BIO VASCULAR INC, 10-K, 1999-01-29

BIO VASCULAR INC
10-K, 1999-01-29
ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the fiscal year ended October 31, 1998

[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the transition period from ___ to ____

Commission file number: 0-13907

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BIO-VASCULAR, INC.
(Exact name of Registrant as specified in its charter)

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Minnesota 41-1526554

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(State of Incorporation) (I.R.S. Employer Identification No.)

2575 UNIVERSITY AVENUE, ST. PAUL, MINNESOTA 55114-1024
(Address of principal executive offices)

TELEPHONE NUMBER: (651) 603-3700

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

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value
Common Stock Purchase Rights

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

Indicate by check mark whether the Registrant (1) has filed all reports required

to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during

the preceding 12 months (or for such shorter period that the Registrant was

required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of January 20, 1999, 9,350,561 shares of Common Stock of the Registrant were
outstanding, and the aggregate market value of the Registrant's outstanding
Common Stock (based upon the last reported sale price of the Common Stock on
that date by the Nasdaq National Market), excluding shares owned beneficially by
executive officers and directors, was approximately $30,032,782.

Parts I and II of this Annual Report on Form 10-K incorporate by reference
information (to the extent specific sections are referred to herein) from the
Registrant's Annual Report to Shareholders for the fiscal year ended October 31,
1998 (the "1998 Annual Report"). Part III of this Annual Report on Form 10-K
incorporates documents incorporated by reference (to the extent specific
sections are referred to herein) from the Registrant's Proxy Statement for its
Annual Meeting of Shareholders to be held February 23, 1999 (the "1998 Proxy
Statement").
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Tissue-Guard(TM), Supple Tissue-Guard(TM), Peri-Strips(R), Peri-Strips Dry(TM),
PSD Gel(TM), Dura-Guard(R), Vascu-Guard(R), Supple Peri-Guard(R), Peri-Guard(R),
CV Peri-Guard(TM), Ocu-Guard(TM), Biograft(R), Flo-Rester (R), Bio-Vascular
Probe(R) and Flo-Thru Intraluminal Shunt(TM) are trademarks of the Company.

Forward-Looking Statements

Certain statements contained in this Annual Report on Form 10-K include
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. For this purpose, any statements contained in
this Form 10-K that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, words such as "may",
"will", "expect", "believe", "anticipate", "estimate" or "continue" or the
negative or other variations thereof or comparable terminology are intended to
identify forward-looking statements. All forward-looking statements in this
document are based on information available to the Company as of the date
hereof, and the Company assumes no obligation to update any forward-looking
statements. Such statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results to differ materially from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such factors may include, among others, the risk
factors set forth in the section below entitled "Important Factors".

PART I

ITEM 1 -- Business

(a) General Development of Business

Introduction

Bio-Vascular, Inc. ("Bio-Vascular" or the "Company") develops, manufactures and
markets branded proprietary and patented specialty medical products for use in
thoracic, cardiac, neuro, vascular and ophthalmic surgery. The Company's branded
products include the Tissue-Guard product line, the Biograft peripheral vascular
graft, and surgical productivity tools used in cardiac and vascular surgery. The
Tissue-Guard product line includes Peri-Strips, Peri-Strips Dry, Dura-Guard,
Vascu-Guard, Supple Peri-Guard, Peri-Guard, Tissue-Guard, Supple Tissue-Guard,
CV Peri-Guard and Ocu-Guard. Tissue-Guard products are made from bovine
pericardium (the thin membrane surrounding the heart of cattle) processed using
proprietary tissue-fixation technology. The Tissue-Guard products, made in
various configurations, 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.

Through the Company's wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc.
("Jer-Neen"), the Company is a value added original equipment manufacturer
("OEM") of micro precision wire-based component products including precision
coils, stylets and related wire products, and guidewire components and
subassemblies used in implantable defibrillation, interventional medicine and
other surgical applications within the medical industry. The Company acquired
Jer-Neen in July 1998.

History

Bio-Vascular was incorporated in July of 1985. Through 1985 and 1986 the Company
acquired the rights to certain cardio-vascular products, including Peri-Guard
and Flo-Rester. In 1985, the Company was spun-off to the shareholders of its
then parent company, thereafter operating as a separate public company

In 1994, the Company's branded products segment introduced Peri-Strips
staple-line buttress for use in lung surgical procedures, primarily lung volume
reduction surgery ("LVRS".) Sales from Peri-Strips fueled significant revenue
growth for the Company from late 1994 through fiscal 1995, increasing from
$685,000 in fiscal 1994 to $5,500,000 in fiscal 1995. In January 1996, the
Health Care Financing Administration ("HCFA"), the agency of the U.S. Government
that controls Medicare, made a non-coverage decision regarding LVRS. (See
Narrative Description of Business - Third Party Reimbursement on Page 12 of this
Report.) This decision by HCFA adversely affected the Company's domestic
revenues from Peri-Strips. Peri-Strips revenue steadily decreased through fiscal
1996 and 1997. Fiscal 1996 revenues dropped 22% to $4,300,000 and experienced a
further decrease in fiscal 1997 to $2,900,000. Led primarily by strong
international sales, revenues from Peri-Strips totaled $3,200,000 in fiscal
1998, representing an 11% increase over fiscal 1997. Since the HCFA decision,
the Company

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has focused increased efforts on its Research and Development projects resulting
in a number of new Tissue-Guard product line extensions and identification of
new product development opportunities. (See Research and Development on Page 11
of this Report.)

Also in 1994, the Company acquired Vital Images, Inc. ("Vital Images"), a
company involved in the development of software for three-dimensional
visualization and analysis of image data. In 1997, the Company completed the
spin-off distribution of all the shares of Vital Images to the shareholders of
Bio-Vascular, with Vital Images thereafter operating as an independent company,
with its own publicly traded securities. The distribution was effected in order
to allow each company to maximize its individual strategic opportunities, as the
direction of Vital Images' business had begun to diverge from the core medical
device business of Bio-Vascular.

In July 1998, the Company completed the acquisition of Jer-Neen. This
acquisition broadens the Company's participation in the medical device industry,
increases the immediate and long-term revenue potential and achieves a balance
of market opportunities consistent with the strategic objectives targeted by the
Company.

Bio-Vascular's principal executive offices are located at 2575 University
Avenue, St. Paul, Minnesota 55114-1024. The Company can be contacted by
telephone at (651) 603-3700, by facsimile at (651) 642-9018, or by electronic
mail at [email protected]. Jer-Neen has its principal office and
manufacturing facility located at 475 Apollo Drive, Lino Lakes, Minnesota 55014.
Jer-Neen can be contacted by telephone at (651) 792-2800 or facsimile at (651)
792-2801.

(b) Financial Information About Industry Segments

The information under the caption "Segment Information" on page 23 in the
Company's 1998 Annual Report is incorporated herein by reference.

The table below summarizes the revenue contributed by the Company's significant
products or product lines for the periods indicated. The component products
segment is included in the fiscal 1998 financial results only for that portion
of the fiscal year commencing on the July 31, 1998 acquisition date.

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Revenue Contribution by Significant Product Years Ended October 31,
or Product Line:
(In thousands) 1998 % 1997 % 1996 %
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<S> <C> <C> <C> <C> <C> <C>
Tissue-Guard Products:
Peri-Strips and Peri-Strips Dry $3,233 27% $ 2,915 30% $ 4,366 43%
Dura-Guard 2,204 18% 1,832 19% 1,410 14%
Other Tissue-Guard Products 2,384 20% 2,020 21% 1,534 15%
Surgical Productivity Tools 2,051 17% 2,127 22% 1,907 19%
Biograft 748 6% 800 8% 938 9%
Component Products 1,397 12% - - - -
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Total Net Revenue $12,017 100% $ 9,694 100% $10,125 100%
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</TABLE>

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Products, Markets and Competition

Description of the Branded Products Segment

The following table summarizes the Company's branded product lines and
associated products, and describes procedures in which such products are used.

<TABLE>
<CAPTION>
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Product Line Product Application/Representative Procedure
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<S> <C> <C>
Tissue-Guard Peri-Strips Stapling buttress for sealing air leaks in lung volume reduction/lung
resection procedures and prothesis for the repair of soft tissue
deficiencies
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Peri-Strips Dry Stapling buttress for sealing air leaks in lung volume reduction/lung
resection procedures
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Vascu-Guard Vascular patch used in carotid endarterectomy and other peripheral
vascular procedures when the artery must be repaired
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Dura-Guard Repair patch used to seal the dura mater in neurosurgeries
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Peri-Guard Tissue patch used for pericardial closure and soft tissue repair
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Supple Peri-Guard More "supple" tissue patch used for pericardial closure and soft tissue
repair
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CV Peri-Guard Tissue patch used for intracardiac patching and great vessel repair in
adults
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Ocu-Guard Opthalmic wrapping material used in enucleation procedures
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Surgical
Productivity Tools Bio-Vascular Probe Tool used to locate arterial blockage in surgical bypass procedures
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Flo-Rester Internal vessel occluder used in coronary artery bypass graft surgery
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Flo-Thru Intraluminal
Shunt Internal vessel stent used during minimally invasive cardiac surgery
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Other Biograft Peripheral vascular bypass graft used in lower limb vascular
reconstruction
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</TABLE>

Tissue-Guard Product Line

The Company's core competency in its branded products business 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 autologous tissue requires the surgeon to excise the
tissue from 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 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 surgical costs
and improving patient outcomes. The Company's branded tissue-based products are
designed to meet the medical need to repair or reconstruct human tissue, repair
vessels and reinforce surgical staple or suture lines to prevent the leaking of
air, blood or other body fluids.

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The Company's Tissue-Guard products are 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 allowing the Tissue-Guard product to integrate into the host
tissue. The Company believes this integration enhances the long-term tensile
strength (the maximum stress a material subjected to a stretching load can
withstand without tearing) of the products in the Tissue-Guard product line.

The bovine pericardium is processed using proprietary and patented
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. 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 four 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.

Peri-Strips and Peri-Strips Dry

Peri-Strips and Peri-Strips Dry soft tissue stapling buttresses are primarily
used in LVRS for late-stage emphysema patients but are also used for lobectomy
(removal of a lobe), excision and destruction of a lesion and segmental
resection of the lung. These products provide for reapproximation and
reinforcement of the surgical staple line to prevent air leaks at the site.
Peri-Strips and Peri-Strips Dry are customized to fit disposable, reusable and
endoscopic staplers of varying sizes made by a variety of manufacturers.

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 and more difficult. Persons with late-stage
emphysema eventually become incapable of 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 often 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, although less expensive than surgical alternatives,
offer only temporary relief and become less effective as the disease progresses.
Lung transplantation is the only known cure for emphysema. This procedure 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. Lung transplant procedures, like other transplant
procedures, are extremely expensive.

LVRS is an alternative to traditional emphysema treatment such as medical
therapy or lung transplant. In LVRS, the surgeon uses a stapling device to
remove sections of damaged tissue, typically 20% to 30% of each lung. By
removing the most diseased tissue, the remaining lung tissue has room to expand,
improving breathing capacity by enabling the diaphragm muscles to regain their
function and allow the rib cage and diaphragm to return to their normal size and
state. In 1994, Dr. Joel Cooper, a pioneer in lung transplant surgery, modified
LVRS using strips of Supple Peri-Guard to reinforce the staple line to prevent
air leakage at the staple-line. Peri-Strips and Peri-Strips Dry were developed
to suit the types of surgical staplers most commonly used in LVRS. While LVRS is
not a cure for emphysema, the results from the procedure to date are very
encouraging based on the peer-reviewed published literature. Generally, the
literature shows that patients undergoing the procedure have reduced shortness
of breath, improved exercise tolerance and improved quality of life.

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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. 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. The dura, the fibrous layer
below the skull which protects the brain and spinal cord must be cut with a
scalpel or scissors and resected to expose the brain during these procedures.
After the specific brain condition has been treated by the surgeon, the dura
must be closed to prevent leakage of cerebral spinal fluid. While the dura is
frequently closed with direct suture, surgeons who consider the prevention of
fluid leakage to be critical to the outcome of the operation will use a dural
repair patch.

Dura-Guard is designed to close dural incisions by fusing with the patient's
dura but with little or no adhesion (an abnormal union between two tissue
surfaces not intended to be joined) to the underlying brain cortex, a
complicating factor following any cranial surgery. Studies commissioned by the
Company 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 cerebral spinal fluid.

Vascu-Guard

Vascu-Guard, a vascular repair patch, is primarily used in carotid
endarterectomy and other peripheral vascular procedures in which an artery must
be repaired and closing the vessel without a patch is not deemed sufficient.
Carotid endarterectomy is a surgical procedure used to remove atherosclerotic
plaque build-up in carotid arteries, the principal arteries located in the neck
that supply blood to the brain.

The build-up of atherosclerotic plaque (fat deposits with a proliferation of
fibrous connective cells along the artery walls) in the carotid arteries
increases the risk of stroke. A substantial portion of strokes is 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 early indications of atherosclerotic plaque build-up.
If the condition progresses to a point where drug therapy is not effective,
surgical intervention is often required

Although the artery often can be closed without a patch, use of a patch is often
suggested to expand the artery, and encourage greater blood flow. Certain
patients require patching due to the small size of their carotid arteries, or to
decrease the incidence of post-operative occlusion. The Company has commissioned
studies that have shown that Vascu-Guard supports endothelialization (growth of
a cell layer normally lining the interior of blood vessels) and that 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 a surgeon to readily verify
normal blood flow after implantation.

Ocu-Guard

Ocu-Guard, an orbital implant wrap, is used in enucleation (removal of the eye)
surgery. Enucleation is a common procedure, which removes a patient's eye as a
result of trauma, malignancy or end-stage diseases such as glaucoma or diabetes.
Following enucleation surgery, a patient commonly receives an orbital implant
from which the visible prosthetic eye is attached. The implant used in the
majority of these procedures requires a soft-tissue wrap, such as Ocu-Guard.

Ocu-Guard is manufactured in convenient, preformed configurations to fit the
most common orbital implant sizes. The preformed configuration reduces implant
preparation time, provides ease of insertion and a snug fit around the implant.
Ocu-Guard has excellent handling characteristics allowing for ease of suturing.
Ocu-Guard also has strength and durability for suture retention necessary for
muscle reattachment, which provides the tracking capabilities of the prosthetic,
eye and also promotes vascular in-growth again promoting the tracking or
motility capabilities of the prosthesis.

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CV Peri-Guard

CV Peri-Guard, an intracardiac repair patch, is used in a variety of surgical
procedures performed on the heart. Specific procedures in which CV Peri-Guard is
used include aortic and atrial patching, atrial and ventricular septal defect
repair, valve annuloplasty, and ventricular aneurysm repair. The Company's
Peri-Guard products have over a 15 year history of clinical use as a cardiac
patch, but cardiac indications for use under the Company's FDA marketing
clearance were previously limited to pericardial closure. With CV Peri-Guard,
marketing clearance was sought from the FDA for a much broader range of cardiac
uses and specifically for intracardiac repair. CV Peri-Guard is the first
biological product cleared by the FDA for intracardiac patching.

Biograft

Biograft, a peripheral vascular graft manufactured from human umbilical veins,
is indicated for use in lower limb vascular reconstruction when a saphenous vein
is not available. 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, bio-synthetic materials or tissue-based grafts, such as
Biograft.

Biograft offers advantages over competitive vein grafts produced from synthetic
materials 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 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 placed around the graft allows for easier
handling and promotes tissue integration for strength and stability.

Surgical Productivity Tools: Flo-Rester, Flo-Thru Intraluminal Shunt and Bio-
Vascular Probe

Flo-Rester, a vessel occluder, is manufactured from medical grade silicone.
Flo-Rester products are designed to interrupt blood flow. In surgical procedures
where continual blood flow is not required, Flo-Rester provides a stented,
blood-free, operative site during surgery. 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 can obstruct
the surgeon's view of the operative site and interfere with precise suturing.
Flo-Rester consists of a flexible shaft with small bulbs at each end that are
inserted into the blood vessel to stop the blood flow at the point where the
artery bypass is sutured to the artery.

Flo-Thru Intraluminal Shunt is intended for use in minimally invasive beating
heart cardiac procedures where the patient is not placed on a heart / lung
bypass machine. The device enables a surgeon to perform a safe, easy and precise
anastomosis during coronary artery bypass by facilitating a bloodless, stented
operative field while maintaining distal blood flow. Flo-Thru Intraluminal Shunt
is a single-piece radiopaque silicone tube with atraumatic bulbs, of varying
size, on either ends of the silicone tube. Similar to Flo-Rester, a radiopaque
tab identifying the outer diameter of the bulbs is attached to the shunt by a
tether, which is used to facilitate positioning and removal.

Bio-Vascular Probe is a flexible shaft with varying sizes of bulbous tips on
either end. Surgeons use Bio-Vascular Probes to locate occlusions or blockages
in arteries and to ascertain the blood flow characteristics of arteries. A
Bio-Vascular Probe is inserted and fed into an artery. When the tip of the probe
meets resistance, the surgeon is

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able to identify the exact location of the occlusion. The probe is then
extracted and a bypass is completed below the occlusion. In addition, a
Bio-Vascular Probe can be used to atraumatically lift the edge of the incision
to assist the surgeon in the accurate placement of sutures.

Competition

The Company's branded products compete primarily on the basis of product
performance, service and price. 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 by centralizing and consolidating their
purchasing functions.

Competition with Tissue-Guard products is primarily from synthetic materials,
other biological tissues and cadaver tissue. The ability of these alternative
products to compete with Tissue-Guard products varies based on each such
product's indication for use, relative feature benefits and surgical preference.
There can be no assurance that competing products will not achieve greater
acceptance or that future products developed by competitors will not offer
similar or enhanced performance advantages relative to the Tissue-Guard
products.

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 and effective in procedures, the Company faces significant price
competition for its Tissue-Guard products. Other multi-purpose patches made from
bovine and other types of animal tissue that compete with the Company's
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. The Company believes that the collagen characteristics exclusive
to tissue, the special configuration of its Tissue-Guard products and the
proprietary and patented tissue-fixation technology it employs offers
significant product performance and it intends to continue to compete on these
bases.

Alternative treatments and competitive products to 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 Biograft, or synthetic grafts made
from PTFE produced by W. L. Gore & Associates, Inc., IMPRA, Inc. or other grafts
made of bio-synthetic materials.

Description of the Component Products Segment

The component products segment produces critical micro components primarily from
wire materials, which it supplies on an OEM basis according to customer
specifications. These products include micro precision coils, stylets and
related wire products and guidewire components and subassemblies. Each of these
component categories comprises approximately one third of the segment's revenues
and all component products are produced to customer specification.

Micro precision coils

Micro precision coils are precision wire components, comprised normally of
several strands of specialty wire materials wound into specific configurations.
These coils are manufactured utilizing proprietary processes and typically
involve the use of specialty metals such as medical grade stainless steel,
silver, platinum, and other similar metals. These micro coils are used to either
carry the electrical current required for operation of a medical device or to
guide the installation of the device.

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Stylets and related wire products

Stylets and related wire products are produced primarily from medical grade
stainless steel and through the use of proprietary processes. This product
category also includes some plastic components. Stylets are typically used in
the placement of cardiovascular and vascular devices within the patient's body.

Guidewire components and subassemblies

Guidewire components and subassemblies are manufactured through a combination of
the above processing techniques and from the above materials, plus the
application of one critical, but adapted, grinding process. A guidewire is
typically used at the beginning of a surgical procedure to locate and provide a
channel for the placement of the diagnostic or therapeutic device involved.

There are two significant trends affecting the growth and development of the
Company's component product business. The first is the rapidly growing use of
implantable defibrillation devices in the treatment of sudden cardiac death. The
second trend is the development of less invasive diagnostic and therapeutic
procedures in the cardiovascular and interventional medicine segments. These
procedures require improved diagnostics, therapies, and placement of medical
devices such as stents. Significant international markets also exist in Europe
and Japan.

The primary companies involved in the industry segments mentioned above include
Medtronic, Inc., Guidant Corporation, the St. Jude Medical and Sulzer
Intermedics. In addition, numerous early stage companies are pursuing new
technologies in cardiovascular and interventional medicine, especially
neurological intervention. The Company anticipates that the cardiovascular and
interventional medicine industry will continue to experience significant
consolidation with the acquisition of earlier stage companies by the major
industry participants. The Company believes that this consolidation will not
hinder its component products segment growth opportunity as the major
participants continue to seek multiple supply sources for critical device
components such as those offered by the Company.

Competition

The component products segment competes on the basis of superior quality of
processes and production, rapid and flexible customer response, and to a modest
degree, price. The component part usually comprises a minor portion of the total
device-level price. Accordingly, vendor performance and responsiveness are
generally more critical factors. There are four primary competitors to the
Company, all of which are privately held. One competitor is substantially larger
than the Company and dominates the industry with annual revenues estimated in
the range of $100,000,000. Given the concentration of the wire component product
industry, the Company believes that medical device customers are generally
motivated to promote healthy competition among their various suppliers in order
to ensure multiple supply sources for their critical device components.

Intellectual Property

Description of the Branded Products Segment

In its branded products business, the Company relies on patents, 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. The Company
owns United States patents related to Peri-Strips, Peri-Strips Dry and
Peri-Guard. The Company also has an exclusive, worldwide, perpetual license to
make, use and sell its Flo-Rester product. The Company currently has a United
States patent pending relating to Ocu-Guard. (See Important Factors -- Risks
associated with Intellectual Property on Page 15 of this Report.)

Description of the Component Products Segment

In its component products business, the Company practices strict trade secret
discipline with all employees, consultants, customers and other parties. A
non-disclosure protocol is maintained on behalf of each of its customers,
consistent with the highly competitive nature of these customers at the base
device-level. The technology and equipment utilized in the manufacturing process
is a combination of proprietary know-how, and the adaptation

9
<PAGE>

of and development utilizing readily-available equipment.

Marketing and Customers

Description of the Branded Products Segment

The Company's branded products strategy is to ensure that the Company has
products of superior quality supported by innovative and effective sales and
marketing programs. These programs include surgical trade shows, support of the
gathering, publication and presentation of clinical data and new product
information by key physicians and the development of strategic physician
alliances. The sales and marketing strategy of the Company also includes
developing and maintaining a close working relationship with the hospitals and
surgeons who purchase and use the Company's products in order to assess and
satisfy their needs.

The Company sells its products through a combination of third-party distributors
and independent sales representatives. The Company's marketing and sales
function works closely with these distributors and representatives on the
implementation of marketing strategy and sales assistance including product
knowledge, training and presentation. The Company generally has written
agreements with its distribution partners. These agreements generally impose
limited geographic exclusivity and minimum purchase obligations. These
agreements are typically terminable upon breach of the agreement by the
distributor, including breach of the minimum sales obligations imposed by the
agreement.

The Company's products are sold to hospitals and surgeons worldwide. For the
fiscal years ended October 31, 1998, 1997 and 1996, approximately 22%, 24%, and
22% of the Company's revenue, respectively, were from sales in international
markets. The majority of the Company's international sales are in Europe and
Asia. In fiscal 1998, three domestic distributors accounted for a total of 39%
of the Company's gross revenues, each in excess of 10%. In fiscal 1997 and 1996,
the same three domestic distributors each accounted for more than 10% of the
Company's gross revenue

Description of the Component Products Segment

The component products segment's strategy is to proactively seek significant
partnerships with each of the primary participants in the medical device markets
it serves. The primary marketing strategy is to provide a rapid, flexible and
creative response to customer needs, coupled with state of the art, high quality
production response. The Company utilizes its Technology Center and Rapid
Response Unit for design, development and prototype services. The utilization of
these highly-technical solutions and timely, effective delivery of development
prototypes is believed to provide a key competitive advantage to both the
customer and the component products business. The component products segment has
also achieved ISO 9002 certification as a further demonstration to its customers
of its quality commitment. The segment's internal sales and marketing function
is supplemented by the capabilities of an external third party sales
representative group.

Information Regarding Both Segments

Backlog

The branded products segment normally does not experience significant backlogs.
Because the component products business is "build-to-order", the component
products segment typically has firm customer orders awaiting manufacture and
future release. The component products order backlog was $1,051,000 at October
31, 1998 as compared to $996,964 at October 31, 1997. The component products
segment does not expect any difficulty fulfilling these backlog orders within
fiscal 1999. The Company does not believe that its backlog is a meaningful
indicator of its future business in the component products segment.

Raw Materials

The Company acquires bovine pericardium for use in the Tissue-Guard product line
from United States Department of Agriculture ("USDA") inspected meat packing
facilities. The Company acquires human umbilical cords for use in Biograft from
various hospitals throughout the United States. The supply of wire, plastics and
plastic components required for the branded surgical productivity tools and
component products is currently adequate. The Company has not experienced any
product shortages arising from interruptions in the supply of any raw materials
or

10
<PAGE>

components, and has identified alternative sources of supply for significant raw
materials and components.

Research and Development

The Company is focusing its research and development expenditures on branded
product opportunities utilizing existing and newly developed technological
expertise in the processing of biological tissues. Current branded development
efforts, at this time, are primarily directed towards a stent covering utilizing
biological tissue and a small diameter graft. In addition, the Company is
committed to the design and engineering of product opportunities within the
component product business. The Company's research, development and engineering
staff consists of four scientists, four engineers, and four technicians. The
Company also expands its research and development activities through the use of
external consultants and research centers' staff and facilities on an as-needed
basis, typically related to pre-clinical studies. The Company spent
approximately $1,548,000, $1,258,000 and $909,000 on research and development in
fiscal 1998, 1997 and 1996, respectively.

The Company is developing a biological tissue stent covering that is responsive
to the technical challenges encountered in the medical industry related to
covering stents, the devices used to hold open blood vessels in certain
angioplasty procedures. The objective of the Company's covering technology is to
produce the ideal tissue profile for use in a broad range of stent applications.
The Company is undertaking a pre-clinical study regarding the use of its
biological tissues as a stent covering with the first preliminary results
expected to take up to six months.

The Company restructured its research and development function and redefined its
leadership, which has resulted in new explorations of the scientific challenges
that were experienced with previous small diameter graft models. The Company has
now developed new technology which may provide better patency outcomes,
addressing certain critical questions identified with the prior graft model.
However, continued research and development efforts are required to deal with a
remaining technological question before the Company can commence pre-clinical
studies. The small diameter graft is anticipated to have both peripheral and
coronary applications.

The Company also targets research resources to the design and engineering of
development stage solutions to meet its component products customers'
specifications. This is a partnership to resolve problems and achieve high
performance solutions, typically occurring when the customer's program is
entering the prototype stage. The component products business provides creative,
highly technical solutions and effective iterative prototype services as the
manufacturing design is developed and refined. The design rights to the
components produced by the segment accrue to the customer in the vast majority
of cases.

Governmental Regulation

General

Food and Drug Administration

FDA regulations classify medical devices as either Class I, II or III devices,
which are subject to general controls, special controls or pre-market approval
("PMA") requirements, respectively. While most Class I devices are exempt from
pre-market submission, it is necessary for most Class II devices, as well as
some Class I devices to be cleared by a 510(k) pre-market notification prior to
marketing. This establishes 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 the manufacturer to submit a PMA application for a Class III
device 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 and relevant prototype tests, laboratory and
animal studies. It must also contain a

11
<PAGE>

complete description of the device , its components and a detailed description
of the methods, facilities and controls used for manufacturing, including the
method of sterilization. In addition, the submission must include the proposed
labeling, advertising literature and training methods, if applicable. The
process of obtaining PMA can be expensive, uncertain, lengthy and frequently
requires anywhere from one to several years from the date of FDA submission, if
approval is obtained at all. Moreover 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 branded products, Biograft is Class III device.
Biograft received marketing clearance from the FDA pursuant to the PMA process.
All other branded products have all been classified as Class II medical devices
and have received 510(k) marketing clearance from the FDA.

The Company's branded products manufacturing operation is subject to periodic
inspections by the FDA, whose primary purpose is to audit the Company's
compliance with the Quality System Regulations ("QSR") published by the FDA and
other applicable government standards. 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.

International Regulation

International regulatory bodies have established varying regulations governing
product standards, packaging and labeling requirements, import restrictions,
tariff regulations and duties and tax. Many of these regulations are similar to
those of the FDA. In Japan, a potentially significant market for the Company's
branded products, clinical trials of certain branded 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 branded products.
The Company relies on its independent distributors to comply with the majority
of the foreign regulatory requirements, including registration of the Company's
branded 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 branded products are marketed. (See
Important Factors -- Risks Associated with Bovine Tissue Products on Page 16 of
this Report.)

The registration system in the European Union ("EU") for the Company's branded
products requires that the Company's quality system conform with the ISO 9001
international quality standard and that its branded products conform with
"essential requirements" set forth by the Medical Device Directive ("MDD"). The
Company's manufacturing facilities and processes under which the Company's
branded products are produced were inspected and audited by the British
Standards Institute ("BSI") to verify the Company's compliance with the
essential requirements of the MDD. BSI also verified 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 branded products produced by the Company. BSI certified the Company's
conformity with both the ISO 9001 standard and the MDD essential requirements,
entitling the Company to place the "CE" mark on the all the Company's current
branded products, except Biograft which is exempt. (See Important Factors --
Risks Associated with Human Tissue Products on Page 15 of this Report.)

Third Party Reimbursement

The Company's branded products are purchased primarily by hospitals and other
end-users, and its unbranded component products are sold directly to medical
device manufacturers which distribute finished medical devices to hospitals and
other end-users. Hospitals and end-users of such products, in turn, bill various
third party payers for the services provided to the patients. These payers,
which include Medicare, Medicaid, private health insurance plans and managed
care organizations, reimburse all or part of the costs and fees associated with
the procedures utilizing the Company's products.

The availability and level of reimbursement from third-party payers is
significant to the Company's business. For Medicare carriers, HCFA may establish
a national coverage policy, including the amount to be reimbursed, for coverage
of claims submitted for reimbursement related to a specific procedure. Private
health insurance plans and managed care organizations make their own
determinations regarding coverage and reimbursement based either upon "usual and
customary" fees or, increasingly, upon a similar prospective payment system.

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<PAGE>

In January 1996, HCFA made a national policy decision not to reimburse LVRS.
These surgeries had been reimbursed nationwide on a regional basis during fiscal
1994 and 1995. The Company estimates that approximately 70% of the patients
undergoing LVRS in fiscal 1995 were Medicare patients. In April 1996, the
National Institute of Health ("NIH") announced a collaborative study of LVRS
with HCFA. This study, the National Emphysema Treatment Trial ("NETT"), as it is
currently structured is limited to a small number of patients relative to the
number of Medicare dependent patients who would otherwise be eligible for the
LVRS procedure. HCFA and NIH have estimated it will take approximately five
years if the study goes to completion and will include approximately 4,700
Medicare patients, with a little more than half of those receiving the LVRS
procedure. This represents less than 2% of those currently estimated to benefit
from LVRS.

The Company believes that many private insurance companies and managed care
organizations are continuing to reimburse LVRS based on their own evaluation of
the procedure and its outcomes. It is unknown whether these private payers will
change their reimbursement practices in the future. If these private payers
change their reimbursement practices, such action would have a negative impact
on the related sales of the Company's Peri-Strips and Peri-Strips Dry products.

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 payers to curb these costs. The development or increased use of
more cost effective treatments for diseases requiring surgeries currently
utilizing the Company's branded products could cause such payers to decrease or
deny reimbursement for such surgeries or to favor non-surgical alternatives.
There has also been a significant increase in the number of Americans enrolling
in some form of managed care plan. Higher managed care utilization typically
drives down the payments for health care 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 payer measures may have on its future business, financial condition
or results of operations.

Employees

At October 31, 1998, the Company employed approximately 175 full-time and
part-time individuals. The Company's employees are not represented by a union,
and the Company considers its relationship with its employees to be good.

(d) Financial Information About Foreign and Domestic Operations and Export Sales

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Net Revenues by Geographic Area: 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
United States $ 9,388,694 $7,399,237 $ 7,906,109
- -------------------------------------------------------------------------------------------------------------
Europe and Middle East 1,559,038 1,412,675 1,371,867
- -------------------------------------------------------------------------------------------------------------
Asia and Pacific Region 824,895 666,201 623,884
- -------------------------------------------------------------------------------------------------------------
Other 244,752 215,934 222,849
- -------------------------------------------------------------------------------------------------------------
Total Revenues $12,017,379 $9,694,047 $10,124,709
- -------------------------------------------------------------------------------------------------------------
Percent of International Revenues to Total Net Revenues 22% 24% 22%
- -------------------------------------------------------------------------------------------------------------
</TABLE>

The Company operates primarily in the United States, Europe and Asia. Revenues
are attributed to countries based on the location of the customer. All of the
Company's assets are located in the U.S.

ITEM 1A -- Important Factors

The following factors are important and should be considered carefully in
connection with any evaluation of the Company's business, financial condition,
results of operations and prospects. Additionally, the following factors could
cause the Company's actual results to materially differ from those reflected in
any forward-looking statements

13
<PAGE>

of the Company.

Risks Associated with the Acquisition of Jer-Neen

Following the recent acquisition of Jer-Neen, the separate businesses and
operations of Bio-Vascular and Jer-Neen have been continued largely intact, with
each continuing to separately manufacture their branded and component products,
respectively, and serve their respective customers and markets, with Jer-Neen
operating as a wholly owned subsidiary of Bio-Vascular. In making this
acquisition, the Company did not contemplate significant integration of the
separate businesses, operations or systems, nor did the acquisition seek
specific operating efficiencies or synergies as a result of the combination of
the two companies. The success of the combined organization will be dependent
upon the ability of each of these separate businesses to accomplish their
respective strategic growth and profitability objectives.

In connection with the acquisition of Jer-Neen, the Company recorded
intangibles, including goodwill, of approximately $6,600,000. The Company will
amortize these intangibles over lives of up to 15 years, and therefore the
related amortization will reduce the Company's pre-tax operating income.

Limitations on Third-Party Reimbursement

The Company's branded products are purchased primarily by hospitals and other
end-users, and its unbranded component products are sold directly to medical
device manufacturers who distribute finished medical products to hospitals and
other end-users. Hospitals and end-users of such products, in turn, bill various
third-party payers, including 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. Third-party payers
may deny reimbursement if they determine that a product used in a procedure was
not used in accordance with established third-party payer protocol regarding
treatment methods or was used for an unapproved indication.

Third-party payers 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
payers. There can be no assurance that procedures in which the Company's
products are directly or indirectly used will continue to be considered
cost-effective by third-party payers, that reimbursement for such procedures
will be available or, if available will continue, or that third-party payers'
reimbursement levels will not adversely affect the Company's ability to sell its
products on a profitable basis. The costs of health care have risen
significantly over the past decade, and there have been, and may continue to be,
proposals by legislators, regulators and third-party payers to curb these costs.
Failure by hospitals and other end-users of the Company's products to obtain
reimbursement from third-party payers, changes in third-party payers' policies
towards reimbursement for procedures directly or indirectly 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.

As discussed above, in January 1996, HCFA made a national policy decision not to
reimburse LVRS, which had been a primary use for the Company's Peri-Strips
product prior to the decision. The Company understands that many private payers,
insurance companies and managed care organizations are continuing to reimburse
LVRS based on their own evaluation of the procedure and its outcomes. The
Company estimates that 80% of its domestic revenues from the sale of Peri-Strips
result from the use of Peri-Strips in LVRS. It is unknown whether these private
payers will change their reimbursement practices in the future. If these private
payers change their reimbursement practices, it could have a material, adverse
impact on the Company's business, financial condition and results of operations.

Highly Competitive Industries and Risk of Technological Obsolescence

The Company faces intense competition. The medical products industry is 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. Additionally, the success of the Company's
component business will depend on the ability of its customers to maintain a
competitive position with their technology. There can be no assurance that the
Company will be able to compete effectively in the marketplace or that products
developed by its competitors, or developed by competitors of its component
business customers, will not render the Company's products obsolete or non-

14
<PAGE>

competitive. Similarly, there can be no assurance that these 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
products currently marketed or to be developed by the Company or its component
business customers.

Several established companies manufacture and sell products which compete with
all of the Company's products. Some of 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 or component supply contracts and the ability to offer
comprehensive pricing for their products, including those that compete with the
Company's products. Competitors who offer broad product lines may also have a
significant advantage in competing with the Company's branded products for sales
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.

Risks Associated with Intellectual Property

The Company protects its technology through trade secrets, proprietary know-how
and 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 (although Peri-Guard is protected by
patent). 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. Additionally, 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 does not, or 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 enforcement, 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 and results of operations.

Risks Associated with Human Tissue Products

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, regulations drafted by the
FDA have outlined requirements for tissue banks. Although the current
regulations have specifically excluded from regulation medical devices subject
to FDA review, including preserved umbilical cord vein grafts such as Biograft,
proposed rules indicate that medical devices containing human tissue products
may be subject to additional controls. As a result, Biograft may be subject to
additional regulations in the United States and the related expensive donor
screening and donor testing procedures. However, it is uncertain when the FDA
impose these additional regulatory requirements on Biograft or that Biograft
would be able to meet any such new requirements.

15
<PAGE>

The long-term future regulatory environment for Biograft in Europe is uncertain.
The MDD issued by the EU explicitly excludes medical devices from human tissue;
however, there is an effort developing to include such devices under a
comprehensive regulatory program. This effort is in the early stages; the
Company understands that a consensus on such a directive could take several
years. 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 a regulatory program. Biograft accounted for 7% and 8% of the
Company's net revenue for the years ended October 31, 1998 and 1997,
respectively.

Risks Associated with Bovine Tissue Products

Bovine Spongiform Encephalopathy ("BSE") has been endemic in cattle in the
United Kingdom and has received much publicity in Europe regarding beef for
dietary consumption. Under the direction of the USDA, the U.S. government has
had an active program of surveillance and import controls since the late 1980's,
designed to prevent the introduction of BSE into U.S. cattle. To date all
evidence indicates that U.S. cattle are free of BSE. The Company obtains all of
its raw pericardium for its Tissue-Guard products from USDA-inspected
slaughterhouses. The Company cannot predict whether or not a case of BSE may
someday be reported in the United States. If a case of BSE were reported in U.S.
cattle, it could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company's notified body under
the MDD, the BSI, and French authorities have specifically reviewed Tissue-Guard
sourcing and manufacturing processes and have then certified the Company's
bovine pericardium products. Although the Company does not anticipate that
countries will prohibit the sale of Tissue-Guard products as a result of
concerns related to BSE, such prohibition by certain countries could have a
material adverse effect on the Company's business, financial condition and
results of operation.

Governmental Regulation

The medical device industry in which the Company's branded products segment and
the customers of the Company's component product segment operate is subject to
extensive and rigorous regulation by the FDA and by comparable agencies in
foreign countries. In the United States, the FDA regulates the introduction,
manufacturing, labeling and record keeping procedures for medical devices,
including the Company's branded products and medical devices incorporating the
Company's component products. 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
branded products and devices incorporating component products that are in the
research and development stage may be subject to a lengthy and expensive 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 branded products or medical devices
incorporating the Company's component products, and has the power to require the
recall of such products, if indicated. If enacted, proposed regulations
currently under consideration by the FDA could also adversely impact the use and
marketing of certain of the Company's branded 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 and various state and foreign regulatory agencies inspect the Company
and its manufacturing facilities for branded products from time to time to
determine whether the Company is in compliance with 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, depending on the
nature of the violation.

International regulatory bodies have established varying regulations governing
product standards, packaging and labeling requirements, import restrictions,
tariff regulations, duties and tax requirements. In Japan, a potentially
significant market for the Company's branded products, clinical trials of
certain of the Company's branded products are required before such products can
be cleared for sale in the Japanese market. The Company relies on independent
distributors to comply with such foreign regulatory requirements. As a result,
communication between foreign regulatory agencies and the Company is indirect as
it occurs through the foreign distributor. The inability or failure of
independent distributors to comply with the varying regulations or the
imposition of new regulations

16
<PAGE>

could restrict such distributors' ability to sell the Company's branded products
internationally and thereby adversely affect the Company's business, financial
condition and results of operations.

The registration process in the EU for the Company's branded products requires
that the Company's quality system conform with the ISO 9001 international
quality standard and that its branded products conform with "essential
requirements" set forth by the MDD. Compliance with these requirements will
allow the Company to issue a "Declaration of Conformity" and apply the CE mark
to branded products, allowing free sale in the EU. While the Company has
obtained the "CE" mark for all of its current branded products (except for
Biograft, which is exempt), there can be no assurance that the Company will be
able to maintain compliance with the regulations to retain the CE mark. In
addition, there can be no assurance that the Company will be successful in
obtaining the CE mark for new product introductions. Devices incorporating the
Company's component products are also subject to these requirements, and there
can be no assurance that the Company's component business customers will be
successful in obtaining or maintaining compliance with the EU regulatory process
for their current or future products.

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. In particular, the Company's principal branded and a
significant portion of its component products are designed to be permanently
placed in the human body, and production or other errors could result in an
unsafe product and injury to the patient. The Company maintains product
liability insurance coverage on a claims-made basis with an annual aggregate
limit of $7 million, subject to an annual aggregate self-insured retention of
$250,000. Although the Company believes these amounts 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. 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 Domestic and International Distributors and Sales Representatives

Sales to both domestic and international distributors and sales representatives
constitute a significant portion of the Company's current business related to
its branded products. For the years ended October 31, 1998 and 1997, three
domestic distributors accounted for an aggregate of 39% and 44%, respectively,
of net revenue, with each of such distributors accounting for in excess of 10%
of the Company's net revenue for those periods. The Company also relies on sales
representative organizations for certain of its domestic branded product
business and relies on a number of distributors for all of its international
branded product business. There can be no assurance that the Company will be
able to maintain its relationships with any of its distributors or sales
representatives, or, in the event of termination of any of such relationships,
that a new replacement distributor or sales representative will be found. The
loss of a significant distributor or a significant number of other distributors
or sales representatives could materially adversely affect the Company's
business, financial condition and results of operations if another suitable
sales organization could not be found on a timely basis to serve the relevant
geographic market.

Year 2000 Compliance

The Company and third parties with which the Company does business are
significantly dependent upon information systems and other systems which may be
susceptible to the so-called Year 2000 problem. The Company has initiated
comprehensive internal Year 2000 identification and remediation efforts,
although there can be no assurance that the Company will be able to fully
identify and address all of its internal Year 2000 issues as a result of these
efforts. As a part of its Year 2000 initiatives, the Company intends to request
information from its business partners as to their Year 2000 compliance in order
to assess and mitigate the Company's risks. There can be no assurance, however,
that Year 2000 issues encountered by such parties will not have a material,
adverse effect on the Company's business, financial condition and results of
operations.

17
<PAGE>

Euro Conversion

On January 1, 1999, eleven of the fifteen member countries of the EU are
scheduled to establish fixed conversion rates between their existing sovereign
currencies and the euro, and to adopt the euro as their common legal currency on
that date. The Company currently denominates all of its foreign transactions in
U.S. dollars, and therefore is not presently faced with the task of converting
its information systems and practices to accommodate euro conversion. Euro
conversion is, however, expected to generally increase cross-border price
transparency among the participating countries and result in a more competitive
European market. The Company is uncertain as to the effect, if any, that euro
conversion will have on its ability to sell its products in the European market.
Euro conversion could potentially impact pricing strategies and demand for the
Company's products in the European market, lead to increased competition within
the European market for the specific types of products manufactured and sold by
the Company, or impact the Company's international distributor relationships.
The Company could also potentially be required to denominate future transactions
in the euro and incur currency risk and conversion start-up costs as a result.
There can be no assurance that euro conversion will not have a material, adverse
effect on the Company's business, financial condition and results of operation.

Dependence on Significant Customer

Sales to one customer of the Company's component products business accounted for
approximately 45% of the business segment's revenue for the twelve-month period
ended October 31, 1998. There can be no assurance that the Company will be able
to maintain its relationship with this significant customer, or in the event of
termination of the relationship, that the Company will be able to replace
production levels with new or existing customers. The loss of the significant
customer could materially adversely affect the Company's business, financial
condition and results of operations.

ITEM 2 -- Properties

The Company leases approximately 36,000 square feet of office and manufacturing
space at 2575 University Avenue, St. Paul, Minnesota. The base rent of this
lease, which commenced August 1, 1995 and expires July 31, 2005, is
approximately $255,000 annually. The Company also leases a 25,000 square foot
manufacturing facility at 475 Apollo Drive, Lino Lakes, Minnesota. The base rent
of this lease, which commenced December 1, 1997 and expires five years from that
date, with a subsequent five year option, is approximately $103,000 annually.
The Company pays apportioned real estate taxes and common costs on both leased
facilities. The Company believes that its current space is adequate for the
foreseeable future.

ITEM 3 -- Legal Proceedings

None.

ITEM 4 -- Submission of Matters to a Vote of Security Holders

No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this Report.

18
<PAGE>

ITEM 4A -- Executive Officers of the Registrant

The Company's executive officers, their ages, and their offices held as of
December 31, 1998 are as follows:

Name Age Title
- ---- --- -----
<S> <C> <C>
M. Karen Gilles..................... 56 President, Chief Executive Officer and Director
David A. Buche...................... 37 Vice President of Marketing and Sales
Connie L. Magnuson ................. 37 Vice President of Finance, Chief Financial Officer and
Corporate Secretary
B. Nicholas Oray, Ph.D. ............ 47 Vice President of Research and Development
Thomas J. Pepin..................... 47 Vice President of Operations
James F. Pfau....................... 56 President of Jer-Neen Manufacturing Co., Inc.

</TABLE>

M. Karen Gilles. Ms. Gilles has served as President and Chief Executive Officer
of the Company since July 1997 and as a Director of the Company since August
1997. Prior to July 1997, Ms. Gilles held the positions of Chief Financial
Officer of the Company from December 1990, Vice President of Finance from 1989,
and Secretary of the Company from November 1991. Ms. Gilles served as the
Director of Finance and Administration of the Company from April 1989 to
December 1989. Ms. Gilles also serves on the Board of Directors of Reuter
Manufacturing, Inc.

David A. Buche. Mr. Buche has served as Vice President of Marketing and Sales
since January 1998. Prior to January 1998, Mr. Buche held the positions of
Director of Marketing from November 1997 and Director of International Marketing
and Sales from March 1995. From 1988 to February 1995, Mr. Buche held various
product and sales management positions at Spectranetics Corporation, a company
that develops and markets technology for interventional cardiovascular therapy.

Connie L. Magnuson. Ms. Magnuson joined the Company as Chief Financial Officer
and Vice-President of Finance in November 1997 and has served as Corporate
Secretary since February 1998. From March 1997 to November 1997, Ms. Magnuson
served as Treasurer of Northern Technologies International Corporation. From
1996 to March 1997, Ms. Magnuson served as a private financial consultant. From
1983 to 1996, Ms. Magnuson held a series of positions with Deloitte and Touche
LLP, a public accounting firm, including Audit Senior Manager and Director of
Human Resources for their Minneapolis office.

B. Nicholas Oray, Ph.D. Dr. Oray joined the Company as Vice-President of
Research and Development in April 1998. From 1997 to April 1998, he served as
Director of Research and Development at Seatrace Pharmaceuticals Inc. From 1993
to 1996, Dr. Oray held a series of positions with CryoLife Inc., including
Director of Bioadhesive Manufacturing and Associate Director of Biomedical
Products Laboratory. From 1991 to 1993, he held several positions with F.A.C.T.,
a clinical research organization, including Director of Regulatory Affairs and
Associate Director of Clinical Trials Operations. From 1988 to 1990, Dr. Oray
served as Director of Manufacturing, Director of Sterile Manufacturing and
Director of Purification and Production Group at Carrington Laboratories, Inc.

Thomas J. Pepin. Mr. Pepin joined the company as Vice President of Operations
in January 1998. From June 1995 to December 1998, Mr. Pepin served as Director
of Peripheral Operations at Schneider Inc., a manufacturer of medical stents,
balloon catheters and guide wires. From September 1990 to March 1995 Mr. Pepin
held positions as the Director of Operations and Quality Affairs at Orthomet
Inc., a designer and manufacturer of orthopedic implants. From 1976 to
September 1990, Mr. Pepin held various management positions at Cardiac
Pacemakers Inc., a manufacturer of pacemakers and defibrillators.

19
<PAGE>

James F. Pfau. Upon completion of the Company's acquisition of Jer-Neen in July
1998, Mr Pfau was named President of Jer-Neen, having previously served as
Managing Director of Jer-Neen since October 1994. From 1990 to 1994, Mr. Pfau
was a business consultant and, for a period during that time, served as CEO and
President of a medical software start-up company.

PART II

ITEM 5 -- Market for Registrant's Common Equity and Related Stockholder Matters

The information under the caption "Common Stock Information" on page 24 of the
Company's 1998 Annual Report is incorporated herein by reference.

ITEM 6 -- Selected Financial Data

The financial information in the table under the caption "Financial Highlights"
in the Company's 1998 Annual Report is incorporated herein by reference.

ITEM 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations

The information under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" on pages 9-12 of the Company's
1998 Annual Report is incorporated herein by reference.

ITEM 7A -- Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

ITEM 8 -- Financial Statements and Supplementary Data

The Company's Consolidated Financial Statements and related Notes thereto and
the Report of Independent Accountants in the Company's 1998 Annual Report are
incorporated herein by reference, as is the unaudited information set forth
under the caption "Quarterly Results" in the Company's 1998 Annual Report.

ITEM 9 -- Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

None.

PART III

ITEM 10 -- Directors and Executive Officers of the Registrant

(a) Directors of the Registrant:

The information under the caption "Election of Directors" in the
Registrant's 1999 Proxy Statement is incorporated herein by reference.

(b) Executive Officers of the Registarnt:

Information concerning Executive Officers of the Company is included in
this Report on page 19 under Item 4A, "Executive Officers of the
Registrant".

The information under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the

20
<PAGE>

Registrant's 1999 Proxy Statement is incorporated by reference herein.

ITEM 11 -- Executive Compensation

The information under the captions "Executive Compensation" and "Election of
Directors - Directors' Compensation" in the Registrant's 1999 Proxy Statement
is incorporated by reference herein.

ITEM 12 -- Security Ownership of Certain Beneficial Owners and Management

The information under the caption "Principal Shareholders and Beneficial
Ownership of Management" in the Registrant's 1999 Proxy Statement is
incorporated by reference herein.

ITEM 13 -- Certain Relationships and Related Transactions

The information under the caption "Certain Transactions" in the Registrant's
1999 Proxy Statement is incorporated by reference herein.

PART IV

ITEM 14 -- Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) List of documents filed as part of this Report:

1) Financial Statements, Related Notes and Report of Independent
Accountants:

The following items are incorporated herein by reference from the
pages indicated in the Company's 1998 Annual Report:

Page
----

- Consolidated Balance Sheets as of October 31, 1998 and 1997 13
- Consolidated Statements of Operations for the Years Ended
October 31, 1998, 1997 and 1996 14
- Consolidated Statements of Shareholders' Equity for the
Years Ended October 31, 1998, 1997 and 1996 15
- Consolidated Statements of Cash Flows for the Years Ended
October 31, 1998, 1997 and 1996 16

- Notes to Consolidated Financial Statements 17-23

- Report of Independent Accountants 24

2) Financial Statement Schedules:

The unaudited selected quarterly financial data included under the
caption "Quarterly Results" on page 24 of the Company's 1998 Annual
Report is incorporated herein by reference.

The following financial statement schedule and Report of Independent
Accountants thereon are included herein and should be read in
conjunction with the Consolidated Financial Statements referred to
above (page numbers refer to pages in this Annual Report on Form
10-K):

Page
----
- Report of Independent Accountants on Financial Statement
Schedule 24
- Schedule II - Valuation and Qualifying Accounts 25

21
<PAGE>

All other financial statement schedules not listed have been omitted
because the required information is included in the Consolidated
Financial Statements or the Notes thereto, or is not applicable.

3) Exhibits:

The exhibits to this Annual Report on Form 10-K are listed in the
Exhibit Index on pages E-1 to E-3 of this Report.

The Company will furnish a copy of any exhibit to a shareholder who
requests a copy in writing upon payment to the Company of a fee of
$5.00 per exhibit. Requests should be sent to: Connie L. Magnuson,
Vice President of Finance and Chief Financial Officer; Bio-Vascular,
Inc.; 2575 University Avenue; St. Paul, Minnesota 55114-1024.

The following is a list of each management contract or compensatory
plan or arrangement required to be filed as an exhibit to this Annual
Report of Form 10-K pursuant to Item 14(c):

A. 1988 Stock Option Plan, as amended, (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended April 30, 1992 (File No.
0-13907)).

B. 1995 Stock Incentive Plan, as amended (filed herewith
electronically).

C. Employee Stock Purchase Plan, as amended (incorporated by
reference to Exhibit 10.18 to the Company's Annual Report of
Form 10-K for the year ended October 31, 1997 (File No. 0-
13907)).

D. Form of Change in Control Agreement entered into between the
Company and Ms. Gilles (incorporated by reference to Exhibit
10.28 to the Company's Annual Report on Form 10-K for the
year ended October 31, 1994 (File No. 0-13907)).

E. Form of Change in Control Agreement entered into between the
Company and each of Ms. Connie L. Magnuson and Mr. Thomas J.
Pepin dated January 12, 1998 and Mr. David Buche dated
January 29, 1998 (incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the
period ended January 31, 1998 (File No. 0-139070)).

F. Employment Agreement dated July 31, 1998 among the Company,
Jer-Neen Manufacturing Co., Inc. and James Pfau
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the period ended July 31,
1998 (File No. 0-13907)).

G. Change in Control Agreement dated July 31, 1998 between the
Company and James Pfau (incorporated by reference to Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q for the
period ended July 31, 1998 (File No. 0-13907)).

22
<PAGE>

(b) Reports on Form 8-K:

During the quarter ended October 31, 1998 the Company filed the following
reports on Form 8-K in connection with the acquisition of Jer-Neen:

i) Current Report on Form 8-K, dated July 31, 1998, reporting Item 2 --
Acquisition or Disposition of Assets.

ii) Amendment No. 1 to Current Report on Form 8-K/A, dated July 31, 1998,
reporting Item 2 -- Acquisition or Disposition of Assets and Item 7
-- Financial Statements and Exhibits. Amendment No. 1 indicated that
financial statements and exhibits were not available at the time of
filing, but would be filed within sixty days from the date that the
report was first required to be filed.

iii) Amendment No. 2 to Current Report on Form 8-K/A, dated July 31, 1998,
reporting Item 7 -- Financial Statements and Exhibits. Amendment No. 2
included audited financial statements of Jer-Neen as of and for the
year ended October 31, 1997, unaudited interim financial statements as
of July 31, 1998 and for the nine month periods ended July 31, 1998
and 1997, and pro forma financial information for the year ended
October 31, 1997 and for the nine month period ended July 31, 1998.

iv) Amendment No. 3 to Current Report on Form 8-K/A dated July 31, 1998,
reporting Item 7 -- Financial Statements and Exhibits. Amendment No. 3
included audited financial statements of Jer-Neen as of and for the
year ended October 31, 1997, unaudited interim financial statements as
of July 31, 1998 and for the nine month periods ended July 31, 1998
and 1997, and pro forma financial information for the year ended
October 31, 1997 and for the nine month period ended July 31, 1998.

The response to this portion of Item 14 is included as a separate section
of this Annual Report on Form 10-K.

(d) Financial Statement Schedules:

The response to this portion of Item 14 is included as a separate section
of this Annual Report on Form 10-K.

23
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE

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

Our report on the consolidated financial statements of Bio-Vascular, Inc. as of
October 31, 1998 and 1997, and for each of the three years in the period ended
October 31, 1998 has been incorporated by reference in this Form 10-K from page
24 of the 1998 Annual Report to Shareholders of Bio-Vascular, Inc. In
connection with our audits of such financial statements, we have also audited
the related financial statement schedule included on page 25 of this Form 10-K.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.

PRICEWATERHOUSECOOPERS LLP

Minneapolis, Minnesota
December 8, 1998

24
<PAGE>

SCHEDULE II

- --------------------------------------------------------------------------------
BIO-VASCULAR, INC.
VALUATION AND QUALIFYING ACCOUNTS
- --------------------------------------------------------------------------------

Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period

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

Allowance for doubtful accounts:

Year ended October 31, 1998.... $ 21,400 $112,655 $5,977 $128,078

Year ended October 31, 1997.... 21,400 -- -- 21,400

Year ended October 31, 1996.... 20,000 36,592 35,192 21,400

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

Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period

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

Reserve for obsolete inventories:

Year ended October 31, 1998.... $373,000 $194,263 $87,443 $479,820

Year ended October 31, 1997.... 368,000 116,031 111,031 373,000

Year ended October 31, 1996.... 46,000 354,822 32,822 368,000

25
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

BIO-VASCULAR, INC.

By /s/ M. Karen Gilles
------------------------------------
M. Karen Gilles, President and
Chief Executive Officer
(Principal Executive Officer)

Dated: January 29, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on January 29, 1999 by the following persons on behalf of
the registrant and in the capacities indicated.

/s/ M. Karen Gilles
- ---------------------------------------
M. Karen Gilles
President, Chief Executive Officer and Director

/s/ Connie L. Magnuson
- ---------------------------------------
Connie L. Magnuson
Vice President of Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)

/s/ Timothy M. Scanlan
- ---------------------------------------
Timothy M. Scanlan
Chairman, Board of Directors

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

/s/ Anton R. Potami
- ---------------------------------------
Anton R. Potami, Director

/s/ William G. Kobi
- ---------------------------------------
William G. Kobi, Director

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

26
<PAGE>

BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1998
- --------------------------------------------------------------------------------

2.1 Acquisition Agreement and Plan of Reorganization by and among the Company,
Jer-Neen Acquisition, Inc., Jer-Neen Manufacturing Co., Inc., George
Nelson, Jr., Ronald Breckner, James Pfau, Willard Sykes and Catherine Sykes
dated July 31, 1998 (incorporated by reference to Exhibit 2.1 to the
Company's Quarterly Report on Form 10-Q for the period ended July 31, 1998
(File No. 0-13907)).

3.1 Restated Articles of Incorporation of the Company, as amended,
(incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended April 30, 1997 (File No. 0-13907)).

3.2 Amendment to Restated Articles of Incorporation of the Company, as amended,
dated March 20, 1997 (incorporated by reference to Exhibit 3.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended April 30,
1997 (File No. 0-13907)).

3.3 Amended and Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Registration Statement on Form S-4 (File
No.33-74750)).

4.1 Form of common stock Certificate of the Company (incorporated by reference
to Exhibit 4.1 to the Company's registration statement on Form 10 (File No.
0-13907)).

4.2 Form of Rights Agreement, dated as of June 12, 1996, between Bio-Vascular,
Inc. and American Stock Transfer & Trust Company, which includes as Exhibit
A the form of Rights Certificate (incorporated by reference to Exhibit 4.1
to the Company's Current Report on Form 8-K dated June 12, 1996 (File No.
0-13907)).

4.3 Restated Articles of Incorporation of the Company, as amended (see Exhibit
3.1).

4.4 Amendment to Restated Articles of Incorporation of the Company, as amended,
dated March 20, 1997 (see Exhibit 3.2).

4.5 Amended and Restated Bylaws of the Company (see Exhibit 3.3).

10.1 Agreement dated as of July 31, 1985 among Genetic Laboratories, Inc.,
Vascular Services Diversified, Inc., and the Company, including first
amendment thereto, dated September 25, 1985 (incorporated by reference to
Exhibit 2.1 to the Company's registration statement on Form 10 (File No.
0-13907)).

10.2 Amendment No. 2 to the Agreement referred to in Exhibit 10.1, effective
July 31, 1985 (incorporated by reference to Exhibit 19.1 to the Company's
Quarterly Report on Form 10-Q for the period ended April 30, 1986 (File No.
0-13907)).

10.3 License Agreement dated September 25, 1985 between the Company and Genetic
Laboratories, Inc. (incorporated by reference to Exhibit 10.1 to the
Company's registration statement on Form 10 (File No. 0-13907)).

10.4 Amendment to License Agreement dated June 13, 1986 between the Company and
Genetic Laboratories, Inc. (incorporated by reference to Exhibit 10.4 to
the Company's Current Report on Form 8-K dated June 15, 1986 (File No. 0-
13907)).

10.5 Debt and Royalty Restatement Agreement dated June 16, 1986 among Genetic
Laboratories, Inc., Vascular Services Diversified, Inc. and the Company
(incorporated by reference to Exhibit 19.3 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File No. 0-
13907)).

10.6 Purchase Agreement dated February 17, 1986, between the Company and Genetic
Laboratories, Inc. including Bill of Sale and Assignment (incorporated by
reference to Exhibit 19.4 to the Company's Quarterly Report on Form 10-Q
(File No. 0-13907)).

E-1
<PAGE>

BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1998
- --------------------------------------------------------------------------------

10.7 Purchase and sale agreement dated October 30, 1989 and closed December 28,
1989 between the Company and Meadox Medicals, Inc. (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated
January 11, 1990 (File No. 0-13907)).

10.8 Assignment and Assumption Agreement dated July 31, 1985 between the
Company and Genetic Laboratories, Inc., including the Purchase Agreement
dated June 4, 1984 between Genetic Laboratories, Inc. and Xomed, Inc.
(incorporated by reference to Exhibit 19.5 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File No.
0-13907)).

10.9 Assignment dated June 13, 1986 by Genetic Laboratories, Inc. to the
Company (incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0-13907)).

10.10 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories, Inc.,
to the Company (incorporated by reference to Exhibit 10.2 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0- 13907)).

10.11 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories, Inc.,
to the Company (incorporated by reference to Exhibit 10.3 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0- 13907)).

10.12 Trademark Assignment Agreement dated June 19, 1986 between the Company and
Genetic Laboratories, Inc. (incorporated by reference to Exhibit 19.10 to
the Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).

10.13 Assignment dated June 26, 1986 between the Company and Genetic
Laboratories, Inc. (incorporated by reference to Exhibit 19.11 to the
Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).

10.14 1988 Stock Option Plan, as amended, (incorporated by reference to Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
April 30, 1992 (File No. 0-13907)).

10.15 1995 Stock Incentive Plan, as amended (filed herewith electronically).

10.16 Employee Stock Purchase Plan, as amended (incorporated by reference to
Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1997 (File No. 0-13907)).

10.17 Form of Change in Control Agreement entered into between the Company and
Ms. Gilles (incorporated by reference to Exhibit 10.28 to the Company's
Annual Report on Form 10-K for the year ended October 31, 1994 (File No.
0-13907)).

10.18 Form of Change in Control Agreement entered into between the Company and
each of Ms. Connie L. Magnuson and Mr. Thomas J. Pepin dated January 12,
1998 and Mr. David Buche dated January 29, 1998 (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the period ended January 31, 1998 (File No. 0-139070)).

10.19 Employment Agreement dated July 31, 1998 among the Company, Jer-Neen
Manufacturing Co., Inc. and James Pfau (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period
ended July 31, 1998 (File No. 0-13907)).

10.20 Change in Control Agreement dated July 31, 1998 between the Company and
James Pfau (incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the period ended July 31, 1998 (File No.
0-13907)).

E-2
<PAGE>

BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1998
- --------------------------------------------------------------------------------

10.21 Lease Agreement effective August 1, 1995 between the Company and CMS
Investors, Inc. (incorporated by reference to Exhibit 10.25 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).

10.22 Purchase and Sale Agreement dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to Exhibit
10.27 to the Company's Annual Report on Form 10-K for the year ended
October 31, 1995 (File No. 0-13907)).

10.23 License Agreement dated December 1, 1995 between the Company and
Uroplasty, Inc. (incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).

10.24 Assignment of U.S. Patent dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to Exhibit
10.29 to the Company's Annual Report on Form 10-K for the year ended
October 31, 1995 (File No. 0-13907)).

13.1 Portions of the Company's 1998 Annual Report to Shareholders incorporated
herein by reference (filed herewith electronically).

21.1 List of Subsidiaries of the Company (filed herewith electronically).

23.1 Consent of PricewaterhouseCoopers LLP (filed herewith electronically).

27.1 Financial Data Schedule for the year ended October 31, 1998 (filed
herewith electronically).

E-3

<PAGE>

Exhibit 10.15

BIO-VASCULAR, INC.

1995 STOCK INCENTIVE PLAN

(As Amended March 19, 1997 and December 31, 1998)

Section 1. Purpose of Plan. The purpose of the Bio-Vascular, Inc. 1995
Stock Incentive Plan (the "Plan") is to advance the interests of Bio-Vascular,
Inc. (the "Company") and its shareholders by enabling the Company and its
Subsidiaries to attract and retain persons of ability to perform services for
the Company and its Subsidiaries by providing an incentive to such individuals
through equity participation in the Company and by rewarding such individuals
who contribute to the achievement by the Company of its economic objectives. In
connection with the Company's distribution of all of the outstanding shares of
the common stock of Vital Images, Inc. ("Vital Images") (the "Spin-Off"),
certain amendments to the Plan have been effected in order to allow awards under
the Plan made to Vital Images employees to continue following the effective date
of the Spin-Off.

Section 2. Definitions. The following terms will have the meanings set
forth below, unless the context clearly otherwise requires:

(a) "Board" means the Board of Directors of the Company.

(b) "Broker Exercise Notice" means a written notice pursuant to which a
Participant, upon exercise of an Option, irrevocably instructs a broker or
dealer to sell a sufficient number of shares or loan a sufficient amount of
money to pay all or a portion of the exercise price of the Option and/or any
related withholding tax obligations and remit such sums to the Company and
directs the Company to deliver stock certificates to be issued upon such
exercise directly to such broker or dealer.

(d) "Code" means the Internal Revenue Code of 1986, as amended.

(e) "Committee" means the group of individuals administering the Plan, as
provided in Section 3 of the Plan.

(f) "Common Stock" means the common stock of the Company, par value $.01
per share, or the number and kind of shares of stock or other securities into
which such Common Stock may be changed in accordance with Section 4(c) of the
Plan.

(g) "Disability" means the disability of the Participant such as would
entitle the Participant to receive disability income benefits pursuant to the
long-term disability plan of the Employer or Subsidiary of the Employer then
covering the Participant or, if no such plan exists or is applicable to the
Participant, the permanent and total disability of the Participant within the
meaning of Section 22(e)(3) of the Code.

(h) "Eligible Recipients" means all employees, non-employee directors,
consultants and independent contractors of the Company or any Subsidiary of the
Company.

(i) "Employer" means the Company if the Participant renders employment or
other services to the Company or any Subsidiary of the Company and means Vital
Images if the Participant renders employment or other services to Vital Images
or any Subsidiary of Vital Images.
<PAGE>

(j) "Exchange Act" means the Securities Exchange Act of 1934, as amended.

(k) "Fair Market Value" means, with respect to the Common Stock, the
following:

(i) if the Common Stock is listed or admitted to unlisted trading
privileges on any national securities exchange or is not so listed or
admitted but transactions in the Common Stock are reported on the Nasdaq
National Market, the closing price of the Common Stock on such exchange or
reported by the Nasdaq National Market as of such date (or, if no shares
were traded on such day, as of the next preceding day on which there was
such a trade).

(ii) if the Common Stock is not so listed or admitted to unlisted
trading privileges or reported on the Nasdaq National Market, and bid and
asked prices therefor in the over-the-counter market are reported by the
Nasdaq SmallCap Market or the National Quotation Bureau, Inc. (or any
comparable reporting service), the closing price as of such date, as so
reported by the Nasdaq SmallCap Market, or, if not so reported thereon, as
reported by the National Quotation Bureau, Inc. (or such comparable
reporting service).

(iii) if the Common Stock is not so listed or admitted to unlisted
trading privileges, or reported on the Nasdaq National Market, and such bid
and asked prices are not so reported, such price as the Committee
determines in good faith in the exercise of its reasonable discretion. The
Committee shall not be required to obtain an appraisal within six months of
the adoption of the Plan. The Committee's determination as to the current
value of the Common Stock shall be final, conclusive and binding for all
purposes and on all persons, including, without limitation, the Company,
the shareholders of the Company, the Participants and their respective
successors-in-interest. No member of the Board of the Committee shall be
liable for any determination regarding current value of the Common Stock
that is made in good faith.

(l) "Incentive Award" means an Option, Restricted Stock Award, Performance
Unit or Stock Bonus granted to an Eligible Recipient pursuant to the Plan.

(m) "Incentive Stock Option" means a right to purchase Common Stock granted
to an Eligible Recipient pursuant to Section 6 of the Plan that qualifies as an
"incentive stock option" within the meaning of Section 422 of the Code.

(n) "Non-Statutory Stock Option" means a right to purchase Common Stock
granted to an Eligible Recipient pursuant to Section 6 of the Plan that does not
qualify as an Incentive Stock Option.

(o) "Option" means an Incentive Stock Option or a Non-Statutory Stock
Option.

(p) "Participant" means an Eligible Recipient who receives one or more
Incentive Awards under the Plan.

(q) "Performance Unit" means a right granted to an Eligible Recipient
pursuant to Section 8 of the Plan to receive a payment from the Company, in the
form of stock, cash or a combination of both, upon the achievement of
established performance or other goals.

(r) "Previously Acquired Shares" means shares of Common Stock that are
already owned by the Participant or, with respect to any Incentive Award, that
are to be issued upon the grant, exercise or vesting of such Incentive Award.

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<PAGE>

(s) "Restricted Stock Award" means an award of Common Stock granted to an
Eligible Recipient pursuant to Section 7 of the Plan that is subject to the
restrictions on transferability and the risk of forfeiture imposed by the
provisions of such Section 7.

(t) "Retirement" means termination of employment or service pursuant to and
in accordance with the regular (or, if approved by the Board of Directors of the
Employer for purposes of the Plan, early) retirement/pension plan or practice of
the Employer or Subsidiary of the Employer then covering the Participant,
provided that if the Participant is not covered by any such plan or practice,
the Participant will be deemed to be covered by the Employer's plan or practice,
for purposes of this determination.

(u) "Securities Act" means the Securities Act of 1933, as amended.

(v) "Stock Bonus" means an award of Common Stock granted to an Eligible
Recipient pursuant to Section 9 of the Plan.

(w) "Subsidiary" means (i) when used in reference to the Company, any
entity that is directly or indirectly controlled by the Company or any entity in
which the Company has a significant equity interest, as determined by the
Committee or (ii) when used in reference to Vital Images, any entity that is
directly or indirectly controlled by Vital Images or any entity in which Vital
Images has a significant equity interest, as determined by the Vital Images
Committee.

(x) "Tax Date" means the date any withholding tax obligation arises under
the Code for a Participant with respect to an Incentive Award.

(y) "Vital Images Committee" means the group of individuals administering
the Vital Images, Inc. 1995 Stock Incentive Adjustment Plan.

Section 3. Plan Administration.

(a) The Committee. So long as the Company has a class of its equity
securities registered under Section 12 of the Exchange Act, the Plan will be
administered by a committee (the "Committee") consisting solely of not less than
two members of the Board who are "disinterested persons" within the meaning of
Rule 16b-3 under the Exchange Act. To the extent consistent with corporate law,
the Committee may delegate to any officers of the Company the duties, power and
authority of the Committee under the Plan pursuant to such conditions or
limitations as the Committee may establish; provided, however, that only the
Committee may exercise such duties, power and authority with respect to Eligible
Recipients who are subject to Section 16 of the Exchange Act. Each
determination, interpretation or other action made or taken by the Committee
pursuant to the provisions of the Plan will be conclusive and binding for all
purposes and on all persons, and no member of the Committee will be liable for
any action or determination made in good faith with respect to the Plan or any
Incentive Award granted under the Plan.

(b) Authority of the Committee.

(i) In accordance with and subject to the provisions of the Plan, the
Committee will have the authority to determine all provisions of Incentive
Awards as the Committee may deem necessary or desirable and as consistent
with the terms of the Plan, including, without limitation, the following:
(A) the Eligible Recipients to be selected as Participants; (B) the nature
and extent of the Incentive Awards to be made to each Participant
(including the number of shares of Common Stock to be subject to each
Incentive Award, any exercise price, the manner in which Incentive Awards
will vest or become exercisable and whether Incentive Awards will be
granted

3
<PAGE>

in tandem with other Incentive Awards) and the form of written agreement,
if any, evidencing such Incentive Award; (C) the time or times when
Incentive Awards will be granted; (D) the duration of each Incentive Award;
and (E) the restrictions and other conditions to which the payment or
vesting of Incentive Awards may be subject. In addition, the Committee will
have the authority under the Plan in its sole discretion to pay the
economic value of any Incentive Award in the form of cash, Common Stock or
any combination of both.

(ii) The Committee will have the authority under the Plan to amend or
modify the terms of any outstanding Incentive Award in any manner,
including, without limitation, the authority to modify the number of shares
or other terms and conditions of an Incentive Award, extend the term of an
Incentive Award, accelerate the exercisability or vesting or otherwise
terminate any restrictions relating to an Incentive Award, accept the
surrender of any outstanding Incentive Award or, to the extent not
previously exercised or vested, authorize the grant of new Incentive Awards
in substitution for surrendered Incentive Awards; provided, however that
the amended or modified terms are permitted by the Plan as then in effect
and that any Participant adversely affected by such amended or modified
terms has consented to such amendment or modification. No amendment or
modification to an Incentive Award, however, whether pursuant to this
Section 3(b) or any other provisions of the Plan, will be deemed to be a
regrant of such Incentive Award for purposes of this Plan.

(iii) In the event of (A) any reorganization, merger, consolidation,
recapitalization, liquidation, reclassification, stock dividend, stock
split, combination of shares, rights offering, extraordinary dividend or
divestiture (including a spin-off) or any other change in corporate
structure or shares, (B) any purchase, acquisition, sale or disposition of
a significant amount of assets or a significant business, (C) any change in
accounting principles or practices, or (D) any other similar change, in
each case with respect to the Company or any other entity whose performance
is relevant to the grant or vesting of an Incentive Award, the Committee
(or, if the Company is not the surviving corporation in any such
transaction, the board of directors of the surviving corporation) may,
without the consent of any affected Participant, amend or modify the
vesting criteria of any outstanding Incentive Award that is based in whole
or in part on the financial performance of the Company (or any Subsidiary
or division thereof) or such other entity so as equitably to reflect such
event, with the desired result that the criteria for evaluating such
financial performance of the Company or such other entity will be
substantially the same (in the sole discretion of the Committee or the
board of directors of the surviving corporation) following such event as
prior to such event; provided, however, that the amended or modified terms
are permitted by the Plan as then in effect.

(c) Cooperation Between Committees. The Committee and the Vital Images
Committee will reasonably cooperate with each other to promote the purposes of
the Plan.

Section 4. Shares Available for Issuance.

(a) Maximum Number of Shares Available. Subject to adjustment as provided
in Section 4(c) of the Plan, the maximum number of shares of Common Stock that
will be available for issuance under the Plan will be 810,000 shares of Common
Stock, plus any shares of Common Stock which, as of the date the Plan is
approved by the shareholders of the Company, are reserved for issuance under the
Company's 1988 Stock Option Plan, the 1990 Management Incentive Stock Option
Plan and the 1992 Stock Option Plan and which are not thereafter issued or which
have been issued but are subsequently forfeited and which would otherwise have
been available for further issuance under such plans. Notwithstanding any other
provisions of the Plan to the contrary, no Participant in the Plan may be
granted any Options, or any other Incentive Awards with a value based solely on
an increase in the value

4
<PAGE>

of the Common Stock after the date of grant, relating to more than 50,000 shares
of Common Stock in the aggregate in any fiscal year of the Company (subject to
adjustment as provided in Section 4(c) of the Plan); provided, however, that a
Participant who is first appointed or elected as an officer, hired as an
employee or retained as a consultant by the Company or who receives a promotion
that results in an increase in responsibilities or duties may be granted, during
the fiscal year of such appointment, election, hiring, retention or promotion,
Options or such other Incentive Awards relating to up to 200,000 shares of
Common Stock (subject to adjustment as provided in Section 4(c) of the Plan).

(b) Accounting for Incentive Awards. Shares of Common Stock that are issued
under the Plan or that are subject to outstanding Incentive Awards will be
applied to reduce the maximum number of shares of Common Stock remaining
available for issuance under the Plan. Any shares of Common Stock that are
subject to an Incentive Award that lapses, expires, is forfeited or for any
reason is terminated unexercised or unvested and any shares of Common Stock that
are subject to an Incentive Award that is settled or paid in cash or any form
other than shares of Common Stock will automatically again become available for
issuance under the Plan. Any shares of Common Stock that constitute the
forfeited portion of a Restricted Stock Award, however, will not become
available for further issuance under the Plan.

(c) Adjustments to Shares and Incentive Awards. In the event of any
reorganization, merger, consolidation, recapitalization, liquidation,
reclassification, stock dividend, stock split, combination of shares, rights
offering, divestiture or extraordinary dividend (including a spin-off) or any
other change in the corporate structure or shares of the Company, the Committee
(or, if the Company is not the surviving corporation in any such transaction,
the board of directors of the surviving corporation) will make appropriate
adjustment (which determination will be conclusive) as to the number and kind of
securities available for issuance under the Plan and, in order to prevent
dilution or enlargement of the rights of Participants, the number, kind and,
where applicable, exercise price of securities subject to outstanding Incentive
Awards.

Section 5. Participation. Participants in the Plan will be those Eligible
Recipients who, in the judgment of the Committee, have contributed, are
contributing or are expected to contribute to the achievement of economic
objectives of the Employer or its Subsidiaries; provided, however, that
Participants will also include those individuals employed by Vital Images as of
the effective date of the Spin-Off who held Awards as of such date, whose Awards
will continue thereafter according to the terms and conditions of the Plan.
Eligible Recipients may be granted from time to time one or more Incentive
Awards, singly or in combination or in tandem with other Incentive Awards, as
may be determined by the Committee in its sole discretion. Incentive Awards will
be deemed to be granted as of the date specified in the grant resolution of the
Committee, which date will be the date of any related agreement with the
Participant.

Section 6. Options.

(a) Grant. An Eligible Recipient may be granted one or more Options under
the Plan, and such Options will be subject to such terms and conditions,
consistent with the other provisions of the Plan, as may be determined by the
Committee in its sole discretion. The Committee may designate whether an Option
is to be considered an Incentive Stock Option or a Non-Statutory Stock Option.
To the extent that any Incentive Stock Option granted under the Plan ceases for
any reason to qualify as an "incentive stock option" for purposes of Section 422
of the Code, such Incentive Stock Option will continue to be outstanding for
purposes of the Plan but will thereafter be deemed to be a Non-Statutory Stock
Option.

(b) Exercise Price. The per share price to be paid by a Participant upon
exercise of an Option will be determined by the Committee in its discretion at
the time of the Option grant, provided that (i) such price will not be less than
100% of the Fair Market Value of one share of Common Stock on the

5
<PAGE>

date of grant with respect to an Incentive Stock Option (110% of the Fair Market
Value if, at the time the Incentive Stock Option is granted, the Participant
owns, directly or indirectly, more than 10% of the total combined voting power
of all classes of stock of the Company or any parent or subsidiary corporation
of the Company), and (ii) such price will not be less than 85% of the Fair
Market Value of one share of Common Stock on the date of grant with respect to a
Non-Statutory Stock Option.

(c) Exercisability and Duration. An Option will become exercisable at such
times and in such installments as may be determined by the Committee in its sole
discretion at the time of grant; provided, however, that no Option may be
exercisable after 10 years from its date of grant.

(d) Payment of Exercise Price. The total purchase price of the shares to be
purchased upon exercise of an Option will be paid entirely in cash (including
check, bank draft or money order); provided, however, that the Committee, in its
sole discretion and upon terms and conditions established by the Committee, may
allow such payments to be made, in whole or in part, by tender of a Broker
Exercise Notice, Previously Acquired Shares, a promissory note (on terms
acceptable to the Committee in its sole discretion) or by a combination of such
methods.

(e) Manner of Exercise. An Option may be exercised by a Participant in
whole or in part from time to time, subject to the conditions contained in the
Plan and in the agreement evidencing such Option, by delivery in person, by
facsimile or electronic transmission or through the mail of written notice of
exercise to the Company (Attention: Secretary) at its principal executive office
in St. Paul, Minnesota and by paying in full the total exercise price for the
shares of Common Stock to be purchased in accordance with Section 6(d) of the
Plan.

Section 7. Restricted Stock Awards.

(a) Grant. An Eligible Recipient may be granted one or more Restricted
Stock Awards under the Plan, and such Restricted Stock Awards will be subject to
such terms and conditions, consistent with the other provisions of the Plan, as
may be determined by the Committee in its sole discretion. The Committee may
impose such restrictions or conditions, not inconsistent with the provisions of
the Plan, to the vesting of such Restricted Stock Awards as it deems
appropriate, including, without limitation, that the Participant remain in the
continuous employ or service of the Employer or a Subsidiary of the Employer for
a certain period or that the Participant or the Employer (or any Subsidiary or
division thereof) satisfy certain performance goals or criteria.

(b) Rights as a Shareholder; Transferability. Except as provided in
Sections 7(a), 7(c) and 13(c) of the Plan, a Participant will have all voting,
dividend, liquidation and other rights with respect to shares of Common Stock
issued to the Participant as a Restricted Stock Award under this Section 7 upon
the Participant becoming the holder of record of such shares as if such
Participant were a holder of record of shares of unrestricted Common Stock.

(c) Dividends and Distributions. Unless the Committee determines otherwise
in its sole discretion (either in the agreement evidencing the Restricted Stock
Award at the time of grant or at any time after the grant of the Restricted
Stock Award), any dividends or distributions (including regular quarterly cash
dividends) paid with respect to shares of Common Stock subject to the unvested
portion of a Restricted Stock Award will be subject to the same restrictions as
the shares to which such dividends or distributions relate. In the event the
Committee determines not to pay such dividends or distributions currently, the
Committee will determine in its sole discretion whether any interest will be
paid on such dividends or distributions. In addition, the Committee in its sole
discretion may require such dividends and distributions to be reinvested (and in
such case the Participants consent to such reinvestment) in

6
<PAGE>

shares of Common Stock that will be subject to the same restrictions as the
shares to which such dividends or distributions relate.

(d) Enforcement of Restrictions. To enforce the restrictions referred to in
this Section 7, the Committee may place a legend on the stock certificates
referring to such restrictions and may require the Participant, until the
restrictions have lapsed, to keep the stock certificates, together with duly
endorsed stock powers, in the custody of the Company or its transfer agent or to
maintain evidence of stock ownership, together with duly endorsed stock powers,
in a certificateless book-entry stock account with the Company's transfer agent.

Section 8. Performance Units. An Eligible Recipient may be granted one or
more Performance Units under the Plan, and such Performance Units will be
subject to such terms and conditions, consistent with the other provisions of
the Plan, as may be determined by the Committee in its sole discretion. The
Committee may impose such restrictions or conditions, not inconsistent with the
provisions of the Plan, to the vesting of such Performance Units as it deems
appropriate, including, without limitation, that the Participant remain in the
continuous employ or service of the Employer or any Subsidiary of the Employer
for a certain period or that the Participant or the Employer (or any Subsidiary
or division thereof) satisfy certain performance goals or criteria. The
Committee will have the sole discretion either to determine the form in which
payment of the economic value of vested Performance Units will be made to the
Participant (i.e., cash, Common Stock or any combination thereof) or to consent
to or disapprove the election by the Participant of the form of such payment.

Section 9. Stock Bonuses. An Eligible Recipient may be granted one or more
Stock Bonuses under the Plan, and such Stock Bonuses will be subject to such
terms and conditions, consistent with the other provisions of the Plan, as may
be determined by the Committee. The Participant will have all voting, dividend,
liquidation and other rights with respect to the shares of Common Stock issued
to a Participant as a Stock Bonus under this Section 9 upon the Participant
becoming the holder of record of such shares; provided, however, that the
Committee may impose such restrictions on the assignment or transfer of a Stock
Bonus as it deems appropriate.

Section 10. Effect of Termination of Employment or Other Service. The
transfer by a Participant of employment or other service from one Employer or
its Subsidiaries to the other Employer or its Subsidiaries will not be deemed to
constitute a termination of employment or other service for purposes of this
Plan.

(a) Termination Due to Death, Disability or Retirement. In the event a
Participant's employment or other service with the Employer and all of its
Subsidiaries is terminated by reason of death, Disability or Retirement:

(i) All outstanding Options then held by the Participant will become
immediately exercisable in full and will remain exercisable for a period of
one year (three months in the case of Retirement) after such termination
(but in no event after the expiration date of any such Option);

(ii) All Restricted Stock Awards then held by the Participant will
become fully vested; and

(iii) All Performance Units and Stock Bonuses then held by the
Participant will vest and/or continue to vest in the manner determined by
the Committee and set forth in the agreement evidencing such Performance
Units or Stock Bonuses.

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<PAGE>

(b) Termination for Reasons Other than Death, Disability or Retirement.

(i) In the event a Participant's employment or other service is
terminated with the Employer and all of its Subsidiaries for any reason
other than death, Disability or Retirement, or a Participant is in the
employ or service of a Subsidiary and the Subsidiary ceases to be a
Subsidiary of the Employer (unless the Participant continues in the employ
or service of an Employer or another Subsidiary thereof), all rights of the
Participant under the Plan and any agreements evidencing an Incentive Award
will immediately terminate without notice of any kind, and no Options then
held by the Participant will thereafter be exercisable, all Restricted
Stock Awards then held by the Participant that have not vested will be
terminated and forfeited, and all Performance Units and Stock Bonuses then
held by the Participant will vest and/or continue to vest in the manner
determined by the Committee and set forth in the agreement evidencing such
Performance Units or Stock Bonuses; provided, however, that if such
termination is due to any reason other than termination by the Employer or
any Subsidiary of the Employer for "cause," all outstanding Options then
held by such Participant will remain exercisable to the extent exercisable
as of such termination for a period of three months after such termination
(but in no event after the expiration date of any such Option).

(ii) For purposes of this Section 10(b), "cause" (as determined by (x)
the Committee if the Employer is the Company or a Subsidiary of the Company
or (y) the Vital Images Committee if the Employer is Vital Images or a
Subsidiary of Vital Images) will be as defined in any employment or other
agreement or policy applicable to the Participant or, if no such agreement
or policy exists, will mean (A) dishonesty, fraud, misrepresentation,
embezzlement or deliberate injury or attempted injury, in each case related
to the Employer or any Subsidiary, (B) any unlawful or criminal activity of
a serious nature, (C) any intentional and deliberate breach of a duty or
duties that, individually or in the aggregate, are material in relation to
the Participant's overall duties, or (D) any material breach of any
employment, service, confidentiality or noncompete agreement entered into
with either Employer or any Subsidiary thereof.

(c) Modification of Rights Upon Termination. Notwithstanding the other
provisions of this Section 10, upon a Participant's termination of employment or
other service with the Employer and all Subsidiaries of the Employer, the
Committee may, in its sole discretion (which may be exercised at any time on or
after the date of grant, including following such termination), cause Options
(or any part thereof) then held by such Participant to become or continue to
become exercisable and/or remain exercisable following such termination of
employment or service and Restricted Stock Awards, Performance Units and Stock
Bonuses then held by such Participant to vest and/or continue to vest or become
free of transfer restrictions, as the case may be, following such termination of
employment or service, in each case in the manner determined by the Committee;
provided, however, that no Option may remain exercisable beyond its expiration
date.

(d) Breach of Confidentiality or Noncompete Agreements. Notwithstanding
anything in the Plan to the contrary, in the event that a Participant materially
breaches the terms of any confidentiality or noncompete agreement entered into
with either Employer or any Subsidiary thereof, whether such breach occurs
before or after termination of such Participant's employment or other service
with the Employer or any Subsidiary of the Employer, the Committee in its sole
discretion may immediately terminate all rights of the Participant under the
Plan and any agreements evidencing an Incentive Award then held by the
Participant without notice of any kind.

(e) Date of Termination of Employment or Other Service. Unless the
Committee otherwise determines in its sole discretion, a Participant's
employment or other service will, for purposes of the Plan, be deemed to have
terminated on the date recorded on the personnel or other records of the

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<PAGE>

Employer or any Subsidiary of the Employer for which the Participant provides
employment or other service, as determined by the Committee or the Vital Images
Committee, as the case may be, in its sole discretion based upon such records.

Section 11. Payment of Withholding Taxes.

(a) General Rules. The Employer is entitled to (i) withhold and deduct from
future wages of the Participant (or from other amounts that may be due and owing
to the Participant from the Employer or any Subsidiary of the Employer), or make
other arrangements for the collection of, all legally required amounts necessary
to satisfy any and all federal, state and local withholding and
employment-related tax requirements attributable to an Incentive Award,
including, without limitation, the grant, exercise or vesting of, or payment of
dividends with respect to, an Incentive Award or a disqualifying disposition of
stock received upon exercise of an Incentive Stock Option, or (ii) require the
Participant promptly to remit the amount of such withholding to the Employer
before taking any action, including issuing any shares of Common Stock, with
respect to an Incentive Award.

(b) Special Rules. The Committee may, in its sole discretion and upon terms
and conditions established by the Committee, permit or require a Participant to
satisfy, in whole or in part, any withholding or employment- related tax
obligation described in Section 11(a) of the Plan by electing to tender
Previously Acquired Shares, a Broker Exercise Notice or a promissory note (on
terms acceptable to the Committee in its sole discretion), or by a combination
of such methods.

Section 12. Change in Control.

(a) Change in Control. For purposes of this Section 12, a "Change in
Control" of the Company will mean the following, provided that it occurs after
the date on which the Company distributes (pursuant to that certain Distribution
Agreement, dated as of May 2, 1997, between Vital Images and the Company (the
"Distribution Agreement")) all of the outstanding shares of Vital Images' common
stock to the Company's shareholders of record on the Record Date (as defined in
the Distribution Agreement):

(i) the sale, lease, exchange or other transfer, directly or
indirectly, of substantially all of the assets of the Company (in one
transaction or in a series of related transactions) to a person or entity
that is not controlled by the Company;

(ii) the approval by the shareholders of the Company of any plan or
proposal for the liquidation or dissolution of the Company;

(iii) a merger or consolidation to which the Company is a party if the
shareholders of the Company immediately prior to effective date of such
merger or consolidation have "beneficial ownership" (as defined in Rule
13d-3 under the Exchange Act), immediately following the effective date of
such merger or consolidation, of securities of the surviving corporation
representing (A) more than 50%, but not more than 80%, of the combined
voting power of the surviving corporation's then outstanding securities
ordinarily having the right to vote at elections of directors, unless such
merger or consolidation has been approved in advance by the Incumbent
Directors (as defined in Section 12(b) below), or (B) 50% or less of the
combined voting power of the surviving corporation's then outstanding
securities ordinarily having the right to vote at elections of directors
(regardless of any approval by the Incumbent Directors);

(iv) any person becomes after the effective date of the Plan the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act),
directly or indirectly, of (A) 20% or more, but

9
<PAGE>

not 50% or more, of the combined voting power of the Company's outstanding
securities ordinarily having the right to vote at elections of directors,
unless the transaction resulting in such ownership has been approved in
advance by the Incumbent Directors, or (B) 50% or more of the combined
voting power of the Company's outstanding securities ordinarily having the
right to vote at elections of directors (regardless of any approval by the
Incumbent Directors);

(v) the Incumbent Directors cease for any reason to constitute at
least a majority of the Board; or

(vi) any other change in control of the Company of a nature that would
be required to be reported pursuant to Section 13 or 15(d) of the Exchange
Act, whether or not the Company is then subject to such reporting
requirements.

(b) Incumbent Directors. For purposes of this Section 12, "Incumbent
Directors" of the Company will mean any individuals who are members of the Board
on the effective date of the Plan and any individual who subsequently becomes a
member of the Board whose election, or nomination for election by the Company's
shareholders, was approved by a vote of at least a majority of the Incumbent
Directors (either by specific vote or by approval of the Company's proxy
statement in which such individual is named as a nominee for director without
objection to such nomination).

(c) Acceleration of Vesting. Without limiting the authority of the
Committee under Section 3(b) of the Plan, if a Change in Control of the Company
occurs, then, unless otherwise provided by the Committee in its sole discretion
either in an agreement evidencing an Incentive Award at the time of grant or at
any time after the grant of an Incentive Award, (i) all Options will become
immediately exercisable in full and will remain exercisable for the remainder of
their terms, regardless of whether the Participants to whom such Options have
been granted remain in the employ or service of the Employer or any Subsidiary
of the Employer; (ii) all outstanding Restricted Stock Awards will become
immediately fully vested; and (iii) all Performance Units and Stock Bonuses then
held by the Participant will vest and/or continue to vest in the manner
determined by the Committee and set forth in the agreement evidencing such
Performance Unit or Stock Bonuses.

(d) Cash Payment for Options. If a Change in Control of the Company occurs,
then the Committee, if approved by the Committee in its sole discretion either
in an agreement evidencing an Incentive Award at the time of grant or at any
time after the grant of an Incentive Award, and without the consent of any
Participant effected thereby, may determine that some or all Participants
holding outstanding Options will receive, with respect to some or all of the
shares of Common Stock subject to such Options, as of the effective date of any
such Change in Control of the Company, cash in an amount equal to the excess of
the Fair Market Value of such shares immediately prior to the effective date of
such Change in Control of the Company over the exercise price per share of such
Options.

(e) Limitation on Change in Control Payments. Notwithstanding anything in
Section 12(c) or 12(d) of the Plan to the contrary, if, with respect to a
Participant, the acceleration of the vesting of an Incentive Award as provided
in Section 12(c) or the payment of cash in exchange for all or part of an
Incentive Award as provided in Section 12(d) (which acceleration or payment
could be deemed a "payment" within the meaning of Section 280G(b)(2) of the
Code), together with any other "payments" which such Participant has the right
to receive from the Company or any corporation that is a member of an
"affiliated group" (as defined in Section 1504(a) of the Code without regard to
Section 1504(b) of the Code) of which the Company is a member, would constitute
a "parachute payment" (as defined in Section 280G(b)(2) of the Code), then the
"payments" to such Participant pursuant to Section 12(c) or 12(d) of the Plan
will be reduced to the largest amount as will result in no portion of such
"payments" being subject to the excise tax imposed by Section 4999 of the Code;
provided, however, that if a

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<PAGE>

Participant is subject to a separate agreement with the Company or a Subsidiary
that expressly addresses the potential application of Sections 280G or 4999 of
the Code (including, without limitation, that "payments" under such agreement or
otherwise will not be reduced or that the Participant will have the discretion
to determine which "payments" will be reduced), then the limitations of this
Section 12(e) will not apply, and any "payments" to a Participant pursuant to
Section 12(c) or 12(d) of the Plan will be treated as "payments" arising under
such separate agreement.

Section 13. Rights of Eligible Recipients and Participants;
Transferability.

(a) Employment or Service. Nothing in the Plan will interfere with or limit
in any way the right of the Employer or any Subsidiary of the Employer to
terminate the employment or service of any Eligible Recipient or Participant at
any time, nor confer upon any Eligible Recipient or Participant any right to
continue in the employ or service of the Employer or any Subsidiary of the
Employer.

(b) Rights as a Shareholder. As a holder of Incentive Awards (other than
Restricted Stock Awards and Stock Bonuses), a Participant will have no rights as
a shareholder unless and until such Incentive Awards are exercised for, or paid
in the form of, shares of Common Stock and the Participant becomes the holder of
record of such shares. Except as otherwise provided in the Plan, no adjustment
will be made for dividends or distributions with respect to such Incentive
Awards as to which there is a record date preceding the date the Participant
becomes the holder of record of such shares, except as the Committee may
determine in its discretion.

(c) Restrictions on Transfer. Except pursuant to testamentary will or the
laws of descent and distribution or as otherwise expressly permitted by the
Plan, no right or interest of any Participant in an Incentive Award prior to the
exercise or vesting of such Incentive Award will be assignable or transferable,
or subjected to any lien, during the lifetime of the Participant, either
voluntarily or involuntarily, directly or indirectly, by operation of law or
otherwise. A Participant will, however, be entitled to designate a beneficiary
to receive an Incentive Award upon such Participant's death, and in the event of
a Participant's death, payment of any amounts due under the Plan will be made
to, and exercise of any Options (to the extent permitted pursuant to Section 10
of the Plan) may be made by, the Participant's legal representatives, heirs and
legatees.

(d) Non-Exclusivity of the Plan. Nothing contained in the Plan is intended
to modify or rescind any previously approved compensation plans or programs of
either Employer or any Subsidiary thereof or create any limitations on the power
or authority of the Board to adopt such additional or other compensation
arrangements as the Board may deem necessary or desirable.

Section 14. Securities Law and Other Restrictions. Notwithstanding any
other provision of the Plan or any agreements entered into pursuant to the Plan,
the Company will not be required to issue any shares of Common Stock under this
Plan, and a Participant may not sell, assign, transfer or otherwise dispose of
shares of Common Stock issued pursuant to Incentive Awards granted under the
Plan, unless (i) there is in effect with respect to such shares a registration
statement under the Securities Act and any applicable state securities laws or
an exemption from such registration under the Securities Act and applicable
state securities laws, and (ii) there has been obtained any other consent,
approval or permit from any other regulatory body which the Committee, in its
sole discretion, deems necessary or advisable. The Company may condition such
issuance, sale or transfer upon the receipt of any representations or agreements
from the parties involved, and the placement of any legends on certificates
representing shares of Common Stock, as may be deemed necessary or advisable by
the Company in order to comply with such securities law or other restrictions.

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<PAGE>

Section 15. Plan Amendment, Modification and Termination. The Board may
suspend or terminate the Plan or any portion thereof at any time, and may amend
the Plan from time to time in such respects as the Board may deem advisable in
order that Incentive Awards under the Plan will conform to any change in
applicable laws or regulations or in any other respect the Board may deem to be
in the best interests of the Company; provided, however, that no amendments to
the Plan will be effective without approval of the stockholders of the Company
if stockholder approval of the amendment is then required pursuant to Rule 16b-3
under the Exchange Act, Section 422 of the Code or the rules of any stock
exchange or Nasdaq. No termination, suspension or amendment of the Plan may
adversely affect any outstanding Incentive Award without the consent of the
affected Participant; provided, however, that this sentence will not impair the
right of the Committee to take whatever action it deems appropriate under
Sections 4(c) and 12 of the Plan.

Section 16. Effective Date and Duration of the Plan. The Plan is effective
as of December 18, 1995, the date it was adopted by the Board. The Plan will
terminate at midnight on December 18, 2005, and may be terminated prior to such
time to by Board action, and no Incentive Award will be granted after such
termination. Incentive Awards outstanding upon termination of the Plan may
continue to be exercised, or become free of restrictions, in accordance with
their terms.

Section 17. Miscellaneous.

(a) Governing Law. The validity, construction, interpretation,
administration and effect of the Plan and any rules, regulations and actions
relating to the Plan will be governed by and construed exclusively in accordance
with the laws of the State of Minnesota.

(b) Successors and Assigns. The Plan will be binding upon and inure to the
benefit of the successors and permitted assigns of the Company and the
Participants.

<PAGE>

Exhibit 13.1

The following information appears on pages 9-12 of the Company's 1998 Annual
Report to Shareholders.

Management's Discussion and Analysis of Financial Condition and Results of
Operations

Forward-Looking Statements:

Certain statements contained in this Annual Report include "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. All forward-looking statements in this document are based on
information available to the Company as of the date hereof, and the Company
assumes no obligation to update any forward-looking statements. Such statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results to differ materially from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such
factors may include, among others, the risk factors listed from time to time in
the Company's filings with the Securities and Exchange Commission, such as the
year-end Annual Report on Form 10-K.

Overview

The Company develops, manufactures and markets branded proprietary and patented
specialty medical products for use in thoracic, cardiac, neuro, ophthalmic and
vascular surgery. The Company's branded products include the Tissue-Guard(TM)
product line, the Biograft(R) peripheral vascular graft and surgical
productivity tools used in cardiac and vascular surgery. Tissue-Guard products
are made from bovine pericardium, the thin membrane surrounding the heart of
cattle, processed using proprietary tissue-fixation technology. The Company's
wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc., is a value added
manufacturer of precision, unbranded wire component products such as micro
coils, wire forms and spring components used in implantable defibrillation,
interventional medicine and other surgical applications within the medical
industry.

The acquisition of Jer-Neen Manufacturing Co., Inc. was completed July 31, 1998,
the end of the Company's third quarter. The Company issued 585,872 shares of
common stock and paid cash of $1.8 million, excluding acquisition costs, in
exchange for all of the stock of Jer-Neen, including the assumption of Jer-
Neen's liabilities as of the closing. The Company paid an additional $950,000
for a ten year non-compete agreement covering the former Jer-Neen shareholders.
The acquisition was recorded as a purchase for accounting purposes. Jer-Neen's
component business contributed $1,397,000 to revenues and $62,000 in operating
income in the Company's fourth quarter of 1998, the first quarter in which Jer-
Neen's financial results were included in the Company's consolidated results of
operations. The Company believes that the addition of Jer-Neen's medical
component business broadens the Company's participation in the medical device
industry, increases the Company's immediate and long-term revenue potential and
achieves a balance of market opportunities consistent with the strategic
objectives targeted by the Company.

Net revenue in fiscal 1998 increased by $2,323,000 to $12,017,000 as compared to
$9,694,000 in 1997. In addition to the Jer-Neen component business revenue
contribution beginning in the fourth quarter of 1998, the branded product
business unit increased its core revenues by $926,000, or 10%. Total 1998
branded product net revenue of $10,620,000 represents an important milestone in
surpassing the highest annual revenue in the Company's history associated with
this business segment. Branded revenue growth came from the Tissue-Guard
product line, exclusive of Peri-Strips(R), which grew at a 19% pace, led by
sales of Vascu-Guard(R)and Dura-Guard(R). Aided by international growth of 27%,
Peri-Strips revenue increased $318,000, or 11%. Domestic Peri-Strips revenue
increased 6% with only a minimal contribution from the National Emphysema
Treatment Trial (NETT). Biograft revenue decreased $52,000, or 7%, to $748,000
from $800,000, continuing a trend. Revenue from sales of surgical productivity
tools decreased 4% to $2,051,000 from $2,127,000.

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The Company has emphasized new product development through the commitment of
significant resources to research and development. The product development
activities in 1998 focused on both near- and long-term opportunities. The near-
term opportunities include leveraging current tissue expertise through product
line expansions while long-term projects include a focus on proactively seeking
to obsolete current technology. During fiscal 1998, the Company's product
development efforts resulted in 510(k) marketing clearance from the FDA for
three new products: Flo-Thru Intraluminal Shunt(TM) received in August 1998, CV
Peri-Guard(TM) received in April 1998 and Ocu-Guard(TM) received in December
1997.

Results of Continuing Operations

Years Ended October 31, 1998 and 1997

Revenue increased $2,323,000, or 24%, to $12,017,000 from $9,694,000. The Jer-
Neen component business contributed $1,397,000 to revenue in 1998. Branded
product growth came from the Tissue-Guard product line, which grew at a 19%
pace, led by sales of Vascu-Guard and Dura-Guard. Aided by international growth
of 27%, Peri-Strips revenue increased $318,000, or 11%. Domestic Peri-Strips
revenue increased 6% with only a minimal contribution from the National
Emphysema Treatment Trial (NETT). Biograft revenue decreased $52,000, or 7%, to
$748,000 from $800,000, continuing a trend. Revenue from sales of surgical
productivity tools decreased 4% to $2,051,000 from $2,127,000.

The Company's gross margin percentage was 57% for 1998 as compared to 59% for
1997. In 1998, the component product line margin was 37%, while the branded
products' margin was 59%. The gross margin in the fourth quarter of 1998, the
first quarter including the operations of both businesses, was 52%. The Company
expects the gross margin percentage for 1999 to be lower than the 1998 level as
the component product business will be included in the consolidated operating
results for the full year in 1999 rather than one quarter as in 1998. The
Company expects that each business unit's gross margin will increase slightly in
1999, due to the impact of increased production volumes in excess of incremental
fixed overhead. This forward looking statement is influenced primarily by the
Company's current estimate of standard costs and production forecasts and would
be impacted by significant increases or decreases in production volumes of the
Company's products, by material changes in the Company's product mix and by the
accuracy of the Company's estimates of standard costs and other manufacturing
costs.

Selling, general and administrative (SG&A) expense increased $888,000, or 15%,
between 1998 and 1997. The inclusion of the component business beginning in the
fourth quarter of 1998 accounts for nearly half of the overall year to year
increase in SG&A expense. The remaining increase is due to the continuing
investment in personnel in the areas of regulatory and clinical affairs, product
development and sales and marketing required to advance the Company's revenue
growth initiatives.

Research and development (R&D) expense increased $290,000, or 23%, between 1998
and 1997. The product development activities in 1998 focused on both near- and
long-term opportunities. The near-term opportunities include leveraging current
tissue expertise through product line expansions while long-term projects
include a focus on proactively seeking to obsolete current technology. During
fiscal 1998, the Company's product development efforts resulted in 510(k)
marketing clearance from the FDA for three new products. The Company continues
to work on a number of new product opportunities. R&D expense is expected to
increase as projects under development continue to progress. This forward-
looking statement will be influenced primarily by the number of projects and the
related R&D personnel requirements, development and regulatory approval path,
expected costs and the timing of those costs for each project.

The operating loss in 1998 was $1,415,000 as compared to an operating loss of
$1,305,000 for 1997. The component business contributed $62,000 in operating
income to 1998.

Other income, primarily net interest income, was $746,000 in 1998 and
$1,067,000 in 1997. The decrease in interest income is related to lower average
investment balances in 1998, primarily due to cash expenditures for the
Company's stock repurchase program and the Jer-Neen acquisition. As a result,
continuing operations had a loss before income taxes of $669,000 in 1998 as
compared to $238,000 in 1997. Operating activities generated positive cash flow
of $322,000 in 1998.

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<PAGE>

The Company's benefit for income taxes in 1998 is $186,000. The 1998 effective
tax rate of 28% is less than the statutory rates primarily due to the impact of
permanent differences including nondeductible goodwill, partially offset by the
impact of Research and Experimental credits. The Company recorded a tax
provision of $365,000 in 1997 due to a $421,000 write-off of an income tax asset
associated with net operating loss carry forwards of its former subsidiary,
Vital Images.

The 1998 loss from continuing operations was $483,000, or $0.05 per share,
compared to $604,000, or $0.06 per share in 1997. In 1997, the Company also
recorded a loss from discontinued operations of $920,000, or $0.10 per share.

Years Ended October 31, 1997 and 1996

Revenue decreased to $9,694,000 from $10,125,000, primarily due to the decrease
in Peri-Strips revenue of $1,421,000, or 33%, to $2,915,000 from $4,336,000.
Revenue from sales of other Tissue-Guard products increased $908,000, or 31%, to
$3,852,000 from $2,944,000. All Tissue-Guard products showed significant
increases over the prior year. Increased revenues from Tissue-Guard products in
the fourth quarter of fiscal 1997 over the same quarter in fiscal 1996 more than
offset the decreased revenue from Peri-Strips for the first time since the
Health Care Financing Administration (HCFA) non-coverage decision for lung
volume reduction surgery in January of 1996. Biograft revenue decreased
$138,000, or 15%, to $800,000 from $938,000, continuing a trend. Revenue from
sales of surgical productivity tools increased $220,000, or 12%, to $2,127,000
from $1,907,000.

The gross margin percentage was 59% for 1997 and 66% for 1996. During fiscal
1996 and 1997, the gross margin percentages declined through the quarters,
primarily due to decreases in production volume consistent with declining demand
for Peri-Strips. The gross margin percentage was 62% by the fourth quarter of
1996 and continued to decrease through the third quarter of 1997. Gross margin
improvements in the fourth quarter of 1997 were primarily due to increased
production volume.

Selling, general and administrative expenses increased $573,000, or 11%, between
1997 and 1996, primarily due to increases in regulatory personnel and related
market clearance costs. Selling expense increases were primarily associated
with the launch of Peri-Strips Dry(TM) in the third quarter of 1997 and
increased marketing efforts in Europe. The Company also incurred expenses
related to efforts to educate Congress and other interested parties about the
devastating effect of the HCFA decision on patients in the late-stages of
emphysema and to seek consideration of a modification or reversal of that
decision.

Research and development expense increased $349,000, or 38%, between 1997 and
1996, with the increase primarily due to the cost of moving projects forward
through research and development efforts, including an increase in the number of
animal studies. R&D activities in 1997 included two new product opportunities,
CV Peri-Guard and Ocu-Guard.

Primarily due to the continued decrease in revenue from Peri-Strips, compounded
by lower gross margins earlier in the year and increased spending on research
and development, regulatory and selling costs, continuing operations had an
operating loss in 1997 of $1,305,000 as compared to operating income of $571,000
for 1996. Other income, primarily interest income, was $1,067,000 and
$1,161,000 in 1997 and 1996, respectively. As a result, continuing operations
had a loss before income taxes in 1997 of $238,000 as compared to income from
continuing operations before income tax of $1,732,000 in 1996.

The Company recorded a provision for income taxes in 1997 of $365,000 including
a $421,000 write-off of an income tax asset associated with net operating loss
carry forwards of Vital Images. In 1996, the Company allocated its provision for
income taxes to continuing and discontinuing operations based on their
respective pretax income contributions and tax attributes. As a result, the
amount of the provision allocated to continuing operations in 1996 was $514,000,
representing an effective tax rate of approximately 30%. Continuing operations'
effective tax rate for 1996 reflected the benefit of recognizing a deferred tax
asset associated with capital loss and research and experimentation credit
carryforwards created in prior years.

Loss from continuing operations was $604,000, or $0.06 per share in 1997,
compared to income of $1,219,000, or $0.12 per share in 1996. In 1997, the
Company also recorded a loss from discontinued operations of $920,000, or

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<PAGE>

$0.10 per share, associated with the spin-off of Vital Images.

Liquidity and Capital Resources

Cash, cash equivalents and marketable securities were $8,400,000 at October 31,
1998 as compared to $17,987,000 at October 31, 1997, a reduction of $9,587,000.
Major uses of available cash during 1998 totaling $9,319,000 were the repurchase
of common stock and the purchase of Jer-Neen (including the repayment of certain
acquired Jer-Neen debt obligations). The Company believes existing cash and
investments will be sufficient to satisfy its cash requirements for the
foreseeable future. This forward looking statement, as well as the Company's
long term cash requirements, will be a function of a number of variables,
including research & development priorities, acquisition opportunities, and the
growth and profitability of the business.

Operating activities provided cash of $322,000 in 1998, as compared to
$1,051,000 (excluding $1,860,000 used by discontinued operations) of net cash
provided by operating activities in fiscal 1997. Cash was provided by
continuing operations in fiscal 1998 through non-cash expenses in excess of the
loss from operations and collection efforts, which generated a reduction in
accounts receivable. These increases in cash were offset by an increase in
inventory levels.

The Company invested $964,000 in equipment and leasehold improvements, primarily
related to new products and related manufacturing processes. Other 1998
investing activities included $2,816,000 used in the purchase of Jer-Neen, net
of the cash acquired. Net investments in marketable securities totaling
$7,235,000 were liquidated in 1998 to provide cash, primarily for financing and
other investing activities.

Financing activities used $6,093,000 of cash in 1998, including $4,095,000 in
cash used to repurchase 978,266 shares of Company common stock in the open
market in accordance with its ongoing stock repurchase program. The program was
originally announced in August 1997, and initially provided for the repurchase
of up to 500,000 shares of common stock. The buyback program was subsequently
expanded during 1998 to provide for the repurchase of a total of 1.5 million
shares. Such purchases are made in the open market from time-to-time as the
Company identifies price opportunities. The repurchase program was initiated
because the Company believed the stock was undervalued. The program will have a
positive impact on earnings per share in periods of profitability. However,
while the Company is generating losses, the stock repurchases have a dilutive
impact on current earnings per share. In addition, the Company repaid certain
debt obligations acquired through the purchase of Jer-Neen totaling $2,408,000
in 1998. The Company has long-term obligations of $1,670,000 at October 31,
1998. Payments are required through 2004.

Year 2000 Readiness

The following Year 2000 disclosure is required by the rules and regulations of
the Securities and Exchange Commission and constitutes a "Year 2000 Readiness
Disclosure" as defined in the Year 2000 Information and Readiness Disclosure
Act.

The "Year 2000" or "Y2K" problem references the problem caused by computer
systems that have historically been written using two digits rather than four
digits to define the applicable year. Additionally, Y2K includes a problem
calculating leap year if a computer system does not correctly identify the year
2000 as being a leap year. Company computer systems and other equipment and
technology having date sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000 and may not recognize the year 2000 as a
leap year. The Company has instituted a Year 2000 readiness program (the "Y2K
Plan") in order to identify, evaluate and address its exposure to these
problems.

For purposes of its Y2K Plan, the Company defines "Year 2000 compliant" to mean
that a product or service accurately process dates and times into and between
the twentieth and twenty-first centuries, into and between the years 1900 and
2000, performs correct leap year calculations and properly exchanges date and
time information with other products or services when used in combination. The
goal of the Y2K Plan is to ensure that the Company's equipment, systems and
processes and those of its significant business partners are sufficiently Year
2000 compliant such that no date/time issue will have any adverse impact on the
services or products that the Company provides its customers or the timely and
accurate processing of transactions.

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<PAGE>

State of Readiness: As part of the Company's Y2K Plan, management is in the
process of evaluating its information technology ("IT") and non-information
("non-IT") technology systems, including manufacturing equipment, telephone and
mechanical systems and other equipment and systems having embedded, date
sensitive technology for Year 2000 compliance. The Company's Y2K Plan is
focused on assessing and assuring compliance in the following areas: IT and non-
IT hardware, operating systems, software applications and custom applications.
Additionally, the Company is reviewing the Year 2000 compliance status of its
customers, vendors and other service providers.

Hardware: The Company is in the process of completing its assessment of its IT
and non-IT hardware for Y2K compliance. The Company estimates that 60% of its
IT and non-IT hardware has either been upgraded for Y2K compliance or has been
certified internally or through the appropriate vendor to be compliant. The
Company expects that the remaining IT and non-IT hardware will be upgraded or
certified as Y2K compliant by June 30, 1999.

Operating Systems: The Company's operating systems are Novell Netware,
Microsoft NT and Microsoft Windows 95. Novell has certified Netware to be Y2K
compliant. Microsoft has certified Windows 95 to be compliant. Microsoft has
certified that its NT 4.x software is compliant upon installation of the most
recent service patches released or the installation of a software upgrade due to
be released late December 1998 or early 1999. The Company expects to install
either the "service patches" or the software upgrade when available.

Software Applications: The Company's primary information system applications
consist of Micro-MAX MRP system, Great Plains Accounting and DataWorks Vantage.
Micro-MAX released a service upgrade in 1998 that addressed its Y2K compliance.
Great Plains Accounting has been certified Y2K compliant for a number of years
and DataWorks has certified Vantage to be Y2K compliant. The Company's
secondary software systems consist of "off-the-shelf" software. The Company is
in the process of obtaining from the vendors certification that each secondary
software package is compliant. None of these secondary software programs are
critical to the Company's ability to accurately and timely process transactions.
The Company expects that all secondary software applications will either be
assessed to be not dependent on date/time accuracy, certified by the vendor to
be Y2K compliant or replaced by June 30, 1999.

Custom Applications: The Company has only a few custom applications written in
"off-the-shelf" software. These applications were written in versions of
software which have been determined not to be Y2K compliant. In each instance
the Company has determined that date/time is either not essential to the
functioning of the application, can be worked around, or that the application's
function can either be accomplished manually or completed in another manner
using alternative software. Accordingly, the Company may choose not to address
the Y2K issues related to these custom applications.

Third Party Relationship:. Because Y2K issues may also impact the Company by
affecting the business and operations of the Company's vendors, customers and
other business partners, the Company is in the process of communicating with
these parties in order to determine their Y2K compliant status. This
communication is in the early stage and accordingly, the Company has not been
able to determine if the failure of a third-party to be Y2K compliant will have
a material adverse affect on the Company. The Company anticipates that this
part of its Y2K plan will be substantially complete by June 1999.

Costs to Address Year 2000 Issues: Although the ultimate cost of attaining Year
2000 compliance is not fully known at this time, management anticipates that
external costs will not be material. These costs will be funded from
operations. The Company does not track internal personnel time spent on IT
projects, including the Y2K project. To date, no IT projects have been delayed
as a result of the Company's Y2K project. In the event the Company's Y2K Plan is
not successful or timely implemented, the Company may need to devote more
resources to the process and additional costs may be incurred. Such a situation
could have a material adverse effect on the Company's financial condition and
results of operations.

The costs of Year 2000 compliance and the expected completion dates are the best
estimates of Company management and are believed to be reasonably accurate.
Estimated costs of the Company's Y2K project and projected completion dates are
forward-looking statements that may be impacted by the Company's current belief
as

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to the extent of its internal exposure to the Y2K problem, the timeliness and
accuracy of information provided by the Company's vendors, customers and other
business partners in response to Y2K compliance inquiries by the Company, the
cost and availability of upgrades, corrections or replacements for IT and non-IT
systems identified as non-compliant, and the cost of and the Company's ability
to procure the services of consultants or qualified personnel to assist with its
Y2K Plan.

Worst Case Scenario: The Company believes that its most reasonably likely,
worst case scenario as a result of the Year 2000 problem will be the failure of
one or more significant vendors, customers or business partners to become Year
2000 complaint and the inability of the Company to determine or react on a
timely basis in order to mitigate the effects on the Company. If the operations
of any significant vendor, customer or other business partner are disrupted due
to the Year 2000 problem and the Company is unable to develop and implement an
effective contingency plan, the Company's ability to carry on essential
activities could be materially impacted. Even though the Company is undertaking
its Y2K Plan in an effort to mitigate its risks, there can be no assurance that
this scenario or any other impact of the Y2K problem will not have a material
adverse effect on the Company's business, financial condition and results of
operations.

Contingency Plans: To date, the Company has not yet developed any detailed
contingency plans to address Year 2000 compliance deficiencies, as it is still
in the process of gathering data from its customers, vendors and other business
partners regarding their Year 2000 compliance and otherwise implementing its Y2K
Plan. To the extent that the Company identifies Year 2000 compliance issues
that cannot be addressed on a timely basis, it will seek to develop appropriate
contingency plans in order to mitigate its risks.

Inflation

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

Foreign Currency Transactions

Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars. Fluctuations in currency exchange rates in other
countries 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.

New Accounting Standards

In June 1997, SFAS No. 130 ("SFAS 130"), Comprehensive Income, was issued by the
Financial Accounting Standards Board. SFAS 130 establishes standards for
reporting and displaying comprehensive income and its components (revenues,
expenses, gains and losses) in the financial statements. The Company's only
component of other comprehensive income is the unrealized gain/loss on
available-for-sale investments. Also issued in June 1997 was SFAS No. 131
("SFAS 131"), Disclosures about Segments of an Enterprise and Related
Information, which establishes new standards for the way public business
enterprises report information about operating segments. The Company must adopt
SFAS 130 and SFAS 131 in fiscal year 1999. Management is currently evaluating
the effect of these changes on its financial reporting.

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The following consolidated financial statements and related notes appears on
pages 13-23 of the Company's 1998 Annual Report to Shareholders.

BIO-VASCULAR, INC.
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
----------- -----------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents...................................... $ 4,383,366 $ 6,766,687
Marketable securities, short-term.............................. 3,990,839 7,229,934
Accounts receivable, net....................................... 2,456,018 1,846,519
Inventories, net............................................... 2,305,924 1,619,395
Deferred income taxes.......................................... 219,754 144,549
Other.......................................................... 527,402 480,955
----------- -----------
Total current assets...................................... 13,883,303 18,088,039

Equipment and leasehold improvements, net...................... 4,353,876 1,670,446
Goodwill and other intangible assets, net...................... 7,240,772 1,003,251
Marketable securities, long-term............................... -- 3,989,896
Deferred income taxes.......................................... 504,268 382,819
----------- -----------
Total assets.............................................. $25,982,219 $25,134,451
=========== ===========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................... $ 460,337 $ 447,167
Accrued expenses............................................... 1,421,054 735,049
Current maturities of long-term obligations.................... 615,961 --
----------- -----------
Total current liabilities................................. 2,497,352 1,182,216

Capital lease obligations...................................... 392,845 --
Other liabilities....... ...................................... 661,648 --
----------- -----------
Total liabilities......................................... 3,551,845 1,182,216
----------- -----------

Commitments (Note 7)

Shareholders' equity:
Preferred stock: authorized 5,000,000 shares of $.01 par value;
none issued or outstanding at October 31, 1998 and 1997...... -- --
Common stock: authorized 20,000,000 shares of $.01 par value;
issued and outstanding, 9,317,183 and 9,563,609
at October 31, 1998 and 1997, respectively................... 93,172 95,636
Additional paid-in capital..................................... 28,695,840 29,664,715
Unearned compensation.......................................... (514,538) (447,254)
Unrealized marketable securities holding gain.................. 1,103 1,288
Accumulated deficit............................................ (5,845,203) (5,362,150)
----------- -----------
Total shareholders' equity................................ 22,430,374 23,952,235
----------- -----------
Total liabilities and shareholders' equity................ $25,982,219 $25,134,451
=========== ===========
</TABLE>

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

7
<PAGE>

BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED OCTOBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net revenue.............................................. $12,017,379 $ 9,694,047 $10,124,709
Cost of revenue.......................................... 5,222,112 3,967,460 3,443,098
----------- ----------- -----------
Gross margin............................................. 6,795,267 5,726,587 6,681,611

Operating expenses:
Selling, general and administrative...................... 6,661,922 5,773,918 5,201,236
Research and development................................. 1,547,920 1,257,904 909,362
----------- ----------- -----------
Operating income (loss).................................. (1,414,575) (1,305,235) 571,013
Other income, net, primarily interest.................... 745,784 1,066,822 1,161,488
Income (loss) from continuing operations before
provision for (benefit from) income taxes............. (668,791) (238,413) 1,732,501
Provision for (benefit from) income taxes................ (185,738) 365,200 514,000
----------- ----------- -----------
Income (loss) from continuing operations................. (483,053) (603,613) 1,218,501

Discontinued operations:
Loss from operations of discontinued business, net of
income taxes.......................................... -- -- (1,048,142)
Loss on disposal of discontinued business, net of
income taxes.......................................... -- (920,000) (1,348,000)
----------- ----------- -----------
Net loss................................................. $ (483,053) $(1,523,613) $(1,177,641)
=========== =========== ===========

Basic earnings per share:
Continuing operations.................................... $ (0.05) $ (0.06) $ 0.13
Discontinued operations.................................. -- (0.10) (0.26)
----------- ----------- -----------
Net loss................................................. $ (0.05) $ (0.16) $ (0.13)
=========== =========== ===========

Diluted earnings per share:
Continuing operations.................................... $ (0.05) $ (0.06) $ 0.12
Discontinued operations.................................. -- (0.10) (0.24)
----------- ----------- -----------
Net loss................................................. $ (0.05) $ (0.16) $ (0.12)
=========== =========== ===========

</TABLE>

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

8
<PAGE>

BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>

Unrealized
Marketable
Additional Securities
Common Stock Paid -In Unearned Holding Accumulated
Shares Par Value Capital Compensation Gain (Loss) Deficit
---------- ---------- ------------- --------------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at October 31, 1995......... 9,379,768 $93,798 $38,352,660 $(430,226) -- $(2,660,896)
Stock option activity, net of tax
benefit.......................... 82,744 827 1,099,719 (150,387)
Warrant activity.................... 28,929 289 115,427
Employee Stock Purchase Plan
activity......................... 5,715 57 36,376
Employee restricted stock
activity......................... (12,258) (123) (16,616) 71,954
Non-employee restricted stock
activity......................... 23,750
Offering costs...................... (87,327)
Unrealized marketable securities
holding loss, net................ $(51,107)
Net loss............................ (1,177,641)
---------- ---------- ------------- --------------- ------------- -----------
Balance at October 31, 1996......... 9,484,898 94,849 39,500,239 (484,909) (51,107) (3,838,537)

Stock option activity, net of tax
benefit.......................... 48,236 482 654,522 (332,462)
Employee Stock Purchase Plan
activity......................... 9,190 92 37,217
Employee restricted stock
activity......................... 22,185 222 62,998 22,954
Non-employee restricted stock
activity......................... 36,000 360 143,640 (112,837)
Stock repurchased by the Company.... (36,900) (369) (149,560)
Distribution of net investment in
Vital Images................... (10,584,341) 460,000
Unrealized marketable securities
holding gain, net.............. 52,395
Net loss............................ (1,523,613)
---------- ---------- ------------- --------------- ------------- -----------
Balance at October 31, 1997......... 9,563,609 95,636 29,664,715 (447,254) 1,288 (5,362,150)

Stock option activity, net of tax
benefit.......................... 80,760 808 248,263 22,849
Employee Stock Purchase Plan
activity......................... 8,247 82 25,371
Employee restricted stock
activity......................... 56,961 570 248,491 (134,797)
Non-employee restricted stock
activity......................... 44,664
Stock repurchased by the Company.... (978,266) (9,783) (4,084,948)
Stock issued in conjunction with
the acquisition of Jer-Neen...... 585,872 5,859 2,593,948
Unrealized marketable securities
holding loss, net................ (185)
Net loss............................ (483,053)
---------- ---------- ------------- --------------- ------------- -----------
Balance at October 31, 1998......... 9,317,183 $93,172 $28,695,840 $(514,538) $1,103 $(5,845,203)
========== ========== ============= =============== ============= ===========
</TABLE>

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

9
<PAGE>

BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ---------------- ---------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITES:
Net loss................................... $(483,053) $(1,523,613) $(1,177,641)
Net loss from discontinued
operations.............................. -- (920,000) (2,396,142)
----------------- ---------------- ---------------
Income (loss) from continuing
operations.............................. (483,053) (603,613) 1,218,501

Adjustments to reconcile income (loss) from
continuing operations to net cash provided
by (used in) operating activities:
Depreciation............................... 493,709 353,964 296,731
Amortization of goodwill and other intangible
assets.................................. 384,288 265,805 294,679
Provision for uncollectible accounts....... 87,655 -- 36,592
Provision for inventory obsolescence....... 179,263 116,031 354,822
Non-cash compensation...................... 220,029 212,367 286,018
Deferred income taxes...................... (166,020) 239,132 (1,096,500)

Changes in operating assets and liabilities:
Accounts receivable........................ 138,986 (380,710) 704,417
Inventories................................ (484,620) 237,302 (359,324)
Other assets............................... 16,960 313,365 (305,345)
Accounts payable and accrued expenses...... (64,870) 297,247 (1,087,297)
----------------- ---------------- ---------------
Net cash provided by continuing
operations.......................... 322,327 1,050,889 343,294
Net cash used in discontinued
operations.......................... -- (1,860,920) (70,046)
----------------- ---------------- ---------------
Net cash provided by (used in) operating
activities.......................... 322,327 (810,031) 273,248
----------------- ---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITES:
Purchase of equipment and improvements,
excluding those obtained in the
purchase of Jer-Neen.................... (964,182) (654,153) (402,290)
Investments in marketable securities...... (8,674,706) (9,000,000) (25,980,000)
Proceeds upon maturity of marketable
securities.............................. 13,159,270 13,750,000 16,795,920
Proceeds upon sale of marketable
securities.............................. 2,750,000 -- --
Purchase of Jer-Neen, net of cash acquired
(Note 2)................................ (2,815,882) -- --
Investments in patents and trademarks,
excluding those obtained in the purchase
of Jer-Neen............................. (66,989) (43,310) (803,272)
Discontinued operations, net............... -- (2,327,360) (379,855)
----------------- ---------------- ---------------
Net cash provided by (used in) investing
activities.......................... 3,387,511 1,725,177 (10,769,497)
----------------- ---------------- ---------------

CASH FLOWS FROM FINANCING ACTIVITES:
Proceeds from issuance of bank
note.................................... 275,000 -- --
Repayments on bank note.................... (14,226) -- --
Offering costs related to the sale of
common stock in 1995.................... -- -- (87,327)
Proceeds related to stock options, employee
stock purchase plan and restricted
stock................................... 236,272 264,821 895,257
Repurchase of the Company's common stock... (4,094,731) (149,930) --
Repayment of capital lease obligations..... (53,426) -- --
Repayments of other long-term
obligations............................. (33,662) -- --
Repayment of debt in conjunction with the
acquisition of Jer-Neen................. (2,408,386) -- --
----------------- ---------------- ---------------
Net cash provided by (used in) financing
activities............................ (6,093,159) 114,891 807,930
----------------- ---------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................. (2,383,321) 1,030,037 (9,688,319)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR................................. 6,766,687 5,736,650 15,424,969
----------------- ---------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF YEAR... $4,383,366 $6,766,687 $5,736,650
================= ================ ===============
</TABLE>

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

10
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------

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

Business Description:

Bio-Vascular, Inc. ("Bio-Vascular" or the "Company") develops, manufactures and
markets branded proprietary and patented specialty medical products for use in
thoracic, cardiac, neuro, vascular and ophthalmic surgery. The Company's
branded products include the Tissue-Guard(TM) product line, the Biograft(R)
peripheral vascular graft and surgical productivity tools used in cardiac and
vascular surgery. The Tissue-Guard product line includes Peri-Strips(R), Peri-
Strips Dry(TM), Dura-Guard(R), Vascu-Guard(R), Supple Peri-Guard(R), Peri-
Guard(R), Tissue-Guard(TM), Supple Tissue-Guard(TM), CV Peri-Guard(TM) and Ocu-
Guard(TM). Tissue-Guard products are made from bovine pericardium (the thin
membrane surrounding the heart of cattle) processed using proprietary tissue-
fixation technology. The Tissue-Guard products, made in various configurations,
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.

The Company's wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc. ("Jer-
Neen"), is a value-added manufacturer of precision component products such as
micro coils, wire forms and spring components used in implantable
defibrillation, interventional medicine and other surgical applications within
the medical device industry. The Company acquired Jer-Neen in July 1998.

Basis of Consolidation:

The consolidated financial statements include the accounts of Bio-Vascular, Inc.
and its wholly-owned subsidiary, Jer-Neen, after elimination of inter-company
accounts and transactions.

Use of Estimates:

The preparation of 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 at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates. The most significant areas
which require the use of management's estimates relate to the determination of
the allowances for doubtful accounts receivable and obsolete inventories and
evaluation of the realizability of intangible and other long-lived assets and
deferred tax assets.

Cash and Cash Equivalents:

Cash and cash equivalents consist of cash and highly liquid investments
purchased with an original maturity of three months or less. Cash at October
31, 1998 was primarily invested in commercial paper and one money market fund.

Marketable Securities:

Investments having original maturities in excess of three months are classified
as marketable securities and generally consist of commercial paper, U.S.
Government or U.S. Government-backed obligations. Investments are classified as
short-term or long-term in the balance sheet based on their maturity date. At
October 31, 1998 and 1997, all of the Company's marketable securities are
classified as available-for-sale. Available-for-sale investments are recorded
at market value with net unrealized holding gains and losses included as a
separate component of shareholders' equity.

Inventories:

Inventories, which are comprised of component parts, subassemblies and finished
goods, are valued at the lower of first-in, first-out (FIFO) cost or market. On
a quarterly basis, the Company compares the amount of the inventories on hand
with its latest forecasted requirements to determine whether write-downs for
excess or obsolete inventories are required.

11
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

Equipment and Leasehold Improvements:

Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are calculated using the straight-line method over the estimated
useful lives of the related assets. Furniture, fixtures and computer equipment
are depreciated over a 3-to 7-year life and manufacturing equipment are
depreciated over a 5-to 10-year life. Leasehold improvements are amortized over
the life of the related facility leases or the asset, whichever is shorter.
Major replacements and improvements are capitalized and maintenance and repairs
which do not improve or extend the useful lives of the respective assets are
charged to operations. The asset and related accumulated depreciation or
amortization accounts are adjusted for asset retirements and disposals with the
resulting gain or loss, if any, is recorded in "Other income, net", on the
Consolidated Statements of Operations.

Long-Lived Assets:

The Company adopted the Statement of Financial Accounting Standard (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of. The Company reviews its long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the asset in question may not be recoverable. Impairment
losses are recorded whenever indicators of impairment are present.

Goodwill and Other Intangible Assets:

Goodwill and other intangible assets are recorded at cost and are amortized
using the straight-line method over their estimated useful lives, generally ten
to seventeen 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:

Revenue is recognized upon shipment of goods to customers, net of estimated
returns.

Research and Development:

Research and development costs are expensed as incurred.

Stock-Based Compensation:

The Company adopted the disclosure-only provisions of Statement of Financial
Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation,
which disclosures are presented in Note 8 "Shareholders' Equity". The Company
continues to account for employee stock-based compensation using the intrinsic
value method as prescribed under Accounting Principles Board Opinion (APB) No.
25, Accounting for Stock Issued to Employees, and related Interpretations.

Income Taxes:

The Company accounts for income taxes using the asset and liability method. The
asset and liability method provides that deferred tax assets and liabilities are
recorded based on the differences between the tax basis of assets and
liabilities and their carrying amounts for financial reporting purposes
("temporary differences"). Temporary differences relate primarily to operating
and capital loss carryforwards, research and experimentation tax credit
carryforwards, depreciation, non-compete obligation and obsolete inventory
reserves.

12
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

Net Income (Loss) Per Common Share:

In February 1997, SFAS No. 128, Earnings per Share (EPS), was issued by the
Financial Accounting Standards Board. This standard, which the Company adopted
in the first quarter of fiscal 1998, requires dual presentation of basic and
diluted EPS. Basic EPS is computed based on the weighted average number of
common shares outstanding, while diluted EPS is computed based on the weighted
average number of common shares outstanding adjusted by the weighted average
number of additional shares that would have been outstanding had the potential
dilutive common shares been issued. Potential dilutive shares of common stock
include stock options and other stock-based awards granted under the Company's
stock-based compensation plans.

(2) ACQUISITION OF BUSINESS:

On July 31, 1998, the Company completed the acquisition of Jer-Neen
Manufacturing Co., Inc. of Lino Lakes, Minnesota. Jer-Neen is a value-added
manufacturer of precision component products used within the medical device
industry. Jer-Neen's product line includes micro coils, wire forms and spring
components used in implantable defibrillation, interventional medicine and other
surgical applications. The acquisition has been accounted for as a purchase.

Pursuant to the terms of the acquisition agreement, all of the issued and
outstanding shares of common stock of Jer-Neen were exchanged for 585,872 shares
of Bio-Vascular common stock, valued at $2,600,000, and an aggregate of
$1,750,000 in cash, excluding transaction costs. The Company also paid $950,000
for a ten-year non-compete agreement covering the former Jer-Neen shareholders.
Goodwill acquired by the Company amounted to $5,200,000 and will be amortized
using the straight-line method over fifteen years. The Company acquired
$2,400,000 of Jer-Neen's outstanding debt, which was paid immediately upon
completion of the transaction. The remaining fair value of net assets of Jer-
Neen acquired in the transaction totaled $1,772,000, including equipment and
improvements of $2,217,000, patents of $387,000, receivables of $848,000,
inventories of $381,000, less capital lease obligations of $677,000, accounts
payable and accrued expenses of $713,000 and other long-term obligations of
$815,000.

The acquisition occurred on July 31, 1998, therefore only the results of Jer-
Neen's operations for the three-month period ended October 31, 1998 are included
in the Company's Consolidated Statement of Operations for 1998.

The following unaudited pro forma financial information reflects the combined
results of the Company and Jer-Neen had the acquisition occurred at the
beginning of each of the fiscal periods presented. The pro forma financial
information presented is not necessarily indicative of either the future
combined operations of the Company or the actual results that would have
occurred had the acquisition of Jer-Neen been consummated on November 1, 1997 or
1996.

1998 1997
----------- -----------

Net revenue....................... $16,179,528 $13,828,222
Operating loss.................... (1,157,574) (1,099,039)
Loss from continuing operations... (560,984) (769,347)
Basic earnings per share.......... (0.06) (0.08)
Diluted earnings per share........ (0.06) (0.08)

13
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

(3) DISCONTINUED OPERATIONS:

On May 12, 1997, the Company completed the spin-off distribution of all shares
of Vital Images, Inc. ("Vital Images") to shareholders of Bio-Vascular, with
Vital Images thereafter operating as an independent company with its own
publicly-traded securities. All Bio-Vascular shareholders of record received one
share of Vital Images common stock for every two shares of Bio-Vascular common
stock held, with cash issued in lieu of fractional shares. The spin-off
distribution was recorded by reducing shareholders' equity by $10,124,000, which
represents $10,000,000 of cash and investments, plus the carrying value of Vital
Images' net assets.

The 1996 loss from operations of the discontinued business included an
allocation of interest income (based on the ratio of net investment assets
contributed to the discontinued business over total investment assets) of
$547,000. The 1996 loss on disposal of discontinued business of $1,348,000
included the estimated future operating losses of Vital Images through the
estimated date of spin-off. In addition to the estimate of future results of
operations, major components of the loss on disposal include $400,000 of
transaction costs, interest income of $200,000 and deferred income tax benefits
of $452,000. The 1997 loss on disposal of $920,000 reflects additional losses
and costs associated with the spin-off transactions, which took longer to
complete than anticipated, and which exceeded the $1,348,000 amount previously
estimated and recorded as of October 31, 1996.

DISCONTINUED OPERATIONS

1998 1997
----------- -----------
Net revenue...................... -- $882,126
Gross margin..................... -- 719,840
Operating loss................... -- (2,357,065)
Loss from operations of
discontinued business, net of
income taxes.................. -- (1,048,142)
Loss on disposal of discontinued
business, net of income taxes. $(920,000) (1,348,000)
Total discontinued operations,
net of income taxes........... (920,000) (2,396,142)

14
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

(4) SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION:

<TABLE>
<CAPTION>
1998 1997
------------------- -----------------
<S> <C> <C>
Marketable securities, short- and long-term:
Commercial paper................................................. $1,998,844 --
U.S. Government and government agency obligations................ 1,991,995 $11,219,830
------------------- -----------------
$3,990,839 $11,219,830
=================== =================
Accounts receivable, net:
Trade receivables................................................ $2,584,096 $1,867,919
Less allowance for doubtful accounts............................. (128,078) (21,400)
------------------- -----------------
$2,456,018 $1,846,519
=================== =================
Inventories, net:
Raw materials and supplies....................................... $1,242,003 $ 580,354
Work in process.................................................. 519,424 405,736
Finished goods................................................... 1,024,317 1,006,305
Less reserve for inventory obsolescence.......................... (479,820) (373,000)
------------------- -----------------
$2,305,924 $1,619,395
=================== =================
Equipment and leasehold improvements, net:
Furniture, fixtures and computer equipment....................... $1,101,256 $ 826,360
Manufacturing equipment.......................................... 1,999,263 991,127
Leasehold improvements........................................... 1,758,872 874,887
Equipment in process............................................. 234,696 --
Furniture, fixtures and computer equipment under capital
leases........................................................ 154,306 --
Manufacturing equipment under capital leases..................... 604,431 --
Less accumulated depreciation and leasehold improvement
amortization.................................................. (1,474,400) (1,021,928)
Less accumulated amortization of capital leases.................. (24,548) --
------------------- -----------------
$4,353,876 $1,670,446
=================== =================
Goodwill and other intangible assets, net:
Goodwill......................................................... $6,756,194 $1,538,374
Patents and other intangibles.................................... 1,162,869 708,880
Non-compete agreement............................................ 950,000 --
Less accumulated amortization.................................... (1,628,291) (1,244,003)
------------------- -----------------
7,240,772 $1,003,251
================== =================
Accrued expenses:
Payroll, other employee benefits and related taxes............... $599,126 $275,015
Accrued income taxes............................................. 280,943 --
Other accrued expenses........................................... 540,985 460,034
------------------- -----------------
$1,421,054 $735,049
================== =================
</TABLE>

15
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

(5) INCOME TAXES:

PROVISION FOR (BENEFIT FROM) INCOME TAXES

1998 1997 1996
------------- -------------- --------------
<S> <C> <C> <C>
Current:
Federal............................................ $(21,511) $95,893 $834,720
State.............................................. 1,793 43,750 34,606
------------- -------------- --------------
(19,718) 139,643 869,326
------------- -------------- --------------
Deferred:
Federal............................................ (142,809) 286,159 (345,518)
State.............................................. (23,211) (60,602) (9,808)
------------- -------------- --------------
(166,020) 225,557 (355,326)
------------- -------------- --------------
Total.............................................. $(185,738) $365,200 $514,000
============= ============== ==============
</TABLE>

RECONCILIATION OF EFFECTIVE INCOME TAX RATE

1998 1997 1996
------------- -------------- --------------
<S> <C> <C> <C>
Income (loss) from continuing operations........... $(668,791) $(238,413) $1,732,501
============= ============== ==============

Statutory federal rate............................. $(227,389) $(81,060) $606,375
Benefit from marginal rate......................... -- -- (17,325)
State taxes, net of federal benefit................ (14,136) (11,122) 24,798
Permanent differences.............................. 56,130 (20,269) 36,206
Write-off of deferred tax asset associated with
discontinued operations......................... -- 421,000 --
Increase (decrease) in valuation allowance......... (2,685) 69,027 (203,058)
Other, net......................................... 2,342 (12,376) 67,004
------------- -------------- --------------
Provision for (benefit from) income taxes.......... $(185,738) $365,200 $514,000
============= ============== ==============

</TABLE>
COMPONENTS OF DEFERRED TAX ASSETS (LIABILITIES)

1998 1997 1996
------------- -------------- --------------
<S> <C> <C> <C>
Operating loss carryforwards....................... $228,456 $169,800 $741,150
Capital loss carryforwards......................... 140,842 149,062 149,750
Credit carryforwards............................... 324,502 269,005 128,300
Depreciation....................................... (220,005) (35,866) (46,013)
Inventory.......................................... 172,659 137,562 131,453
Non-compete obligation............................. 240,293 -- --
Other, net......................................... (21,883) (18,668) 66,360
Less valuation allowance........................... (140,842) (143,527) (74,500)
------------- -------------- --------------
Net deferred tax assets............................ $724,022 $527,368 $1,096,500
============= ============== ==============
</TABLE>

Income tax payments included in the Consolidated Statements of Cash Flows
totaled $2,525, $5,850 and $410,769 for the years ended October 31, 1998, 1997
and 1996, respectively. A tax benefit of $3,961, $119,738 and $682,200 related
to the exercise of stock options was recorded to additional paid-in capital in
1998, 1997 and 1996, respectively. In conjunction with the acquisition of Jer-
Neen, the Company acquired net deferred tax assets of $30,634.

The valuation allowance relates solely to capital loss carryforwards, which have
been determined to be unrealizable.

16
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

Net operating loss carryforwards begin to expire in 2012-2013 and credit
carryforwards begin to expire in 2009-2013. Management expects to fully utilize
its remaining deferred tax assets against future taxable income.

(6) CAPITAL LEASES AND LONG-TERM OBLIGATIONS:

In connection with the acquisition of Jer-Neen, the Company acquired certain
long-term obligations.

Long-term obligations consist of the following at October 31, 1998:

Capital leases................................. $ 623,228
Term note payable to bank...................... 260,774
Contractual obligations to landlord............ 306,401
Contractual obligation to former
shareholder of Jer-Neen..................... 476,520
Other note payable to bank..................... 3,531
----------
1,670,454
Less current portion........................... (615,961)
----------
$1,054,493
==========

The Company is the lessee of certain machinery and equipment under capital lease
obligations expiring from 1999 through 2002. The assets and liabilities under
capital leases have been recorded at the fair value of the asset when placed in
service. Interest rates on capitalized leases vary from 9.75% to 15.24% and are
imputed based on the lessor's implicit rate of return.

Subsequent to October 31, 1998, the Company has paid the term note in full and
as such, has reflected the total amount payable at October 31, 1998 in the
current portion of long-term obligations.

The contractual obligations to the landlord relate to leasehold improvements and
are payable in monthly installments of $7,561 through January 2003. The
obligations were financed at fixed interest rates ranging from 10% to 12%.

The contractual obligation to a former shareholder of Jer-Neen is payable in
monthly installments of $8,333 through October 2004. The interest is imputed
based on the Company's borrowing rate of 10%.

Aggregate maturities of capital leases and long-term obligations are as follows:

Year Ending
October 31 Amount
----------- ----------
1999............................................. $615,961
2000............................................. 369,159
2001............................................. 293,762
2002............................................. 181,367
2003............................................. 106,937
Thereafter....................................... 103,268
----------
$1,670,454
==========

17
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

(7) COMMITMENTS:

Operating Leases:

The Company is committed under non-cancelable operating leases for the rental of
its office and production facilities. At October 31, 1998, the remaining terms
on the leases range from four to seven years. In addition to base rent charges,
the Company also pays apportioned real estate taxes and common costs on its
leased facilities. Total facilities rent expense, including real estate taxes
and common costs, was $458,176, $382,886 and $296,486 for the years ended
October 31, 1998, 1997 and 1996, respectively.

As of October 31, 1998, future minimum lease payments, excluding real estate
taxes and common costs, due under existing non-cancelable operating leases are
as follows:

Year Ending
October 31 Amount
----------- ----------

1999........................................... $ 385,509
2000........................................... 385,509
2001........................................... 372,979
2002........................................... 357,941
2003........................................... 281,066
Thereafter..................................... 447,039
----------
$2,230,043
==========

Royalties:

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

- - 5% on net sales of Peri-Strips and Peri-Strips Dry until the expiration of
the related patents through May 2015.

- - 2.5% of net sales of the Biograft through December 1998.

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

Royalty expense was approximately $203,000, $191,000 and $291,000 for the years
ended October 31, 1998, 1997, and 1996, respectively, and is included in cost of
revenue.

(8) SHAREHOLDERS' EQUITY:

Authorized Shares and Designation of Preferred Class of Stock:

In 1997, the shareholders approved an increase in authorized shares of capital
stock from 20,000,000 shares to 25,000,000 shares and reservation of 5,000,000
such shares as undesignated shares of preferred stock, having such rights,
preferences and designations as determined by the Board of Directors. As a
result, the Company's authorized capital stock consists of 20,000,000 shares of
common stock and 5,000,000 shares of undesignated preferred stock.

Stock Repurchase Plan:

In 1997, the Company's Board of Directors adopted a stock repurchase plan (the
"Plan") and authorized the purchase of up to 500,000 shares of its common stock.
During 1998, the Company's Board of Directors amended the Plan to authorize the
repurchase of up to 1,500,000 common shares.

18
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

As of October 31, 1998, the Company had repurchased a total of 1,015,166 shares
of its common stock since the inception of the Plan.

Warrants:

During 1995, in connection with a public offering of its common shares, the
Company issued the underwriter warrants to purchase 90,000 shares of common
stock at an exercise price of $16.375 per share. These warrants became
exercisable in September 1996 and will remain exercisable until September 1999.

Under the agreement governing the Company's spin-off of Vital Images, Vital
Images is required to assume its respective obligations represented by such
underwriter warrants and to issue 45,000 shares of its common stock upon the
exercise thereof, based upon the spin-off distribution ratio of one share of
Vital Images common stock for each two shares of Bio-Vascular common stock. In
exchange, the spin-off agreement provides that Vital Images will receive a
proportionate share of the exercise price set by the terms of the agreement.
Accordingly, upon exercise of the warrants, Bio-Vascular will receive proceeds
of $13.0283 per share and Vital Images will receive proceeds of $3.3467 per
share.

Shareholder Rights Plan:

In June 1996, the Company's Board of Directors declared a dividend distribution
of one Common Stock purchase right (a "Right") for each outstanding share of the
Company's Common Stock on July 15, 1996. The Company also entered into a Rights
Agreement governing the terms of the Rights, and each share of Common Stock
issued subsequent to July 15, 1996, has been issued with an attached Right
pursuant to the terms of the Rights Agreement.

Upon exercise, each Right entitles the holder thereof to purchase one-tenth of a
share of Common Stock at a purchase price currently set at $6.00 per share,
subject to adjustment to reflect the value of the Company following the spin-off
of Vital Images, Inc. Upon the occurrence of certain events in connection with:
(i) a person or group acquiring 15% or more of the Company's outstanding Common
Stock; (ii) a third party announcing an offer to purchase a 15% or greater stake
in the Company; or (iii) the Board of Directors declaring a person to be an
"adverse person" based upon such person being a holder of 10% or more of the
Company's outstanding stock and the Board's belief that such person's shares
were acquired for short-term financial gain or that the shareholder might
otherwise adversly affect the Company's business or prospects, the Rights become
exercisable and entitle each holder thereof (other than the acquiring person or
"adverse person") to purchase, for a price equal to ten times the then-current
purchase price of the Right, shares of Common Stock (or other securities of the
Company) or equity securities of the acquiring company, as the case may be,
having a market value equal to twenty times the then-current purchase price of
the Right. In general, the Company is entitled to redeem the Rights in whole at
a price of $.001 per Right (payable in cash, stock or other consideration deemed
appropriate by the Board of Directors) prior to the first to occur of any such
events. Each Right will expire on June 11, 2006, if not previously redeemed or
exercised.

Stock-Based Compensation:

The Company has various stock award and stock option plans and an employee stock
purchase plan (ESPP). Under the stock award and stock option plans, the Company
is authorized to grant up to 1,490,135 shares of its common stock for issuance
under these plans. At October 31, 1998, 282,718 shares remained available for
grant under these plans. Under the ESPP, the Company is authorized to sell and
issue up to 300,000 shares of its common stock to its full-time employees. At
October 31, 1998, 276,848 shares remained available for grant under the ESPP.

The Company has also reserved 211,720 shares of its common stock for issuance in
connection with outstanding stock option grants that were not made pursuant to a
formal stock incentive plan.

The Company applies APB No. 25 and related interpretations to account for its
stock-based compensation plans. During 1997, the Company adopted the
disclosure-only provisions of SFAS No. 123 which requires pro forma disclosures
regarding the Company's plans.

19
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

Stock Awards:

Under certain compensation agreements, an arrangement which provides for awards
of common stock to key management was adopted in 1992. These awards of common
stock are subject to forfeiture if employment terminates prior to the end of the
prescribed periods. Vesting periods range from three to four years. The market
value of the shares at the time of grant is recorded as unearned stock
compensation. The unearned amount is amortized to compensation expense over the
periods during which the vesting lapse.

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 shares.
The number of shares bought back by the Company from employees totaled 7,911,
10,655 and 17,124 during 1998, 1997 and 1996, respectively. Stock awards
granted to employees is summarized as follows:

Unearned Stock Awards Market Value
Balance Shares At Grant
-------------- -------------- -----------------
<S> <C> <C> <C>
Balance October 31, 1995.............. $ 382,726 76,528 $3.25 - $14.50

Granted............................... 131,414 11,868 8.63 - 14.00
Earned................................ (172,463) (35,061) 8.25 - 14.50
Canceled/Forfeited.................... (30,905) (4,002) 4.75 - 14.00
-------------- --------------

Balance October 31, 1996.............. 310,772 49,333 3.25 - 14.50

Granted............................... 220,064 46,545 4.25 - 6.50
Earned................................ (134,021) (27,101) 3.25 - 14.50
Canceled/Forfeited.................... (108,997) (13,705) 4.75 - 14.50
-------------- --------------
Balance October 31, 1997.............. 287,818 55,072 4.25 - 14.00

Granted............................... 427,504 99,548 3.50 - 5.13
Earned................................ (142,451) (27,937) 3.50 - 14.00
Canceled/Forfeited.................... (150,256) (34,676) 3.69 - 4.75
-------------- --------------

Balance October 31, 1998.............. $ 422,615 92,007 3.50 - 14.00
============== ==============
</TABLE>

Shares of common stock have also been awarded to certain medical professionals
as compensation for services provided in the Company's product development
activities. These awards vest in accordance with the service agreement and
totaled 36,000 shares granted in 1997. There were no such awards granted in
1998 or 1996.

The weighted average market value at grant date for stock awards was $4.29,
$4.41 and $11.02 for 1998, 1997 and 1996, respectively.

Stock Options:

The exercise price of each stock option generally equals 100% of the market
price of the Company's stock on the date of grant and has a maximum term of up
to ten years. Employee option grants generally vest ratably over four years,
while options granted to non-employee directors of the Company generally vest
ratably over three years. A summary of the status of the Company's stock
options for the years ended October 31 is as follows:

20
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>

1998 1997 1996
------------------------ --------------------------- --------------------------

Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year..... 1,305,106 $5.43 1,148,764 $5.60 1,014,263 $ 3.97
Granted.............................. 463,989 4.50 419,262 5.16 267,108 10.44
Exercised............................ (80,760) 2.91 (48,236) 3.23 (82,744) 2.59
Canceled............................. (466,796) 6.52 (214,684) 5.20 (49,863) 8.38
------------ ------------ ------------
Outstanding at end of year........... 1,221,539 4.82 1,305,106 5.43 1,148,764 5.60
============ ============ ===========
Options exercisable at end of year... 669,920 4.99 794,743 4.98 692,623 4.26
============ ============ ===========
</TABLE>

The following table summarizes information about stock options outstanding at
October 31, 1998:
<TABLE>
<CAPTION>

Options Outstanding Options Exercisable
--------------------------------------------------- -----------------------------
Weighted
Average Weighted
Number of Weighted Remaining Number of Average
Options Average Contractual Options Exercise
Range of Prices Outstanding Exercise Price Life (Years) Exercisable Price
-------------------- --------------- ---------------- ---------------- --------------- ------------
<S> <C> <C> <C> <C> <C>
$ 1.87-$ 3.86 320,009 $3.20 4.10 266,049 $3.15
4.00 - 4.44 287,936 4.29 8.11 78,315 4.32
4.45 - 5.00 318,449 4.90 6.61 89,134 4.72
5.05 - 9.03 287,150 6.91 4.27 230,446 7.30
9.53- 12.21 7,995 10.56 4.49 5,976 10.57
-------------- --------------
1.87- 12.21 1,221,539 4.82 5.74 669,920 4.99
============== ==============
</TABLE>

Employee Stock Purchase Plan:

The Company sponsors an Employee Stock Purchase Plan (ESPP) under which 300,000
shares of common stock were reserved for future issuance. The ESPP was
established to enable employees of the Company to invest in Company stock
through payroll deduction. Options are granted to employees to purchase shares
of stock at a price that is the lower of 85% of the fair market value of the
stock on the first or last day of each offering period. There were 8,247, 9,190
and 5,715 shares purchased through the Plan in 1998, 1997 and 1996,
respectively.

SFAS No. 123 Disclosure:

For the year ended October 31, compensation expense recorded for stock-based
compensation awards (stock awards and stock options) was as follows:

21
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

1998 1997 1996
------------- ------------- --------------
<S> <C> <C> <C>
Employee.............................................. $135,301 $149,608 $247,268
Non-employee.......................................... 84,728 62,759 38,750
------------- ------------- --------------
Total stock-based compensation expense................ $220,029 $212,367 $286,018
============= ============= ==============
</TABLE>

Non-employee expense includes amounts related to performance option awards for
up to 25,000 shares, assuming maximum performance payout.

Had compensation expense for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates consistent with SFAS No.
123, the Company's net loss and loss per share would have been increased to the
pro forma amounts indicated below:

Net loss................................As Reported $(483,053) $(1,523,613) $(1,177,641)
................................Pro Forma (946,091) (4,634,523) (2,252,420)

Basic loss per share....................As Reported (0.05) (0.16) (0.13)
....................Pro Forma (0.10) (0.49) (0.24)

Diluted loss per share..................As Reported (0.05) (0.16) (0.12)
..................Pro Forma (0.10) (0.49) (0.23)

</TABLE>

The pro forma information includes stock options granted and purchases under the
ESPP in 1998, 1997 and 1996. Additionally, the 1997 pro forma information
reflects the impact of the modification of previously granted stock options
occurring as part of the spin-off of Vital Images, a former subsidiary of the
Company.

The weighted average fair value per option granted during 1998, 1997 and 1996
was $1.40, $2.18 and $3.60, respectively for the ESPP and $3.04, $2.99 and
$8.38, respectively for all other options. The weighted average fair value was
calculated by using the fair value of each option on the date of grant. The
fair value of the ESPP options was based on the 15 percent purchase discount.
The fair value of all other options was estimated using the Black-Scholes option
pricing model with the following weighted average assumptions:

1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Expected option term................. 6.4 years 4.2 years 6.6 years
Expected volatility factor........... 69% 72% 69%
Expected dividend yield.............. 0% 0% 0%
Risk-free interest rate.............. 5.73% 6.33% 6.02%
</TABLE>

(9) EARNINGS PER SHARE:

The Company adopted SFAS No. 128 during the first quarter of fiscal year 1998.
Earnings per share for all periods presented have been prepared in accordance
with the provisions of SFAS No. 128. The following table sets forth the
computation of basic and diluted shares outstanding for the years ended October
31:

22
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
1998 1997 1996
-------------- --------------- ---------------
<S> <C> <C> <C>
Numerator:
Income (loss) from continuing operations........ $(483,053) $(603,613) $1,218,501
Loss from operations of discontinued business,
Net of income (1,048,142)
taxes........................................
Loss on disposal of discontinued business,
net of income taxes.......................... -- (920,000) (1,348,000)
-------------- --------------- ---------------
Net loss........................................ $(483,053) $(1,523,613) $(1,177,641)
============== =============== ===============

Denominator:
Denominator for basic earnings per share -
Weighted-average common shares............... 9,228,265 9,498,827 9,386,824

Effect of dilutive securities:
Shares associated with deferred compensation.... -- -- 45,759
Shares associated with option plans............. -- -- 443,855
-------------- --------------- ---------------
Dilutive potential common shares................ -- -- 489,614
-------------- --------------- ---------------

Denominator for diluted earnings per share -
Weighted-average common shares and
Dilutive potential common shares............. 9,228,265 9,498,827 9,876,438
============== =============== ===============
</TABLE>

In fiscal 1998 and 1997, none of the options outstanding were included in the
computation of diluted earnings per share for the year then ended because the
Company had incurred net losses during those periods, and the inclusion of
options would have been anti-dilutive. In fiscal 1996, outstanding options
totaling 338,700 were excluded from the computation of diluted earnings per
share because the options' exercise price was greater than the average market
price of the common shares.

(10) RELATED PARTY TRANSACTIONS:

In fiscal 1997, the Company entered into a distribution agreement with Scanlan
International, Inc., a medical and surgical products distributor. The Chairman
of the Board of Directors of the Company is President and Chief Executive
Officer of the Scanlan Group of Companies, the parent company of Scanlan
International. The agreement grants Scanlan International the exclusive right,
acting as a sales representative of Bio-Vascular, to solicit orders, work with
distributors and market listed products within Latin America until October 31,
2000 subject to annual renewal thereafter. Scanlan International receives a
commission of 20% on net sales to Latin America during the term of the
agreement. Commissions paid to Scanlan International totaled $2,000 for 1998.
There was no sales activity resulting from this agreement in 1997.

(11) EMPLOYEE BENEFIT PLAN:

Salary Reduction Plan:

The Company sponsors salary reduction plans for all full-time employees, which
qualify under Section 401(k) of the Internal Revenue Code. Employee
contributions are limited to 15% of their annual compensation, subject to annual
limitations. At its discretion, 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 plans since inception.

23
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

(12) SEGMENT INFORMATION:

As a result of the acquisition of Jer-Neen, the Company now operates in two
different business segments: branded products and component products.

Branded Products

The branded products segment develops, manufactures and markets branded
proprietary and patented specialty medical products used in thoracic, cardiac,
neuro, vascular and opthalmic surgery.

Component Products

The component products segment manufactures precision component products such as
micro coils, wire forms and spring components used in implantable
defibrillation, interventional medicine and other surgical applications within
the medical device industry.

Information on the Company's business segments for the year ended October 31,
1998 is as follows:

<TABLE>
<CAPTION>
Operating
Net Revenues Income (Loss)
---------------------- ---------------------
<S> <C> <C>
Branded products............................ $10,620,021 $(1,476,302)
Component products.......................... 1,397,358 61,727
---------------------- ---------------------
$12,017,379 $(1,414,575)
====================== =====================

Identifiable Capital
Assets Expenditures
---------------------- ---------------------
Branded products............................ $16,113,687 $847,685
Component products.......................... 9,868,532 116,497
---------------------- ---------------------
$25,982,219 $964,182
====================== =====================

Depreciation Amortization of
Expense Intangible Assets
---------------------- ---------------------
Branded products............................ $427,869 $261,971
Component products.......................... 65,840 122,317
---------------------- ---------------------
$493,709 $384,288
====================== =====================
</TABLE>

24
<PAGE>

BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
- --------------------------------------------------------------------------------

(13) MAJOR CUSTOMERS AND NET REVENUE BY GEOGRAPHIC AREA:

Substantially all of the Company's international net revenues are negotiated,
invoiced and paid in U.S. dollars. The following tables summarize significant
customers and international net revenues by geographic area:

<TABLE>
<CAPTION>
1998 1997 1996
-------------- --------------- ---------------
<S> <C> <C> <C>
Percent of accounts receivable by significant
Customers:
A............................................... 9% 20% 21%
B............................................... 11% 13% 16%
C............................................... 11% 10% 14%
D............................................... 13% -- --

</TABLE>

The company does not require collateral from its customers to support their
accounts receivable.

Percent of net revenues by significant
customers:
<S> <C> <C> <C>
A............................................... 16% 19% 18%
B............................................... 12% 14% 15%
C............................................... 11% 11% 12%

International net revenues by geographic area:
Europe and Middle East.......................... $1,559,038 $1,412,675 $1,371,867
Asia and Pacific Region......................... 824,895 666,201 623,884
Other........................................... 244,752 215,934 222,849
-------------- --------------- ---------------
Total.......................................... $2,628,685 $2,294,810 $2,218,600
============== =============== ===============

Percent of total net revenues.................. 22% 24% 22%

</TABLE>

(14) NEW ACCOUNTING STANDARDS:

In June 1997, SFAS No. 130, Comprehensive Income, was issued by the Financial
Accounting Standards Board. SFAS 130 establishes standards for reporting and
displaying comprehensive income and its components (revenues, expenses, gains
and losses) in the financial statements. The Company's only component of other
comprehensive income is the unrealized gain/loss on available-for-sale
investments. Also issued in June 1997 was SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information, which establishes new
standards for the way public business enterprises report information about
operating segments. The Company must adopt SFAS 130 and SFAS 131 in fiscal year
1999. Management is currently evaluating the effect of these changes, if any,
on its financial reporting.

25
<PAGE>

The following information appears on page 24 of the Company's Annual Report to
Shareholders.

Report of Independent Accountants

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

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity, and cash flows
present fairly, in all material respects, the financial position of Bio-
Vascular, Inc. as of October 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
October 31, 1998, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of Bio-Vascular, Inc.'s
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.

PricewaterhouseCoopers LLP

Minneapolis, Minnesota
December 8, 1998

26
<PAGE>

The following information appears on page 24 of the Company's 1998 Annual Report
to Shareholders.

Common Stock Information

Price Range

The Company's Common Stock is currently traded on the Nasdaq National Market
under the symbol "BVAS". The following table sets forth, for each of the fiscal
periods indicated, the range of high and low closing sale prices per share as
reported by the Nasdaq National Market. These prices do not include adjustments
for retail mark-ups, mark-downs or commissions.

<TABLE>
<CAPTION>
1998 1997
Quarter Ended High Low High Low
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
January 31 $4.188 $3.250 $7.750 $6.000
April 30 5.375 4.063 6.000 5.000
July 31 5.125 4.375 5.875 3.875
October 31 4.500 3.000 5.000 3.750
</TABLE>

Dividends

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.

Shareholders

As of November 30, 1998, there were approximately 4,600 beneficial owners and
1,200 registered shareholders of the Company's Common Stock

27
<PAGE>

The following information appears on page 24 in the Company's 1998 Annual Report
to Shareholders.

Bio-Vascular, Inc.
Quarterly Results

(In thousands except per share amounts)

First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 1998 (unaudited)

Net revenue $2,463 $2,727 $2,760 $4,068

Gross margin 1,424 1,650 1,618 2,103

Operating income (loss) (553) (366) (276) (219)

Income (loss) from continuing operations (205) (101) (43) (134)

Income (loss) per share from
continuing operations (0.02) (0.01) 0.00 (0.01)

Fiscal 1997 (unaudited)

Net revenue $2,325 $2,481 $2,409 $2,479

Gross margin 1,321 1,463 1,456 1,486

Operating income (loss) (68) (123) (498) (616)

Income (loss) from continuing operations 125 97 (491) (334)

Income (loss) per share from
continuing operations: 0.01 0.01 (0.05) (0.04)

Quarterly calculations of net income (loss) per share are made independently
during the fiscal year.

Earnings per share amounts, for all periods presented, have been prepared
pursuant to the provisions of Statement of Financial Accounting Standard No.
128, Earnings Per Share; see Note 9 to the financial statements.

28
<PAGE>

The following information appears on the inside cover of the Company's 1998
Annual Report to Shareholders.

Bio-Vascular, Inc.
Financial Highlights

Summary Statement of Operations Data:

For the Years Ended October 31 1998 1997 1996 1995 1994
- ------------------------------ ------------ ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Net revenue $ 12,017,379 $ 9,694,047 $10,124,709 $10,426,076 $4,951,743

Gross margin 6,795,267 5,726,587 6,681,611 6,964,259 3,027,708

Operating income (loss) (1,414,575) (1,305,235) 571,013 2,121,096 (255,951)

Income (loss) from continuing operations (483,053) (603,613) 1,218,501 1,659,162 (697,025)

Earnings per share from
continuing operations:
Basic (0.05) (0.06) 0.13 0.22 (0.10)
Diluted (0.05) (0.06) 0.12 0.21 (0.10)

Weighted average shares outstanding:
Basic 9,228,265 9,498,827 9,386,824 7,508,641 7,248,620
Diluted 9,228,265 9,498,827 9,876,438 8,061,832 7,248,620

</TABLE>

The above information excludes discontinued operations; see Note 3 to the
financial statements.

Earnings per share amounts have been prepared pursuant to the provisions of
Statement of Financial Accounting Stardard No. 128, Earnings Per Share; see Note
9 to the financial statements.

Summary Balance Sheet Data:
<TABLE>
<CAPTION>

As of October 31 1998 1997 1996 1995 1994
- ---------------- ------------ ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Working capital $ 11,385,951 $16,905,823 $22,106,990 $24,059,746 $6,261,521

Total assets 25,982,219 25,134,451 37,881,279 37,303,375 7,431,793

Long-term obligations 1,054,493 - - - -

Shareholders' equity 22,430,374 23,952,235 35,220,535 35,355,336 6,785,539

</TABLE>

In connection with the 1997 spin-off of Vital Images Inc., Shareholders' Equity
was reduced by $10,124,000 which represents the contribution of cash equivalents
and marketable securities plus the carrying value of Vital Images' net assets.

<PAGE>

Exhibit 21.1

BIO-VASCULAR, INC.
LIST OF SUBSIDIARIES OF THE COMPANY
FOR THE YEAR ENDED OCTOBER 31, 1998
- --------------------------------------------------------------------------------

Name of Subsidiary Jurisdiction/State of Incorporation
- ------------------ -----------------------------------

1) Jer-Neen Manufacturing Co., Inc. Minnesota

2) Bio-Vascular B.V., Breda Netherlands

3) BVI (Barbados), Inc. Barbados

<PAGE>

Exhibit 23.1

CONSENT OF PRICEWATERHOUSECOOPERS LLP

We consent to the incorporation by reference in the Registration Statements on
Form S-8 of Bio-Vascular, Inc. (Registration Nos. 33-85394; 33-22302; 33-94588;
333-14093; 333-14137; and 333-26783) and the Registration Statement of Bio-
Vascular, Inc. on Form S-3 (Registration No. 333-64563) of our reports dated
December 8, 1998 on our audits of the consolidated financial statements and the
related financial statement schedule of Bio-Vascular, Inc. as of October 31,
1998 and 1997, and for the years ended October 31, 1998, 1997, and 1996, which
reports are included or incorporated by reference in this Annual Report on Form
10-K. We also consent to the references to our firm under the caption "Experts"
or "Incorporation of Documents by Reference" or "Incorporation of Certain
Documents by Reference" in certain Registration Statements on Form S-8 of Bio-
Vascular, Inc. (Registration Nos. 33-94588; 333-14093; 333-14137; and 333-26783)
and under the caption "Experts" in the Registration Statement on Form S-3 of
Bio-Vascular, Inc. (Registration No. 333-64563).

PRICEWATERHOUSECOOPERS LLP

Minneapolis, Minnesota
January 29, 1999

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES FOR THE PERIOD ENDED OCTOBER
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-01-1997
<PERIOD-END> OCT-31-1998
<CASH> 4,383,366
<SECURITIES> 3,990,839
<RECEIVABLES> 2,584,096
<ALLOWANCES> 128,078
<INVENTORY> 2,305,924
<CURRENT-ASSETS> 13,883,303
<PP&E> 5,852,824
<DEPRECIATION> 1,498,948
<TOTAL-ASSETS> 25,982,219
<CURRENT-LIABILITIES> 2,497,352
<BONDS> 0
0
0
<COMMON> 93,172
<OTHER-SE> 22,337,202
<TOTAL-LIABILITY-AND-EQUITY> 25,982,219
<SALES> 12,017,379
<TOTAL-REVENUES> 12,017,379
<CGS> 5,222,112
<TOTAL-COSTS> 2,978,800
<OTHER-EXPENSES> 5,231,042
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (668,791)
<INCOME-TAX> (185,738)
<INCOME-CONTINUING> (483,053)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (483,053)
<EPS-PRIMARY> (.05)
<EPS-DILUTED> (.05)

</TABLE>