(the thin membrane surrounding the heart of cattle) processed using the
Company's proprietary tissue-fixation technologies. These products are used in a
wide variety of surgical procedures and are designed to reinforce, reconstruct
and repair tissue and prevent leaks of air, blood and other body fluids.
Biograft is used to bypass blocked blood vessels and is produced from modified
human umbilical veins. The Surgical Business also markets and sells two surgical
tools used in cardiac and vascular surgery. The Company also has an early stage
medical imaging software business which develops, markets and supports certain
software products for interactive visualization and analysis of three-
dimensional ("3-D") image data (the "Medical Imaging Software Business").

The Company's Peri-Strips surgical staple line reinforcement product is a
recent addition to the Tissue-Guard product line and has been primarily
responsible for the Company's revenue growth in fiscal 1994 and fiscal 1995.
Peri-Strips are special configurations of tissue produced from bovine
pericardium using proprietary tissue-preservation, sterilization and other
tissue fixation techniques developed by the Company. Peri-Strips are used
primarily in lung volume reduction ("LVR") surgery and other surgical procedures
on the lung. LVR surgery is performed primarily on late-stage emphysema patients
who have significantly reduced respiratory function. During the procedure, a
portion of each diseased lung is removed from the patient to provide relief from
the symptoms of emphysema. Peri-Strips are designed to prevent air leakage at
the surgical staple line which is essential to successful LVR surgery. Early
data available to the Company suggests that after undergoing the procedure,
patients have improved breathing capacity, improved exercise tolerance and
improved quality of life. However, there presently does not exist a
statistically significant body of clinical data from which to draw conclusions
concerning the efficacy and long-term outcomes associated with the LVR
procedure. The American Lung Association estimates that in 1992 there were
approximately 1.9 million Americans suffering from emphysema. However, only a
small portion of those suffering from emphysema have late-stage emphysema, meet
certain surgical criteria and are considered candidates for the LVR procedure.

The Company also manufactures and markets a number of other products in its
Tissue-Guard product line. Dura-Guard, a dural patch used in cranial surgery, is
designed to reduce post-surgical adhesions and fluid leakage. Vascu-Guard, a
vascular patch used primarily in carotid endarterectomy procedures, is designed
to improve tissue integration and reduce sutureline bleeding. In addition, the
Company markets Supple Peri-Guard and Peri-Guard as multi-purpose patching
materials for use in specialty surgical procedures.

The Medical Imaging Software Business has developed VoxelView, high-speed
volume imaging software, which provides complete and accurate 3-D rendering of
data collected by advanced scanning devices such as spiral CT scanners, magnetic
resonance imaging devices ("MRI"), positron emission tomography scanning devices
("PET") and ultrasound sonagraphic devices ("Ultrasound"). This product has been
licensed to approximately 70 medical and research institutions as a research
tool. The Medical Imaging Software Business is currently focusing its efforts on
the development and commercialization of an improved version of VoxelView which
is intended to assist physicians in clinical diagnosis, surgical planning and
patient screening.

3
<PAGE>

The Company was incorporated in Minnesota in July 1985. As used herein, the
term "Company" refers to Bio-Vascular, Inc. and its wholly-owned subsidiary
Vital Images, Incorporated. The Company's principal executive offices are
located at 2575 University Avenue, St. Paul, Minnesota 55114-1024, and its
telephone number is (612) 603-3700.

THE OFFERING

Common Stock offered.............. 1,500,000 shares.
Common Stock to be outstanding
after the Offering.............. 8,946,488 shares (1)
Use of proceeds................... Working capital and infrastructure associated
with sales and marketing, research and
development and other general corporate
purposes. See "Use of Proceeds."
Nasdaq symbol..................... BVAS

SUMMARY CONSOLIDATED FINANCIAL DATA
(In thousands, except per share data)

The following table sets forth summary consolidated financial data of the
Company and should be read in conjunction with the Consolidated Financial
Statements, related Notes thereto and other financial information included
herein.
<TABLE>
<CAPTION>

YEARS ENDED OCTOBER 31, NINE MONTHS ENDED JULY 31,
---------------------------- ---------------------------
STATEMENT OF OPERATIONS DATA: 1992 1993 1994 1994 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net revenue........................ $6,011 $6,144 $ 6,632 $ 4,702 $8,131
Gross margin....................... 3,605 3,628 4,198 2,879 5,564
Operating income (loss)............ (309) (457) (1,431) (991) 528
Income (loss) before income taxes.. (145) (138) (1,869) (1,371) 629
Net income (loss).................. (159) (158) (1,880) (1,374) 597
Net income (loss) per share........ $ (.02) $ (.02) $ (.26) $ (.19) $ .07
Weighted average shares
outstanding...................... 6,743 7,055 7,277 7,266 8,207

JULY 31, 1995
---------------
BALANCE SHEET DATA: ACTUAL AS ADJUSTED(2)
------ --------------
Working capital.................... $5,121 $
Total assets....................... 9,050
Long-term debt..................... --
Shareholders' equity............... 7,578
</TABLE>
(1) Excludes, as of July 31, 1995, 795,489 shares of Common Stock issuable upon
exercise of options outstanding under the Company's stock option plans (the
"Stock Option Plans"), which have an average exercise price of $3.10;
266,720 shares of Common Stock issuable upon exercise of other outstanding
options (the "Other Options"), which have an average exercise price of
$4.12; an additional 556,986 shares of Common Stock reserved for future
issuance under the Stock Option Plans; 32,143 shares of Common Stock
issuable upon exercise of certain warrants (the "Warrants"), with an
exercise price of $4.00; and up to 86,250 shares of Common Stock issuable
upon exercise of the warrants to be issued at the completion of this
Offering to the Underwriter (the "Underwriter Warrants"). See Note 6 of
Notes to Consolidated Financial Statements, "Description of Capital Stock --
Warrants" and "Underwriting."

(2) Adjusted to reflect the sale of 1,500,000 shares of Common Stock offered by
the Company at an assumed offering price of $________ per share and the
application of the estimated net proceeds therefrom. See "Use of Proceeds."

4
<PAGE>

RISK FACTORS

An investment in the shares of Common Stock being offered hereby involves a
high degree of risk. In addition to the other information in this Prospectus,
the following risk factors should be considered carefully.

HISTORY OF LOSSES; UNCERTAIN PROFITABILITY PROSPECTS

The Company has experienced a net loss during each of the three years in the
period ended October 31, 1994, although the Surgical Business has had operating
income for each of these years. The imaging business has incurred losses since
inception, and the Company does not expect that the Medical Imaging Software
Business will be profitable in the near term. There can be no assurance that
the Company will achieve profitability for the year ended October 31, 1995, or
at any time in the future. Profitability for fiscal 1995 and in the near term
thereafter will depend upon the continued success of Peri-Strips, of which there
can be no assurance. See "Management's Discussion and Analysis of Results of
Operations and Financial Condition."

DEPENDENCE ON LUNG VOLUME REDUCTION PROCEDURE

The growth in revenue and profitability of the Company for the first nine
months of fiscal 1995 as compared to the corresponding period in fiscal 1994 was
primarily due to increased sales of Peri-Strips. Peri-Strips accounted for
approximately 43% of the Company's net revenue for the nine months ended July
31, 1995. The Company believes that sales of Peri-Strips will be the primary
factor in revenue growth and profitability in the foreseeable future. This
product is used primarily in lung volume reduction ("LVR") surgery, a procedure
that was abandoned 35 years ago due to unacceptable mortality and complication
rates. The LVR procedure was re-introduced in 1994, modified and enabled by the
use of a surgical stapler in combination with the Company's Peri-Strips product.
Due to the recent re-introduction of the modified procedure, the number of
patients who have undergone the procedure and for whom a clinically acceptable
post-operative period of evaluation has elapsed is still relatively small.
Similarly, the number of physicians performing the procedure and from whom data
is available to the Company is small. Accordingly, there presently does not
exist a statistically meaningful body of clinical data from which to draw
conclusions concerning the efficacy and long-term outcomes associated with the
LVR procedure. The Company believes that patients who have undergone the LVR
procedure may require an additional year or more of follow-up examination before
the procedure can be properly evaluated by the medical community. If the LVR
procedure is ultimately determined to provide only temporary benefits or
otherwise results in unfavorable or unacceptable outcomes, this would adversely
affect sales of the Company's Peri-Strip product and have a material adverse
effect on the Company's results of operations. The success of Peri-Strips will
also depend on the acceptance of the product by surgeons performing LVR surgery.
The Company estimates that there will be approximately 500 surgeons
worldwide trained to perform the LVR procedure by the end of fiscal 1995.
Although additional surgeons are being trained, the growth in Peri-Strips sales
has been and will continue to be closely related to the number of surgeons
trained in the LVR procedure and the willingness of such surgeons to perform the
LVR procedure. If the number of surgeons trained and effectively performing the
LVR procedure does not grow as rapidly as the Company anticipates, the Company's
business, results of operations and financial condition will be adversely
affected. Growth in the number of LVR procedures performed is also dependent
upon the criteria used by surgeons in selecting patients deemed appropriate
candidates for such surgery. If the selection criteria become too rigorous, the
number of LVR procedures performed and related sales of the Peri-Strips product
may decrease, which would have a material adverse effect on the Company's
business, results of operations and financial condition. See "Business--
Surgical Business -- Markets and Medical Need."

HIGHLY COMPETITIVE INDUSTRIES AND RISK OF TECHNOLOGICAL OBSOLESCENCE

The Company faces intense competition in both its Surgical Business and its
Medical Imaging Software Business. The medical product and imaging industries
are highly competitive and characterized by rapid innovation and technological
change. The Company expects technology to continue to develop rapidly, and the
Company's success will depend to a large extent on its ability to maintain a
competitive position with its technology. There can be no assurance that the
Company will be able to compete effectively in the marketplace

5
<PAGE>

or that products developed by its competitors will not render its products
obsolete or non-competitive. Similarly, there can be no assurance that the
Company's competitors will not succeed in developing or marketing products that
are viewed by physicians as providing superior clinical performance or are less
expensive relative to the Company's products currently marketed or to be
developed. Several established companies manufacture and sell surgical products
which compete with all of the Company's surgical products, other than Peri-
Strips. The Company believes that at least two established companies are
developing products intended to compete with Peri-Strips. The competition in
the imaging industry is also intense and consists largely of established
manufacturers of imaging equipment. The companies with which the Company
competes have greater distribution capabilities, substantially greater capital
resources and larger marketing, research and development staffs and facilities
than the Company. In addition, many of the Company's competitors offer broader
product lines within the Company's specific product markets. Broad product
lines may give the Company's competitors the ability to negotiate exclusive,
long-term medical product supply contracts and the ability to offer
comprehensive pricing for their products, including those that compete with the
Company's products. By offering a broader product line in the general field of
medical products and supplies, competitors may also have a significant advantage
in marketing competing products to group purchasing organizations and managed
care organizations that increasingly seek to reduce costs. There can be no
assurance that the Company will be able to compete effectively with such
manufacturers in either its Surgical Business or its Medical Imaging Software
Business. See "Business -- Surgical Business -- Competition" and "-- Medical
Imaging Software Business -- Competition."

ABILITY TO MANAGE GROWTH

To support the anticipated growth due to sales of its Peri-Strips product, the
Company will require additional supply, manufacturing, quality assurance,
inventory management, marketing and sales capabilities. Although the Company is
taking steps to meet these needs, there can be no assurance that the Company
will be able to secure the necessary personnel and systems capabilities to
sustain and support the current rate of growth. See "Business--Surgical
Business--Marketing" and "--Manufacturing."

INTELLECTUAL PROPERTY

The Company protects its technology through trade secrets and proprietary
know-how and through patents, both owned and licensed. The Company seeks to
protect its trade secrets and proprietary know-how through confidentiality
agreements with employees, consultants and other parties. Supple Peri-Guard,
which is used in the manufacture of the majority of the Company's Tissue-Guard
products, is protected exclusively by trade secrets. There can be no assurance
that the Company's trade secrets or confidentiality agreements will provide
meaningful protection of the Company's proprietary information or, in the event
of a breach of any confidentiality agreement, that the Company will have
adequate remedies. There can be no assurance that any pending or future patent
applications will result in issued patents, or that any current or future
patent, regardless of whether the Company is an owner or licensee of such
patent, will not be challenged, invalidated or circumvented or that the rights
granted thereunder or under its licensing agreements will provide a competitive
advantage to the Company. Furthermore, there can be no assurance that others
will not independently develop similar technologies or duplicate any technology
developed by the Company or that the Company's technology will not infringe
patents or other rights owned by others.

The medical product industry is characterized by frequent and substantial
intellectual property litigation, and competitors may resort to intellectual
property litigation as a means of competition. Intellectual property litigation
is complex and expensive, and the outcome of such litigation is difficult to
predict. Any future litigation, regardless of the outcome, could result in
substantial expense to the Company and significant diversion of the efforts of
the Company's technical and management personnel. Litigation may also be
necessary to enforce patents issued to the Company and license agreements
entered into by the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. An adverse determination in any such proceeding
could subject the Company to significant liabilities to third parties, or
require the Company to seek licenses from third parties or pay royalties that
may be substantial. Furthermore, there can be no assurance that necessary
licenses would be available to the

6
<PAGE>

Company on satisfactory terms, if at all. Accordingly, an adverse determination
in a judicial or administrative proceeding or failure to obtain necessary
licenses could prevent the Company from manufacturing or selling certain of its
products which in turn would have a material adverse effect on the Company's
business, financial condition and results of operations. See
"Business--Intellectual Property."

RISKS ASSOCIATED WITH HUMAN TISSUE PRODUCTS

The future regulatory environment for Biograft in Europe is unclear. While
the Medical Device Directive ("MDD") issued by the European Union ("EU")
explicitly excludes medical devices derived from human tissue from regulation,
certain European medical device manufacturers are actively lobbying for the re-
inclusion of such devices in the MDD. If this effort is successful, the
earliest date for applying for CE mark approval for Biograft is expected to be
1998. In addition, if extensive donor screening and donor testing requirements
are imposed, such requirements could make it uneconomical to sell Biograft in
Europe even under the CE mark. Biograft accounted for 12% and 25% of the
Company's net revenue and international net revenue, respectively, for the nine
months ended July 31, 1995.

EARLY STAGE OF THE MEDICAL IMAGING SOFTWARE BUSINESS

The Company's imaging business incurred operating losses of $708,000, $790,000
and $1,183,000 in fiscal 1992, 1993 and 1994, respectively, and has incurred an
operating loss of $797,000 for the nine months ended July 31, 1995. The Company
recently granted a perpetual, exclusive license to its imaging technology for
geoscience applications so that the Medical Imaging Software Business could
focus exclusively on medical applications of its imaging technology. With this
exclusive license, the Company will no longer be receiving revenue from sales
for these geoscience applications. The Company does not anticipate that expenses
of the imaging business will decrease proportionally to this decrease in
revenue. As a result, the imaging business will likely incur operating losses.
Currently, the Company has not received FDA 510(k) clearance to market its
VoxelView product as a medical product and does not anticipate significant
revenues from its medical imaging products in the near term even if FDA
clearance is received. The Company expects to continue to invest significant
resources in the research and development of VoxelView. The Company believes
that successful commercialization of VoxelView primarily depends upon the
development of an improved and application specific user interface. In addition,
VoxelView currently can only be used on hardware manufactured by a single
manufacturer, and therefore, the VoxelView product will be affected in the short
term by the success or failure of this hardware manufacturer. Furthermore, the
success of the VoxelView software currently under development will depend upon
the ability and willingness of physicians to use such 3-D software in clinical
diagnosis, surgical planning and patient screening, of which there can be no
assurance. See "Business--Medical Imaging Software Business -- Products and
Product Development."

LIMITATIONS ON THIRD-PARTY REIMBURSEMENT

The Company's products are purchased by hospitals and other users, which bill
various third-party payors, such as government health programs, private health
insurance plans, managed care organizations and other similar programs, for the
health care goods and services provided to their patients. Payors may deny
reimbursement if they determine that a product used in a procedure was not used
in accordance with established payor protocol regarding cost-effective treatment
methods or was used for an unapproved indication. Third-party payors are also
increasingly challenging the prices charged for medical products and services
and, in some instances, have put pressure on medical device suppliers to lower
their prices. The Company is unable to predict what changes will be made in the
reimbursement methods used by third-party health care payors. There can be no
assurance that the surgical procedures in which the Company's products are used
will continue to be considered cost effective by third-party payors, that
reimbursement for such surgeries or imaging services will

7
<PAGE>

be available or, if available, that payors' reimbursement levels will not
adversely affect the Company's ability to sell its products on a profitable
basis. The Company's medical imaging products have been purchased to date by a
limited number of medical institutions for research applications. Under the
current reimbursement system, end-users of the Company's medical imaging
products will not receive reimbursement for such products until FDA marketing
clearance for such products has been obtained. In addition, the cost of health
care has risen significantly over the past decade, and there have been and may
continue to be proposals by legislators, regulators and third-party payors to
curb these costs. Failure by hospitals and other users of the Company's
products to obtain reimbursement from third-party payors, changes in third-party
payors' policies towards reimbursement for procedures using the Company's
products or legislative action could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Third Party Reimbursement and Cost Containment."

GOVERNMENTAL REGULATION

The Company's products, development activities and manufacturing processes are
subject to extensive and rigorous regulation by the United States Food and Drug
Administration ("FDA") and by comparable agencies in foreign countries. In the
United States, the FDA regulates the introduction, manufacturing, labeling and
recordkeeping procedures for medical devices, including medical imaging
software. The process of obtaining marketing clearance from the FDA for new
products and new applications for existing products can be time-consuming and
expensive, and there is no assurance that such clearances will be granted or
that FDA review will not involve delays that would adversely affect the
Company's ability to commercialize additional products or additional
applications for existing products. In addition, certain of the Company's
surgical products that are in the research and development stage may be subject
to a lengthy and expensive pre-market approval ("PMA") process with the FDA.
Even if regulatory approvals to market a product are obtained from the FDA,
these approvals may entail limitations on the indicated uses of the product.
Product approvals by the FDA can also be withdrawn due to failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
approval. The FDA could also limit or prevent the manufacture or distribution
of the Company's products and has the power to require the recall of such
products. 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 affect
the Company. The FDA, various state agencies and foreign regulatory agencies
inspect the Company and its facilities from time to time to determine whether
the Company is in compliance with various regulations relating to manufacturing
practices, validation, testing, quality control and product labeling. A
determination that the Company is in violation of such regulations could lead to
imposition of civil penalties, including fines, product recalls or product
seizures and, in extreme cases, criminal sanctions.

Approximately 21% of the Company's net revenue in the first nine months of
fiscal 1995 resulted from sales of its products outside the United States
through independent distributors. International regulatory bodies have
established varying regulations governing product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. The Company relies on independent distributors to
comply with these foreign regulatory requirements and communication between
foreign regulatory agencies and the Company is indirect and occurs through the
foreign distributor. The inability or failure of independent distributors to
comply with the varying regulations or the imposition of new regulations could
restrict such distributors' ability to sell the Company's products
internationally and thereby adversely affect the Company's business, financial
condition and results of operations. See "Business--Governmental Regulation."

The new registration scheme in the EU requires that the Company's quality
system conform with the ISO 9001 international quality standard and that its
products conform with the "essential requirements" set forth by the MDD for the
class of products produced by the Company. Compliance with these requirements
will allow the Company to issue a "Declaration of Conformity" and apply the "CE"
mark to products, allowing free sale in the EU. While the Company is currently
undergoing a review procedure to verify compliance with the ISO 9001 standard
and the essential requirements, there can be no assurance that the Company will
obtain the CE mark in a timely manner, or at all. Failure to obtain the CE mark
by 1998 would limit the Company's ability to sell

8
<PAGE>

its products in Europe and would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Governmental Regulation."

EXPOSURE TO PRODUCT LIABILITY CLAIMS; RISK OF PRODUCT RECALL

The medical product industry historically has been litigious, and the
manufacture and sale of the Company's products inherently entails a risk of
product liability claims. Since the Company's principal products are designed
to be permanently placed in the human body, production errors could result in an
unsafe product and injury to the patient. Although the Company maintains
product liability insurance in amounts believed to be adequate based upon the
nature and risks of its business in general and its actual experience to date,
there can be no assurance that one or more liability claims will not exceed the
coverage limits of such policies or that such insurance will continue to be
available on commercially reasonable terms, if at all. Furthermore, the Company
does not expect to be able to obtain insurance covering its costs and losses as
the result of any recall of its products due to alleged defects, whether such a
recall is instituted by the Company or required by a regulatory agency. On one
occasion in 1992, the Company initiated a product recall to correct the
mislabeling of one of its surgical tool products. The mislabeling did not
result in injury to any patient and did not have an adverse effect on the
Company's business, financial condition or results of operations. A product
liability claim, recall or other claim with respect to uninsured liabilities or
in excess of insured liabilities could have a material adverse effect on the
business, financial condition and results of operations of the Company.

DEPENDENCE ON DISTRIBUTOR SALES

Sales to distributors constitute a significant portion of the Company's current
business. In the nine months ended July 31, 1995, three domestic distributors
accounted for an aggregate of 46.6% of the Surgical Business' gross revenue,
with each of such distributors accounting for in excess of 10% of the Surgical
Business' gross revenue for the period. There can be no assurance that the
Company will be able to maintain its relationships with these significant
distributors, or, in the event of termination of any of such relationships, that
a new replacement distributor will be found. The loss of a significant
distributor could materially adversely affect the Company's business, financial
condition and results of operations if a new distributor or other suitable sales
organization could not be found on a timely basis in the relevant geographic
market. See "Business--Surgical Business--Marketing."

POSSIBLE VOLATILITY OF SHARE PRICE

The trading price of the Company's Common Stock could be subject to
significant fluctuations in response to quarterly variations in the Company's
operating results, announcements of technological innovations by the Company or
its competitors, governmental regulation and other events or factors. In
addition, market prices of securities of medical technology companies have from
time to time experienced extreme price and volume fluctuations, which may have
been unrelated to the operating performance of those companies. These broad
market fluctuations may materially adversely effect the market price of the
Company's Common Stock.

DILUTION AND ABSENCE OF DIVIDENDS

Purchasers of the Common Stock in this Offering will incur immediate dilution
in the net tangible book value of their shares. Additional dilution is likely
to occur upon exercise of outstanding warrants and stock options. The Company
has not paid any cash dividends since its inception and does not anticipate
paying cash dividends in the foreseeable future. See "Dilution" and "Dividend
Policy."

ANTI-TAKEOVER CONSIDERATIONS

As a Minnesota corporation, the Company is subject to certain anti-takeover
provisions of the Minnesota Business Corporation Act (the "MBCA"). The
provisions of the MBCA could have the effect of delaying, deferring or
preventing a change in control of the Company, may discourage bids for the
Company's Common Stock at a premium over the then prevailing market price of the
Common Stock, and may adversely affect the market price of, and the voting and
other rights of the holders of, Common Stock. See "Description of Capital Stock
- - Certain Limited Liability, Indemnification and Anti-Takeover Provisions."

USE OF PROCEEDS

The net proceeds to be received by the Company from the sale of the Common
Stock offered hereby (at an assumed offering price of $ per share), after
deducting the underwriting discount and estimated expenses of this Offering, are
estimated to be approximately $ .

The Company intends to use the net proceeds of this Offering for working
capital and infrastructure associated with sales and marketing, research and
development and other general corporate purposes. In addition, the Company may
also use a portion of the net proceeds to finance collaborative arrangements or
to acquire

9
<PAGE>

businesses, assets, technologies or product lines that complement the Company's
existing businesses if such transactions could be effected on terms deemed
favorable by the Company. The Company from time to time considers such
transactions, but currently has no definitive plans or negotiations pending.
Pending the use of the net proceeds of this Offering, the Company will invest
the funds in short-term, interest-bearing, investment-grade securities.

PRICE RANGE OF COMMON STOCK

The Company's Common Stock is currently quoted on the Nasdaq SmallCap Market
under the symbol BVAS. The Company has applied for quotation on the Nasdaq
National Market upon completion of this Offering. The following table sets
forth, for each of the quarters indicated, the range of high and low bid
quotations per share of Common Stock as reported on the Nasdaq SmallCap Market.
These prices represent prices between dealers, without mark-up, mark-down or
commission, and do not necessarily represent actual transactions.
<TABLE>
<CAPTION>

HIGH LOW
------- ------
<S> <C> <C>
FISCAL 1993
First Quarter................... $ 5.50 $3.00
Second Quarter.................. 4.00 2.75
Third Quarter................... 3.00 1.81
Fourth Quarter.................. 4.06 1.81
FISCAL 1994
First Quarter................... $ 3.63 $2.63
Second Quarter.................. 3.81 2.88
Third Quarter................... 3.75 2.75
Fourth Quarter.................. 5.75 3.25
FISCAL 1995
First Quarter................... $ 5.75 $4.63
Second Quarter.................. 7.38 5.25
Third Quarter................... 14.63 6.88
Fourth Quarter (through
August , 1995)...............
</TABLE>

For a recent closing bid quotation for the Common Stock, see the cover page
of this Prospectus.

DIVIDEND POLICY

The Company has not declared or paid any cash dividends on its Common Stock
since its inception, and the Board of Directors presently intends to retain all
earnings for use in the business for the foreseeable future.

DILUTION

As of July 31, 1995, the Company's net tangible book value was $6,913,519, or
$.93 per share. Net tangible book value per share represents the amount of the
Company's total tangible assets less the Company's total liabilities, divided by
the number of shares of Common Stock outstanding. Without taking into account
any other changes in such net tangible book value after July 31, 1995, other
than to give effect to the sale of 1,500,000 shares offered by the Company
hereby (at an assumed offering price of $_____ per share and after deduction of
the estimated underwriting discount and estimated offering expenses), the net
tangible book value of the Company as of July 31, 1995 would have been
$_____________, or $___ per share. This represents an immediate increase in the
net tangible book value of $____ per share to the existing shareholders, and an
immediate dilution in net tangible book value of $___ per share to purchasers of
Common Stock in the Offering. The foregoing assumes no exercise of outstanding
stock options or warrants. As of July 31, 1995, the Company had 795,489 shares
of Common Stock issuable upon exercise of options outstanding under the Stock
Option Plans, which have an average exercise price of $3.10; 266,720 shares of
Common Stock issuable upon exercise of the Other Options, which have an average
exercise price of $4.12; an additional 556,986 shares of Common

10
<PAGE>

Stock reserved for future issuance under the Stock Option Plans; 32,143 shares
of Common Stock issuable upon exercise of the Warrants with an exercise price of
$4.00; and up to 86,250 shares of Common Stock issuable upon exercise of the
Underwriter Warrants to be issued at the completion of this Offering. See Note
6 of Notes to Consolidated Financial Statements, "Description of Capital
Stock -- Warrants" and "Underwriting."

CAPITALIZATION

The following table sets forth the short-term debt and capitalization of the
Company as of July 31, 1995 and as adjusted to give effect to the sale by the
Company of the 1,500,000 shares of Common Stock offered hereby at an assumed
offering price of $_____ per share and the application of the estimated net
proceeds therefrom. See "Use of Proceeds." This table should be read in
conjunction with the Consolidated Financial Statements and the related Notes
thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JULY 31, 1995
---------------------
ACTUAL AS ADJUSTED
------ -----------
(In thousands)
<S> <C> <C>

Short-term debt............................................... $ 6 $
======= ==========
Long-term debt................................................ --
Shareholders' equity:
Common Stock, $.01 par value; 20,000,000 shares authorized;
7,446,488 shares issued and outstanding, 8,946,488
shares issued and outstanding, as adjusted (1).............. 74
-------
Additional paid-in capital................................... 12,167
-------
Accumulated deficit.......................................... (4,250)
------- ----------
Unearned compensation and restricted stock................... (413)
-------
Total shareholders' equity.................................. 7,578
------- ----------
Total capitalization........................................ $ 7,578 $
======= ==========

</TABLE>
(1) Excludes, as of July 31, 1995, 795,489 shares of Common Stock issuable upon
exercise of options outstanding under the Stock Option Plans, which have an
average exercise price of $3.10; 266,720 shares of Common Stock issuable
upon exercise of the Other Options, which have an average exercise price of
$4.12; an additional 556,986 shares of Common Stock reserved for future
issuance under the Stock Option Plans; 32,143 shares of Common Stock
issuable upon exercise of the Warrants with an exercise price of $4.00; and
up to 86,250 shares of Common Stock issuable upon exercise of the
Underwriter Warrants to be issued at the completion of this Offering. See
Note 6 of Notes to Consolidated Financial Statements, "Description of
Capital Stock -- Warrants" and "Underwriting."

11
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share data)

The selected consolidated financial data presented below for, and as of the
end of, each of the years in the five-year period ended October 31, 1994, are
derived from the financial statements of Bio-Vascular, Inc. and Vital Images,
Incorporated ("Vital Images") after restatement for the 1994 pooling-of-
interests. The consolidated financial statements of Bio-Vascular, Inc. as of
October 31, 1993 and 1994 and for the years then ended and the separate
financial statements of Vital Images as of December 31, 1991 and 1992, and for
the years then ended have been audited by Coopers & Lybrand L.L.P., independent
accountants. The separate financial statements of Bio-Vascular, Inc. as of
October 31, 1992 and for the year then ended have been audited by Deloitte &
Touche LLP, independent accountants. The separate financial statements of Bio-
Vascular, Inc. as of October 31, 1990 and 1991, and for the years then ended and
the separate financial statements of Vital Images as of December 31, 1990 and
for the year then ended have been audited by independent accountants. Vital
Images financial statements were reported on a calendar year basis prior to the
merger with Bio-Vascular. Vital Images financial statements have been restated
to be on a fiscal year basis for the year ended October 31, 1993. Vital Images
financial statements prior to fiscal 1993 are combined on a calendar year basis
with Bio-Vascular fiscal years ended October 31. Accordingly, results for Vital
Images for the months of November and December 1992 are included in both the
1992 and 1993 amounts below. Vital Images' revenues were $404 and the net loss
was $33 during this two-month period. The selected financial data presented
below for the nine-month periods ended July 31, 1994 and 1995 are derived from
the unaudited consolidated financial statements of the Company included
elsewhere in this Prospectus. In the opinion of management, the unaudited
financial statements reflect all normal recurring adjustments necessary to
present fairly the financial data for the unaudited periods described above.
The results of operations of the Company for the nine-month period ended
July 31, 1995 should not necessarily be taken as indicative of the results of
operations that may be expected for the entire fiscal year ending October 31,
1995.

The selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>

YEARS ENDED OCTOBER 31, NINE MONTHS ENDED JULY 31,
-------------------------------------------- ----------------------------
1990 1991 1992 1993 1994 1994 1995
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenue.............................. $4,423 $5,086 $6,011 $6,144 $ 6,632 $ 4,702 $8,131
Gross margin............................. 2,358 3,349 3,605 3,628 4,198 2,879 5,564
Operating income (loss).................. (280) (294) (309) (457) (1,431) (991) 528
Income (loss) before extraordinary item.. (345) (337) (159) (158 (1,880) (1,374) 597
Extraordinary item-gain on early
extinguishment of debt................. -- 59 -- -- -- -- --
Net income (loss)........................ (345) (278) (159) (158) (1,880) (1,374) 597
Per common share data:
Loss before extraordinary item......... (.07) (.05) (.02) (.02) (.26) (.19) .07
Extraordinary item..................... -- .01 -- -- -- -- --
Net income (loss) per share............ $ (.07) $ (.04) $ (.02) $ (.02) $ (.26) $ (.19) $ .07
Weighted average shares outstanding...... 4,630 6,162 6,743 7,055 7,277 7,266 8,207

BALANCE SHEET DATA:
Working capital.......................... $1,039 $5,241 $5,535 $6,577 $ 5,236 $ 5,576 $5,121
Total assets............................. 4,359 8,283 8,626 9,469 7,913 8,108 9,050
Long-term debt........................... 1,087 167 99 52 -- -- --
Shareholders' equity..................... 2,119 7,449 7,643 8,477 6,786 7,217 7,578
</TABLE>

12
<PAGE>

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

OVERVIEW

The Company has two business segments which market products on a
worldwide basis. Its primary business is the Surgical Business, which develops,
manufactures and markets proprietary specialty medical products, for use in
thoracic, cardiac, neuro and vascular surgery. The Company, through its wholly-
owned subsidiary, Vital Images, also develops, markets and supports certain
software products for interactive visualization and analysis of three
dimensional image data for medical applications. Net revenue generated by Vital
Images is derived from software licensing and maintenance fees.

The Company has been in a period of significant growth, driven
primarily by the revenue contribution of its Peri-Strips product (part of the
Tissue-Guard product line). Peri-Strips, which enables LVR surgery for late-
stage emphysema patients, received marketing clearance from the FDA in May 1994
but was not released fully to the market until late October 1994. Net revenue
resulting from sales of Peri-Strips increased from $249,000 for the nine months
ended July 31, 1994 to $3,533,000 for the nine months ended July 31, 1995. The
Company anticipates that sales of Peri-Strips will continue to constitute an
increasing share of the Company's revenue. To accommodate growth in its Peri-
Strips business, the Company, beginning in April 1994, made significant
additional investments in personnel, plant and infrastructure, including moving
to a new and larger manufacturing facility for the Surgical Business in July
1995. Further increases in all areas, especially marketing and support
personnel additions, are planned to support anticipated Peri-Strips sales
growth. Due to the recent re-introduction of the modified LVR procedure, there
presently does not exist a statistically significant body of clinical data from
which to draw conclusions concerning the efficacy and long-term outcomes
associated with the LVR procedure. Accordingly, the rate and pattern of growth,
if any, of the Peri-Strips business, and its related personnel, plant and
infrastructure support requirements, are especially difficult to predict.

The Company acquired Vital Images on May 24, 1994. The acquisition
was a "pooling-of-interests," and financial results for all reporting periods
have been restated as if Vital Images had been merged into the Company from
inception. Historically, Vital Images was engaged in developing and marketing
3-D volume rendered, imaging software for various disciplines and industries,
but principally for confocal microscopy, other medical research, and gas and oil
exploration (the "Imaging Business"). After the acquisition, the Company
decided to exit the microscopy business due to the limited market opportunity in
microscopy and its relatively low margins. Although the Company continues to
provide support to existing microscopy customers, it does not actively pursue
new microscopy customers. At the time of the acquisition, the largest near-term
market opportunity for the Imaging Business was the VoxelGeo product for gas and
oil exploration applications. The Company funded the research and development
of the second generation of this product, VoxelGeo 2.0, in order to generate
revenue to fund future development of clinical medical applications of the
Company's imaging software. In the process of developing VoxelGeo 2.0, the
Company rewrote the entire code of its core 3-D volume rendering technology. A
significant portion of all of the Company's 3-D volume rendered imaging software
results from certain "core technology," and therefore improvements or changes to
this "core technology" advance all applications of the software. In order to
conserve resources and receive the benefit of industry expertise, the Company
entered into a global marketing alliance in August 1994 with CogniSeis
Development, Inc. ("CogniSeis"), a company with complementary software
technologies for gas and oil exploration and an established presence in the
industry. Under the agreement, CogniSeis assumed exclusive marketing and
customer support responsibilities for VoxelGeo in exchange for 50% of software
license and maintenance fee revenue.

In order to concentrate the Imaging Business on medical applications,
the Company entered into a source code license agreement in August 1995 with
CogniSeis, granting it a worldwide, perpetual, exclusive license for use in gas
and oil exploration applications. Under this agreement, CogniSeis becomes both
the exclusive developer and exclusive marketer of VoxelGeo. Upon validation of
the source code by CogniSeis, the Company will receive a license fee payment of
$1.5 million, which will be recorded as revenue at that time. The Company
anticipates that such payment will be made in the fourth quarter of fiscal 1995.
The agreement further provides for the payment to the Company on a quarterly
basis of royalties based upon the receipt of revenues

13
<PAGE>

generated by VoxelGeo, which payments, if any, the Company anticipates will
begin in calendar 1997. Royalties will terminate upon the earlier of March 31,
2001 or the aggregate payment of $2.0 million in royalties.

The Company's Imaging Business is now dedicated to the development of
medical applications of its imaging technology. Excluding the one-time source
code license fee discussed above, the Company anticipates that its Imaging
Business revenue will continue to decrease in the near term due to declining
microscopy revenue and no additional VoxelGeo revenue until 1997, when royalties
on VoxelGeo are anticipated to begin. Historically, microscopy and gas and oil
exploration revenue has accounted for more than 70% of the Imaging Business
revenue. In addition, the Company does not anticipate that expenses of the
Imaging Business will decrease proportionally to the decrease in revenue as the
Company intends to continue to invest in VoxelView. The Company does not have
FDA 510(k) clearance to market its VoxelView product as a medical product, and
does not anticipate significant revenues from its medical imaging products in
the near term even if FDA clearance is received.

RESULTS OF OPERATIONS

The following table sets forth the net revenue, gross margin and
operating income (loss) of the Company and for each business segment for the
periods shown:
<TABLE>
<CAPTION>

YEARS ENDED OCTOBER 31, NINE MONTHS ENDED JULY 31,
---------------------------- ----------------------------
1992 1993 1994 1994 1995
------- ------- ---------- ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NET REVENUE
Surgical............... $4,185 $4,423 $ 4,952 $ 3,401 $7,046
Imaging................ 1,826 1,721 1,680 1,301 1,085
------ ------ --------- ------- ------
Total................ 6,011 6,144 6,632 4,702 8,131
====== ====== ========= ======= ======

GROSS MARGIN
Surgical............... 2,519 2,586 3,028 1,981 4,667
Imaging................ 1,086 1,042 1,170 898 897
------ ------ --------- ------- ------
Total................ 3,605 3,628 4,198 2,879 5,564
====== ====== ========= ======= ======

OPERATING INCOME (LOSS)
Surgical............... 399 333 171 24 1,325
Imaging................ (708) (790) (1,183) (591) (797)
------ ------ --------- ------- ------
Total................ (309) (457) (1,431)* (991)* 528
====== ====== ========= ======= ======
</TABLE>
*Includes approximately $420 of acquisition costs not allocated to a
business segment.

COMPARISON OF THE NINE MONTHS ENDED JULY 31, 1995 WITH THE NINE MONTHS ENDED
JULY 31, 1994

Net Revenue. Net revenue increased 73% to $8,131,000 for the nine
months ended July 31, 1995 from $4,702,000 for the nine months ended July 31,
1994. Net revenue of the Surgical Business increased 107% to $7,046,000 for the
nine months ended July 31, 1995 from $3,401,000 for the comparable period in the
previous year. These increases were substantially due to increases in sales of
Peri-Strips, which increased to $3,533,000 for the nine months ended July 31,
1995 from $249,000 for the nine months ended July 31, 1994.

Net revenue from sales of the other products in the Tissue-Guard
product line, Dura-Guard, Vascu-Guard, Supple Peri-Guard and Peri-Guard,
increased by 80% to $1,193,000 for the nine months ended July 31, 1995 from
$664,000 for the nine months ended July 31, 1994. Approximately 10% of this
increase was due to sales of Dura-Guard, which received marketing clearance from
the FDA in June 1995. The Company believes that the increase in sales of the
other Tissue-Guard products was the result of the Company's heightened

14
<PAGE>

visibility in the surgical community.

Net revenue from sales of Biograft decreased 20% for the nine months
ended July 31, 1995 when compared to the nine months ended July 31, 1994.
Biograft revenue has been decreasing since late fiscal 1993. The Company
believes that the revenue decrease is a result of a trend towards non-surgical
intervention for peripheral vascular obstruction and the higher price of
Biograft when compared to synthetic grafts.

Net revenue from sales of surgical productivity tools (Flo-Rester and
the Bio-Vascular Probe) increased 7% for the nine months ended July 31, 1995
when compared to the nine months ended July 31, 1994. The Company believes that
sales of these products will not increase materially from current levels in the
foreseeable future.

Net revenue of the Imaging Business decreased 17% to $1,085,000 for
the nine months ended July 31, 1995 from $1,301,000 for the nine months ended
July 31, 1994 due primarily to the delayed release of VoxelGeo 2.0, the
CogniSeis revenue sharing agreement, and the Company's decision not to actively
pursue new customers in the microscopy market.

Gross Margin. The gross margin percentage increased to 68% of net
revenue for the nine months ended July 31, 1995 from 61% of net revenue for the
nine months ended July 31, 1994. Gross margin percentages of the Surgical
Business were 66% and 58% for the nine months ended July 31, 1995 and 1994,
respectively. The vast majority of gross margin improvement was due to changes
in product mix as a result of the large volume of Peri-Strips sales, the
spreading of overhead costs over a larger volume of production, and, to a lesser
extent, initial improvement in productivity related to the manufacture of Peri-
Strips. The Company believes that gross margin as a percent of net revenue is
likely to decrease in the short term due to increased overhead associated with
the facility and additional operations and quality assurance personnel.

Selling, General and Administrative. Selling, general and
administrative expense increased 47% to $3,491,000 for the nine months ended
July 31, 1995 from $2,378,000 for the nine months ended July 31, 1994, but
decreased as a percent of net revenue between comparable periods to 43% from
51%. The increase in expense was attributable entirely to the Surgical Business
and the increases in personnel and related overhead required to support the
Company's revenue growth.

Research and Development. Research and development expense increased
45% to $1,545,000 for the nine months ended July 31, 1995 from $1,068,000 for
the nine months ended July 31, 1994. The Surgical Business and the Imaging
Business accounted for 31% and 69%, respectively, of these expenditures for the
nine months ended July 31, 1995, as compared to 28% and 72%, respectively, of
these expenditures for the nine months ended July 31, 1994. The majority of the
research and development expense for the Imaging Business was attributable to
advancing the core technology associated with the development of VoxelView.
Developing and manufacturing software is expensive and the investment in product
development often involves a long pay-back cycle. The Company's plans include
continued investment in software development for medical applications for which
significant revenue is not anticipated in the near term. The Company expects
that expenditures for research and development in the Surgical Business will
grow, while those for the Imaging Business will remain at the current level for
the foreseeable future.

Operating Income (Loss). Operating income was $528,000 for the nine
months ended July 31, 1995, compared to an operating loss of $991,000 for the
nine months ended July 31, 1994. All of the operating income in the nine months
ended July 31, 1995 was attributable to the Surgical Business, principally due
to the increased revenue from sales of Peri-Strips. The operating loss incurred
in the nine months ended July 31, 1994 includes one-time acquisition costs of
approximately $420,000 related to the Vital Images transaction.

Other Income and Expense. The Company had net other income of
$101,000 in the nine months ended July 31, 1995. In the nine months ended July
31, 1994, the Company had net other expense of $380,000 primarily due to capital
losses on an investment in mutual fund shares of the Piper Jaffray Institutional
Government

15
<PAGE>

Income Portfolio in which the Company invested in 1994 (the "Fund"). The Fund
invested in various bonds and other obligations issued or guaranteed as to
payment of principal and interest by the United States Government. Included in
the investments of the Fund were mortgage-related securities and their
derivatives, such as interest-only and principal-only securities and inverse
floating rate securities. During the first quarter of calendar 1994, the Fund's
value declined. The Company closely monitored its investment in the Fund and
held discussions with the Fund's management concerning their recovery strategy.
The Company decided to sell its shares in the Fund when it believed that any
meaningful recovery was no longer possible in a reasonable timeframe, and as
concern about the Fund continued to aggravate the immediate downside potential.
The Company liquidated these mutual fund shares late in fiscal 1994.

Affiliates of the Fund have entered into a settlement agreement with
plaintiffs in certain litigation relating to the Fund. The settlement agreement
has received preliminary approval from the United States District Court where
the litigation is venued, but is subject to acceptance by a large percentage of
the Fund shareholders. The Company would be entitled to participate in the
settlement payment if the settlement agreement is accepted by Fund shareholders
and receives final court approval. The amount and timing of any such settlement
payment to the Company is not yet determinable.

Income Taxes. The Company has recorded a provision for income taxes
of $32,000 for the nine months ended July 31, 1995 representing its estimated
effective income tax rate for 1995. The provision for income taxes for the
nine months ended July 31, 1994 represented alternative minimum taxes. As of
October 31, 1994, the Company had net operating loss ("NOL") carryforwards of
approximately $1,000,000 available to offset income from operations which the
Company now expects to fully utilize in fiscal 1995. The Company also has
research and experimentation tax credit carryforwards. It also has
carryforwards of $500,000 available to offset future capital gains and
$2,400,000 of carryforwards arising from pre-merger losses of Vital Images
available to offset post-merger income of Vital Images if it reaches
profitability. A portion of the pre-merger loss carryforwards that may be used
in any year is restricted due to limitations resulting from the significant
change of ownership. These carryforwards begin to expire in 2005. The deferred
tax assets associated with the pre-merger carryforwards and the capital loss
carryforward have been totally offset by a valuation allowance because of
uncertainty that sufficient taxable income will be generated prior to the
expiration of the carryforwards.

COMPARISON OF THE YEAR ENDED OCTOBER 31, 1994 WITH THE YEAR ENDED OCTOBER 31,
1993

Net Revenue. Net revenue increased 8% to $6,632,000 for fiscal 1994
from $6,144,000 for fiscal 1993. The increase was due entirely to a 12%
increase in revenue of the Surgical Business when comparing these periods.
Tissue-Guard net revenue increased 88% to $1,675,000 for fiscal 1994 from
$891,000 for fiscal 1993. Peri-Strips accounted for 88% of the increase in
Tissue-Guard product line net revenue.

Biograft net revenue decreased 14% for fiscal 1994 when compared to
fiscal 1993. The Company believes that this decline was strongly influenced by
the changing health care environment, specifically cost containment, which
prompted surgeons to choose drug therapy more frequently than surgical
intervention in the treatment of peripheral vascular disease. Net revenue of
the surgical productivity tools increased 3% between fiscal 1994 and fiscal
1993.

Net revenue of the Imaging Business decreased 2% between fiscal 1994
and fiscal 1993. The Company believes that the decrease, which was primarily in
software license revenues, arose from the market's anticipation of VoxelGeo 2.0
and customers' decisions to delay software purchases until the delivery of this
version of the VoxelGeo software, offset by maintenance revenue increases.

Gross Margin. The gross margin percentage increased to 63% of net
revenue for fiscal 1994 from 59% of net revenue for fiscal 1993. Gross margin
percentages of the Surgical Business were 61% and 58% in fiscal 1994 and fiscal
1993, respectively. This improvement in the Surgical Business gross margin was
primarily due to the lower average cost of labor associated with the addition of
significant numbers of entry-level production personnel in response to
anticipated sales increases of Peri-Strips. Gross margin percentages of the
Imaging Business were 70% and

16
<PAGE>

60% in fiscal 1994 and 1993, respectively. The increase in the Imaging Business
gross margin percentage was due to product and service mix.

Selling, General and Administrative. Selling, general and
administrative expense increased 13% to $3,541,000 for fiscal 1994 from
$3,126,000 for fiscal 1993 and increased slightly as a percentage of sales to
53% for fiscal 1994 from 51% for fiscal 1993. The increase in expense was
primarily attributable to retention of a Chief Operating Officer in April 1994
and the increased level of business activity of the Surgical Business.

Research and Development. Research and development expense increased
74% to $1,669,000 for fiscal 1994 from $959,000 for fiscal 1993 and increased as
a percentage of net revenue to 25% for fiscal 1994 from 16% in fiscal 1993. The
majority of the increase was attributable to advancing the core technology of
the Imaging Business concurrent with the development of VoxelGeo 2.0. In both
fiscal 1994 and fiscal 1993, 25% of research and development expenditures were
for the Surgical Business and 75% were for the Imaging Business.

Acquisition Costs. The costs of the acquisition of Vital Images,
which were all incurred in fiscal 1994 were $420,000. These one-time costs,
which accounted for 29% of the operating loss incurred by the Company in fiscal
1994, were for legal, accounting, and other professional fees.

Operating Income (Loss). The Company had operating losses of
$1,431,000 and $457,000 in fiscal 1994 and fiscal 1993, respectively. The
Surgical Business had operating income of $171,000 and $333,000 and the Imaging
Business had operating losses of $1,183,000 and $790,000 for fiscal 1994 and
fiscal 1993, respectively. The increase in the Company's operating loss arose
primarily from the increase in research and development expenditures and the
cost of the acquisition of Vital Images.

Other Income and Expense. During fiscal 1994, the Company invested
some of its excess cash in the Fund. The Company sold its investment in the
Fund during September and October of 1994 and realized a capital loss of
$610,000 which resulted in net other expense of $438,000 in that fiscal year.

Income Taxes. The tax provisions recorded in fiscal 1994 and fiscal
1993 represented alternative minimum taxes due to limitations in the use of NOL
carryforwards and state minimum taxes.

COMPARISON OF THE YEAR ENDED OCTOBER 31, 1993 WITH THE YEAR ENDED OCTOBER 31,
1992

Net Revenue. Net revenue increased 2% to $6,144,000 for fiscal 1993
from $6,011,000 for fiscal 1992. All of the increase was attributable to the
Surgical Business, and primarily to increased revenue from Biograft and Supple
Peri-Guard. Net revenue from the Surgical Business increased by 6% and net
revenue from the Imaging Business decreased by 6%. The increase in Surgical
Business net revenue was solely as a result of increases in unit sales volumes,
as average selling prices for all Surgical Business products effectively
decreased due to a greater number of sales made to distributors at wholesale
prices.

Supple Peri-Guard, an alternative soft-tissue patch developed by the
Company, was introduced to international markets at the beginning of fiscal 1992
and to the domestic market at the beginning of fiscal 1993. Net revenue from
this product increased 296% between fiscal 1992 and fiscal 1993.

Net revenue from sales of Biograft increased 23% from fiscal 1992 to
fiscal 1993, with large increases in the first part of 1993 relative to 1992,
offset by decreasing revenue and unit sales in the latter half of 1993 as
proposed health care reform and cost concerns accelerated. Net revenue from
surgical productivity tools decreased 7% between fiscal 1992 and fiscal 1993.

The 6% decrease in Imaging Business net revenue between fiscal 1992
and fiscal 1993 was primarily the result of an increase in maintenance revenue
which was offset by a decrease in software license revenue. The increase in
maintenance revenue was due to maintenance contracts from an increasing
installed base of software.

Gross Margin. Gross margin percentages of both the Surgical Business
and Imaging Business were relatively flat for fiscal 1993 and fiscal 1992.

17
<PAGE>

Selling, General and Administrative. Selling, general and
administrative expense decreased 7% to $3,126,000 for fiscal 1993 from
$3,349,000 for fiscal 1992, and decreased as a percentage of net revenue to
51% for fiscal 1993 from 56% for fiscal 1992, due to reduced staffing levels in
both business segments.

Research and Development. Research and development expense increased
70% to $959,000 for fiscal 1993 from $565,000 for fiscal 1992 and was 16% and 9%
of net revenue for those respective years. Research and development expense of
the Surgical Business increased to $240,000 for fiscal 1993 from $46,000 for
fiscal 1992. This increase was the early result of a strategic decision to
develop a full research and development capability for the Surgical Business.
Research and development expense of the Imaging Business increased 39% to
$719,000 for fiscal 1993 from $519,000 for fiscal 1992.

Operating Income (Loss). The Company had operating losses of $457,000
and $309,000 in fiscal 1993 and fiscal 1992, respectively. The Surgical
Business had operating income of $333,000 and $399,000 and the Imaging Business
had operating losses of $790,000 and $708,000 in fiscal 1993 and fiscal 1992,
respectively.

Other Income and Expense. During fiscal 1993, the Company made its
first investment in the Fund. The Company sold its investment in the Fund in
fiscal 1993, realizing a capital gain of $101,000. Dividend and capital gain
income on this investment contributed significantly to the Company's net other
income of $319,000 in fiscal 1993. In fiscal 1992, the Company had net other
income of $165,000.

Income Taxes. The tax provisions recorded in fiscal 1993 and fiscal
1992 represented alternative minimum taxes due to limitations in the use of NOL
carryforwards and state minimum taxes.

LIQUIDITY AND CAPITAL RESOURCES

The Company's cash, cash equivalents and marketable securities
balances decreased by $1,497,000 to $2,122,000 at July 31, 1995 from $3,619,000
at October 31, 1994. Working capital at July 31, 1995 was $5,121,000, decreasing
from $5,236,000 at October 31, 1994.

Historically, the cash needs of the Company have been met by cash
generated from operations and investments. During the nine months ended July
31, 1995, the Company used $1,541,000 to increase levels of inventories and
accounts receivable associated with the growth in Surgical Business revenue.
The Company made capital expenditures during this period primarily for the
Surgical Business totaling $1,297,000, which included $246,000 for manufacturing
equipment and modular workspace, $300,000 for computer hardware and software,
and $948,000 for leasehold improvements, of which $300,000 was refunded and an
additional $300,000 is refundable upon certification of completion of the new
facility construction. The Company anticipates making capital expenditures of
less than $400,000 in the fourth quarter of fiscal 1995. The Company currently
has no commitments or plans for material capital expenditures in fiscal 1996.
Investments in marketable securities which matured provided $1,271,000 during
the nine months ended July 31, 1995.

The Company believes its present level of cash and cash equivalents,
as well as the proceeds of this Offering, will be sufficient to satisfy the
Company's cash requirements for the foreseeable future.

INFLATION

Management believes that inflation has not had a material effect on
the Company's results of operations or financial condition.

FOREIGN CURRENCY TRANSACTIONS

Substantially all of the Company's international transactions are
denominated in U.S. dollars. Fluctuations in currency exchange rates may
therefore reduce the demand for the Company's products by increasing the price
of the Company's products in the currency of the countries in which the products
are sold.

18
<PAGE>

QUARTERLY OPERATING DATA

The following table sets forth certain unaudited operating data for
the four quarters in fiscal 1993 and 1994 and the first three quarters of fiscal
1995. In the opinion of management, the data includes all adjustments,
consisting of only normal recurring adjustments, necessary to present fairly the
information set forth therein.
<TABLE>
<CAPTION>

1993 1994 1995
------------------------------------- ------------------------------------- ---------------------------
First Second Third Fourth First Second Third Fourth First Second Third
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------- -------- -------- -------- -------- -------- -------- -------- -------- ------- -------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue............... $1,645 $1,633 $1,478 $1,388 $1,569 $1,574 $1,559 $1,930 $2,126 $2,817 $3,189
Gross margin.............. 959 992 871 806 925 1,006 947 1,320 1,445 1,928 2,191
Operating income (loss)... (71) (102) (67) (217) (284) (299) (408) (440) (153) 206 475
Net income (loss)......... 17 (51) (28) (96) (243) (250) (881) (506) (115) 238 474
Net income (loss) per
share................... $ .00 $ (.01) $ (.00) $ (.01) $ (.03) $ (.03) $ (.12) $ (.07) $ (.02) $ .03 $ .06
</TABLE>

The first through third quarters of 1994 were impacted by acquisition
costs of $420,000, while the third and fourth quarters of 1994 were impacted due
to non-operating losses of $539,000 and $71,000, respectively, arising from the
Company's investment in the Fund. The Company expects to receive a one-time
license fee payment of $1,500,000 in the fourth quarter of fiscal 1995 as a
result of its license of VoxelGeo to CogniSeis for gas and oil exploration
applications. With this exclusive license, the Company will no longer be
receiving revenue from sales of VoxelGeo until royalty payments, if any, under
the licensing agreement begin, which are anticipated to begin in calendar 1997.
In addition, the Company does not anticipate that expenses of the Imaging
Business will decrease proportionally to the decrease in revenue as the Company
intends to continue to invest in VoxelView. As a result, operating data in
future consecutive and comparable quarters may not compare favorably to the
fourth quarter of fiscal 1995.

19
<PAGE>

BUSINESS
GENERAL

The Company's operations include a surgical business ("Surgical
Business") and a medical imaging software business ("Medical Imaging Software
Business"). The Surgical Business has constituted and is expected to constitute
the majority of the Company's net revenue and earnings, if any, for the
foreseeable future.

In its Surgical Business, the Company develops, manufactures and markets
proprietary specialty medical products for use in thoracic, cardiac, neuro and
vascular surgery. Tissue products offered by the Company include the Tissue-
Guard product line and the Biograft peripheral vascular graft. The Tissue-Guard
product line includes various configurations of bovine pericardium processed
using the Company's proprietary tissue-fixation technologies. These products are
designed to be used in a variety of surgical procedures for reinforcing,
reconstructing and repairing tissue and preventing leaks of air, blood and other
body fluids. Peri-Strips was introduced in 1994 and has been responsible for the
Company's revenue growth in fiscal 1994 and fiscal 1995. The Biograft peripheral
vascular graft is used to bypass blocked blood vessels and is produced from
modified human umbilical veins. The Surgical Business also markets and sells two
surgical productivity tools used in cardiac and vascular surgery.

In May 1994, the Company acquired Vital Images, a company involved in the
development, marketing and support of certain software products for three-
dimensional ("3-D") visualization and analysis of image data. The Company
recently granted an exclusive, perpetual source code license for its geoscience
imaging technology and is focusing its imaging technology exclusively on medical
applications. The Company developed VoxelView, high speed volume imaging
software, which has been licensed to approximately 70 medical and research
institutions as a research tool. The Medical Imaging Software Business is
currently focusing its efforts on developing an improved version of VoxelView
intended to assist physicians in clinical diagnosis, surgical planning and
patient screening.

STRATEGY

The Company's long-term business strategy is to leverage its proprietary
technologies in tissue processing and bio-materials to become a leader in
implantable tissue products used in a wide variety of surgical specialties and
procedures. Additionally, the Company plans to further develop its Medical
Imaging Software Business to provide innovative 3-D visualization software for
the purposes of clinical diagnosis, surgical planning and patient screening.

The following are key elements of the Company's business strategy:

. Broaden Surgical Product Line. The Company will continue to expand its
Tissue-Guard product line by leveraging its proprietary tissue-processing
technologies to create new and unique product configurations for specific
surgical procedures in which tissue must be repaired or the leakage of air,
blood or other body fluids creates patient risk.

. Emphasize Clinical Advantage. The Company focuses on developing products
which enable surgical procedures to be more clinically effective by
reducing patient risk and improving surgical outcomes.

. Develop Physician Relationships. The Company's marketing and sales strategy
emphasizes building strong working relationships with surgeons,
radiologists and other medical personnel in order to assess and satisfy
their needs for products and services. The Company will continue to
sponsor both domestic and international training sessions to educate
physicians in the use of the Company's products. The Company expects that
as these relationships develop and as use of the Company's Tissue-Guard
products becomes more widespread, surgeons will develop additional uses for
these products.

20
<PAGE>

. Commercialize Medical Imaging Technology. The Company intends to use its
research and development capability and its current presence in leading
medical teaching institutions such as Duke University and Stanford Medical
Center to further develop and permit commercialization of its 3-D
visualization software for clinical diagnosis, surgical planning and
patient screening.

. Reduce Production Costs. The Company seeks to design and develop cost
competitive products that have significant clinical advantages. In
addition, the Company will continue to improve its manufacturing processes
to achieve decreases in per unit production cost while maintaining the
highest level of quality assurance and physician satisfaction.

. Increase International Market Presence. The Company intends to increase
international physician training and marketing activities to promote
acceptance of its core technologies in markets outside the United States.
The Company also expects to expand and strengthen its distribution network
to address additional foreign markets.

SURGICAL BUSINESS

MARKETS AND MEDICAL NEED

While the trend in medicine is toward less invasive surgical procedures,
substantially all surgical procedures, whether invasive or not, involve the
cutting of tissue to access, repair or remove tissue at or from the surgical
site. Tissue which has been cut must either be repaired or replaced so that it
can heal properly. Proper repair of incised tissue is dependent upon a number
of variables, including whether (i) the repair must be leak-proof, either for
air, blood or other body fluids, (ii) the incised tissue is under tension or
subject to shrinkage such that additional tissue is needed to bridge the two
tissue surfaces to be repaired, and (iii) the tissue subject to the repair must
be strengthened to accommodate the natural stresses of the human body. In
certain instances, suturing of two tissue surfaces will be effective. In other
instances, however, a patching material, whether autologous (from the body of
the patient), synthetic (from man-made materials) or tissue-based (from
processed living tissue), may be needed. The Company's tissue-based products
are designed to fulfill the medical need for repairing human tissue and
preventing leaks at the surgical site in certain existing surgical procedures,
as well as offering a potential medium for techniques and procedures currently
being developed.

The Company's core competency is the development and manufacture of tissue-
based, implantable medical products for use by surgeons in various surgical
procedures where reinforcing, reconstructing and repairing tissue and preventing
leaks of air, blood or other body fluids is necessary for the achievement of a
favorable outcome. Historically, surgeons primarily used autologous tissue in
situations where tissue repair was necessary. Harvesting the autologous
material, which is still performed in many circumstances, necessarily requires
that the surgeon cut into another part of the patient's body. The second
surgical site increases the cost of the procedure and lengthens the time the
patient is under anesthesia, thereby increasing the risk of complication and
resulting in additional pain and recovery time for the patient. To the extent a
surgeon is confident that the performance of a readily available medical
product, whether tissue-based or synthetic, is equal to or is better than the
patient's own tissue, the Company believes the surgeon will choose the tissue-
based or synthetic product to avoid a second surgical site as a means of
reducing costs and improving outcomes.

Surgical procedures that are enabled or enhanced by the Company's tissue-
based products include lung volume reduction, craniotomy, carotid endarterectomy
and lower limb vascular reconstruction. Sales of the

21
<PAGE>

Company's products used in these procedures accounted for 50% of the Company's
net revenue in fiscal 1994 and 70% of the Company's net revenue in the nine
months ended July 31, 1995.

Lung Volume Reduction (LVR) Surgery. Emphysema, most often caused by
cigarette smoking, is a progressive disease of the lungs characterized by air-
filled expansions or pocket-like blisters in the tissue of the lungs. Because
the air in the lungs cannot be fully expelled, the effort to inhale fresh air
becomes increasingly difficult, pushing the lung walls farther out and causing
the lungs to expand and lose their elasticity. The diaphragm, the major muscle
used for breathing, becomes flattened and loses its ability to function. As the
disease advances and patient health is progressively compromised, breathing
becomes more difficult. Persons with late-stage emphysema eventually become
incapable of even minor physical activity and often become dependent upon
continuous supplemental oxygen even when at rest. As a result, late-stage
emphysema can significantly reduce mobility, leaving individuals with late-stage
emphysema unable to care for themselves or engage in normal daily activities.
Because of the weakened respiratory condition of these patients, common
illnesses involving pulmonary functions can result in emergency room visits and
hospitalization.

Non-surgical therapies for patients suffering from emphysema include (i)
bronchodilators (pills and inhalers), to open up airways to temporarily relieve
wheezing or shortness of breath, (ii) steroids, to reduce inflammation in the
airways, (iii) pulmonary rehabilitation, to increase endurance, and (iv) oxygen
supplements to help decrease the feeling of shortness of breath. Each of these
non-surgical therapies, however, offers only temporary relief and each becomes
less effective as the disease progresses. Data gathered by the Company
indicates that the cost of medication and oxygen supplements for late-stage
emphysema patients can range from $5,000 to $8,000 annually. In addition, for
persons suffering the effects of late-stage emphysema, the need for periodic
emergency room care can increase costs substantially.

Lung transplantation is the only known cure for emphysema. A lung
transplant surgical procedure, however, costs up to $250,000 and is typically
used only as a last resort because of the high degree of risk associated with
the procedure, an inadequate supply of donor lungs, and the requirement that the
patient receive anti-rejection drugs for the remainder of his or her lifetime.
Only 688 lung transplants were performed in the United States in 1994.

In the 1950s, a surgical procedure was developed to treat the symptoms of
late-stage emphysema by removing damaged lung tissue. Due to air leaks around
the suture lines, these experimental LVR procedures resulted in a high mortality
rate and long, painful post-surgical recovery periods. As a result, the LVR
procedure was abandoned. In the late 1980s, various surgeons began to develop
specialized techniques for accessing and resecting the lung. The use of
surgical staples was introduced to perform the LVR procedure more quickly, a
particularly important consideration in light of the debilitated condition of
the patients requiring the surgery. Despite many advances in the LVR procedure,
multiple small air leaks caused by the staples in the lung continued to limit
the effectiveness of the procedure. In 1994, Dr. Joel Cooper, a pioneer in lung
transplant surgery, modified the LVR procedure using strips of Supple Peri-Guard
to reinforce the staple line to prevent air leakage around the staples.

During LVR surgery, the surgeon collapses one lung, while allowing the
patient to continue breathing with the other lung with supplemental oxygen.
Using a stapling device, the surgeon removes sections of damaged tissue,
typically 20% to 30% of each lung. The Company's Peri-Strips, manufactured from
processed bovine pericardium, are used to strengthen these staple lines and
prevent air leakage. By removing the most diseased tissue, the remaining lung
tissue has room to expand, improving breathing capacity by, among other things,
enabling the muscles used in breathing to regain their function and allowing the
rib cage and diaphragm to return to their normal size. The Company estimates
that the current cost of an LVR surgical procedure ranges from $30,000 to
$45,000 per procedure.

The American Lung Association estimates that in 1992 there were
approximately 1.9 million Americans suffering from emphysema. The LVR
procedure, however, is currently only being performed on a small portion of
these patients who have late-stage emphysema and who meet certain criteria
established by the attending surgeons. Currently, most surgeons require that an
LVR candidate be less than 75 years old, quit

22
<PAGE>

smoking at least six months prior to LVR surgery, have no documented history of
heart disease or previous lung surgery and have no other major diseases. In
addition, most surgeons performing the LVR procedure require that candidates
have documented lung function testing and chest x-rays detailing the severity of
the condition. The Company believes that the patient selection criteria will
continue to be refined as surgeons become more familiar with the LVR procedure
and as long-term clinical results become available.

While LVR surgery is not a cure for emphysema, the results from the
procedure to date are encouraging based on information available to the Company.
Generally, this information suggests that patients undergoing the procedure have
reduced shortness of breath, improved exercise tolerance and improved quality of
life. However, LVR surgery was only recently re-introduced into the United
States. As a result, the number of patients who have undergone the procedure
and for whom a clinically acceptable post-operative period of evaluation has
elapsed is still relatively small. Similarly, the number of physicians
performing the procedure and from whom data and reporting is available is small.
Accordingly, there presently does not exist a statistically significant body of
clinical data from which to draw conclusions concerning the efficacy and long-
term outcomes associated with the LVR procedure. The Company believes that
patients who have received the LVR procedure may require an additional year or
more of follow-up examination before the procedure can be properly evaluated by
the medical community.

Craniotomy. Craniotomies (surgical operations involving the brain and
skull) are typically performed to treat various brain conditions, such as
tumors, aneurysms, blood clots, head injuries and abscesses. To access the
brain, the surgeon is required to cut through several of the protective layers
surrounding the brain. The dura, the fibrous protective layer below the skull,
protects the brain and spinal cord from bacterial infection and trauma and
provides a fluid tight seal. Once the surgeon has cut through the scalp and the
skull, the dura must be cut with a scalpel or scissors and resected to expose
the brain.

After the specific brain condition has been treated by the surgeon, the
dura often must be closed to prevent cerebral spinal fluid leakage. While the
dura is often closed with direct suture, surgeons who consider the prevention of
fluid leakage to be critical to the success of the operation will use a dural
patch. Dural patches currently available are either autologous or are produced
from processed cadaver tissue or bovine pericardium. The Company's Dura-Guard
Dural Repair Patch is designed to be sewn to the dura to close the incision by
fusing to the native dura with little or no adhesion (an abnormal union between
two tissue surfaces not intended to be joined) to the underlying brain cortex.

The Company estimates that in the United States approximately 100,000
cranial operations were performed in 1994. Whether a dural patch is used in
such operations is subject to surgical conditions and surgeon discretion. Dural
patching is most often used when the dura shrinks after incision such that
sutures alone may not provide adequate closure.

Carotid Endarterectomy. Stroke is the third leading cause of death in the
United States with an estimated 500,000 new cases per year. The build-up of
atherosclerotic plaque (fat deposits with a proliferation of fibrous connective
cells along the artery walls) in the carotid arteries (the principal arteries
located in the neck that supply blood to the brain) increases the risk of
stroke. A substantial portion of strokes are caused by a fragment of
atherosclerotic plaque breaking away from the inner wall of the carotid artery
and becoming lodged in an artery in the brain.

Drug therapy is often prescribed to treat the early indications of
atherosclerotic plaque build-up. If the condition progresses to a point where
drug therapy is not effective, surgical intervention may be required. Carotid
endarterectomy is a surgical procedure used to remove atherosclerotic plaque
build-up in the carotid artery. The endarterectomy procedure begins with an
incision in the internal carotid artery. A temporary shunt may be inserted to
maintain blood flow to the brain during the surgery. Once the artery is opened,
the plaque and inner layer of the artery are carefully removed, and the incised
artery must be repaired. Although the artery often can be closed without a
patch, use of an autologous or prosthetic patch is often suggested to expand the
artery, encouraging greater blood flow. In addition, certain patients require
patching due to the small size of

23
<PAGE>

their carotid arteries, or in some patients with a normal carotid artery
diameter, a patch is used to decrease the incidence of post-operative stenosis
or occlusion.

While the Company estimates that in the United States approximately 100,000
carotid endarterectomy procedures were performed in 1994, the use of a patching
material in such procedures is subject to surgeon discretion. Once a surgeon
determines a vascular patch is necessary or desirable, the surgeon has
additional discretion in determining the type of patching material to use.
Characteristics of an effective vascular patch include the ability to imitate
human tissue, to exhibit good blood flow characteristics and to reapproximate
around sutures to prevent blood leaks. The primary patching materials include
autologous tissue, synthetic patches made out of polytetraflurothylene ("PTFE"),
silicone fabric or tissue-based patches made out of bovine pericardium, such as
Vascu-Guard.

Lower Limb Vascular Reconstruction. Certain diseases, such as diabetes,
can cause a restriction or occlusion in the arteries which provide blood to the
legs. If left untreated, insufficient blood flow can ultimately result in the
need for amputation. If drug therapy is not deemed an effective treatment based
upon the severity of the restriction or blockage, the use of a graft in
peripheral vascular reconstructive surgery may be needed. In this type of
surgical procedure, the surgeon can bypass the blocked artery to regain blood
circulation, thereby saving the affected limb. Diabetics, in particular, are
often at risk for amputation of a lower limb due to insufficient blood flow in
the femoral artery in the thigh. By implanting a graft from the upper portion
of the femoral artery to either the lower femoral artery or to the popliteal
artery below the knee, the surgeon is able to increase blood flow below the site
of the restriction or blockage. Long-term patency (openness), and a thrombo-
resistant surface that provides smooth blood flow are essential qualities of an
effective graft.

Saphenous veins (autologous veins from the leg) typically provide the most
effective grafting material. In many instances, however, a suitable saphenous
vein may be unavailable in sufficient quantity or quality, and a substitute
graft must be used. The primary alternative substitute grafts involve synthetic
grafts made from PTFE or bio-synthetic materials or tissue-based grafts, such as
the Biograft. The Company estimates that in the United States approximately
55,000 lower limb vascular reconstructions were performed in 1994.

24
<PAGE>

PRODUCTS

The following table summarizes the Company's Surgical Business product
lines and primary products, the procedures in which such products are used and
the type of regulatory clearance obtained for such products:
<TABLE>
<CAPTION>

REPRESENTATIVE REGULATORY
PRODUCT LINE PRODUCT APPLICATION PROCEDURE CLEARANCE
------------ ------- ----------- -------------- ----------
<S> <C> <C> <C> <C>
Tissue-Guard
Peri-Strips Staple line reinforcement Lung volume reduction/lung resection 510(k)

Dura-Guard Dural repair patch Craniotomy 510(k)

Vascu-Guard Peripheral vascular patch Carotid Endarterectomy 510(k)

Supple Peri- General soft tissue patch Various surgical procedures 510(k)
Guard

Peri-Guard General soft tissue patch Various surgical procedures 510(k)*
Biograft
Biograft Peripheral vascular Lower limb vascular reconstruction PMA**
bypass graft
Surgical
Productivity Tools
Bio-Vascular Locator of arterial Various surgical bypass procedures 510(k)
Probe blockages

Flo-Rester Internal vessel occluder Coronary artery bypass graft surgery 510(k)*
</TABLE>

The following table summarizes the net revenue contributed by the Company's
primary Surgical Business products and various product lines for the periods
indicated:
<TABLE>
<CAPTION>

PRODUCT/ YEARS ENDED OCTOBER 31, NINE MONTHS ENDED JULY 31,
PRODUCT LINE ----------------------- --------------------------
- ------------ 1993 1994 1994 1995
---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Peri-Strips.......................... $ -- $ 685 $ 249 $3,533

Tissue-Guard Products
(excluding Peri-Strips)............. 891 990 664 1,193

Biograft............................. 1,770 1,525 1,171 943

Surgical Productivity Tools.......... 1,646 1,700 1,276 1,371
</TABLE>

- --------------------------
* Licensed by the Company in July 1985.
** Licensed by the Company in December 1989.

25
<PAGE>

TISSUE-GUARD PRODUCT LINE. The Company's Tissue-Guard products are all
produced from bovine pericardium. Many of the product characteristics and
competitive advantages of this product line are derived from the collagen
configuration of the bovine pericardium. Collagen, which is a fibrous protein
found in all multi-cellular animals, makes the pericardium durable and provides
superior fluid interface properties, similar to autologous tissue. These
characteristics allow for effective host tissue incorporation. Host cells
deposit a collagen matrix on the surface of the pericardial product, which helps
the Tissue-Guard product integrate into the host tissue and which the Company
believes enhances the long-term tensile strength (the maximum stress a material
subjected to a stretching load can withstand without tearing) of all the
products in the Tissue-Guard product line.

The Company processes the bovine pericardium using proprietary tissue-
fixation technologies. The tissue is treated with glutaraldehyde and other
proprietary chemical treatments to prevent degradation of the tissue and to
render it biologically compatible with the host tissue. As a result of the
Company's proprietary tissue-fixation technologies, the Tissue-Guard products
have a shelf life of three years and resist infection, which potentially reduces
hospital recovery time and the need for drugs and future surgical intervention.
In addition, according to studies commissioned by the Company, the tissue-
fixation technologies used by the Company reduce the level of residual
glutaraldehyde remaining in the processed tissue to less than six parts per
million, resulting in a lower incidence of host tissue inflammatory response and
promoting host tissue incorporation similar to the body's natural healing
process.

Surgeons have indicated that different pericardial patch characteristics
are useful in different surgical procedures. Accordingly, depending on the
particular tissue-fixation technology used by the Company, the bovine
pericardium is processed into either Supple Peri-Guard or Peri-Guard. While the
raw material used is the same, Supple Peri-Guard has greater elasticity and
flexibility than Peri-Guard which allows for greater conformity to the surgical
site. The Company's Peri-Guard and Supple Peri-Guard products are produced in
square or rectangular sheets of different sizes, ranging from 4 cm x 4 cm to 12
cm x 25 cm, for use as a multi-purpose material designed for reinforcing,
reconstructing and repairing tissue and preventing leaks of air, blood and other
body fluids. Each of such products has received 510(k) clearance from the FDA
as a general soft-tissue patch.

The products in the Tissue-Guard product line described below are special
configurations of Supple Peri-Guard designed to enable specific surgical
procedures.

PERI-STRIPS. Peri-Strips, staple line reinforcements, are currently used
primarily in LVR surgery but are also used for lobectomy (removal of a lobe),
excision/destruction of a lesion and segmental resection of the lung. The key
competitive features of Peri-Strips include the following:

. Reapproximation. Due to the elastic-like nature of the collagen fibers
in the tissue, Peri-Strips reapproximate (close around) surgical
staples to prevent pulmonary air leaks at the staple site.

. Prevents Enlargement. The elasticity of Peri-Strips prevents staple
holes from enlarging, which could lead to additional air leaks and
require additional surgery.

. Reinforcement. The use of Peri-Strips strengthens the entire staple
line, which makes it more durable and less likely to tear. Also,
Peri-Strips are thin enough to allow for staple lines to be
overlapped, which is often required during the LVR procedure.

. Sleeve Configuration. The sleeve configuration of Peri-Strips is
customized to fit disposable, reusable and endoscopic staplers of
varying sizes and produced by different manufacturers. The sleeve
configuration allows for greater ease of use and reduced surgical time
resulting in lower costs.

The number of Peri-Strips used in an LVR procedure is dependent upon the
amount of lung resected and the preferred technique of the surgeon performing
the procedure. In the typical LVR procedure in which 20% to 30% of each lung is
removed, the surgeon will have multiple staple firings using one unit of Peri-
Strips

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per firing. As a result, the Company estimates that net revenue to the Company
is approximately $1,500 per LVR procedure.

DURA-GUARD. Dura-Guard, a dural repair patch, is primarily used in
craniotomy procedures when the dura must be repaired and suturing without a
patch is not deemed sufficient. Dura-Guard offers advantages over competitive
dural patches produced from autologous or cadaver tissue. Harvesting autologous
tissue necessarily involves a second surgical site, thereby increasing costs and
recovery time. Cadaver tissue is subject to rigorous tissue bank regulations,
which could impact upon the availability of such tissue, and is considered by
some to present a greater risk of disease transmission than bovine pericardium.
Certain other competitive advantages of Dura-Guard relate to the specific
benefits produced by the physical properties of Dura-Guard in connection with
the craniotomy procedure. Observations in the course of subsequent surgical
procedures on patients receiving Dura-Guard patches have shown that there is
little or no adhesion formation on the Dura-Guard surface that faces the
cerebral cortex, a complicating factor following any cranial surgery. In
addition, Company commissioned studies have shown that fibrous bone cells invade
the Dura-Guard surface facing the cranium, as they do the human dura, inviting
good host tissue incorporation. The collagen configuration of the processed
bovine pericardium in Dura-Guard reapproximates around the sutures used to affix
the patch, thereby providing a barrier between the skull and the tissue layers
underlying the dura and preventing the leakage of cerebrospinal fluid. To date,
synthetic materials have been unable to perform as effective dura substitutes
and have been associated with late subdural hematoma formation (bleeding between
the dura and the brain).

VASCU-GUARD. Vascu-Guard, a vascular repair patch, is primarily used in
carotid endarterectomy procedures when the carotid artery must be repaired and
closing the vessel without a patch is not deemed sufficient. Vascu-Guard offers
advantages over competitive carotid artery repair patches produced from
autologous tissue or synthetics. The use of autologous tissue necessarily
involves a second surgical site and results in increased costs and additional
recovery time. Synthetic patches, which lack the collagen configuration of
tissue, do not reapproximate around sutures as does the Vascu-Guard product,
thereby increasing the risk of sutureline bleeding and resulting in longer
operating times. In addition, unlike synthetic patches, the physical attributes
of Vascu-Guard imitate human tissue and certain characteristics associated with
human tissue. Specifically, Company commissioned studies have shown that, once
healed, Vascu-Guard supports endothelialization (growth of a cell layer normally
lining the interior of blood vessels) and its non-thrombogenic blood flow
surface imitates the blood flow characteristics of autologous vessels. In
addition, its pulsatility (ability to reflect movement signifying the rhythmic
pumping of the heart) allows the surgeon to readily verify normal blood flow
after implantation.

BIOGRAFT. Biograft, a peripheral vascular graft manufactured from human
umbilical veins, is indicated for use in lower limb vascular reconstructions
when a saphenous vein is not available. Biograft offers advantages over
competitive vein grafts produced from synthetics, like PTFE, due to its thrombo-
resistant surface, which provides smooth blood flow and minimizes turbulence and
risk of occlusion. Other competitive advantages of Biograft include its long-
term patency (ability to remain open to blood flow) and its similarity to an
autologous blood vessel, minimizing intimal hyperplasia (a build up of cells on
the interior of the blood vessel which results in restricted blood flow). In
addition, a knitted and supportive Dacron mesh is placed around the graft, which
allows for easier handling and promotes tissue integration for strength and
stability.

SURGICAL PRODUCTIVITY TOOLS. The Company's Flo-Rester products are vessel
occluders manufactured from medical grade silicone. The Flo-Rester products are
designed to interrupt blood flow in arteries and to stent (hold open) them
during surgery, thereby facilitating the suturing together of vessels. These
products are primarily used during coronary artery bypass graft surgeries in
which blood is routed past the heart through a heart-lung bypass machine in
order to keep the heart free of blood during surgery. During such procedures,
incidental blood flow obstructs the surgeon's view of the operative site and
interferes with precise suturing. Flo-Rester consists of a flexible shaft with
small bulbs at each end that are inserted into the blood vessel at the point
where the artery bypass is sutured to the artery to stop the blood flow.
Competitive procedures involve external occlusion through the use of clamps,
snares or tapes. The Bio-Vascular Probe is a flexible shaft with varying sizes
of bulbous tips on either end. Surgeons use the Bio-Vascular Probe to locate
occlusions or blockages in arteries and to ascertain the blood flow
characteristics of arteries. The Bio-Vascular Probe is inserted and fed into an

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artery. When the tip of the probe meets resistance, the surgeon is able to
identify the exact location of the occlusion. The Bio-Vascular Probe is then
extracted and a bypass is completed below the occlusion. In addition, the Probe
can be used to atraumatically lift the edge of the incision to assist the
surgeon in accurately placing sutures, which can improve the functioning of
bypass grafts.

RESEARCH AND DEVELOPMENT

The Company generally allocates its research and development resources
among three broad functions in its Surgical Business: supporting current
products through training of Company personnel and writing and publishing
research papers on existing products; developing product line extensions by
improving current products or developing new applications for current products;
and developing new products for surgical uses that utilize the Company's
proprietary technologies and core competencies in tissue processing and bio-
materials.

As an integral part of both its research and development and sales and
marketing strategies, the Company strives to involve its surgeon-customers to a
large extent in its product development activities. The Company consults with
selected surgeons frequently as to market needs and assessments of products
under development. The Company believes that this practice allows it to receive
surgeon assessments of products in development at an early stage.

The Company's Surgical Business research and development staff currently
consists of three scientists and two technicians. The Surgical Business also
expands its research and development activities through the use of external
consultants and research staff and facilities at research centers and hospitals
on an as-needed basis. With a portion of the proceeds of this Offering, the
Company expects to add additional personnel to its Surgical Business research
and development staff.

MARKETING

The sales and marketing strategy of the Surgical Business includes
developing and maintaining a close working relationship with the hospitals and
surgeons which purchase and use the Company's products in order to assess and
satisfy their needs. The Company's current primary marketing focus is assisting
in the education of surgeons in the use of Peri-Strips in LVR surgery through
sponsorship of workshops and training programs. These workshops and training
sessions are being conducted in the United States, Canada and certain European
and Far Eastern countries. The Company estimates that approximately 500
surgeons will have been trained in LVR surgery by the end of fiscal 1995. The
Company also sponsors surgeon workshops and training programs in the use of
Biograft.

The Company's sales and marketing strategy is also designed to ensure that
the Company has an innovative "first in the mind of the customer" focus that
results in timely and effective marketing programs and new product
introductions. These programs include surgical trade shows, support of the
presentation of clinical data and new product information by key physicians,
limited direct-mail campaigns and the development of strategic physician
alliances and utilization of the Company's scientific advisory boards. The
Company believes these efforts to be cost effective in producing awareness of,
and loyalty to, the Company's products.

The Company's Surgical Business products are sold to hospitals and surgeons
worldwide. For the fiscal years ended October 31, 1992, 1993 and 1994 and the
nine months ended July 31, 1995, approximately 31%, 33%, and 30% and 19% of the
Company's Surgical Business sales, respectively, were to international markets.
The decrease in the percent of Surgical Business sales attributed to
international markets during the first nine months of fiscal 1995 was due to
increases of sales of Peri-Strips in the United States. The majority of the
Company's Surgical Business international sales are in western Europe.

In the United States, the Company sells its Surgical Business products
through a combination of 14 distributors and independent sales representatives
managed by the Surgical Business' two regional sales managers. To further
strengthen the direct relationship between the Company and the end users of its
products, the Company requires distributors to provide the Company with the
names and addresses of such end users and the Company ships products directly to
end users for a limited period of time when there is a new product

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application. In addition to strengthening customer relationships, this practice
provides the Company with some protection in the event a distributor is
terminated and resists providing the Company with customer lists.

Internationally, the Company's Surgical Business products are sold through
29 distributors. In some situations, sales in a country may occur through more
than one distributor due to distributors' varying market strengths and focus.

In the fiscal years 1992 and 1994, the Surgical Business had no single
customer or distributor who accounted for 10% or more of the Surgical Business'
gross revenue. In fiscal 1993, one domestic distributor accounted for 11% of
the Surgical Business' gross revenue. In the nine months ended July 31, 1995
three domestic distributors accounted for an aggregate of 46.6% of the Surgical
Business' gross revenue, with each of such distributors accounting for in excess
of 10% of the Surgical Business' gross revenue for the period.

The Company currently has written agreements with 19 of its domestic and
international independent sales representatives and distributors. These
agreements generally impose limited geographic exclusivity and minimum purchase
obligations on the Company's independent sales representatives and distributors.
However, significant overlap occurs in many of the Company's international
distribution agreements. These agreements are typically terminable upon breach
of the agreement by the distributor, including breach of the minimum sales
obligations imposed by the agreement, as well as certain extraordinary events.

The Surgical Business' marketing and sales department and its national and
international distribution network is managed by the Vice President of Marketing
and Sales. The Surgical Business' marketing and sales department currently
consists of 12 employees. These employees include domestic regional and
international sales managers, product managers and customer service personnel.
The Company intends to build the Surgical Business' marketing and sales staff
during fiscal 1996.

COMPETITION

The Company competes primarily on the basis of product performance, service
and price. The Company believes that product performance is the single most
important factor in selling any of its products and develops and produces its
products accordingly. The surgical products market in which the Company
competes is characterized by intense competition. This market is dominated by
established manufacturers that have broader product lines, greater distribution
capabilities, substantially greater capital resources and larger marketing,
research and development staffs and facilities than the Company. Many of these
competitors offer broader product lines within the Company's specific product
market, particularly in the Company's surgical tool product markets and/or in
the general field of medical devices and supplies. Broad product lines give
many of the Company's competitors the ability to negotiate exclusive, long-term
medical device supply contracts and, consequently, the ability to offer
comprehensive pricing for their products, including those that compete with the
Company's products. By offering a broader product line in the general field of
medical devices and supplies, competitors may also have a significant advantage
in marketing competing products to group purchasing organizations, health
maintenance organizations and other managed care organizations that increasingly
seek to reduce costs through centralization of purchasing functions.

The Company is not aware of any tissue or synthetic products that are
configured for use with surgical staplers in LVR surgery which compete with
Peri-Strips. To the best of the Company's knowledge, the FDA has not cleared for
marketing any staple line reinforcement product, other than Peri-Strips, for use
in LVR surgery. To the Company's knowledge, the dural patches that are currently
available and compete with Dura-Guard are either autologous or are produced from
processed cadaver tissue, including Tutoplast/TM/, a processed cadaver product
manufactured by Biodynamics International, Inc. In addition to specifically
configured patches, there are multi-purpose patches made from bovine and other
types of animal tissue that compete with the Company's Supple Peri-Guard, Peri-
Guard, and Vascu-Guard products, including bovine pericardium products produced
by Medtronic, Inc. and Baxter International Inc. The Company does not believe
that these alternative bovine pericardium products have specific FDA marketing
clearance for use in the lung, although such products are FDA cleared for
pericardial closure and soft tissue repair. In addition, synthetic multi-purpose
patches made out of PTFE

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or silicone fabric are currently available. W. L. Gore & Associates, Inc.,
manufacturer of Gore-Tex(R), is believed to have a prominent position in the
synthetic patch market. Synthetic patches are generally cheaper to produce and
to the extent that comparable synthetic patches are available, the Company faces
significant price competition for their Tissue-Guard products. The Company
believes, however, that the collagen characteristics exclusive to tissue, the
special configuration of its Tissue-Guard products and the proprietary tissue-
fixation technologies employed by the Company offer significant product
performance advantages over competing products.

Alternative treatments and competitive products to the Biograft include
drug therapies and surgical procedures that use autologous or synthetic grafts.
Once the decision has been made to use surgical intervention, surgeons generally
prefer the patient's own vessels for lower limb vascular reconstruction. When
the patient's own vessels are not available in sufficient quality or quantity,
surgeons choose a prosthesis graft such as the Biograft or synthetic grafts made
from expanded PTFE produced by W. L. Gore & Associates, Inc., IMPRA, Inc. or
other grafts made of bio-synthetic materials.

MANUFACTURING

The Company manufactures all of its Surgical Business products except the
Bio-Vascular Probe at its St. Paul, Minnesota facility. In July 1995, the
Company moved to a new 36,000 square foot facility, which more than doubled its
total space and nearly quadrupled its manufacturing capacity. The Company
acquires bovine pericardium for use in the Tissue-Guard product line from a
private independent contractor who obtains the tissue from local United States
Department of Agriculture inspected meat packing facilities. The Company
acquires human umbilical cords for use in Biograft from various hospitals
throughout the United States. Tissue processing using the Company's
glutaraldehyde tissue-fixation technologies typically is begun within one day of
delivery to the Company. The Company has not experienced any product shortages
arising from interruptions in the supply of any raw materials or components, and
has identified alternative sources of supply for such raw materials and
components.

The Bio-Vascular Probe is manufactured to the Company's specifications by a
contract manufacturer, with certain final cleaning, packaging and sterilization
testing procedures performed by the Company at its St. Paul facility. While the
Company has not experienced any interruption in supply of this product to date,
it has not identified any alternative source of supply and any significant
interruption in supply of this product in the future could have an adverse
effect on the Company's sales of the Bio-Vascular Probe.

MEDICAL IMAGING SOFTWARE BUSINESS

General. The Medical Imaging Software Business develops and markets 3-D
volume imaging software products for the visualization and analysis of imaging
data for medical applications. The Medical Imaging Software Business is
conducted through the Company's wholly-owned subsidiary, Vital Images, which was
acquired in May 1994. Prior to its acquisition by the Company, Vital Images also
developed and produced 3-D volume imaging software for use in geoscience
applications. On August 25, 1995, the Company granted an exclusive, perpetual
source code license to CogniSeis for the Company's geoscience product which will
allow the Company to focus exclusively on medical applications for its software
technology. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition."

The Company's Medical Imaging Software Business is continuing development
of VoxelView, the first product developed by Vital Images for medical
applications. VoxelView provides complete and accurate 3-D rendering of data
collected by advanced medical imaging devices such as spiral CT scanners,
magnetic resonance imaging devices ("MRI"), positron emission tomography
scanning devices ("PET"), and ultrasound sonagraphic devices ("Ultrasound").
The 3-D images rendered by VoxelView are intended to enhance the ability of
radiologists, surgeons and other physicians to screen for specific pathologies,
diagnose pathological conditions and plan surgical procedures.

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Industry Background. The use of CT scan, MRI, PET and Ultrasound is
widespread in the United States medical community and, to a lesser extent, in
other industrialized countries. CT scan, MRI, PET and Ultrasound capture and
record digital information describing the dimensions and properties of scanned
objects. Historically, these imaging devices produced digital output in a
variety of proprietary formats. The imaging scanner manufacturers have now
adopted an international standard called DICOM3 that will greatly simplify the
process of using a VoxelView-powered workstation in conjunction with the latest
generation of imaging systems. In the United States, the market for CT and MRI
scanners has evolved as scanners with higher resolution and faster data
acquisition have been developed. VoxelView's value to the end-user increases
with the speed and greater sophistication of the imaging equipment in use.

While the number of imaging devices used in hospitals and clinics is large,
the use of 3-D rendering of imaging data collected by such devices has been
exploited primarily by leading medical institutions. Until now, the
workstations required to run 3-D volume visualization software were very
expensive, limiting the number of institutions which could afford them.
Additionally, the number of images that was able to be captured was low enough
that diagnosis could be done by viewing only 2-D slices. Recent enhancements in
scanner technology yield a greater number of images in much more detail, which
can only be successfully "read" when rendered in 3-D. The Company believes that
its volume rendering technology will be more effective in analyzing data than
the mathematically modeled "surface rendering" approach used by others.

Products and Product Development. VoxelView is an interactive, volume
imaging and analysis software system designed to accept large volumes of data
from any medical digital imaging technology, manipulate the data at high speeds
and display it in accurate 3-D images. VoxelView is based upon a high speed
volume renderer, the Voxel Engine, which can image volume data at a speed which
permits "real-time" viewing of data sets. VoxelView has been designed to enhance
the ability of radiologists, surgeons and other physicians to screen for
specific pathologies, diagnose pathological conditions and plan surgical
procedures. The Company has licensed VoxelView software packages to
approximately 70 medical and research institutions as a research tool.
Currently, VoxelView only operates on high-speed graphics-oriented work stations
marketed by Silicon Graphics, Inc. ("Silicon Graphics").

The Company is currently developing VoxelView 2.5, an updated and improved
version of VoxelView. The Company is developing VoxelView 2.5 so that it can be
marketed to a broader group of medical institutions. In order for VoxelView 2.5
to be successfully commercialized, the Company must (i) improve the product's
interface qualities and make it more user-friendly, (ii) receive marketing
clearance from the FDA to permit specific marketing of the product as a medical
device by the Company and enable reimbursement by third party payors, and (iii)
enable the product to operate on work stations manufactured by companies other
than Silicon Graphics. In addition, the Company filed a 510(k) pre-market
notification with the FDA on July 9, 1995 seeking market clearance for VoxelView
2.5 as a software aid to be used in conjunction with CT Scan and MRI data. The
Company has also adopted the industry standard graphics language OpenGL(R),
which should enable the Company's products to operate on hardware platforms
manufactured by companies such as Hewlett-Packard Company and IBM. There can be
no assurance that the Company will be able to successfully commercialize
VoxelView 2.5.

The Company has also developed a modular enhancement to VoxelView called
Voxel Animator, which allows the user to create "fly throughs." A "fly
through," for example, would allow a radiologist to perform virtual endoscopies
by navigating through the 3-D data of patients' blood vessels and/or organs to
detect disease. This technology is designed to assist the physician in lowering
patient risk and diagnostic cost and achieving better surgical outcomes.

Markets. If and when development of VoxelView 2.5 is completed and FDA
510(k) clearance for such product is obtained, the Company intends to begin
aggressively marketing VoxelView 2.5. The Company will initially target
approximately 250 of the largest academic medical institutions that are
potential users of VoxelView 2.5 and an additional 300 secondary and tertiary
care institutions. Additionally, as the price of high speed work stations
decreases, the Company intends to market VoxelView 2.5 to a broader audience of
medical institutions.

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The Medical Imaging Software Business will continue its strategy of direct
marketing within the United States and will use distributors and other marketing
partners to reach international markets. The Company also has an OEM agreement
with Precision Therapy International Inc. ("PTI"), a leading supplier of 3-D
radiation treatment planning systems, under which the Company has granted an
exclusive license for a portion of the VoxelView technology to PTI as a tool for
use in radiation therapy planning. The Company will continue to seek
advantageous OEM and third party relationships that increase its ability to
reach attractive markets.

Research and Development. The majority of the Medical Imaging Software
Business' employees are engaged in research and development. The Company also
collaborates with researchers at several universities and maintains close ties
with lead engineering groups at Silicon Graphics. The Company expects to spend
approximately $1.4 million on research and development in fiscal 1995 and
intends to concentrate its research and development efforts on improving
VoxelView as a medical diagnostic tool, including refinements that will increase
clinical applications of VoxelView by improving human interface qualities,
making the product more user-friendly.

Competition. The medical digital imaging market in which the Company
competes is characterized by intense competition. This market is dominated by
established manufacturers of imaging equipment that have broader product lines,
greater distribution capabilities, substantially greater capital resources and
larger marketing, research and development staffs and facilities than the
Company. The Company competes with major imaging equipment vendors, such as GE
Medical Systems, Picker International Inc. and Siemens AG, who currently offer
3-D rendering or will do so in the near future. These large equipment vendors
have an entrenched position in major radiology departments and significantly
greater marketing resources than the Company. In addition, the Company competes
with other medical imaging software developers, including ISG, Inc. and Cemax,
Inc., which offer competing after-market software for medical imaging and these
competitors currently have greater marketing and distribution resources and
capabilities than the Company.

The Company competes primarily in two ways. First, the Company specializes
in direct volume rendering technology and has developed a high level of
expertise in the effective implementation of this known technology, resulting in
much higher levels of data fidelity than other 3-D methods used in medical
applications. Second, the Company has developed a unique feature of its imaging
software, Voxel Animator, allowing a user to conduct "fly through" examinations
similar to a virtual reality environment. The Company believes that no
competitor has developed this "fly through" capability.

GOVERNMENTAL REGULATION

The manufacture and sale of the Company's surgical and medical imaging
products are subject to regulation by numerous governmental authorities,
principally the FDA and corresponding foreign agencies. In the United States,
the FDA administers the Federal Food, Drug and Cosmetics Act and amendments
thereto contained in the Safe Medical Devices Act of 1990. The Company is
subject to the standards and procedures respecting manufacture and marketing of
medical devices contained in the Federal Food, Drug and Cosmetics Act and the
regulations promulgated thereunder and is subject to inspection by the FDA for
compliance with such standards and procedures.

These regulations classify medical devices as either Class I, II or III
devices, which are subject to general controls, special controls or premarket
approval requirements, respectively. All Class I and II devices as well as some
Class III devices marketed prior to the effective date of the Medical Device
Amendments of 1976 can be cleared for marketing pursuant to a 510(k) pre-market
notification, establishing that the device is "substantially equivalent" to a
device that was legally marketed prior to May 28, 1976, the date on which the
Medical Device Amendments of 1976 became effective. The 510(k) pre-market
notification must be supported by data establishing the claim of substantial
equivalence to the satisfaction of the FDA. The process of obtaining a 510(k)
clearance typically can take several months to a year or longer. If substantial
equivalence cannot be established, or if the FDA determines that the device or
the particular application for the device requires a more rigorous review, the
FDA will require that the manufacturer submit a Pre-Market Approval ("PMA")
application

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that must be carefully reviewed and approved by the FDA prior to sale and
marketing of the device in the United States. The PMA application must contain
the results of clinical trials, the results of all relevant prototype tests,
laboratory and animal studies, a complete description of the device and its
components, and a detailed description of the methods, facilities and controls
used for manufacturing, including the method of sterilization and its assurance.
In addition, the submission must include the proposed labeling, advertising
literature and training methods, if applicable. Most Class III devices are
subject to the PMA requirements rather than the 510(k) pre-market notification
procedure. The process of obtaining a PMA can be expensive, uncertain and
lengthy, frequently requiring anywhere from one to several years from the date
of FDA submission, if approval is obtained at all. Moreover, a PMA, if granted,
may include significant limitations on the indicated uses for which a product
may be marketed. FDA enforcement policy strictly prohibits the marketing of
approved medical devices for unapproved uses. In addition, product approvals
can be withdrawn for failure to comply with regulatory standards or the
occurrence of unforeseen problems following initial marketing.

Of the Company's current products, Biograft and Peri-Guard (when marketed
as a pericardial patch) are Class III devices. Biograft received marketing
clearance from the FDA pursuant to a PMA, while Peri-Guard received clearance
for use as a pericardial patch as the result of a 510(k) submission. Peri-
Strips (as marketed in both strip and sleeve configurations), Vascu-Guard, Dura-
Guard, Peri-Guard (when marketed as a patch for soft tissue deficiency), Supple
Peri-Guard (when marketed as a patch for soft tissue deficiency and as a
pericardial patch) and both the disposable and reusable Flo-Rester and the Bio-
Vascular Probe have all been classified as Class II medical devices and have
received 510(k) marketing clearance from the FDA. The Company believes the
Medical Imaging Software Business' VoxelView 2.5 product will also be classified
as a Class II medical device. A 510(k) application was submitted for VoxelView
2.5 in July 1995.

Both the United States and Europe have recently focused attention on the
safety of tissue banks, spurred by incidents of the transmission of human
disease during tissue transplantation. In the United States, recent FDA draft
regulations have outlined requirements for tissue banks. The legislation has
specifically excluded medical devices subject to FDA review, including preserved
umbilical cord vein grafts such as Biograft. As a result, the Company does not
expect Biograft to be subject to tissue bank regulations in the United States,
including the expensive donor screening and donor testing procedures. In
response to the increased scrutiny of umbilical cord vein grafts, the Company
commissioned an independent virology laboratory to test Biograft for viral
inactivation. The results of the testing demonstrated that Biograft's chemical
manufacturing processes inactivate a variety of viruses, resulting in a sterile
product. The Company has informed the FDA of these test results and does not
anticipate that the FDA will impose additional regulatory requirements on
Biograft. There can be no assurance, however, that the FDA will not impose
additional regulatory requirements on Biograft at some later date or that
Biograft would be able to meet any such new requirements.

The Company is also subject to regulation in most of the foreign countries
in which it sells its products with regard to product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to the
Company's products in such countries are similar to those of the FDA. The
national health or social security organizations of certain of such countries
require the Company's products to be qualified before they can be marketed in
those countries. In Japan, a potentially significant market for the Company's
products, clinical trials of certain of the Company's products are required
before such products can be cleared for sale in the Japanese market. To date,
this has delayed the Company's market entry in some cases, but has not
ultimately prevented sales in Japan of any of the Company's devices sold in the
United States. The Company relies on its independent distributors to comply
with the majority of the foreign regulatory requirements, including registration
of the Company's products with the appropriate governmental authorities. To
date, the Company has been successful in complying with the regulatory
requirements in most foreign countries in which its products are marketed,
although the responsible authorities in France have raised concerns regarding
the Company's products produced from bovine tissue. If France prohibits sales
of Tissue-Guard products, it is not expected to have a material adverse effect
on the Company. Although the Company does not anticipate that any other EU
countries will prohibit the sale of Tissue-Guard products, such prohibition by
certain EU countries could have a material adverse effect on the Company's
business, financial condition and results of operation.

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The Company is subject to periodic inspections by the FDA, whose primary
purpose is to audit the Company's compliance with good manufacturing practices
("GMP") established by the FDA and other applicable government standards.
Before the Company will be allowed to sell Biograft produced at its new
facility, the new facility must undergo FDA GMP inspection. The Company
believes it has sufficient inventory of its Biograft product to meet demand
until notification of a successful GMP inspection. Strict regulatory action may
be initiated in response to audit deficiencies or to product performance
problems. The Company believes that its manufacturing and quality control
procedures are in compliance with the requirements of the FDA regulations.

The Company's new manufacturing facilities and processes are also
undergoing an inspection and audit process by the British Standards Institute
("BSI") in conjunction with the Company's efforts to achieve compliance with the
requirements of the Medical Device Directive (the "MDD") issued by the EU. The
BSI is the "Notified Body" that the Company has selected to verify that the
Company's quality system conforms with the ISO 9001 international quality
standard and that its products conform with the "essential requirements" set
forth by the MDD for the class of products produced by the Company.
Certification by BSI of conformity with both the ISO 9001 standard and the MDD
essential requirements would enable the Company to prepare a Declaration of
Conformity supporting the placement of the "CE" mark on the Company's products.
The CE mark would enable the Company's products to be marketed, sold and used
throughout the EU, subject to limited "safeguard" powers of member states.
Presently, the CE mark is not required to be affixed to the Company's products
(or those of its competitors) sold in the EU, but may be affixed during a
transition period currently in effect and which began January 1, 1995. This
transition period will end on June 15, 1998, when all of the Company's current
products (and those of its competitors) will be required to comply with the
essential requirements in order to be marketed in the EU. BSI completed a pre-
assessment of certain of the Company's facilities and processes in May 1995,
identifying areas requiring a moderate degree of modification to comply with the
essential requirements. A second pre-assessment focusing on other aspects of
the Company's operations is scheduled for October 1995, and a final assessment
has been tentatively scheduled for February 1996. Authority to prepare a
Declaration of Conformity will require the successful completion of a final
audit by BSI and submission and clearance of a dossier on each of the Company's
products, demonstrating compliance with the essential requirements of the MDD.
The Company believes that these steps will be completed by the summer of 1996,
although there can be no assurance that the Company will be successful in
receiving certification by BSI.

The future regulatory environment for the Biograft in Europe is unclear.
The MDD explicitly excludes from coverage medical devices derived from human
tissue; however, certain European medical device manufacturers are actively
lobbying for the re-inclusion of such devices in the MDD. If this effort is
successful, the earliest date for applying for CE mark approval for the Biograft
is expected to be 1998. In addition, if extensive donor screening and donor
testing requirements are imposed, such requirements could make it uneconomical
to sell the Biograft in Europe even under the CE mark. As a result of
significant problems with their blood supply, France has passed national laws
and regulations requiring extensive donor screening and testing on products
derived from human tissue. Accordingly, the Biograft is not being sold in
France. It is not known whether a CE mark for the Biograft would override such
national requirements or whether other countries in the EU will adopt
regulations similar to those of France. The Company is seeking Biograft
registration in Germany, but cannot predict when or if it will achieve such
registration. Biograft is not marketed generally in Germany, but rather is
prescribed by physicians on a prescription-by-prescription basis. If the CE
mark is unavailable for Biograft or if the requirements for obtaining a CE mark
are too burdensome, the Company will seek country-by-country registration of the
product where such registration requirements exist. The Company cannot predict
when or if it would obtain such registrations.

The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States with respect to the provision of services or
products to patients who are Medicare or Medicaid beneficiaries. The "fraud and
abuse" laws and regulations prohibit the knowing and willful offer, payment or
receipt of anything of value to induce the referral of Medicare or Medicaid
patients for services or goods. In addition, the physician anti-referral laws
prohibit the referral of Medicare or Medicaid patients for certain "Designated
Health Services" to entities in which the referring physician has an ownership
or compensation interest. Violations of these laws and regulations may result
in civil and criminal penalties, including substantial fines and imprisonment.
In a number of states, the

34
<PAGE>

scope of fraud and abuse or physician anti-referral laws and regulations, or
both, have been extended to include the provision of services or products to all
patients, regardless of the source of payment, although there is variation from
state to state as to the exact provisions of such laws or regulations. In other
states, and, on a national level, several health care reform initiatives have
been proposed which would have a similar impact. The Company believes that its
operations and its marketing, sales and distribution practices currently comply
in all respects with all current fraud and abuse and physician anti-referral
laws and regulations, to the extent they are applicable. Although the Company
does not believe that it will need to undertake any significant expense or
modification to its operations or its marketing, sales and distribution
practices to comply with federal and state fraud and abuse and physician anti-
referral regulations currently in effect or proposed, financial arrangements
between manufacturers of medical devices and other health care providers may be
subject to increasing regulation in the future. Compliance with such regulation
could adversely affect the Company's marketing, sales and distribution
practices, and may affect the Company in other respects not presently
foreseeable, but which could have an adverse impact on the Company's business,
financial condition and results of operations.

THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT

The Company's surgical products are purchased primarily by hospitals which
then bill various third-party payors for the services provided to the patients.
These payors, which include Medicare, Medicaid, private insurance companies and
managed care organizations, reimburse part or all of the costs and fees
associated with the procedures utilizing the Company's products. The Company's
medical imaging products have been purchased to date by a limited number of
academic medical institutions for research applications. End-users of the
Company's medical imaging products will not be eligible to receive reimbursement
for such products until FDA marketing clearance for such products has been
obtained.

Medicare and Medicaid reimbursement for hospitals is based on a fixed
amount for admitting a patient with a specific diagnosis. Because of this fixed
reimbursement method, hospitals have incentives to use less costly methods in
treating Medicare and Medicaid patients, and will frequently make capital
expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique, and as a result hospitals are generally willing to
implement new cost saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been and may in the future be reduced in the
event of changes in the resource-based relative value scale method of payment
calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using the Company's products or the eligibility (or the extent or
amount of coverage) of the Company's products could have an adverse impact on
the Company's business, financial condition and results of operations.

In response to the focus of national attention on rising health care costs,
a number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be proposals by legislators and regulators
and third-party payors to curb these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan,
and over 80% of hospitals participate in or have agreements with HMOs. It has
become a typical practice for hospitals to affiliate themselves with as many
managed care plans as possible. Higher managed care penetration typically
drives down the prices of healthcare procedures, which in turn places pressure
on medical supply prices. This causes hospitals to implement tighter vendor
selection and certification processes, by reducing the number of vendors used,
purchasing more products from fewer vendors and trading discounts on price for
guaranteed higher volumes to vendors. Hospitals have also sought to control and
reduce costs over the last decade by joining group purchasing organizations or
purchasing alliances. The Company cannot predict what continuing or future
impact these practices, the existing or proposed legislation, or such third-
party payor measures may have on its future business, financial condition or
results of operations.

Because the Company's surgical products are primarily used in thoracic,
neuro, cardiac and vascular surgeries, changes in reimbursement policies and
practices of third party payors with respect to these surgeries

35
<PAGE>

could have a substantial and material impact on sales of the Company's products.
The development or increased use of more cost effective treatments for diseases
requiring these surgeries could cause such payors to decrease or deny
reimbursement for such surgeries or to favor these other treatments over
surgical treatment.

INTELLECTUAL PROPERTY

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

On July 9, 1995, the Company received notice of allowance of a United
States patent which relates to the use of tissue on a removable backing and
covers the sleeve configuration of Peri-Strips. In connection with this same
application, the Company has filed divisional patent applications relating to
the combination of tissue with a surgical stapling gun and methods of performing
a surgical procedure to remove diseased tissue. There can be no assurance that
these divisional patent applications will be granted. Other than the notice of
allowance of a patent on the sleeve configuration of Peri-Strips, the Company
holds no patents and pays no royalties on Supple Peri-Guard or the
configurations of Supple Peri-Guard marketed as Dura-Guard or Vascu-Guard. In
December 1994, the Company entered into an agreement with Surgical Research,
Inc., a company with which Dr. Cooper is affiliated, which obligates the Company
to pay royalties of five percent (5%) on net revenue from sales of Peri-Strips
for the life of any patents, if any are issued, or for seven years. The Company
owns exclusive, worldwide, perpetual licenses to develop, manufacture and market
its Peri-Guard and Flo-Rester products.

In its Surgical Business, the Company also relies on trade secrets and
proprietary know-how which it seeks to protect, in part, through confidentiality
agreements with employees, consultants and other parties. Supple Peri-Guard,
which is used in the manufacture of the majority of the Company's Tissue-Guard
products, is protected exclusively by trade secrets. There can be no assurance
that these agreements will not be breached, that the Company will have adequate
remedies for any breach, or that the Company's trade secrets will not otherwise
become known to or independently developed by competitors.

In its Medical Imaging Software Business, the Company relies on a
combination of license agreements, contracts, confidentiality agreements and
trade secrets to establish and protect its proprietary rights in its technology.
The Company distributes its products under software license agreements that
grant customers licenses to use, rather than ownership of, the software. The
Company also employs encryption technology to prevent the use of its software on
work stations that have not been specifically designated by the Company.
Effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries. In September 1988, the Company acquired the
exclusive perpetual license to use, further develop and market the technology
underlying VoxelView on a worldwide basis.

The surgical products and medical imaging industries are characterized by
frequent and substantial intellectual property litigation, and competitors may
resort to intellectual property litigation as a means of competition. The
surgical products and medical imaging markets are characterized by extensive
patent and other intellectual property claims that can create greater potential
than in less developed markets for possible allegations of infringement,
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 outcome, could
result in substantial expense to the Company and significant diversion of the
efforts of the Company's technical and management personnel. Litigation may
also be necessary to enforce patents issued to and licenses held by the Company,
to protect trade secrets or know-how owned by the Company or

36
<PAGE>

to determine the enforceability, scope and validity of the proprietary rights of
others. An adverse determination in any such proceeding could subject the
Company to significant liabilities to third parties, or require the Company to
seek licenses from third parties or pay royalties that may be substantial.
Furthermore, there can be no assurance that necessary licenses would be
available to the Company on satisfactory terms, if at all. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent the Company from manufacturing or
selling certain of its products which in turn would have a material adverse
effect on the Company's business, financial condition or results of operations.

The Company has registered United States trademarks, including Peri-Strips,
Vascu-Guard, Peri-Guard, Biograft, Flo-Rester, VoxelView and VoxelGeo.

EMPLOYEES

The Company employs approximately 108 persons full-time and 3 persons part-
time, including 16 in research and development, 67 in manufacturing, 17 in sales
and marketing and 11 in general and administrative functions. The Company's
employees are not represented by a union, and the Company considers its
relationship with its employees to be good.

FACILITIES

The Company leases 36,027 square feet of office and manufacturing space at
2575 University Avenue, St. Paul, Minnesota for use in its Surgical Business and
approximately 8,800 square feet located in Fairfield, Iowa for use in its
Medical Imaging Software Business. The Company believes that its current space
is adequate for the foreseeable future.

37
<PAGE>

MANAGEMENT

DIRECTORS AND CERTAIN OFFICERS

The directors and certain officers of the Company are as follows:
<TABLE>
<CAPTION>

Name Age Title
- ---- --- -----
<S> <C> <C>
John T. Karcanes 49 President, Chief Executive Officer
and Director

Vincent Argiro, Ph.D. 39 Vice President of the Company,
President of Vital Images, Incorporated
and Director

M. Karen Gilles 53 Vice President of Finance, Chief Financial Officer,
and Corporate Secretary

Bruce A. MacFarlane, Ph.D. 43 Vice President of Regulatory Affairs and Quality Assurance

Robert P. Nelson 50 Vice President of Operations

Kemal Schankereli 42 Vice President of Research and Development

Frank A. Stephenson 42 Vice President of Marketing and Sales

James F. Lyons 65 Chairman of the Board
and Director

Richard W. Perkins 64 Director

Lawrence Perlman 57 Director

Edward E. Strickland 68 Director
</TABLE>

John T. Karcanes. Mr. Karcanes has served as President, Chief Operating
Officer and a director of the Company since May 1994 and as Chief Executive
Officer of the Company since November 1994. From June 1992 to April 1994, Mr.
Karcanes acted as an independent consultant and an interim executive officer,
working primarily with early-stage technology companies. From 1987 to June 1992,
Mr. Karcanes served as President and Chief Executive Officer of Crosfield
Lightspeed, Inc., a technology company serving the publishing industry. Mr.
Karcanes served as President of Palladian Software, Inc., a software development
company, from 1984 to 1986, and from 1981 to 1984, he served in a number of
executive positions in international operations and sales and marketing with
Cullinet Software, Inc., a database and application software company, and
Computer Pictures Corporation, a software company specializing in executive
information systems.

Vincent Argiro. Dr. Argiro has served as President of Vital Images and as
Vice President and a director of the Company since joining the Company in May
1994 in connection with the acquisition of Vital Images. Dr. Argiro, the
founder of Vital Images, served as Chairman of the Board of Vital Images from
1988 until May 1994. From 1988 to 1990 and from September 1991 to June 1992,
Dr. Argiro also served as President of Vital Images. In September 1991, Dr.
Argiro became Chief Executive Officer of Vital Images. From 1984 to June 1992,
Dr. Argiro served as an Associate Professor of Physiology at Maharishi
International University where he conducted research in neuroscience and cell
biology.

38
<PAGE>

M. Karen Gilles. Ms. Gilles has served as Chief Financial Officer of the
Company since December 1990, Vice President of Finance since 1989 and Secretary
of the Company since November 1991 after serving as the Director of Finance and
Administration from April 1989 to December 1989. From 1985 to 1989, Ms. Gilles
served as Controller for VEE Corporation, a production company, and Colin
Companies, a related concession company. From 1983 to 1985, Ms. Gilles was an
accountant with McGladrey & Pullen, a public accounting firm.

Bruce A. MacFarlane. Dr. MacFarlane has served as Vice President of
Regulatory Affairs and Quality Assurance since June 1995 after serving as
Director of Regulatory Affairs from November 1991 to June 1995. From 1985 to
October 1991, Dr. MacFarlane served as Director of New Product Development and
Regulatory Affairs at Medical Devices, Inc., a medical device company which
manufactures electromedical devices.

Robert P. Nelson. Mr. Nelson has served as Vice President of Operations since
September 1991. From 1988 until August 1991, Mr. Nelson served as Director of
Operations for Rexton, Inc., a hearing aid manufacturer. From 1977 through
1987, he served as Director of Operations for heart valve manufacturing at
Medtronic, Inc., a medical device company.

Kemal Schankereli. Mr. Schankereli has served as Vice President of Research
and Development since December 1993 after serving as Director of Research and
Development from January 1993 to December 1993. From 1991 to December 1992, Mr.
Schankereli served as a private consultant to the bio-medical device industry.
From 1983 to 1991, Mr. Schankereli held the position of Manager of Vascular
Product Research at St. Jude Medical, Inc., a medical device company. From 1978
to 1983, Mr. Schankereli served as a Senior Research Scientist at Meadox
Medicals, Inc., a medical device company.

Frank A. Stephenson. Mr. Stephenson has served as Vice President of Marketing
and Sales since December 1994. From 1989 to August 1994, Mr. Stephenson served
as Vice President of Marketing and Sales for Spectranetics Corporation, a
medical laser company. From 1985 to 1989, Mr. Stephenson held a series of
marketing management positions with Boston Scientific, Inc., a manufacturer of
medical devices, and served as a senior sales representative and trainer from
1982 to 1985 with Codman & Shurtleff, a distributor of neurosurgical products,
which is a division of Johnson and Johnson, Inc.

James F. Lyons. Mr. Lyons has served on the Board of the Company since 1990
and has been Chairman since November 1991. Mr. Lyons served as the Company's
Chief Executive Officer from 1993 through October 1994. From 1977 through
1990, Mr. Lyons served as President and Chief Executive Officer of Bio-Medicus,
Inc., a manufacturer of bio-medical products. Mr. Lyons has been employed in
the health care industry for more than 30 years. Mr. Lyons also serves on the
Board of Directors of AVECOR Cardiovascular Inc., ATS Medical, Inc. and Spine-
Tech, Inc.

Richard W. Perkins. Mr. Perkins has served on the Board of the Company since
1987. He has served as President, Chief Executive Officer and a director of
Perkins Capital Management, Inc., an investment management firm, since 1984.
Mr. Perkins also serves on the Board of Directors of LifeCore Biomedical, Inc.,
Atrix International, Inc., Celox Corporation, Children's Broadcasting
Corporation, CNS, Inc., Nortech Systems, Inc., Garment Graphics, Inc., Discus
Acquisition Corporation and Eagle Pacific Industries, Inc.

Lawrence Perlman. Mr. Perlman has served on the Board of the Company since
December 1994. He currently serves as Chairman of the Board, President and
Chief Executive Officer of Ceridian Corporation, an information services and
defense electronics company ("Ceridian"). He was named Chairman of the Board of
Ceridian in November 1992, and has been President and Chief Executive Officer of
Ceridian since 1990. Mr. Perlman served as President and Chief Operating
Officer of Ceridian from 1988 to 1990. He also serves on the Board of Directors
of Inter-Regional Financial Group, Inc., Kmart Corporation, Seagate Technology,
Inc., The Valspar Corporation and Computer Network Technology Corporation. Mr.
Perlman is also a member of the National Advisory Board of the Chemical Banking
Corporation.

39
<PAGE>

Edward E. Strickland. Mr. Strickland has served on the Board of the Company
since 1988. Mr. Strickland has been an independent financial consultant since
1986. Mr. Strickland serves on the Board of Directors of Communications
Systems, Inc., Hector Communications, Inc., AVECOR Cardiovascular Inc., and as
Chairman of the Board of Reuter Manufacturing, Inc., formerly Green Isle
Environmental Services, Inc.

40
<PAGE>

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of July 24, 1995 (except
as otherwise indicated below), by each (i) shareholder who is known by the
Company to own beneficially more than five percent of the outstanding Common
Stock, (ii) director of the Company, and (iii) all directors and executive
officers of the Company as a group.

<TABLE>
<CAPTION>
PERCENTAGE OWNERSHIP
--------------------------------
DIRECTORS, OFFICERS AND NUMBER OF SHARES PRIOR TO AFTER THE
OTHER BENEFICIAL OWNERS BENEFICIALLY OWNED(1) THE OFFERING (1) OFFERING (1)
- ----------------------- --------------------- ---------------- ------------
<S> <C> <C> <C>
Perkins Capital Management, Inc. (2) 1,022,575 13.8% 11.5%
730 East Lake Street
Wayzata, MN 55391-1769

John T. Karcanes (3) 62,500 * *

Vincent Argiro, Ph.D. (4) 511,320 6.9% 5.7%
505 North 4th Street
Fairfield, IA 52556

James F. Lyons (5) 191,250 2.5% 2.1%

Richard W. Perkins (6) 157,750 2.1% 1.8%

Lawrence Perlman (7) 10,000 * *

Edward E. Strickland (8) 182,000 2.4% 2.0%

All executive officers and 1,233,836 15.9% 13.3%
directors as a group (11 persons) (9)
</TABLE>
- ----------------------------
* Less than 1%.

(1) Shares not outstanding but deemed beneficially owned by virtue of the right
of a person or member of a group to acquire them within 60 days are treated
as outstanding only when determining the amount and percent owned by such
person or group.

(2) Based upon a Schedule 13G filed as of February 3, 1995 with the Securities
and Exchange Commission. Excludes shares beneficially owned by Richard W.
Perkins, a director of the Company and the controlling shareholder of
Perkins Capital Management, Inc., a registered investment advisor ("PCM").
Of the 1,022,575 shares held for the account of clients of PCM, for which
beneficial ownership has been disclaimed by PCM (the "PCM Shares"), PCM has
sole investment power and no voting power with regard to all such shares.

(3) Includes 50,000 shares Mr. Karcanes has the right to acquire within 60 days
upon the exercise of options. Does not include 150,000 shares subject to
options held by Mr. Karcanes that are not exercisable within the next 60
days.

41
<PAGE>

(4) Includes 7,000 shares Dr. Argiro has the right to acquire within 60 days
upon the exercise of options. Does not include 14,000 shares subject to
options held by Dr. Argiro that are not exercisable within the next 60
days. Does not include 8,640 shares of Restricted Stock granted to Dr.
Argiro which will not vest within the next 60 days.

(5) Includes 132,000 shares Mr. Lyons has the right to acquire within 60 days
upon the exercise of options. Does not include 6,000 shares subject to
options held by Mr. Lyons that are not exercisable within the next 60
days.

(6) Includes 5,000 shares held by the Perkins Foundation, 79,500 shares held by
various trusts of which Mr. Perkins is the sole trustee, and 56,250 shares
held by Quest Venture Partners, of which Mr. Perkins is a 40% partner. Also
includes 17,000 shares Mr. Perkins has the right to acquire within 60 days
upon the exercise of options. Does not include 6,000 shares subject to
options held by Mr. Perkins that are not exercisable within the next 60
days. Excludes the 1,022,575 PCM Shares. Mr. Perkins disclaims beneficial
ownership of the PCM Shares.

(7) Does not include 60,000 shares subject to options held by Mr. Perlman that
are not exercisable within the next 60 days.

(8) Includes 62,000 shares Mr. Strickland has the right to acquire within 60
days upon the exercise of options. Does not include 6,000 shares subject
to options held by Mr. Strickland that are not exercisable within the
next 60 days.

(9) Includes 354,794 shares which may be acquired within 60 days upon the
exercise of options. Does not include 329,876 shares subject to options
that are not exercisable within the next 60 days. Does not include 8,640
shares of Restricted Stock which will not vest within the next 60 days.

<PAGE>

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 20,000,000 shares
of Common Stock, par value $.01 per share.

COMMON STOCK

As of a recent date, there were 7,450,518 shares of Common Stock issued
and outstanding held by 1,408 shareholders of record. All outstanding shares of
Common Stock are, and the shares offered hereby will be, fully paid and
nonassessable. The holders of Common Stock are entitled to one vote for each
share held of record on all matters voted upon by shareholders and may not
cumulate votes for the election of directors. Accordingly, the owners of a
majority of the shares of Common Stock outstanding have the power to elect all
of the directors. Each share of outstanding Common Stock is entitled to
participate equally in any distribution of net assets made to the shareholders
in liquidation, dissolution or winding up of the Company and is entitled to
participate equally in dividends as and when declared by the Board of Directors.
There are no redemption, sinking fund, conversion or preemptive rights with
respect to the shares of Common Stock. All shares of Common Stock have equal
rights and preferences.

The transfer agent and registrar for the Common Stock is American Stock
Transfer & Trust Company.

WARRANTS

Prior to the acquisition by the Company, on September 26, 1991 Vital Images
issued a warrant to purchase 32,143 shares of its common stock at an exercise
price of $4.00 per share to John G. Kinnard & Company, Incorporated ("Kinnard")
in connection with the private placement of its common stock. Subsequently, the
warrant was subdivided and warrants to purchase an aggregate of 2,214 shares of
Common Stock were assigned to three persons affiliated with Kinnard
(collectively, the "Warrants"). The Warrants became exercisable six months after
issuance and remain exercisable until September 26, 1996. The Warrants remained
in effect following the acquisition of Vital Images by the Company, with shares
of Common Stock substituted for the Vital Images common stock on a one-for-one
basis. The Warrants provide that if the Company proposes to register any of its
securities under the Securities Act (except by Form S-4 or Form S-8) within two
years after the initial exercise of the Warrants, notice must be given to the
holders of the Warrants or any shares issued thereunder, and such holders will
have the right to demand registration of the shares subject to the Warrants,
subject to certain limitations.

In conjunction with the closing of this Offering, the Company will grant
Piper Jaffray Inc. the Underwriter Warrants to purchase an aggregate of 75,000
shares of Common Stock (86,250 shares if the Underwriter's over-allotment option
is exercised in full). See "Underwriting."

CERTAIN LIMITED LIABILITY, INDEMNIFICATION AND ANTI-TAKEOVER PROVISIONS

Article Five of the Company's Bylaws provides that the Company will
indemnify such persons, for such expenses and liabilities, in such manner, under
such circumstances, and to such extent, as permitted by Minnesota Statutes
Section 302A.521 as enacted and as amended.

Section 302A.521 of the Minnesota Business Corporation Act provides that a
Minnesota business corporation shall indemnify any director, officer, employee
or agent of the corporation made or threatened to be made a party to a
proceeding, by reason of the former or present official capacity (as defined) of
the person, against judgments, penalties, fines, settlements and reasonable
expenses incurred by the person in connection with the proceeding if certain
statutory standards are met. "Proceeding" means a threatened, pending or
completed civil, criminal, administrative, arbitration or investigative
proceeding, including one by or in the right of the corporation. Section
302A.521 contains detailed terms regarding such right of indemnification and
reference is made thereto for a complete statement of such indemnification
rights.

<PAGE>

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or persons controlling the Company
pursuant to the foregoing provisions, the Company has been informed that in the
opinion of the Securities and Exchange Commission (the "Commission") such
indemnification is against public policy as expressed in the Securities Act, and
is therefore unenforceable.

The Company is subject to the provisions of Sections 302A.671 and 302A.673
of the Minnesota Business Corporation Act. Sections 302A.671 and 302A.673 of the
Minnesota Business Corporation Act may deny shareholders the receipt of a
premium on their Common Stock and may also have a depressive effect on the
market price of the Company's Common Stock. In general, Section 302A.671
provides that the shares of a corporation acquired in a "control share
acquisition" have no voting rights unless voting rights are approved in a
prescribed manner. A "control share acquisition" is an acquisition, directly or
indirectly, of beneficial ownership of shares that would, when added to all
other shares beneficially owned by the acquiring person, entitle the acquiring
person to have voting power of 20% or more in the election of directors. In
general, Section 302A.673 prohibits a public Minnesota corporation from engaging
in a "business combination" with an "interested shareholder" for a period of
four years after the date of the transaction in which the person became an
interested shareholder, unless the business combination is approved in a
prescribed manner. "Business combination" includes mergers, asset sales and
other transactions resulting in a financial benefit to the interested
shareholder. An "interested shareholder" is a person who is the beneficial
owner, directly or indirectly, of 10% or more of the corporation's voting stock
or who is an affiliate or associate of the corporation and at any time within
four years prior to the date in question was the beneficial owner, directly or
indirectly, of 10% or more of the corporation's voting stock.

UNDERWRITING

Piper Jaffray Inc. (the "Underwriter"), has agreed, subject to the terms
and conditions of the Purchase Agreement, to purchase from the Company 1,500,000
shares of Common Stock. The Underwriter is committed to purchase and pay for
all such shares if any are purchased (excluding shares covered by the over-
allotment option granted therein).

The Underwriter has advised the Company that it proposes to offer the
Common Stock directly to the public initially at the public offering price set
forth on the cover page of this Prospectus and to certain dealers at such price
less a concession of not more than $ per share. Additionally, the
Underwriter may allow, and such dealers may re-allow, a concession not in excess
of $ per share to certain other dealers. After the public offering,
the public offering price and other selling terms may be changed by the
Underwriter.

In connection with this Offering, the Underwriter may engage in passive
market making transactions in the Common Stock on the Nasdaq SmallCap Market
immediately prior to the commencement of sales in this Offering, in accordance
with Rule 10b-6A under the Securities and Exchange Act of 1934, as amended (the
"Exchange Act"). Passive market making consists of displaying bids on the
Nasdaq SmallCap Market limited by the bid prices of independent market makers
and purchases limited by such prices. Net purchases by a passive market maker
on each day are limited to a specified percentage of the passive market maker's
average daily trading volume in the Common Stock during a specified 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.

The Company has granted to the Underwriter an option, exercisable by the
Underwriter within 30 days from the date of this Prospectus, to purchase up to
an additional 225,000 shares of Common Stock at the same price per share to be
paid by the Underwriter for the other shares offered hereby. The Underwriter
may exercise this option only for the purpose of covering over-allotments, if
any, made in connection with the distribution of the Common Stock offered
hereby.

In connection with this Offering, the Company has agreed to issue and sell
to the Underwriter for nominal consideration, warrants (the "Underwriter
Warrants") to purchase an aggregate of 75,000 shares of Common Stock (86,250 if
the Underwriter's over-allotment option is exercised in full). These warrants
will be

<PAGE>

exercisable at the price per share equal to the market price of the Common Stock
on the day prior to the execution of the Purchase Agreement, commencing one year
from the date of this Prospectus, and will continue to be exercisable for a
period of four years after such date. Holders of the Underwriter Warrants are
entitled to certain demand and incidental registration rights with respect to
the shares issuable upon exercise of such warrants. The number of shares covered
by the Underwriter Warrants and the exercise price thereof are subject to
adjustment in certain events to prevent dilution.

The Company, its officers and directors, and certain other shareholders of
the Company have agreed that they will not sell, offer to sell, issue,
distribute or otherwise dispose of any shares of Common Stock for a period of 90
days after commencement of this Offering without the prior written consent of
the Underwriter.

The Company has agreed to indemnify the Underwriter and its controlling
persons against certain liabilities, including liabilities under the Securities
Act, or to contribute to payments the Underwriter may be required to make in
respect thereof.

LEGAL MATTERS

The validity of the shares of Common Stock being offered hereby is being
passed upon for the Company by Oppenheimer Wolff & Donnelly, Minneapolis,
Minnesota. Certain legal matters relating to the Offering will be passed upon
for the Underwriter by Faegre & Benson P.L.L.P., Minneapolis, Minnesota.

EXPERTS

The consolidated financial statements of Bio-Vascular, Inc. as of October
31, 1993 and 1994 and for the years then ended and the financial statements of
Vital Images, Incorporated for the year ended December 31, 1992 and the
combination of such financial statements with those of Bio-Vascular, Inc. for
the year ended October 31, 1992, after restatement for the 1994 pooling-of-
interests (which consolidated financial statements of the Company are included
herein and incorporated by reference in the Registration Statement) have been
audited by Coopers & Lybrand L.L.P., independent accountants, whose report
thereon appears herein and is incorporated by reference in the Registration
Statement. The separate statements of operations, changes in shareholders'
equity and cash flows of Bio-Vascular, Inc. for the year ended October 31, 1992
prior to restatement for the merger with Vital Images, Incorporated have been
audited by Deloitte & Touche LLP, independent accountants, whose report thereon
appears herein and is incorporated by reference in the Registration Statement.
All of such consolidated financial statements of the Company are included herein
and are incorporated by reference in the Registration Statement in reliance on
the reports of such firms given upon their authority as experts in accounting
and auditing.

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Exchange
Act, and in accordance therewith files reports and other information with the
Commission. Such reports, proxy and information statements and other information
filed by the Company may be inspected and copied at the Commission's Public
Reference Section, Room 1024, 450 Fifth Street, N.W., Judiciary Plaza,
Washington D.C. 20549, as well as at the Commission's Regional Offices at Seven
World Trade Center, Suite 1300, New York, New York 10048; and Citicorp Center,
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such
material may be obtained at prescribed rates from the Commission's Public
Reference Section at 450 Fifth Street, N.W., Washington, D.C. 20549.

Additional information regarding the Company and the shares offered hereby
is contained in the Registration Statement on Form S-3 and the exhibits thereto
filed with the Commission under the Securities Act. For further information
with respect to the Company and the shares, reference is made to the
Registration Statement and the exhibits thereto, copies of which may be
inspected without charge at, or obtained at prescribed rates from, the
Commission's Public Reference Section at 450 Fifth Street, N.W., Washington,
D.C. 20549.

<PAGE>

DOCUMENTS INCORPORATED BY REFERENCE

The Company's Annual Report on Form 10-K for the fiscal year ended
October 31, 1994 and its Quarterly Reports on Form 10-Q for the quarters ended
January 31, April 30 and July 31, 1995 are incorporated herein by reference. All
documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or 15(d) of
the Exchange Act subsequent to the date of this Prospectus and prior to the
termination of the offering hereunder 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 in a document 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 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 to whom this
Prospectus is delivered, upon the written or oral request of such person, a copy
of any or all of the documents incorporated by reference in this Prospectus
(except for certain exhibits to such documents). Written requests for such
copies should be directed to M. Karen Gilles, Vice President of Finance, Chief
Financial Officer and Corporate Secretary, Bio-Vascular, Inc., 2575 University
Avenue, St. Paul, Minnesota 55114-1024; telephone number (612) 603-3700.

<PAGE>

BIO-VASCULAR, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
----

Reports of Independent Accountants................................. F-2 and F-3

Consolidated Balance Sheets as of
October 31, 1993 and 1994 and July 31, 1995....................... F-4

Consolidated Statements of Operations for the years
ended October 31, 1992, 1993 and 1994 and the nine
months ended July 31, 1994 and 1995............................... F-5

Consolidated Statements of Shareholders' Equity
for the years ended October 31, 1992, 1993 and 1994
and the nine months ended July 31, 1995........................... F-6

Consolidated Statements of Cash Flows
for the years ended October 31, 1992, 1993 and 1994
and the nine months ended July 31, 1994 and 1995.................. F-7

Notes to Consolidated Financial Statements......................... F-8

F-1
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of
Bio-Vascular, Inc.:

We have audited the accompanying consolidated balance sheets of Bio-Vascular,
Inc. as of October 31, 1993 and 1994 and the related consolidated statements of
operations, shareholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Bio-Vascular, Inc.
as of October 31, 1993 and 1994, and the consolidated results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles.

We previously audited and reported on the statements of operations,
stockholders' equity and cash flows of Vital Images, Incorporated for the year
ended December 31, 1992. Such financial statements were audited and reported on
prior to their restatement for the 1994 pooling-of-interests described in Note
2. The contribution of Vital Images, Incorporated to combined net revenue
represented 30 percent of the 1992 restated total and Vital Images, Incorporated
contributed a net loss of $714,201 to the combined 1992 restated net loss total
of $158,718. Separate financial statements of Bio-Vascular, Inc. included in
the 1992 restated consolidated statements of operations, shareholders' equity
and cash flows were audited and reported on separately by other auditors. We
also audited the combination of the consolidated statements of operations,
shareholders' equity and cash flows for the year ended October 31, 1992, after
restatement for the 1994 pooling-of-interests; in our opinion, such consolidated
statements have been properly combined on the basis described in Note 1 of Notes
to Consolidated Financial Statements.

COOPERS & LYBRAND L.L.P.

Minneapolis, Minnesota
December 16, 1994, except for the last
paragraph of Note 6, as to which the
date is January 2, 1995

F-2
<PAGE>

INDEPENDENT AUDITORS' REPORT

Bio-Vascular, Inc.

We have audited the statements of operations, changes in shareholders' equity,
and cash flows of Bio-Vascular, Inc. (the Company) for the year ended October
31, 1992 prior to restatement for the merger with Vital Images, Incorporated.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.

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

In our opinion, such financial statements (not presented herein) present fairly,
in all material respects, the results of operations and cash flows of the
Company for the year ended October 31, 1992 in conformity with generally
accepted accounting principles.

DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
December 11, 1992

F-3

<PAGE>

BIO-VASCULAR, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS
<TABLE>
<CAPTION>
October 31, October 31, July 31,
1993 1994 1995
----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents.............................. $5,582,365 $2,347,954 $ 2,121,697
Marketable securities.................................. -- 1,270,841 --
Accounts receivable, net of an allowance for doubtful
accounts of $30,000 in 1993 and
$40,000 in 1994 and 1995.............................. 966,581 1,466,669 2,293,090
Inventories............................................ 890,220 1,132,669 1,814,886
Prepaid expenses and other current assets.............. 64,717 123,631 349,192
---------- ---------- -----------
Total current assets.................................. 7,503,883 6,341,764 6,578,865
Equipment and leasehold improvements, net............... 653,794 773,060 1,801,194
Software development costs, net of accumulated
amortization of $310,795 at October 31, 1993........... 212,653 -- --
Intangibles and other assets, net....................... 1,098,563 797,872 669,559
---------- ---------- -----------

Total assets.......................................... $9,468,893 $7,912,696 $ 9,049,618
========== ========== ===========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Current portion of long-term debt...................... $ 83,413 $ 11,968 $ 5,618
Accounts payable....................................... 171,409 455,338 438,109
Accrued expenses....................................... 375,581 485,020 729,172
Deferred revenues...................................... 296,435 153,512 285,155
----------- ---------- -----------
Total current liabilities............................. 926,838 1,105,838 1,458,054
Long-term debt, less current portion.................... 52,076 -- --
Deferred revenue, less current portion.................. 13,237 21,319 13,668
----------- ---------- -----------
Total liabilities.................................. 992,151 1,127,157 1,471,722
----------- ---------- -----------
Commitments (Note 7)....................................
Shareholders' equity:
Common stock: authorized 10,000,000 shares in 1993
and 1994 and 20,000,000 shares in 1995 of $.01 par
value; issued and outstanding, 7,232,823 shares and
7,318,125 shares in 1993 and 1994, respectively, and
7,446,488 shares...................................... 72,328 73,181 74,465
Additional paid-in capital............................. 11,485,997 11,685,163 12,166,913
Accumulated deficit.................................... (2,967,840) (4,847,362) (4,249,968)
Unearned compensation.................................. (54,420) (12,625) (2,000)
Unearned restricted stock.............................. (59,323) (112,818) (411,514)
----------- ---------- -----------
Total shareholders' equity............................. 8,476,742 6,785,539 7,577,896
----------- ---------- -----------
Total liabilities and shareholders' equity.......... $ 9,468,893 $7,912,696 $ 9,049,618
=========== ========== ===========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

F-4
<PAGE>

BIO-VASCULAR, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
For the Nine Months
For the Years Ended October 31, Ended July 31,
------------------------------------- ------------------------
1992 1993 1994 1994 1995
---------- ---------- ----------- ----------- ----------
(Unaudited)
<S> <C> <C> <C> <C> <C>

Net revenue.......................... $6,010,899 $6,144,273 $ 6,631,518 $ 4,701,975 $8,131,416
Cost of revenue...................... 2,406,038 2,516,691 2,433,368 1,823,360 2,567,365
---------- ---------- ----------- ----------- ----------

Gross margin........................ 3,604,861 3,627,582 4,198,150 2,878,615 5,564,051

Operating expenses:
Selling, general and administrative.. 3,349,207 3,125,779 3,540,582 2,378,260 3,491,054
Research and development............. 564,874 958,534 1,668,813 1,067,642 1,545,113
Acquisition costs.................... -- -- 419,920 423,220 --
---------- ---------- ----------- ----------- ----------

Operating income (loss)............. (309,220) (456,731) (1,431,165) (990,507) 527,884

Other income (expense), net.......... 164,597 318,702 (438,007) (380,017) 101,480
---------- ---------- ----------- ----------- ----------

Income (loss) before income taxes.... (144,623) (138,029) (1,869,172) (1,370,524) 629,364

Income tax provision................. 14,095 20,115 10,350 3,180 31,970
---------- ---------- ----------- ----------- ----------

Net income (loss)................... $ (158,718) $ (158,144) $(1,879,522) $(1,373,704) $ 597,394
========== ========== =========== =========== ==========

Net income (loss) per share.......... $ (.02) $ (.02) $ (.26) $ (.19) $ .07
========== ========== =========== =========== ==========

Weighted average shares outstanding.. 6,743,000 7,055,000 7,277,000 7,266,000 8,207,000
========== ========== =========== =========== ==========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

F-5
<PAGE>

BIO-VASCULAR, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
Common Stock Additional Unearned Retained
------------------------- Paid-in Deferred Restricted Earnings
Shares Par Value Capital Compensation Stock (Deficit) Total
------------- ---------- ------------ ------------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>

Balances at October 31, 1991....... 6,589,801 $ 65,898 $10,197,262 $(130,220) $(2,650,978) $ 7,481,962
Issuance of common stock in
connection with product license
agreement........................ 100,000 1,000 199,000 200,000
Stock options granted............. 42,000 (42,000)
Stock options canceled............ (42,348) 42,348
Exercise of stock options......... 34,314 342 72,171 72,513
Restricted stock granted.......... 39,279 393 177,087 $(177,480)
Restricted stock purchased by the
Company.......................... (4,029) (40) (18,131) (18,171)
Restricted stock earned........... 59,905 59,905
Compensation expense.............. 38,409 38,409
Net loss.......................... (158,718) (158,718)
--------- ------- ---------- --------- --------- ----------- -----------
Balances at October 31, 1992....... 6,759,365 67,593 10,627,041 (91,463) (117,575) (2,809,696) 7,675,900
Exercise of stock options......... 85,160 852 167,112 167,964
Issuance of common stock in
connection with product license
agreement........................ 50,000 500 99,500 100,000
Issuance of stock, net of
offering costs of $58,158........ 297,500 2,975 533,867 536,842
Stock options canceled............ (19,203) 19,203
Restricted stock granted.......... 11,246 112 45,968 (46,080)
Restricted stock purchased by the
Company.......................... (3,183) (32) (10,712) (10,744)
Restricted stock earned........... 59,584 59,584
Compensation expense.............. 17,840 17,840
Restricted stock forfeited........ (9,944) (99) (44,649) 44,748
Stock issued for services......... 42,679 427 87,073 87,500
Net loss.......................... (158,144) (158,144)
--------- ------- ---------- --------- --------- ----------- -----------
Balances at October 31, 1993....... 7,232,823 72,328 11,485,997 (54,420) (59,323) (2,967,840) 8,476,742
Exercise of stock options......... 36,115 361 66,882 67,243
Stock options canceled............ (18,495) 18,495
Restricted stock granted.......... 58,578 586 198,476 (199,062)
Restricted stock canceled......... (10,564) (106) (45,167) 45,273
Restricted stock purchased by the
Company.......................... (4,650) (46) (22,848) (22,894)
Restricted stock earned........... 58,174 58,174
Compensation expense/compensation
paid in stock.................... 12,500 125 43,625 23,300 67,050
Restricted stock forfeited........ (12,252) (123) (41,997) 42,120
Stock issued for services......... 5,575 56 18,690 18,746
Net loss.......................... (1,879,522) (1,879,522)
--------- ------- ---------- --------- --------- ----------- -----------
Balances at October 31, 1994....... 7,318,125 73,181 11,685,163 (12,625) (112,818) (4,847,362) 6,785,539
Stock options granted............. 15,863 15,863
Exercise of stock options......... 55,200 552 175,200 175,752
Restricted stock granted.......... 72,452 725 349,486 (350,211)
Restricted stock purchased by the
Company.......................... (22,394) (224) (168,318) (168,542)
Restricted stock earned........... 122,765 122,765
Compensation expense/compensation
paid in stock.................... 2,105 21 9,979 10,625 20,625
Stock issued for services......... 21,000 210 99,540 (71,250) 28,500
Net income........................ 597,394 597,394
--------- -------- ----------- --------- --------- ----------- -----------
Balances at July 31, 1995
(Unaudited)....................... 7,446,488 $ 74,465 $12,166,913 $ (2,000) $(411,514) $(4,249,968) $ 7,577,896
========= ======== =========== ========= ========= =========== ===========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

F-6
<PAGE>

BIO-VASCULAR, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
For the Nine Months
For the Years Ended October 31, Ended July 31,
--------------------------------------- --------------------------

1992 1993 1994 1994 1995
------------ ----------- ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).............................................. $ (158,718) $ (158,144) $(1,879,522) $(1,373,704) $ 597,394
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization................................ 725,356 689,488 851,872 536,047 423,042
Provision for inventory obsolescence......................... -- 10,000 -- -- 33,000
Provision for uncollectible accounts......................... 5,885 12,890 10,000 -- --
Issuance of common stock in connection with
product license agreement................................... -- 100,000 -- -- --
Gain (loss) on disposal of fixed assets...................... -- -- 40,961 -- --
Non-cash compensation........................................ 98,314 164,924 143,970 107,193 187,753
(Gain) loss on sale of marketable securities................. -- (100,555) 609,653 539,149
Changes in assets and liabilities, exclusive of investing and
financing activities:
Accounts receivable....................................... 31,219 172,428 (510,088) (203,919) (826,421)
Inventories............................................... (162,030) 23,265 (242,449) (15,582) (715,217)
Other current assets...................................... 90,673 (10,604) (58,914) (88,280) (225,561)
Other assets.............................................. -- (132) -- -- --
Accounts payable.......................................... 66,421 37,271 283,929 44,723 (17,229)
Accrued expenses.......................................... 216 19,838 86,513 17,768 244,152
Deferred revenues......................................... 106,231 101,462 (134,841) (42,705) 123,992
----------- ---------- ----------- ----------- -----------
Net cash provided by (used in) operating activities..... 803,567 1,062,131 (798,916) (479,310) (175,095)
----------- ---------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements......................... (320,800) (169,908) (504,725) (196,528) (1,296,571)
Additions to intangibles....................................... (9,601) (748) (10,190) (11,096) (26,777)
Capitalization of software development costs................... (68,991) (173,547) -- (43,654) --
Investments in marketable securities........................... (1,559,825) -- (3,301,877) (2,031,170) --
Redemptions of marketable securities........................... 1,916,905 2,351,562 1,421,383 -- 1,270,841
Change in other assets......................................... (657) -- 16,192 15,673 485
----------- ---------- ----------- ----------- -----------
Net cash provided by (used in) investing activities........... (42,969) 2,007,359 (2,379,217) (2,266,775) (52,022)
----------- ---------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt........................... 155,171 -- -- -- --
Payments on debt............................................. (185,915) (123,680) (123,521) (120,657) (6,350)
Proceeds related to the sale, issuance and repurchase
of common stock and exercise of stock options............... 72,513 704,806 67,243 6,439 7,210
----------- ---------- ----------- ----------- -----------
Net cash provided by (used in) financing activities........... 41,769 581,126 (56,278) (114,218) 860
----------- ---------- ----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS.......................................... 802,367 3,650,616 (3,234,411) (2,860,303) (226,257)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD.......................................... 1,224,440 1,931,749 5,582,365 5,582,365 2,347,954
----------- ---------- ----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD.................................................. $ 2,026,807 $5,582,365 $ 2,347,954 $ 2,722,062 $ 2,121,697
=========== ========== =========== =========== ===========
SUPPLEMENTAL DISCLOSURE:
Cash paid for interest....................................... $ 26,320 $ 21,867 $ 7,617
=========== ========== ===========
Cash paid for income taxes................................... $ 12,926 $ 6,635 $ 17,490
=========== ========== ===========
Acquisition of equipment under capital leases................ $ 6,792 $ 27,162 $ 12,049
=========== ========== ===========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

F-7
<PAGE>

BIO-VASCULAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

(1) BUSINESS DESCRIPTION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Business Description:

As a result of the acquisition of Vital Images, Incorporated (Vital Images)
in fiscal 1994 (Note 2), Bio-Vascular, Inc. (the Company or Bio-Vascular) has
two businesses, a Surgical Business (the business which existed prior to the
acquisition of Vital Images) and an Imaging Business (the business of Vital
Images prior to the merger). The Surgical Business develops, manufactures and
markets proprietary specialty medical products used in thoracic, cardiac, neuro
and vascular surgery. The Company, through its wholly owned subsidiary, Vital
Images, also markets and supports certain software products for interactive
visualization and analysis of three-dimensional image data. The end users of the
Imaging Business' software have been primarily researchers and innovators who
have adapted the core technology to meet their needs. During fiscal 1994 and
1995, the primary focus of the Imaging Business was one of development, directed
towards more specific industry applications of its core technology. Also during
fiscal 1994 and 1995, the Imaging Business has sought to establish marketing and
customer support alliances, enabling it to direct more of its resources to this
development process.

Consolidation:

The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiary. All significant intercompany accounts and
transactions have been eliminated in consolidation.

Accounting Periods:

Vital Images financial statements were reported on a calendar year basis
prior to the merger with Bio-Vascular. Vital Images financial statements have
been restated to be on a fiscal year basis for the year ended October 31, 1993.
Vital Images financial statements for the year ended 1992 are combined on a
calendar year basis with the Company's financial statements for the fiscal year
ended October 31, 1992. As a result, the Company's restated consolidated
financial statements for the fiscal years ended October 31, 1993 and 1992, both
include results of Vital Images for the months of November and December of 1992.
Vital Images revenues were $403,975 and its net loss was $32,854 for this two-
month period.

Cash Equivalents:

The Company considers all highly liquid investments with original maturities
of less than three months to be cash equivalents. The Company's cash and cash
equivalents balances are concentrated in a money market fund with one financial
institution.

Marketable Securities:

Investments with original maturities of three months or more are classified
as marketable securities and generally consist of United States Government or
United States Government backed instruments. Marketable securities are carried
at amortized cost, as the Company has the intention and the ability to hold
these securities to maturity (which maturity is less than one year). Unrealized
holding gains and losses were not significant.

F-8

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

Inventories:

Inventories are valued at the lower of cost or market, utilizing standard
costs which approximate the first-in, first-out method. All inventories are
held by the Surgical Business.

Equipment and Leasehold Improvements:

Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are computed using accelerated and straight-line methods over the
estimated useful lives (three to seven years) or lease life. Major replacements
and improvements are capitalized, and maintenance and repairs which do not
improve or extend the lives of the respective assets are charged to operations.
The asset and related accumulated depreciation or amortization accounts are
adjusted for asset retirement or disposal with the resulting gain or loss shown
in non-operating income.

Software Development Costs:

Software development costs incurred in the research and development of new
software products are expensed as incurred until technological and market
feasibility have been established. After technological and market feasibility
are established, any additional development or enhancement costs for these
products are capitalized until the product is available for sale to customers.
Amortization of capitalized costs is computed using the straight-line method
based upon a one to three year estimated economic life of the software products.
If delays in product releases lead to uncertainty concerning the ultimate
recovery of capitalized costs, those costs are expensed at the time recovery
becomes uncertain.

Goodwill, Product Licenses and Other Intangibles:

Goodwill, product licenses and other intangibles of the Surgical Business are
recorded at cost and are being amortized using the straight-line method over ten
years. In 1992, the Imaging Business acquired a license (Note 7) which is
being amortized on a straight-line basis over the estimated period of
realizability of three years. The Company evaluates the net realizability of
goodwill and other intangibles on an ongoing basis based on current and
anticipated undiscounted cash flows.

Revenue Recognition:

The Company recognizes Surgical Business revenue and software revenues of the
Imaging Business upon shipment of the products. Included in the sales price of
the Imaging Business' software products is an initial maintenance contract
varying in length from three to six months. Renewal maintenance contracts are
generally one year in length. Revenue from maintenance contracts, including
those sold as part of its software products and those sold separately, is
deferred and recognized on a straight-line basis over applicable maintenance
contract periods. Costs associated with maintenance revenues are charged to
operations as incurred.

Research and Development:

Research and development costs are expensed as incurred.

F-9
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

Income Taxes:

The Company accounts for income taxes using the liability method. The
liability method provides that deferred tax assets and liabilities are recorded
based on the differences between the tax bases of assets and liabilities and
their carrying amounts for financial reporting purposes ("temporary
differences").

Use of Estimates:

The preparation of the Company's consolidated financial statements in
conformity with generally accepting accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities and the reported
amounts of revenues and expenses during the reporting periods.

Net Income (Loss) Per Common Share:

Net income (loss) per common share is computed by dividing net income (loss)
by the weighted average number of common and common equivalent shares
outstanding. Common equivalent shares relate to common stock options and
warrants, when their effect is not antidilutive.

Interim Periods:

The consolidated balance sheet at July 31, 1995 and the consolidated
statements of operations and cash flows for the nine-month periods ended July
31, 1994 and 1995, and the consolidated statement of shareholders' equity for
the nine-month period ended July 31, 1995, together with the related notes, are
unaudited, but, in the opinion of management of the Company, include all
adjustments (which consist only of accruals of a normal recurring nature)
necessary to present fairly, in all material respects, the financial condition
at July 31, 1995 and the results of operations and cash flows for the Company
for the nine-month periods ended July 31, 1994 and 1995.

(2) ACQUISITION:

On May 24, 1994, Bio-Vascular acquired Vital Images. The acquisition was
effected through a "stock for stock" exchange of 1,645,025 shares of Bio-
Vascular common stock for the 1,645,025 shares of Vital Images common and Series
A preferred stock outstanding. The merger was accounted for under the "pooling-
of-interests" method of accounting for financial reporting purposes.
Accordingly, the accompanying consolidated financial statements have been
restated to retroactively include the financial position, results of operations
and cash flows of Vital Images for all periods presented.

Combined and separate results of Bio-Vascular and Vital Images for periods
prior to the acquisition are set forth in the table below. Costs related to the
acquisition of approximately $420,000 were expensed as incurred in the first
through third quarters of fiscal year 1994.

F-10
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

Bio-Vascular Vital Images Combined
------------ ------------ --------
<S> <C> <C> <C>
YEAR ENDED OCTOBER 31, 1992:
Net revenue................... $4,185,110 $1,825,789 $6,010,899
Net income (loss)............. 555,483 (714,201) (158,718)

YEAR ENDED OCTOBER 31, 1993:
Net revenue................... 4,422,775 1,721,498 6,144,273
Net income (loss)............. 650,634 (808,778) (158,144)

SIX MONTHS ENDED APRIL 30, 1994
(unaudited):
---------
Net revenue 2,228,152 915,138 3,143,290
Net loss...................... (203,586) (289,565) (493,151)
</TABLE>
(3) CERTAIN CONSOLIDATED FINANCIAL STATEMENT INFORMATION:
<TABLE>
<CAPTION>

Inventories consisted of the following:
October 31, October 31, July 31,
1993 1994 1995
----------- ----------- --------
<S> <C> <C> <C>
Raw materials and supplies...................... $ 167,420 $ 224,949 $ 379,120
Work-in-process................................. 80,467 292,746 336,493
Finished goods.................................. 642,333 614,974 1,099,273
---------- ----------- -----------
$ 890,220 $ 1,132,669 $ 1,814,886
========== =========== ===========
Equipment and leasehold improvements consisted
of the following:
Furniture, fixtures and computer
equipment..................................... $1,100,321 $ 1,450,998 $ 1,835,839
Laboratory equipment............................ 72,903 81,686 127,849
Manufacturing equipment......................... 281,556 254,480 444,889
Leasehold improvements.......................... 145,070 155,242 830,400
---------- ----------- -----------
Less accumulated depreciation and
amortization................................. (946,056) (1,169,346) (1,437,783)
---------- ----------- -----------
$ 653,794 $ 773,060 $ 1,801,194
========== =========== ===========
</TABLE>

F-11
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

<TABLE>
<CAPTION>
October 31, October 31, July 31,
1993 1994 1995
----------- ---------- --------
<S> <C> <C> <C>
Intangibles and other assets consisted
of the following:
Goodwill................................................ $1,318,499 $1,318,499 $1,318,499
Less accumulated amortization......................... (460,101) (603,167) (710,467)
---------- ---------- ----------
858,398 715,332 608,032
---------- ---------- ----------
Product licenses and other intangibles.................. 667,797 679,366 706,143
Less accumulated amortization......................... (449,721) (602,491) (649,798)
---------- ---------- ----------
218,076 76,875 56,345
---------- ---------- ----------
Other assets............................................ 22,089 5,665 5,182
---------- ---------- ----------
$1,098,563 $ 797,872 $ 669,559
========== ========== ==========
Accrued expenses consisted of the following:
Payroll and other employee benefits................... $ 144,923 $ 215,910 $ 356,123
Royalties............................................. 68,040 85,233 116,123
Research reimbursement, shareholder................... 91,482 91,482 80,000
Other................................................. 71,136 92,395 176,926
---------- ---------- ----------
$ 375,581 $ 485,020 $ 729,172
========== ========== ==========
</TABLE>

<TABLE>
<CAPTION>
For the Nine Months
For the Years Ended October 31, Ended July 31,
------------------------------- -------------------
1992 1993 1994 1994 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Depreciation and amortization
consisted of the following:
Depreciation............................................. $288,291 $327,784 $ 344,496 $ 234,856 $268,437
Amortization of intangibles.............................. 223,109 256,501 294,723 192,448 154,605
Amortization of software
development costs....................................... 213,956 105,203 212,653 108,743 --
-------- -------- --------- --------- --------
$725,356 $689,488 $ 851,872 $ 536,047 $423,042
======== ======== ========= ========= ========

Other income (expense) net, consisted of the following:

Interest income.......................................... $176,340 $234,653 $ 221,023 $ 163,479 $100,343
Interest expense......................................... (27,425) (21,867) (7,617) (7,192) (649)
Capital gain (loss) on sale
of investment (1)....................................... -- 100,555 (609,653) (539,149) --
Gain (loss) on disposal of
equipment, net.......................................... -- -- (40,961)
Miscellaneous income (expense)........................... 15,682 5,361 (799) 2,845 1,786
-------- -------- --------- --------- --------
$164,597 $318,702 $(438,007) $(380,017) $101,480
======== ======== ========= ========= ========
</TABLE>
(1) Relates entirely to the Company's investment during 1993 and 1994 in mutual
fund shares of the Piper Jaffray Institutional Government Income Portfolio.

(4) LINE OF CREDIT:

In February 1995, the Company obtained a $250,000 revolving line of credit
which expires January 31, 1996. There were no borrowings under the line of
credit or previous similar lines of credit during the fiscal years ended

F-12
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

October 31, 1993 and 1994 and the nine months ended July 31, 1995. The current
line of credit bears interest at prime plus 1.0% and is collateralized by
primarily all assets. After completion of the merger, the Company paid all
long-term debt of Vital Images.

(5) INCOME TAXES:

The recorded tax provisions for the years ended October 31, 1992, 1993 and
1994 and for the nine-month period ended July 31, 1994, respectively, represent
alternative minimum taxes due to limitations in the use of net operating loss
carryforwards and state minimum taxes. The Company has recorded a tax provision
for the nine-month period ended July 31, 1995 of $32,000 on expected taxable
income after use of net operating loss carryforwards. The Surgical Business of
the Company utilized approximately $717,000 and $740,000 of net operating loss
carryforwards in fiscal 1992 and 1993, respectively. The Company incurred a
loss for the year ended October 31, 1994.

As of October 31, 1994, the Company has net operating loss carryforwards of
approximately $1,000,000 available to offset income from operations and $500,000
to offset future and past capital gains, as well as research and experimentation
tax credit carryforwards. The net operating loss carryforwards expire in 2002
to 2009, while the capital loss carryforward expires in 1999. The Company
currently expects to completely utilize the $1,000,000 of net operating loss
carryforwards as well as a portion of the tax credit carryforwards in fiscal
1995. The Company also has carryforwards arising from the pre-merger losses of
Vital Images totaling approximately $2,400,000. These pre-merger carryforwards
can only be applied to the post-merger net income of the Imaging Business and
are restricted as to the amount that can be utilized in any year due to
limitations resulting from the significant change of ownership. These
carryforwards begin to expire in 2005.

There are no significant differences between the tax bases of assets and
liabilities and their financial reporting amounts. The deferred tax assets
associated with the pre-merger loss carryforwards and the capital loss
carryforward have been totally offset by a valuation allowance because of
uncertainty that the Company and the Imaging Business will generate sufficient
taxable income of the appropriate type prior to the expiration of the
carryforwards.

(6) SHAREHOLDERS' EQUITY:

Increase in Authorized Shares:

In March 1995, the shareholders approved an increase in authorized shares of
common stock from 10,000,000 shares to 20,000,000 shares.

Warrants:

As a result of the merger, the Company assumed the warrant obligations of
Vital Images which were outstanding at the time of the merger. During 1991, in
connection with the private placement and issuance of common shares, Vital
Images issued stock warrants for the purchase of 32,143 shares of common stock.
The warrants are exercisable through October 1996, at an exercise price of $4.00
per share. No warrants have been exercised through July 31, 1995.

In connection with a proposed stock offering, the Company has agreed to issue
and sell to the underwriter warrants to purchase up to 86,250 shares of common
stock, exercisable at a price per share equal to the market

F-13
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

price of the common stock on the day prior to the execution of the Purchase
Agreement, commencing one year from the date of this Prospectus, and will
continue to be exercisable for a period of four years after such date.

Restricted Stock:

Under certain compensation agreements, an arrangement which provides for
awards of restricted common stock to key management was adopted in 1992. These
awards of restricted common stock are subject to forfeiture if employment
terminates prior to the end of the prescribed periods. Vesting periods range
from two to four years. The market value of the shares at the time of grant is
recorded as unearned restricted stock. The unearned amount is amortized to
compensation expense over the periods during which the restrictions lapse.
During the years ended October 31, 1992, 1993, and 1994 and the nine-month
period ended July 31, 1995, 13,093, 13,744, 14,302 and 25,185 restricted shares,
respectively, were earned. At July 31, 1995, 78,250 shares of restricted stock
which were granted at per share prices of $3.25 to $6.0625, and generally vests
over a period of four years remain unearned. As part of these same compensation
agreements, the Company agreed to buy back the number of shares which would
allow the employees to meet their income tax obligations arising from the non-
cash compensation related to the earned restricted shares.

Deferred Compensation:

Prior to the merger, Vital Images granted stock options at prices different
from the estimated market value of the underlying common stock. The difference
between the estimated market value and the exercise price was recorded as
deferred compensation and is amortized on a straight-line basis over the vesting
periods of the related options.

Stock Option Plans:

The Company has four stock option plans, an Employee Incentive Stock Option
Plan (the "1988 Plan"), a Directors' Stock Option ("DSO") Plan, and two plans,
the obligations of which were assumed by the Company as a result of the
acquisition of Vital Images: the 1990 Management Incentive Stock Option Plan
(the "1990 Plan"), and the 1992 Stock Option Plan (the "1992 Plan"). The
Company does not intend to grant further options under either the 1990 or the
1992 plans.

Under the Company's plans, 556,986 shares of common stock remain reserved for
issuance to directors, officers and employees at July 31, 1995. Options under
the plans are exercisable over periods of up to ten years from the date of
grant. The Company has reserved and granted 266,720 shares of common stock for
issuance in connection with non-plan options which have been granted to
consultants, an officer, and directors of the

F-14
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

Company. These options are exercisable over periods of up to seven years from
the date of grant. Option activity is summarized as follows:
<TABLE>
<CAPTION>

Plans Non-Plan Price Per Share
--------- --------- ---------------
<S> <C> <C> <C>

Balances at October 31, 1991.. 302,450 169,850 $ 1.00 - $5.375

Granted..................... 391,075 5,000 $ 2.00 - $6.875
Exercised................... (17,550) (16,764) $ 1.06 - $4.250
Canceled.................... (18,300) (9,236) $ 1.00 - $5.375
-------- --------

Balances at October 31, 1992.. 657,675 148,850 $ 1.00 - $6.875

Granted..................... 101,100 24,000 $1.875 - $4.750
Exercised................... (28,600) (56,560) $1.250 - $2.500
Canceled.................... (136,000) (9,900) $ 1.00 - $6.500
-------- --------

Balances at October 31, 1993.. 594,175 106,390 $ 1.00 - $6.875

Granted..................... 74,000 226,000 $2.00 - $3.4375
Exercised................... (7,725) (28,390) $ 1.00 - $2.375
Canceled.................... (45,600) (29,000) $ 1.00 - $5 375
-------- --------

Balances at October 31, 1994.. 614,850 275,000 $ 1.00 - $6.875
Granted..................... 262,438 118,000 $4.75 - $12.125
Exercised................... (43,200) (12,000) $ 1.00 - $4.75
Canceled.................... (38,599) (114,280) $ 2.00 - $3.50
-------- -------- ---------------

Balances at July 31, 1995..... 795,489 266,720 $1.00 - $12.125
======== ======== ===============
</TABLE>

Options for the purchase of 630,950 shares of common stock at prices ranging
from $1.00 to $6.875 were exercisable at July 31, 1995.

Subsequent to the end of the 1994 fiscal year, the Company granted options
for 180,442 shares of common stock under various stock option programs,
exercisable over periods beginning October 31, 1995 and ending October 31, 1998.
These options were granted at the market value on the date of grant at prices
ranging from $4.75 to $5.125 per share. In addition, the Company granted to
employees 60,252 shares of restricted common stock, vesting over periods
beginning October 31, 1995 and ending October 31, 1998. These restricted stock
shares were granted at the market value on the date of grant at a price of $4.75
per share.

(7) COMMITMENTS:

Operating Leases:

In February 1995, the Company entered into a new noncancelable operating
lease for rental of a combined office and production facility housing their
Surgical Business in St. Paul, Minnesota beginning August 1, 1995 and expiring
July 31, 2005. Total annual base rental expense for this new lease is $255,441.
Total base rental

F-15
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

expense for the prior facility operating leases aggregated $91,308 for each of
the years ended October 31, 1992, 1993 and 1994. Base rental expense was
$68,481 and $78,753 for the nine months ended July 31, 1994 and 1995. The
Company also pays apportioned real estate taxes and common costs on its leased
facilities.

Vital Images leases office facilities for the Imaging Business in Fairfield,
Iowa, under a non-cancelable operating lease expiring on June 1, 1997. The
lease includes an option to renew for one four-year period. Total base rental
expense for the Iowa facility was $83,074 for the year ended December 31, 1992
and $55,064 and $72,090 for the years ended October 31, 1993 and 1994. Base
rental expense was $67,755 and $55,755 for the nine months ended July 31, 1994
and 1995.

Future minimum payments under all operating leases at both facility locations
(St. Paul, MN and Iowa) at July 31, 1995 as adjusted to also include the new
lease for the Surgical Business are payable as follows: 1995 -$82,445, 1996 -
$329,781, 1997 - $298,806, 1998 - $255,441, 1999 - $255,441 and thereafter
$1,468,803.

Royalties:

In connection with the acquisition of product licenses and product
manufacturing rights, the Company is obligated for the payment of royalties as
follows:

Surgical Business Royalties:

- 2.5% or 3% of net sales of the Biograft through 1998 (2.5% if Biograft annual
sales are under $2,000,000; 3.0% if annual sales are over $2,000,000). In
addition, a royalty of an additional 5% of net sales was in place through
November 2, 1993 (which coincides with the expiration of the patent)

- 5% on net sales of Peri-Strips through December 2001, or if a patent issues,
until the expiration of the patent

- 5.5% of net sales of the Flo-Rester occluder under two agreements with 3%
payable through July 1995 and 2.5% payable through September 1996

- 3% of net sales of Peri-Guard Processed Bovine Pericardium and Cardio-Cool
through July of 1995

- 3% of net sales of the Bio-Vascular Probe through 2001

- 5% on the next $1,369,555 of aggregate net sales of the Bioflow/(R)/ Small
Diameter Graft after October 31, 1994, and 7% on all net sales thereafter,
payable through October 1998. The Company no longer actively markets this
product.

Royalty expense for the Surgical Business was approximately $231,000,
$247,000, and $169,000 for the years ended October 31, 1992, 1993, and 1994,
respectively, and $114,000 and $365,000 for the nine months ended July 31, 1994
and 1995, and is included in cost of revenue.

Imaging Business Royalties:

- 5% of net sales of licensed volume visualization software (which encompasses
the core technology) and direct descendant software. The royalty will
terminate on May 24, 1996, two years after the merger of

F-16
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

Vital Images with and into the Company. Prior to June 1992, the royalty was
based on 10% of the net computed value of Vital Images' gross revenue from
all sources, less cost of goods sold, returns, discounts, taxes (excluding
income taxes), allowances, and research and development costs. In June 1992,
Vital Images issued 100,000 shares of common stock to the licensor in
exchange for the modification of the royalty agreement to the 5% of net sales
amount. Royalty fee expense under this arrangement totaled $52,381 for the
year ended December 31, 1992, $56,278 for the year ended October 31, 1993,
$58,875 for the year ended October 31, 1994 and $43,150 and $25,141 for the
nine months ended July 31, 1994 and 1995 and is included in cost of revenue.

- Base royalty of 6% on net sales for the period fifteen months from the first
commercial sales of any product using the technology developed under a
licensing/research agreement with the licensor entered into in January 1993.
This agreement provides for exclusive (domestic and international) rights to
make, market, and further develop existing technology and future improvements
relating to certain computer programs and electronic designs for use in the
fields of obstetrics and gynecology, and nonexclusive rights in all other
fields or applications. Under the research portion of the agreement, which
expired in July of 1993, development costs of up to $200,000 were to be paid
by Vital Images. During the year ended October 31, 1993, Vital Images paid
$108,518 and had accrued $91,482, the remaining maximum potential amount
related to the development costs under this agreement, all of which were
included in research and development in the statement of operations. In
exchange for the license agreement, the Company paid an initial licensing fee
of $100,000, which was charged to research and development in the statement
of operations for the year ended October 31, 1993. This initial licensing
fee was concurrently used, by the licensor for the purchase of 50,000 shares
of common stock. An additional royalty (in addition to the 6% of net
revenues) is payable in the amount of $1,000 for each system sold by the
Imaging Business incorporating the technology. To maintain the exclusivity
of the license agreement, the Company is subject to minimum annual payments,
payable on the first through fifth anniversary of the date of first
commercial sale of a product derived from the licensed technology. The
minimum royalty obligation is $1,600,000 and is payable as $75,000, $225,000,
$500,000, and $800,000 on the successive anniversary dates. The minimum
annual payments can be applied against the base and additional royalty
obligations. Under terms of the agreement, the royalty will terminate
seven years from the first commercial sale of the product. Commercial sales
of this product have not yet commenced at July 31, 1995. It is not certain
that the Imaging Business will ever develop a product from the technology
obtained under this agreement.

(8) EMPLOYEE BENEFIT PLANS:

The Company has a salary reduction plan established on January 1, 1991, which
qualifies under Section 401(k) of the Internal Revenue Code. Employee
contributions are limited to 20% of their annual compensation, subject to yearly
limitations. At the discretion of the Board of Directors, the Company may make
matching contributions equal to a percentage of the salary reduction or other
discretionary amount. The Company has made no contributions to the plan since
its inception.

(9) BUSINESS SEGMENTS AND MAJOR CUSTOMERS:

The following is information relating to the Company's business segments,
including foreign revenues. A description of these segments appears in Note 1.
Cost allocations are necessary in the determination of operating results by
segment. For this reason, management does not represent that these segments, if
operated as independent businesses, would result in the operating results shown.

F-17
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(INFORMATION AS OF JULY 31, 1995 AND FOR THE
NINE MONTHS ENDED JULY 31, 1994 AND 1995 IS UNAUDITED)

<TABLE>
<CAPTION>
For the Years Ended For the Nine Months
October 31, Ended July 31,
-------------------------------------- -----------------------
1992 1993 1994 1994 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net revenue:
Surgical Business............. $4,185,110 $4,422,775 $ 4,951,743 $3,401,405 $7,046,310
Imaging Business.............. 1,825,789 1,721,498 1,679,775 1,300,570 1,085,106
---------- ---------- ----------- ---------- ----------
Total net revenue.............. 6,010,899 6,144,273 6,631,518 4,701,975 8,131,416
========== ========== =========== ========== ==========

Operating income (loss):
Surgical Business............. 399,046 333,058 171,363 24,137 1,324,773
Imaging Business.............. (708,266) (789,789) (1,182,608) (591,424) (796,889)
Corporate..................... -- -- (419,920) (423,220) --
---------- ---------- ----------- ---------- ----------
Total operating income (loss).. (309,220) (456,731) (1,431,165) (990,507) 527,884
========== ========== =========== ========== ==========

Total assets:
Surgical Business............. 7,489,005 8,363,642 7,087,981 7,295,248 8,215,998
Imaging Business.............. 1,137,143 1,105,251 824,715 812,769 833,620
---------- ---------- ----------- ---------- ----------
Total assets................... 8,626,148 9,468,893 7,912,696 8,108,017 9,049,618
========== ========== =========== ========== ==========

Depreciation and
amortization expense:
Surgical Business............. 303,509 334,416 407,372 262,076 268,350
Imaging Business.............. 421,847 355,072 444,500 273,971 154,692
---------- ---------- ----------- ---------- ----------
Total depreciation and
amortization expense:........ 725,356 689,488 851,872 536,047 423,042
========== ========== =========== ========== ==========

Capital expenditures:
Surgical Business............. 241,341 59,388 273,908 118,604 1,040,684
Imaging Business.............. 79,459 110,520 230,817 77,924 255,886
---------- ---------- ----------- ---------- ----------
Total capital expenditures..... 320,800 169,908 504,725 196,528 1,296,570
========== ========== =========== ========== ==========
</TABLE>

Foreign Revenues:

All of the Company's foreign revenues are derived from the sale of products
produced in the United States. All of the Company's foreign transactions are
negotiated, invoiced and paid in United States dollars. Foreign sales (primary
to Europe) totaled 28%, 29% and 32% of fiscal 1992, 1993 and 1994 net revenue
and 21% of the nine months ended July 31, 1995 net revenue.

Major Customers:

In the nine months ended July 31, 1995 three domestic distributors accounted
for an aggregate of 46.6% of the Surgical Business' gross revenue, with each of
such distributors accounting for in excess of 10% of the Surgical Business'
gross revenue for the period.

(10) SUBSEQUENT EVENT (Unaudited):

In August 1995, the Company signed a source code license agreement with
CogniSeis Development, Inc., granting them a worldwide, perpetual, exclusive
license to VoxelGeo software for gas and oil exploration applications. The
Company, upon CogniSeis' validation of the source code, will receive a license
fee payment of $1.5 million, which is expected to be recorded as revenue in the
fourth quarter of 1995. In addition, the agreement provides for future royalty
payments based upon sales of VoxelGeo software. Such royalties, if any, will
not exceed $2.0 million.

F-18
<PAGE>

1,500,000 SHARES
No dealer, salesperson or any other
person has been authorized to give
any information or make any
representation not contained in this
Prospectus in connection with the
offer made by this Prospectus and,
if given or made, such information
or representation must not be relied
upon as having been authorized by [BIO-VASCULAR LOGO]
the Company or the Underwriter.
This Prospectus does not constitute
an offer to sell or a solicitation
of an offer to buy any of the
securities offered hereby by anyone COMMON STOCK
in any jurisdiction in which such
offer or solicitation is not
authorized or in which the person
making such offer or solicitation is ---------------
not qualified to do so or to anyone PROSPECTUS
whom it is unlawful to make such ---------------
offer or solicitation. Neither the
delivery of this Prospectus nor any
sale made hereunder shall under any
circumstances create any implication
that the affairs of the Company
since the date hereof of or the
information herein is correct as of
any time subsequent to the date of
of this Prospectus.

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

TABLE OF CONTENTS
<TABLE>
<CAPTION>

Page
----
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 5
Use of Proceeds................................ 9
Price Range of Common Stock.................... 10
Dividend Policy................................ 10
Dilution....................................... 10
Capitalization................................. 11
Selected Consolidated Financial Data........... 12
Management's Discussion and Analysis of
Results of Operations and Financial Condition.. 13
Business....................................... 20
Management..................................... 34
Principal Shareholders......................... 41
Description of Capital Stock................... 43
Underwriting................................... 44
Legal Matters.................................. 45
Experts........................................ 45
Available Information.......................... 45
Documents Incorporated by Reference............ 46
Consolidated Financial Statements.............. F-1
</TABLE>

PIPER JAFFRAY INC.

_______________, 1995
<PAGE>

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The table below sets forth estimated expenses in connection with the issuance
and distribution of the Common Stock being offered hereby. All of such expenses
are estimates, except for the SEC registration fee, the NASD fee and the Nasdaq
fee.
<TABLE>
<CAPTION>

<S> <C>
SEC registration fee.............................. $ 8,405
NASD fee.......................................... 2,937
Nasdaq fee........................................ 40,000
Printing expenses................................. 57,000
Fees and expenses of counsel for the Company...... 110,000
Fees and expenses of accountants for the Company.. 65,000
Transfer agent and registrar fees................. 1,000
Blue Sky fees and expenses........................ 10,000
Miscellaneous..................................... 5,658
--------

Total......................................... $300,000
========
</TABLE>

ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.

Article Five of the Company's Bylaws provides that the Company will
indemnify such persons, for such expenses and liabilities, in such manner, under
such circumstances, and to such extent as permitted by Minnesota Statutes
Section 302A.521 as enacted and as amended.

Minnesota Statutes Section 302A.521 provides that a Minnesota business
corporation shall indemnify any director, officer, employee or agent of the
corporation made or threatened to be made a party to a proceeding, by reason of
the former or present official capacity (as defined) of the person, against
judgments, penalties, fines, settlements and reasonable expenses incurred by the
person in connection with the proceeding if certain statutory standards are met.
"Proceeding" means a threatened, pending or completed civil, criminal,
administrative, arbitration or investigative proceeding, including one by or in
the right of the corporation. Section 302A.521 contains detailed terms
regarding such right of indemnification and reference is made thereto for a
complete statement of such indemnification rights.

The Company maintains directors' and officers' liability insurance,
including a reimbursement policy in favor of the Company.

Pursuant to Section 6 of the Purchase Agreement, the directors and officers
of the Company are indemnified against certain liabilities as they may incur
under the Securities Act of 1933, as amended, in connection with this
Registration Statement and the related Prospectus.

II-1
<PAGE>

ITEM 16. EXHIBITS

1.1 Form of Purchase Agreement (to be filed by amendment).

4.1 Restated Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.2 to the Company's registration statement on
Form 10, File No. 0-13907).

4.2 Amendment to Restated Articles of Incorporation of the Company, dated as of
June 21, 1995 (filed herewith).

4.3 Bylaws of the Company (incorporated by reference to Exhibit 3.3 to the
Company's registration statement on Form 10, File No. 0-13907).

5.1 Opinion and Consent of Oppenheimer Wolff & Donnelly (filed herewith).

23.1 Consent of Coopers & Lybrand L.L.P. (filed herewith).

23.2 Consent of Deloitte & Touche LLP (filed herewith).

23.3 Consent of Oppenheimer Wolff & Donnelly (included in Exhibit 5.1).

24.0 Power of Attorney (included on page II-4).

ITEM 17. UNDERTAKINGS

(a) Incorporation by Reference

The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.

(b) Acceleration of Effectiveness

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.

II-2
<PAGE>

(2) For the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating
to the securities offered herein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.

II-3
<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Minneapolis and State of Minnesota, on August 28,
1995.

BIO-VASCULAR, INC.

By: /s/ John T. Karcanes
-------------------------------------------------------
John T. Karcanes, President and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints John T. Karcanes and M. Karen Gilles, and each of them,
as his or her true and lawful attorney-in-fact and agent, each with full powers
of substitution and re-substitution, for him or her and in his or her name,
place and stead, in any and all capacities, to sign any or all amendments
(including post-effective amendments) to this Registration Statement, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorney-in-fact and agent, full power and authority to do and perform each and
every act and thing requisite or necessary to be done in and about the premises,
as fully to all intents and purposes as he or she might or could do in person,
hereby ratifying and confirming all that said attorney-in-fact and agent, or his
or her substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.

Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons on August 28,
1995 in the capacities indicated.

Signature Title
--------- -----

/s/ John T. Karcanes President and Chief Executive Officer (Principal
- -------------------- Executive Officer) and Director
John T. Karcanes

/s/ M. Karen Gilles Vice President of Finance and Chief Financial
- ------------------- Officer (Principal Financial and Accounting Officer)
M. Karen Gilles

/s/ James F. Lyons Chairman of the Board of Directors
- ------------------
James F. Lyons

/s/ Vincent Argiro Director
- ------------------
Vincent Argiro

/s/ Richard W. Perkins Director
- ----------------------
Richard W. Perkins

/s/ Lawrence Perlman Director
- --------------------
Lawrence Perlman

/s/ Edward E. Strickland Director
- ------------------------
Edward E. Strickland

II-4
<PAGE>

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION PAGE
------- ----------- ----
<C> <S> <C>
1.1 Form of Purchase Agreement (to be filed by amendment).

4.1 Restated Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.2 to the Company's registration statement on Form 10
(File No. 0-13907)).

4.2 Amendment to Restated Articles of Incorporation of the Company, dated as of
June 21, 1995 (filed herewith).................................................

4.3 Bylaws of the Company (incorporated by reference to Exhibit 3.3 to the
Company's registration statement on Form 10 (File No. 0-13907)).

5.1 Opinion and Consent of Oppenheimer Wolff & Donnelly (filed herewith)...........

23.1 Consent of Coopers & Lybrand L.L.P. (filed herewith)...........................

23.2 Consent of Deloitte & Touche LLP (filed herewith)..............................

23.3 Consent of Oppenheimer Wolff & Donnelly (included in Exhibit 5.1).

24.0 Power of Attorney (included on page II-4).
</TABLE>

<PAGE>

Exhibit 4.2
#23

[SEAL OF THE STATE OF MINNESOTA]

MINNESOTA SECRETARY OF STATE
AMENDMENT OF ARTICLES OF INCORPORATION

BEFORE COMPLETING THIS FORM, PLEASE READ INSTRUCTIONS LISTED BELOW.

CORPORATE NAME:(List the name of the company prior to any desired name change)

Bio-Vascular, Inc.
- --------------------------------------------------------------------------------

This amendment is effective on the day it is filed with the Secretary of State,
unless you indicate another date, no later than 30 days after filing with the
Secretary of State.

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

The following amendment(s) of articles regulating the above corporation were
adopted: (Insert full text of newly amended article(s) indicating which
article(s) is (are) being amended or added.) If the full text of the amendment
will not fit in the space provided, attach additional numbered pages. (Total
number of pages including this form 1 .)
-----
ARTICLE 3.1
-----------
of the Restated Articles of Incorporation

3.1 Authorized Shares. The aggregate number of shares that the corporation has
authority to issue shall be Twenty Million (20,000,000) shares of common
stock. Such shares shall have a par value of one cent ($.01) per share
solely for the purpose of a statute or regulation imposing a tax or fee
based upon the capitalization of a corporation.

This amendment has been approved pursuant to Minnesota Statutes chapter 302A or
317A. I certify that I am authorized to execute this amendment and I further
certify that I understand that by signing this amendment, I am subject to the
penalties of perjury as set forth in section 609.48 as if I had signed this
amendment under oath.

/s/ M. Karen Gilles
-----------------------------------------
M. Karen Gilles, Secretary
(Signature of Authorized Person)

- --------------------------------------------------------------------------------
INSTRUCTIONS FOR OFFICE USE ONLY

1. Type or print with black ink.
2. A Filing Fee of: $35.00, made payable STATE OF MINNESOTA
to the Secretary of State. DEPARTMENT OF STATE
3. Return completed forms to: FILED

Secretary of State JUN 21 1995
180 State Office Building
St. Paul, MN 55155-1299 JOAN ANDERSON GROWE
(612)296-2803 Secretary of State

<PAGE>

EXHIBIT 5.1

August 28, 1995

Bio-Vascular, Inc.
2575 University Avenue
St. Paul, MN 55114-1024

Re: Bio-Vascular, Inc.
Registration Statement on Form S-3

Ladies and Gentlemen:

We are acting as counsel for Bio-Vascular, Inc., a Minnesota corporation (the
"Company"), in connection with the registration by the Company of 1,725,000
shares of the Company's Common Stock, par value $.01 per share (the "Shares"),
which includes 225,000 Shares subject to the Underwriter's over-allotment
option, pursuant to the Company's Registration Statement on Form S-3 to be filed
with the Securities and Exchange Commission on August 28, 1995 (the
"Registration Statement").

In connection with rendering this opinion, we have examined and relied upon
originals or copies, certified or otherwise identified to our satisfaction, of
such corporate records, agreements and other instruments, certificates of
officers, certificates of public officials and other documents as we have deemed
necessary or appropriate as a basis for the opinions expressed herein. In
connection with our examination, we have assumed the genuineness of all
signatures, the authenticity of all documents tendered to us as originals, the
legal capacity of all natural persons and the conformity to original documents
of all documents submitted to us as certified or photostatic copies.

Based on the foregoing, and subject to the qualifications and limitations stated
herein, it is our opinion that:

1. The Company has the corporate authority to issue the Shares in the
manner and under the terms set forth in the Registration Statement.

2. The Shares have been duly authorized and, when issued, delivered to
and paid for by the Underwriter referred to in the Registration
Statement, will be validly issued, fully paid and nonassessable.

We express no opinion with respect to laws other than those of the State of
Minnesota and the federal law of the United States of America, and we assume no
responsibility as to the applicability thereto, or the effect thereon, of the
laws of any other jurisdiction.

We hereby consent to the filing of this opinion as Exhibit 5.1 to the
Registration Statement to its use as part of the Registration Statement, and to
the use of our name under the caption "Legal Matters" in the Prospectus
constituting a part of the Registration Statement.
<PAGE>
Bio-Vascular, Inc.
August 28, 1995
Page 2

We are furnishing this opinion to the Company solely for its benefit in
connection with the Registration Statement as described above. It is not to be
used, circulated, quoted or otherwise referred to for any other purpose. Other
than the Company, no one is entitled to rely on this opinion.

Very truly yours,

/s/ Oppenheimer Wolff & Donnelly
- --------------------------------
OPPENHEIMER WOLFF & DONNELLY

<PAGE>

EXHIBIT 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the inclusion and incorporation by reference in this
registration statement on Form S-3 of our report dated December 16, 1994,
except for the last paragraph of Note 6, as to which the date is January 2,
1995, on our audits of the consolidated financial statements of Bio-
Vascular, Inc. as of October 31, 1993 and 1994, and for the years then
ended and on our audit of the financial statements of Vital Images,
Incorporated for the year ended December 31, 1992 and the combination of
such financial statements with those of Bio-Vascular, Inc. for the year
ended October 31, 1992, after restatement for the 1994 pooling-of-interest.
We also consent to the reference to our Firm under the captions "Selected
Consolidated Financial Data" and "Experts."

COOPERS & LYBRAND L.L.P.

Minneapolis, Minnesota
August 28, 1995

<PAGE>

EXHIBIT 23.2

INDEPENDENT AUDITORS' CONSENT

We consent to the use in this Registration Statement of Bio-Vascular, Inc.
on Form S-3 of our report dated December 11, 1992, included in and
incorporated by reference in the Annual Report on Form 10-K of Bio-
Vascular, Inc. for the year ended October 31, 1994, and to the use of our
report dated December 11, 1992, appearing in the Prospectus, which is part
of this Registration Statement. We also consent to the reference to us
under the headings "Selected Consolidated Financial Data" and "Experts" in
such Prospectus.

DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
August 28, 1995