GLIATECH INC, S-3/A, 1998-05-26

GLIATECH INC
S-3/A, 1998-05-26
BIOLOGICAL PRODUCTS, (NO DIAGNOSTIC SUBSTANCES)

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 26, 1998

REGISTRATION STATEMENT NO. 333-52825

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

AMENDMENT NO. 1

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

GLIATECH INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C>
DELAWARE 34-1587242
--------------------------- -------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
</TABLE>

23420 COMMERCE PARK ROAD
CLEVELAND, OHIO 44122
(216) 831-3200
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

THOMAS O. OESTERLING, PH.D.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
GLIATECH INC.
23420 COMMERCE PARK ROAD
CLEVELAND, OHIO 44122
(216) 831-3200
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)

COPIES TO:

<TABLE>
<S> <C>
THOMAS C. DANIELS, ESQ. ALEXANDER D. LYNCH, ESQ.
JONES, DAY, REAVIS & POGUE BABAK YAGHMAIE, ESQ.
901 LAKESIDE AVENUE BROBECK, PHLEGER & HARRISON LLP
CLEVELAND, OHIO 44114 1633 BROADWAY, 47TH FLOOR
(216) 586-3939 NEW YORK, NEW YORK 10019
(212) 581-1600
</TABLE>

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement has become effective.

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

If any of the securities being registered on this Form are being offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 (the "Securities Act"), other than securities offered only in connection
with dividend or interest reinvestment plans, please check the following box.
[ ]

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

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

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

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

================================================================================
<PAGE> 2

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

PROSPECTUS (Subject to Completion)

Dated May 26, 1998

2,000,000 SHARES

GLIATECH LOGO

COMMON STOCK
---------------------------

All of the 2,000,000 shares of Common Stock, $0.01 par value per share (the
"Common Stock"), offered hereby are being issued and sold by Gliatech Inc.
("Gliatech" or the "Company"). The Common Stock is quoted on the Nasdaq National
Market under the symbol "GLIA." On May 22, 1998, the last reported sale price of
the Common Stock on the Nasdaq National Market was $19.50.

---------------------------
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6 OF THIS PROSPECTUS.
---------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
=============================================================================================================
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
<S> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------
Per Share......................... $ $ $
Total (3)......................... $ $ $
=============================================================================================================
</TABLE>

(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933. See
"Underwriting."

(2) Before deducting expenses payable by the Company, estimated to be $410,000.

(3) The Company has granted the Underwriters an option, exercisable within 30
days from the date hereof, to purchase an aggregate of up to 300,000
additional shares at the Price to Public less Underwriting Discounts and
Commissions to cover over-allotments, if any. If all such additional shares
are purchased, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $ , $ , and
$ , respectively. See "Underwriting."
---------------------------
The Common Stock is offered by the several Underwriters named herein when,
as and if received and accepted by them, and subject to their right to reject
orders in whole or in part and subject to certain other conditions. It is
expected that the delivery of certificates for the shares will be made at the
offices of Cowen & Company, New York, New York on or about ,
1998.
---------------------------

COWEN & COMPANY

FURMAN SELZ

VECTOR SECURITIES INTERNATIONAL, INC.

, 1998
<PAGE> 3
[PHOTO]
ADCON-L is a proprietary, resorbable, carbohydrate polymer gel designed to
inhibit scarring and adhesions following lumbar surgeries. The Company obtained
regulatory clearance in 1995 to affix CE Marking for ADCON-L and currently
markets the product in 29 countries outside the U.S. The Company has received a
letter from the FDA stating that the premarket approval application for ADCON-L
is approvable subject to the satisfactory completion of an FDA inspection of the
ADCON-L manufacturing facilities, methods and controls.

[PHOTO]

LUMBAR DISC SURGERY
WITHOUT USE OF ADCON-L

After surgery, scarring and adhesions may bind and tether the spinal nerve root
to surrounding tissues, possibly causing pain and loss of function.

[PHOTO]

LUMBAR DISC SURGERY
WITH USE OF ADCON-L

ADCON-L is applied around the nerve root and provides a resorbable physical
barrier to inhibit unwanted scarring and adhesions at the surgical site.

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

ADCON(R) is a registered trademark of the Company. Trade names and
trademarks of other companies appearing elsewhere in this Prospectus are the
property of their respective holders.
------------------------

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT COVERING
TRANSACTIONS AND PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON
THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE
"UNDERWRITING."
<PAGE> 4

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information appearing elsewhere in this
Prospectus and in the documents incorporated into this Prospectus by reference.
Unless otherwise indicated or the context otherwise requires, all information in
this Prospectus assumes no exercise of the Underwriters' over-allotment option.
The shares of Common Stock offered hereby involve a high degree of risk. This
Prospectus contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere in this Prospectus. Investors should
consider carefully the information set forth under the heading "Risk Factors."
As used in this Prospectus, unless otherwise indicated or the context otherwise
requires, all references to "Gliatech" or the "Company" include Gliatech Inc.
and its wholly owned subsidiaries.

THE COMPANY

Gliatech is a leader in the research, development and commercialization of
proprietary, resorbable, carbohydrate polymer medical devices designed to
inhibit surgical scarring and adhesions. The Company has developed its family of
ADCON medical devices to be used prophylactically as a physical barrier between
tissues to inhibit scarring and adhesions in all patients undergoing certain
surgical procedures. The Company's most developmentally advanced product,
ADCON-L, a proprietary, resorbable, carbohydrate polymer gel, is designed to
inhibit surgical scarring and adhesions and to reduce postsurgical pain
following lumbar surgeries. On April 6, 1998, the Company received a letter from
the Food and Drug Administration ("FDA") stating that the premarket approval
application ("PMA") for ADCON-L is approvable subject to the satisfactory
completion of an FDA inspection of the ADCON-L manufacturing facilities, methods
and controls. The Company expects to receive a final decision regarding the
approval of ADCON-L from the FDA in mid-1998; however, there can be no assurance
as to the satisfactory completion of the manufacturing review process or the
decision of the FDA to approve ADCON-L for marketing in the U.S. ADCON-L is
currently being marketed in 29 countries outside the U.S., including the 19
countries which recognize CE Marking. See "Risk Factors -- Uncertainty of
Regulatory Approval for ADCON-L," "-- Reliance on Third Party for Manufacturing;
Comprehensive Regulation of Manufacturing of Products" and
"Business -- Government Regulation." In addition to the ADCON family of medical
devices, the Company is pursuing the development of small molecule drug
candidates for the treatment of several central nervous system disorders,
including Attention Deficit Hyperactive Disorder ("ADHD"), sleep disorders,
obesity, anxiety and Alzheimer's Disease ("AD"). The Company is pursuing its AD
program through its strategic alliance with Janssen Pharmaceutica, N.V. of
Belgium ("Janssen"), a wholly-owned subsidiary of Johnson & Johnson.

Surgical scarring is a significant medical problem often resulting in
adhesions at the surgical site, thereby binding together tissues, nerves and
organs following either open incision or minimally invasive surgery. Scarring
and adhesions may lead to many significant postsurgical complications, including
recurrent pain and impairment of function following lumbar surgery, infertility
following pelvic surgery and limited range of motion following tendon and
peripheral nerve surgery of the hand. Excessive scarring also can obstruct
access to the surgical site when reoperation is necessary making additional
surgery difficult. Due to the differences in the surgical environments in which
each of these products would be used, each ADCON product is designed to be
adapted for use at different surgical sites. ADCON-L is designed to inhibit
scarring and adhesions and reduce postsurgical pain following lumbar surgery. In
1995, approximately 450,000 lumbar surgeries were performed in the U.S. The
Company's European clinical trial has shown that approximately 90% of lumbar
surgery patients experience a certain amount of scarring following such surgery.
This clinical trial also demonstrated that 8% to 44% of patients who received
ADCON-L experienced a lower incidence of activity-related pain in the
performance of all evaluated activities of daily living.

3
<PAGE> 5

some postsurgical scarring and adhesions. The Company has initiated a
double-blind, controlled clinical trial and has completed enrollment of 41
patients; 23 patients for evaluation in reoperations to remove adhesions and 18
patients for evaluation in uterine tumor surgeries. Upon completion of the pilot
trial, which is currently anticipated to occur in the second half of 1998, the
Company intends to submit a request to the FDA to conduct a pivotal clinical
trial for ADCON-P. See "Risk Factors -- Early Commercialization; Uncertainty of
Market Acceptance of ADCON Family of Products," "-- Uncertainty Related to
Development of ADCON Products" and "-- Government Regulation."

In addition, the Company is developing ADCON-T/N, a proprietary,
resorbable, carbohydrate polymer gel, which is designed to inhibit tendon and
peripheral nerve postsurgical scarring and adhesions, which may cause recurrent
pain and limited range of motion. In 1994, approximately 260,000 tendon and
peripheral nerve surgeries were performed in the U.S. The Company has initiated
a pivotal clinical trial for ADCON-T/N in the U.S. The pivotal trial is designed
to demonstrate that ADCON-T/N inhibits postsurgical scarring and adhesions
following carpal tunnel release, the surgical procedure to treat carpal tunnel
syndrome after the first surgery has failed.

The Company is currently marketing ADCON-L and ADCON-T/N outside the U.S.
through independent medical device distributors in 29 countries, including the
major countries in the European Union. Upon receipt of regulatory approval from
the FDA, the Company intends to market ADCON-L in the U.S. through a network of
independent manufacturers' agents with an aggregate sales force of approximately
175 sales representatives who serve the orthopaedic and neurosurgical markets.
In addition, the Company signed a development and exclusive license agreement in
December 1996 with Chugai Pharmaceutical Co. Ltd. ("Chugai") for the sale of
ADCON-L and ADCON-T/N in Japan. Chugai has filed applications requesting
regulatory approval to market ADCON-L and ADCON-T/N in Japan. The Company is
also in the early stages of development of several other ADCON products,
including: ADCON-A, for use in abdominal surgeries; ADCON-I for use in
implant/prosthetic surgeries; and ADCON-C for use in cardiac surgeries. In 1994,
approximately 2.5 million abdominal surgeries, approximately 1.4 million
implant/prosthetic surgeries and approximately 1.0 million cardiac surgeries
were performed in the U.S.

In addition to developing its ADCON family of products, the Company is
engaged in the discovery and development of therapeutic products for its
Cognition Modulation program and AD program. The Company is pursuing these
therapeutic programs by engaging in the research and development of small
molecule drug candidates for the treatment of several central nervous system
disorders. The Company's Cognition Modulation program is focused on a class of
compounds designed to act on the histamine H(3) receptor in the brain which
regulates sleep/wakeful states and modulates the level of arousal and alertness.
An antagonist to this receptor could lead to enhanced states of alertness and
may be used to treat obesity, narcolepsy, ADHD and the cognitive deficit in AD
patients. An agonist to the histamine H(3) receptor could reduce levels of
wakefulness and arousal, making such an agonist a candidate for use in the
treatment of anxiety and insomnia. The Company anticipates that it will identify
a lead compound as an antagonist to the histamine H(3) receptor in the second
half of 1998 and expects that it will begin human clinical trials with respect
to such compound in late 1998. See "Risk Factors -- Early Stage of Development
for Therapeutic Programs" and "-- Government Regulation."

The Company is also engaged in the research and development of therapeutic
products for the treatment of AD. In October 1994, the Company entered into an
agreement with Janssen (the "Janssen Agreement") to collaborate on the research
and development of therapeutic products to treat AD. Pursuant to the Janssen
Agreement, the Company has developed a number of high throughput in vitro assay
systems that have been used to screen Janssen's pharmaceutical library and has
identified several lead compounds. The Company anticipates that lead compounds
will be selected for preclinical testing in late 1998. See "Risk
Factors -- Early Stage of Development for Therapeutic Programs" and
"-- Government Regulation."

The Company was incorporated under the laws of the State of Delaware on
August 12, 1987 and commenced operations in 1988. The Company's executive
offices are located at 23420 Commerce Park Road, Cleveland, Ohio 44122,
telephone number (216) 831-3200.

4
<PAGE> 6

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered hereby.................. 2,000,000 shares
Common Stock to be outstanding after the
offering................................... 9,613,248 shares(1)
Use of proceeds.............................. For the funding of the U.S. development of
ADCON-P and ADCON-T/N, for the costs
associated with the market introduction in
the U.S. of ADCON-L, for the continued
research and development of the Company's
drug programs and additional ADCON products,
and for working capital and other general
corporate purposes.
Nasdaq National Market symbol................ GLIA
</TABLE>

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

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------- -------------------------
1995 1996 1997 1997 1998
--------- --------- --------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues
Research contracts and licensing fees............... $ 2,217 $ 2,855 $ 2,954 $ 739 $ 739
Product sales....................................... 182 901 1,536 345 512
Government grants................................... 255 122 410 50 150
--------- --------- --------- --------- ---------
Total revenues.................................... 2,654 3,878 4,900 1,134 1,401
Operating costs and expenses
Research and development............................ 5,107 6,120 6,952 1,855 2,253
Selling, general and administrative................. 2,599 4,070 4,401 1,070 1,233
Depreciation and amortization....................... 170 166 293 65 87
Cost of products sold............................... 123 342 614 125 167
--------- --------- --------- --------- ---------
Total operating costs and expenses................ 7,999 10,698 12,260 3,115 3,740
--------- --------- --------- --------- ---------
Loss from operations.................................. (5,345) (6,820) (7,360) (1,981) (2,339)
Settlement of claim................................... (2,025)
Interest income, net.................................. 360 1,120 824 237 147
--------- --------- --------- --------- ---------
Net loss.............................................. $ (4,985) $ (5,700) $ (8,561) $ (1,744) $ (2,192)
========= ========= ========= ========= =========
Basic and diluted net loss per common share(2)........ $ (3.28) $ (0.78) $ (1.16) $ (0.24) $ (0.29)
========= ========= ========= ========= =========
Shares used for purposes of computing net loss per
common share........................................ 1,519 7,313 7,354 7,333 7,451
</TABLE>

<TABLE>
<CAPTION>
AT MARCH 31, 1998
---------------------------------
ACTUAL AS ADJUSTED(3)
----------- --------------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments......... $ 8,042 $ 44,195
Working capital........................................... 7,136 43,289
Total assets.............................................. 11,659 47,812
Deficit accumulated during the development stage.......... (44,206) (44,206)
Total stockholders' equity................................ 9,247 45,400
</TABLE>

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

(1) Excludes an aggregate of 1,107,175 shares of Common Stock issuable upon
exercise of stock options outstanding at March 31, 1998, at a weighted
average exercise price of $7.54 per share granted under the Company's stock
option plans. An additional 20,000 shares of Common Stock have been reserved
for issuance upon the exercise of warrants at an exercise price of $7.50 per
warrant, subject to certain adjustments.

(2) See Note A to Consolidated Financial Statements of the Company for
information concerning the computation of basic and diluted net loss per
common share.

(3) Adjusted to reflect the sale by the Company of the 2,000,000 shares of
Common Stock offered hereby at an assumed public offering price of $19.50
per share (the last reported sale price on May 22, 1998) and the receipt of
the net proceeds therefrom. See "Use of Proceeds" and "Capitalization."

5
<PAGE> 7

RISK FACTORS

Prospective investors in the shares of Common Stock offered hereby should
consider carefully the following risk factors, in addition to the other
information contained in this Prospectus. This Prospectus contains forward-
looking statements which involve risks and uncertainties. The Company's actual
results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed below and in "Management's Discussion
and Analysis of Financial Condition and Results of Operations," as well as those
discussed elsewhere in this Prospectus.

UNCERTAINTY OF REGULATORY APPROVAL FOR ADCON-L

In December 1996, the Company submitted a PMA application to the FDA for
ADCON-L, which was granted expedited review by the FDA in February 1997. Based
on the results of the Company's European pivotal clinical trial for ADCON-L and
interim data from the U.S. clinical trial currently underway, the Orthopaedic
and Rehabilitation Devices Advisory Panel (the "Advisory Panel") recommended in
December 1997 that ADCON-L be approved by the FDA for marketing in the U.S.
subject to certain conditions and labeling requirements. The Company believes
that the FDA will approve labeling indicating that based on the six month
pivotal European clinical trial, patients treated with ADCON-L had a
statistically significant reduction of scarring and of activity-related pain at
six months, and that with regard to adverse safety events, the European clinical
trial showed no statistically significant difference between the ADCON-L and
control groups. The Company believes that the FDA will approve labeling
indicating that based on the 12-month post-study surveillance of the European
clinical trial of available patients, patients treated with ADCON-L had a
statistically significant reduction of scarring at 12 months, but there was no
statistically significant difference between patients treated with ADCON-L and
the control group for activity-related pain at 12 months. The European clinical
trial had a six-month end-point. In addition, the Company believes that the
approved labeling will reflect interim six month results from the U.S. clinical
trial, which showed that ADCON-L patients had a statistically significant
reduction in scarring and a lower incidence of pain while performing certain
daily living activities. Based on discussions with the FDA, the Company believes
that labeling presenting this information will be approved by the FDA; however,
there can be no assurance that this labeling will ultimately be approved. In
addition, there can be no assurance that the FDA will not require changes in any
approved labeling to reflect the final U.S. clinical trial results if they are
not consistent with the interim results or the European clinical trial. On April
6, 1998, the Company received a letter from the FDA stating that the PMA for
ADCON-L is approvable subject to the satisfactory completion of an FDA
inspection of the ADCON-L manufacturing facilities, methods and controls. There
can be no assurance that such inspection will not result in reports of
non-compliance that could delay or prevent FDA approval. A delay in receipt of
or failure to receive FDA approval for ADCON-L would have a material adverse
effect on the Company's business, prospects, financial condition and results of
operations. See "-- Reliance on Third Party for Manufacturing; Comprehensive
Regulation of Manufacturing of Products" and "Business -- Government
Regulation."

EARLY COMMERCIALIZATION; UNCERTAINTY OF MARKET ACCEPTANCE OF ADCON FAMILY OF
PRODUCTS

Since commencement of operations in 1988, the Company has been engaged in
the research, development and commercialization of medical devices designed to
inhibit postsurgical scarring and adhesions and the research and development of
pharmaceutical products for use in the treatment of several central nervous
system disorders. Although the Company has entered into agreements with
distributors for the sale of ADCON-L and ADCON-T/N in selected European
countries and certain other countries outside the U.S., it has generated only
limited revenues from such products and no assurances can be given that
commercialization of these products will be successful. The Company currently
has no products approved for sale in the U.S. The Company's success will depend
in part upon the acceptance of the Company's products, in particular, its ADCON
family of products, by the medical community, including health care providers,
such as hospitals and physicians, and third-party payors. Such acceptance may
depend upon the extent to which the medical community perceives the Company's
products as a safe, reliable and cost-effective alternative to certain existing
products, a few of which are already accepted by the medical community. See
"Business -- Competition." In addition, the Company is marketing its ADCON-L
medical device outside the U.S. in new packaging, which includes a redesigned
applicator, that will

6
<PAGE> 8

require separate U.S. regulatory approval. There can be no assurance that such
U.S. approval will be obtained. See "--Government Regulation." There can be no
assurance of market acceptance of the new packaging or redesigned applicator in
Europe, or, upon approval, in the U.S. The market acceptance of the Company's
ADCON products is also dependent on the Company's ability to convince surgeons
and other medical professionals that the benefits associated with the Company's
ADCON products justify the modification of standard medical techniques in order
to use the Company's ADCON devices safely and effectively. There can be no
assurance that the Company's products will achieve significant market acceptance
on a timely basis, if at all. Failure of some or all of the Company's products
to achieve significant market acceptance could have a material adverse effect on
the Company's business, prospects, financial condition and results of
operations.

UNCERTAINTY RELATED TO DEVELOPMENT OF ADCON PRODUCTS

The Company has products other than ADCON-L under development. ADCON-P and
ADCON-T/N are in clinical trials in the U.S. No assurances can be given as to
when such clinical trials will be completed, or that, if completed, ADCON-P or
ADCON-T/N will prove to be safe and effective in such U.S. clinical trials or
that required U.S. regulatory approvals or non-U.S. regulatory approvals will be
obtained for such products. Even if the Company is able to receive such required
regulatory approvals, there can be no assurance as to the extent, if any, that
any such product will receive market acceptance. In addition, the Company is
conducting preclinical studies with respect to ADCON-A, ADCON-I and ADCON-C.
These ADCON products are in a very early stage of development and will require
substantial additional research and development, including preclinical studies
and extensive clinical trials, before applying for regulatory approval with
applicable authorities. There can be no assurance that the Company will be
successful in developing these other ADCON products or, if developed, will prove
to be safe and effective in clinical trials and receive necessary regulatory
approvals. The Company may also encounter problems relating to research,
development, manufacturing, distribution and marketing of these products. The
failure or inability to address such problems adequately would have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations.

EARLY STAGE OF DEVELOPMENT FOR THERAPEUTIC PROGRAMS

The Company is engaged in the discovery and development of therapeutic
products for use in the treatment of certain central nervous system disorders.
Although several of these therapeutic products are in preclinical evaluation,
the products currently under development will require substantial additional
research and development, including preclinical studies and extensive clinical
trials, before applying for regulatory approval with applicable authorities.
There can be no assurance that the Company's research and development activities
will lead to the discovery or development of any suitable drugs or drug
candidates. The Company has not conducted any clinical trials with respect to
any such drug candidates, and accordingly, there can be no assurance that any
such drug candidates will prove to be safe and effective. Moreover, the drugs
developed or being developed by the Company may prove to have undesirable and
unintended side effects or may require complex delivery systems that may prevent
or limit their commercial use. Even if the Company is able to develop
therapeutic products for use in the treatment of certain central nervous system
disorders and even if such therapeutic products receive required regulatory
approvals, there can be no assurance as to the extent, if any, that any such
product will receive market acceptance. See "-- Government Regulation" and
"Business -- Government Regulation."

HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE
PROFITABILITY; FLUCTUATING RESULTS OF OPERATIONS

The Company is a development stage company that has not generated any
material revenues from operations. As a result, the Company has had net
operating losses since its inception and expects such losses to continue unless
and until such time as revenues are sufficient to fund its operations. The
Company has accumulated a deficit of $44.2 million for the period from inception
of operations (August 31, 1988) through March 31, 1998. The Company expects to
continue to incur losses over at least the next several years and the amount of
future net losses and time required by the Company to reach profitability are
uncertain. The Company's ability to generate significant revenue and become
profitable is dependent in large part on its success in obtaining regulatory
approvals or clearances for its products, commercializing ADCON products that
have

7
<PAGE> 9

obtained required regulatory approvals, developing and marketing new products,
the success of its independent distributors in marketing its products, entering
into additional marketing agreements where appropriate, and the ability of its
strategic partners to commercialize successfully products incorporating the
Company's technologies. There can be no assurance that the Company will generate
significant revenue or become profitable on a sustained basis, if at all. In
addition, the Company's results of operations have fluctuated in the past on an
annual and quarterly basis and may fluctuate significantly from period to period
in the future, depending upon a number of factors, many of which are outside of
the Company's control. Such factors include the conduct and timing of clinical
trials, the timing of government approvals, market acceptance of the Company's
products, the success of competitive products, the ability of the Company to
enter into strategic alliances with corporate partners, the expenses associated
with patent matters, and the timing of expenses related to product launches. Due
to one or more of these factors, in one or more future quarters, the Company's
results of operations may fall below the expectations of securities analysts and
investors. In that event, the market price of the Common Stock of the Company
could be materially and adversely affected. See "Selected Consolidated Financial
Data" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING

The Company's future capital requirements will depend on many factors,
including the commercial success of its ADCON family of products, the progress
of the Company's research and development, the scope and results of preclinical
studies and clinical trials, the cost of obtaining regulatory approvals, its
success in consummating the strategic alliances required to fund certain of its
programs, the rate of technological advances, determinations as to the
commercial potential of certain of the Company's product candidates, the status
of competitive products and the establishment of additional manufacturing
capacity. No assurance can be given that there will not be material adverse
changes in the Company's business or in the regulatory environment in which the
Company operates that will consume the Company's available capital resources. In
addition, the Company will need to raise or obtain substantial additional funds
to conduct research and preclinical and clinical trials, to apply for the
regulatory approvals necessary to bring additional products to market, and to
develop the necessary marketing, distribution and support capabilities required
to sell and distribute the Company's products and proposed products. No
assurance can be given that additional financing will be available or, if
available, that it will be available on satisfactory terms. Any subsequent
equity financing could result in dilution to the Company's then existing
stockholders. If adequate funds are not available, the Company may be required
to scale back or discontinue one or more of its product development programs, or
obtain funds through strategic alliances that may require the Company to
relinquish rights to certain of its technologies, product candidates or
products, if any. The Company expects that its existing capital resources,
together with the net proceeds of the offering and the interest earned thereon,
will enable the Company to maintain its current and planned operations for at
least the next two years. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."

DEPENDENCE ON INDEPENDENT DISTRIBUTORS; NO DIRECT SALES FORCE

The Company has entered into distribution agreements with third-party
distributors for its ADCON-L and ADCON-T/N products in 29 countries outside the
U.S. In addition, the Company has entered into a development and exclusive
license agreement with Chugai, which provides for the sale of ADCON-L and
ADCON-T/N in Japan upon receipt of regulatory approval to market such products.
Upon receipt of regulatory approval from the FDA, the Company intends to market
ADCON-L through a network of independent manufacturers' agents with an aggregate
sales force of approximately 175 sales representatives who serve the orthopaedic
and neurosurgical market. The Company has not, to date, engaged in direct
marketing or sale of its products. In order to market its product in additional
countries and sell any additional products that it may ultimately have available
for commercial sale, the Company will need to contract with additional
distributors for sales and marketing functions. These distributors are, and the
manufacturers' agents will be, independent third parties, who are not employees
of the Company and are not directly under the control or supervision of the
Company. There can be no assurance that the current relationships with
distributors will continue on acceptable terms and conditions to the Company,
nor can there be any assurances that the Company's arrangements with independent
manufacturer's agents will prove to be satisfactory to the Company or that
additional distributorship arrangements with third

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parties for such functions will be obtained on acceptable terms. Moreover, there
can be no assurance that the distributors or agents will devote sufficient time
and resources to the Company's products or other products to enable the products
to be successfully commercialized. Furthermore, there can be no assurance that
the Company will be successful in marketing its ADCON products because the
Company does not control the distribution of its products and relies exclusively
on third parties for the distribution of its products. Failure of some or all of
the Company's products to be successfully and efficiently distributed could have
a material adverse effect on the Company's business, prospects, financial
condition and results of operations. See "Business -- Marketing and Sales."

RELIANCE ON THIRD-PARTY FOR MANUFACTURING; COMPREHENSIVE REGULATION OF
MANUFACTURING OF PRODUCTS

The Company does not have any manufacturing facilities and is currently
relying solely on a foreign contractor, European Medical Contract Manufacturing
("EMCM"), a third-party manufacturer located in Nijmegen, The Netherlands, for
the supply of ADCON-L, ADCON-P and ADCON-T/N for its commercial or clinical
requirements, as the case may be. There can be no assurance that the Company's
current manufacturer will comply with all applicable regulatory standards, that
such manufacturer will have the capacity to provide the Company with a future
supply of products that is adequate to meet the Company's commercialization or
clinical requirements or that the Company would be able to identify an alternate
source of supply on terms acceptable to the Company.

Manufacturers of medical devices and drugs also are required to adhere to
the FDA regulations setting forth Quality System Regulations requirements
("QSR") for medical devices and Good Manufacturing Practices requirements
("GMP") for drugs, and to similar requirements in other countries, which include
requirements relating to product testing and quality assurance as well as the
corresponding maintenance of records and documentation. Failure to comply with
applicable manufacturing regulations, other applicable regulatory standards, or,
where required by law, the standards of International Organization for
Standardization ("ISO"), could result in sanctions being imposed on the Company
or the manufacturer of its products, including warning letters, fines,
injunctions, civil penalties, failure of the FDA or other regulatory authorities
to grant premarket clearance or premarket approval of medical devices and drugs,
operating restrictions and criminal prosecution. There can be no assurance that
the current manufacturer of the Company's products will comply with all
applicable regulatory requirements or that the Company would be able to identify
new or additional manufacturers for its products on terms acceptable to the
Company. The failure of the Company's current manufacturers to comply with
applicable regulatory requirements or to make acceptable arrangements for the
manufacture of its products could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations.
See " -- Uncertainty of Regulatory Approval for ADCON-L,"
"Business -- Manufacturing and Suppliers" and "-- Government Regulation."

DEPENDENCE ON STRATEGIC ALLIANCES

The Company's strategy for its AD and Cognition Modulation programs entails
entering into various arrangements with collaborative partners, licensors,
licensees and others for the development, marketing and distribution of
products, and is dependent upon the subsequent success of these outside parties
in performing their responsibilities. In October 1994, the Company entered into
a collaborative agreement with Janssen to research and develop treatments for AD
which extends through October 1998. Janssen has retained its right to extend the
Janssen Agreement for an additional period of one year. As of March 31, 1998,
the Company has received $9.7 million in revenues under the Janssen Agreement.
Although the current term of this arrangement does not expire until October 1998
with an optional renewal for one year, there can be no assurance that Janssen
will exercise its right to renew the collaboration agreement beyond the current
term. See "Business -- Neurologic Drug Development Programs" and "-- The Janssen
Agreement." In addition, although the Company is currently funding the
development of its ADCON family of products and its Cognition Modulation program
independently of strategic partners, the Company may enter into agreements with
strategic partners for certain of its ADCON products, other than ADCON-L, and
may enter into agreements with strategic partners prior to the completion of
clinical trials for therapeutic products relating to its Cognition Modulation
program. There can be no assurance that the Company will be able to enter into
an agreement with such a strategic partner for such ADCON products

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<PAGE> 11

or its Cognition Modulation program on acceptable terms, if at all. Furthermore,
there can be no assurance that development of such ADCON products, the AD
program or the Cognition Modulation program will be successfully completed or
that the Company will be able to successfully commercialize the products
developed as part of any collaborative efforts for such ADCON products, pursuant
to the Janssen Agreement, or as part of any future Cognition Modulation
collaborative arrangements. Failure to obtain or maintain strategic alliances,
including its alliance with Janssen, or the failure of any such strategic
alliances to successfully commercialize such products, could have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations.

UNCERTAINTY OF HEALTH CARE REIMBURSEMENT

The Company's ability to successfully commercialize its products will
depend in part on the extent to which reimbursement for the costs of such
products and related treatments will be available from government health
administration authorities, private health coverage insurers and other
organizations. In addition, in both the U.S. and elsewhere, sales of health care
products are dependent on the availability of reimbursement to the consumer from
third-party payers, such as government and private insurance plans. Significant
uncertainty exists as to the reimbursement status of newly approved health care
products, and third-party payers are increasingly challenging the prices charged
for medical products and services. There can be no assurance that ADCON-L and
the other ADCON products will be considered cost effective or that reimbursement
will be available or will be sufficient to allow the Company to sell its
products on a competitive basis. There can be no assurance that the Company's
business, prospects, financial condition and results of operations will not be
materially adversely affected by the continuing efforts of governmental and
third-party payors to contain or reduce the costs of health care. For example,
in certain international markets the pricing or profitability of health care
products is subject to government control. In the U.S., there have been, and the
Company expects that there will continue to be, a number of federal and state
proposals to implement similar government control. While the Company cannot
predict whether any legislative or regulatory proposals or reforms will be
adopted, such proposals or reforms could have a material adverse effect on the
Company's business, prospects, financial condition or results of operations.
Inadequate coverage or reimbursement by government and third-party payers for
uses of the Company's products, particularly ADCON-L, could adversely effect the
market acceptance of these products which would have a material adverse effect
on the Company's business, prospects, financial condition and results of
operations. See "-- Early Commercialization; Uncertainty of Market Acceptance of
ADCON Family of Products," "-- Government Regulation" and
"Business -- Government Regulation."

RELIANCE ON SINGLE SOURCE SUPPLIER

The Company currently obtains one of its key components for the production
of its ADCON products from one supplier. The Company currently has no
contractual supply agreement with such supplier. The Company also has developed
its own proprietary process to manufacture this key component and is currently
manufacturing it on a pilot basis through a contract manufacturer according to
QSR requirements. In addition, the Company is pursuing qualification of
additional suppliers. There can be no assurance that the current supply of raw
materials will continue to be provided on acceptable terms and conditions to the
Company, if at all, or that such alternative sources will be successfully
located or developed. The failure to obtain adequate supplies from the sole
source or to locate or develop alternative supplies could have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations. See "Business -- Manufacturing and Suppliers."

GOVERNMENT REGULATION

The manufacture and sale of the Company's products are subject to
regulation by numerous authorities, principally the FDA, and corresponding state
and foreign agencies. The regulatory process is lengthy, expensive and
uncertain. Prior to commercial sale in the U.S., most medical devices and new
drugs, including the Company's products under development, must be cleared or
approved by the FDA. Securing FDA clearances and approvals may require the
submission of extensive clinical data and supporting information to the FDA.
Product clearances and approvals can be withdrawn for failure to comply with
regulatory requirements or upon the occurrence of unforeseen problems following
initial marketing. Sales of the Company's products outside of the

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<PAGE> 12

U.S. are subject to foreign regulatory requirements that may vary widely from
country to country. Prior to commercial sale of medical devices in the countries
of the European Union, the Company is required to comply with the Essential
Requirements of the Medical Devices Directive, which primarily relate to safety
and performance, and to undergo conformity assessment certification by a
Notified Body in order to qualify for CE Marking. The regulation of drugs in the
European Union is subject to a separate and different regulatory framework which
requires, among other things, premarket approval by the applicable regulatory
agencies before sale of such products. The time required to obtain clearance
from a foreign country may be longer or shorter than that required by the FDA or
other such agencies, and clearance or approval or other regulatory requirements
may differ. There can be no assurance that the Company will be able to obtain
necessary regulatory clearances or approvals on a timely basis, if at all, for
any of its products under development, and delays in receipt or failure to
receive such clearances or approvals, the loss of previously received clearances
or approvals, or failure to comply with existing or future regulatory
requirements could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations. Moreover, regulatory
clearances or approvals for products such as medical devices and new drugs, even
if granted, may include significant limitations on the uses for which such
products may be marketed. Additionally, product clearances or approvals can be
withdrawn for failure to comply with regulatory requirements. In addition,
certain material changes to medical devices and drugs also are subject to FDA
and other foreign governmental review and approval. For example, the Company is
marketing its ADCON-L medical device outside the U.S. in a redesigned applicator
that will require separate U.S. regulatory approval. There can be no assurance
that any clearances or approvals that are required, will be obtained or that
once obtained will not be withdrawn or that compliance with other regulatory
requirements can be maintained. In addition, because certain of the Company's
products are in research or development phases, the Company cannot accurately
predict all relevant regulatory requirements or related issues. Changes in
existing laws, regulations or policies and the adoption of new laws, regulations
or policies could prevent the Company from, or could affect the timing of,
achieving compliance with regulatory requirements, including current and future
regulatory clearances or approvals, where necessary. See "-- Risks Associated
with International Sales" and "Business -- Government Regulation."

RISKS ASSOCIATED WITH INTERNATIONAL SALES

The Company intends to market the Company's products in international
markets as well as domestically. To date, all of the Company's product sales
were generated in international markets. A number of risks are inherent in
international transactions. In order for the Company to market its products in
Europe, Australia, Canada and certain other non-U.S. jurisdictions, the Company
must obtain and maintain required regulatory approvals or clearances and
otherwise comply with extensive regulations regarding safety, manufacturing
processes and quality. These regulations, including the requirements for
approvals or clearances to market, may differ from the FDA regulatory scheme and
may be subject to change or modification after the Company has obtained approval
or complied with the existing regulatory scheme. There can be no assurance that
the Company will obtain or maintain regulatory approvals or clearances in such
countries, as the case may be, or that it will not be required to incur
significant costs in obtaining or maintaining its foreign regulatory approvals
or clearances, as the case may be. In addition, in the event existing
regulations are changed or modified, there can be no assurance that the Company
will be able to comply with any such changes or modifications or that such
changes or modifications will not result in significant costs to the Company in
order to comply with such changes or modifications. Delays in receipt of
approvals or clearances to market the Company's products in international
countries, failure to receive such approvals or clearances or the future loss of
previously received approvals or clearances could have a material adverse effect
on the Company's business, prospects, financial condition and results of
operations. International sales also may be limited or disrupted by political
instability, price controls, trade restrictions and the impositions of or
changes in tariffs, any of which could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations.
There can be no assurance that the Company will be able to successfully
commercialize its current or future products in any international market. See
"-- Government Regulation" and "Business -- Government Regulation."

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TECHNOLOGICAL CHANGE

The field of technology relating to the Company's research and development
activities has undergone rapid and significant technological development. The
Company expects that the technology associated with the Company's research and
development will continue to develop rapidly, and the Company's success will
depend in large part on its ability to maintain a competitive position with
respect to this technology. Rapid technological development by the Company or
others may result in products or processes becoming obsolete before the Company
recovers any or all of its research, development and commercialization expenses.
Failure of the Company to adapt to or outpace technological development, as the
case may be, could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.

COMPETITION

There is substantial competition in the medical device and pharmaceutical
industries, both from specialized firms and from major medical device,
pharmaceutical, chemical and surgical supply companies. Many of the Company's
competitors have product development capabilities and financial and human
resources greater than the Company, and have manufacturing, marketing, sales and
distribution capabilities that the Company does not have. The Company also
competes with universities and other research institutions in the development of
technologies and processes and, in some instances, competes with others in
acquiring technology from universities and research institutions. There can be
no assurance that the Company will be able to produce medical devices or drugs
that are commercially viable. Even if the Company achieves significant product
commercialization, one or more of the Company's competitors may achieve product
commercialization or patent protection earlier or more effectively than the
Company. Further, certain products that may compete with the Company's ADCON-P
medical device are already marketed in the U.S., such as Interceed and
Seprafilm. In addition, the Company's products may be subject to competition
from related products developed by competitors or different products developed
using technology other than those developed by the Company or based on advances
that may render the Company's products less competitive, obsolete or
uneconomical. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competition will not
have a material adverse effect on the Company's business, prospects, financial
condition and results of operations. See "Business -- Competition."

PATENTS, LICENSES AND PROPRIETARY RIGHTS

The Company's success will depend to a significant extent on its ability to
obtain and maintain patent protection for its products and technologies, to
preserve trade secrets and to operate without infringing the proprietary rights
of others. The patent situation in the field of biopharmaceutical products
generally is highly uncertain and involves complex legal, scientific and factual
questions. To date, there has emerged no consistent policy regarding the breadth
of claims allowed in biopharmaceutical patents. Accordingly, there can be no
assurance that patent applications filed by or on behalf of the Company will
result in patents being issued or that, if issued, the patents will afford
protection against competitors with similar technology. Furthermore, there can
be no assurance that others will not independently develop similar technologies
or technologies which are superior to those developed by the Company. Because of
the extensive time required for development, testing and regulatory review of a
potential product, it is possible that before any of the Company's potential
products can be commercialized, any related patent may expire, or remain in
existence for only a short period following commercialization, thus reducing any
advantage of the patent.

The Company owns three issued U.S. patents, one of which expires in 2014,
and two of which expire in 2015, three pending U.S. patent applications, and
corresponding foreign patent applications relating to its ADCON products. The
issued patents cover compositions included in the ADCON products and methods for
their use. Claims directed to related compositions and methods are being pursued
in the pending applications.

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<PAGE> 14

could incur substantial costs and diversion of management resources with respect
to the defense of any such lawsuit, which costs and diversion could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations. Further, there can be no assurance that
infringement of these two patents will not be found to exist, that the Company
will not be enjoined from making, using and selling its ADCON products, or that
the Company will not be ordered to pay damages that would have a material
adverse effect on the Company's ability to conduct its business. Moreover, there
can be no assurance that a sublicense under these patents, if necessary, will be
available on reasonable terms, if at all.

A U.S. patent application, filed solely by the Company, has been issued
covering the composition of matter for a series of synthetic histamine H(3)
receptor antagonist compounds, which is due to expire in 2015. Several
additional U.S. patent applications and their corresponding foreign applications
for additional series of histamine H(3) receptor antagonists and one series of
histamine H(3) receptor agonist compounds, their methods of medical use and
pharmaceutical compositions, are pending. No assurance can be given that any
claims relating to these products and methods will be issued.

The Company's processes and potential products may conflict with patents
which have been or may be granted to competitors, universities or others. As the
biopharmaceutical industry expands and more patents are issued, the risk
increases that the Company's processes and products may give rise to claims that
they infringe the patents of others. Such other persons could bring legal
actions against the Company claiming damages and seeking to enjoin manufacture,
use or sale of the affected product or process. If any such actions are
successful, in addition to any potential liability for damages, the Company
could be required to obtain a license in order to continue to manufacture, use
or sell the affected product or process. There can be no assurance that the
Company would prevail in any such action or that any license required under any
such patent would be made available on acceptable terms, if at all. If the
Company becomes involved in litigation, litigation could consume a substantial
portion of the Company's resources.

The Company is prosecuting its patent applications with the U.S. Patent and
Trademark Office ("USPTO"), but the Company does not know whether any of its
applications will result in the issuance of any patents or, if any patents are
issued, whether any issued patent will provide significant proprietary
protection or will be circumvented or invalidated. During the course of patent
prosecution, patent applications are evaluated, inter alia, for utility,
novelty, nonobviousness and enablement. The USPTO may require that the claims of
an initially filed patent application be amended if it is determined that the
scope of the claims includes subject matter that is not useful, novel,
nonobvious or enabled. Furthermore, in certain instances, the practice of a
patentable invention may require a license from the holder of dominant patent
rights. In cases where one party believes that it has a claim to an invention
covered by a patent application or patent of a second party, the first party may
provoke an interference proceeding in the USPTO or such a proceeding may
otherwise be declared by the USPTO. In general, in an interference proceeding,
the USPTO would review the competing patents and/or patent applications to
determine the validity of the competing claims, including but not limited to
determining priority of invention. Any such determination would be subject to
appeal in the appropriate U.S. federal courts.

There can be no assurance that additional patents will be obtained by the
Company or that issued patents will provide substantial protection or be of
commercial benefit to the Company. The issuance of a patent is not conclusive as
to its validity or enforceability, nor does it provide the patent holder with
freedom to operate without infringing the patent rights of others. A patent
could be challenged by litigation and, if the outcome of such litigation were
adverse to the patent holder, competitors could be free to use the subject
matter covered by the patent, or the patent holder may license the technology to
others in settlement of such litigation. The invalidation of key patents owned
by or licensed to the Company or non-approval of pending patent applications
could create increased competition, with potential adverse effects on the
Company and its business prospects. In addition, there can be no assurance that
any applications of the Company's technology will not infringe patents or
proprietary rights of others or that licenses that might be required as a result
of such infringement for the Company's processes or products would be available
on commercially reasonable terms, if at all.

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<PAGE> 15

proprietary rights of others. The Company may participate in interference
proceedings which may in the future be declared by the USPTO to determine
priority of invention, which could result in substantial cost to the Company.
There can be no assurance that the outcome of any such litigation or
interference proceedings will be favorable to the Company or that the Company
will be able to obtain licenses to technology that it may require or that, if
obtainable, such technology can be licensed at a reasonable cost. See
"Business -- Patents, Trademarks and Trade Secrets."

The Company also relies upon unpatented trade secrets, and no assurance can
be given that others will not independently develop substantially equivalent
proprietary information and techniques, or otherwise gain access to the
Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its right to its unpatented trade secrets.

EXPOSURE TO PRODUCT LIABILITY; LIMITED INSURANCE COVERAGE

The research, development and commercialization of medical devices, drugs
and therapeutic products entail significant product liability risks. If the
Company succeeds in commercializing ADCON-L, ADCON-P or ADCON-T/N and if it
succeeds in developing additional devices and new drugs, the use of such
products in clinical trials and the commercial sale of such products may expose
the Company to liability claims. These claims might be made directly by
consumers or by pharmaceutical companies or others selling such products. The
Company currently has product liability insurance in an aggregate amount of two
million dollars; however, there can be no assurance that the Company will be
able to maintain such insurance on acceptable terms or that such insurance will
be sufficient to protect the Company against potential claims or that insurance
will be available in the future in amounts sufficient to protect the Company. A
product liability claim, product recall or other claim, as well as any claims
for uninsured liabilities or in excess of insured liabilities, could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations.

DEPENDENCE ON KEY MANAGEMENT AND QUALIFIED PERSONNEL

Recruiting and retaining qualified scientific and management personnel is
critical to the Company's success. Although the Company believes that it has
been successful in attracting and retaining skilled and experienced personnel,
there can be no assurance that the Company will be able to continue to attract
and retain such personnel as employees, advisors and consultants on acceptable
terms. Certain executive officers are covered by key man life insurance policies
and have employment agreements with the Company. In addition, the Company's
anticipated growth and expansion into areas and activities requiring additional
expertise, such as clinical testing, obtaining government approvals,
manufacturing and marketing, will place increased demands on the Company's
management resources. These demands are expected to require the addition of new
management personnel. The Company has a limited number of executive personnel
with prior relevant business experience. The failure to acquire additional
qualified personnel could materially adversely affect prospects for the
Company's success. Certain advisors and consultants to the Company are employed
by others and may have commitments to, or consulting or advisory contracts with,
other entities that limit their availability to the Company.

ANTI-TAKEOVER PROVISIONS

The Company's Second Restated Certificate of Incorporation (the "Second
Restated Certificate") divides the Board of Directors into three classes. In
addition, the Board of Directors have the authority, without any action by
stockholders, to fix the rights of any shares of preferred stock, par value
$0.01 per share (the "Preferred Stock"). On July 1, 1997, the Company declared a
dividend distribution of one right (a "Right") for each outstanding share of
Common Stock. The terms of the Rights are set forth in a Rights Agreement, dated
July 1, 1997, between the Company and American Stock Transfer & Trust Company,
as Rights Agent. In the absence of further action by the Board of Directors, the
Rights generally will become exercisable and allow the holder to acquire Common
Stock at a discounted price if a person or group acquires 15% or more of the
outstanding shares of Common Stock of the Company. The Company is also subject
to provisions of the Delaware General Corporate Law which, subject to certain
exceptions, will prohibit the Company from engaging in any "business
combination" with a person who, together with affiliates and associates, owns
15% or more of the Company's Common Stock (an "Interested Stockholder") for a
period of three years following the date that such person
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<PAGE> 16

became an Interested Stockholder, unless the business combination is approved in
a prescribed manner or certain other requirements are satisfied. It is possible
that the existence of a staggered Board of Directors, the ability of the Board
of Directors to issue Preferred Stock and the Rights Agreement, as well as
certain provisions of the Delaware General Corporation Law, could have the
effect of deterring hostile takeovers or delaying or preventing changes in
control or management of the Company.

DILUTION

Purchasers of the Common Stock offered hereby will experience immediate and
substantial dilution in the net book value per share of their investment of
$14.86 per share. See "Dilution."

SHARES ELIGIBLE FOR FUTURE SALE

Future sales of shares of Common Stock by the Company or its existing
stockholders could adversely affect the prevailing market price of the Common
Stock. The 2,000,000 shares of Common Stock offered hereby and the 2,300,000
outstanding shares of Common Stock previously registered will be freely
transferable by persons without restriction or further registration under the
Securities Act, except for any such shares that may be acquired by an
"affiliate" of the Company, as such term is defined in Rule 144 under the
Securities Act ("Rule 144"), which shares will be subject to the resale
limitations and other limitations under Rule 144. In reliance on Rule 144, an
additional 4,885,407 shares of Common Stock are freely transferable by persons
who are not affiliates of the Company. An additional 427,841 shares of Common
Stock held by affiliates of the Company are eligible for sale in the public
market subject to compliance with the resale volume limitations and other
restrictions of Rule 144. The Company has registered on Form S-8, 1,460,000
shares of Common Stock reserved for issuance under the Company's stock option
plans as of the date of this Prospectus. Of the 5,313,248 outstanding shares of
Common Stock eligible for sale under Rule 144, 427,841 shares are subject to
lock-up agreements with the Underwriters pursuant to which the Company's
directors and executive officers and certain stockholders have agreed for a
period of 90 days following the date of this Prospectus that they will not,
without the prior written consent of Cowen & Company, offer, sell, contract to
sell or otherwise dispose of any shares of Common Stock or securities
convertible into, exchangeable or exercisable for Common Stock, except pursuant
to the Underwriting Agreement and except that the Company may grant stock
options or issue shares upon the exercise of options previously granted. In
addition, the Company has granted certain demand and "piggyback" registration
rights to certain of its existing stockholders with respect to 1,333,069 of the
foregoing shares. Sales of substantial amounts of Common Stock in the public
market, or the perception that such sales may occur, could have a material
adverse effect on the market price of the Common Stock.

FORWARD-LOOKING STATEMENTS

Certain statements in this Prospectus constitute "forward-looking
statements." When used in this Prospectus, the words "believes," "anticipates,"
"expects," "intends" and other predictive, interpretive and similar expressions
are intended to identify such forward-looking statements. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results of the Company to be different from
expectations expressed or implied by such forward-looking statements. Such
factors include, but are not limited to, the uncertainty of final regulatory
approvals of the PMA application for ADCON-L, including the timing and content
of decisions made by the FDA, commercial uncertainty of market acceptance of the
Company's ADCON family of products, delays in product development of other ADCON
products, uncertainty due to the early stage of development for the therapeutic
programs, the possible need for additional funding, the ability of the Company
to establish and maintain collaborative arrangements with others, the potential
market size for ADCON products, the ability to renew research collaborations,
the productivity of distributors of the ADCON products, shortages of supply of
ADCON products from the Company's sole manufacturer, the lack of supply of raw
materials for the Company's products, particularly from the sole source supplier
of certain key components for its ADCON products, uncertainty of future
profitability, uncertainties related to the Company's proprietary rights in its
products, the loss of key management personnel, and technological change. These
statements are based on certain assumptions and analysis made by the Company in
light of its experience and its perception of historical trends, current
conditions, expected future developments and other factors it believes are
appropriate in the circumstances. Such statements are subject to a number of
other assumptions, risks, uncertainties, general economic and business
conditions, and the business opportunities
15
<PAGE> 17

(or lack thereof) that may be presented to and pursued by the Company.
Prospective investors are cautioned that any such statements are not indicative
of future performance and that actual results or developments may differ
materially from those projected in the forward-looking statements. The
accompanying information contained in this Prospectus, including, without
limitation, the information set forth in this section and under the headings
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" identifies important factors that could cause such
differences.

16
<PAGE> 18

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 2,000,000 shares of
Common Stock offered hereby at an assumed public offering price of $19.50 per
share (the last sale price on May 22, 1998) and after deducting underwriting
discounts and commissions and estimated offering expenses will be approximately
$36,152,500 ($41,636,875 if the Underwriters' over-allotment option is exercised
in full).

The Company intends to use the net proceeds of this offering for the
funding of the U.S. development of ADCON-P and ADCON-T/N, for the costs
associated with the market introduction in the U.S. of ADCON-L, for the
continued research and development of the Company's drug programs and additional
ADCON products, and for working capital and other general corporate purposes. To
date, the Company has funded the development of its ADCON family of products and
Cognition Modulation programs independently of strategic partners. The Company,
however, may enter into agreements with strategic partners for certain of its
ADCON products, other than ADCON-L, and does not anticipate funding clinical
trials relating to its Cognition Modulation program through completion of such
clinical trials without the collaboration of a strategic partner. The actual
amount and the timing of expenditures for each of the foregoing uses of proceeds
from this offering will depend on the progress of the Company's clinical trials
and sales of ADCON-P, ADCON-L and ADCON-T/N, its research and development
efforts, its success in entering into strategic alliances, the timing of
regulatory approvals and technological advances, and determinations as to the
commercial potential and status of competitive products. Pending such uses, the
Company intends to invest such funds in short-term, interest-bearing, investment
grade securities.

PRICE RANGE OF COMMON STOCK
AND DIVIDEND POLICY

The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol "GLIA." The following table sets forth for the periods indicated the
high ask and low bid prices for the Company's Common Stock:

<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
1998
Second Quarter (through May 22, 1998)..................... $19 5/8 $11 1/2
First Quarter............................................. 12 1/4 7 7/8
1997
Fourth Quarter............................................ $14 $ 7 5/8
Third Quarter............................................. 12 1/8 7 3/4
Second Quarter............................................ 10 1/4 7 5/8
First Quarter............................................. 14 3/8 7 11/16
1996
Fourth Quarter............................................ $10 1/8 $ 7 5/8
Third Quarter............................................. 11 6 5/8
Second Quarter............................................ 15 1/2 9
First Quarter............................................. 16 3/4 8
</TABLE>

The last sale price of Common Stock on May 22, 1998, as reported on the
Nasdaq National Market was $19.50 per share. There were approximately 287
holders of record of Common Stock of the Company as of May 12, 1998.

The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying any cash dividends in the foreseeable
future. The payment of future dividends, if any, will be at the discretion of
the Company's Board of Directors after taking into account various factors,
including the Company's financial condition, operating results, current and
anticipated cash needs and plans for expansion.

17
<PAGE> 19

CAPITALIZATION

The following table sets forth at March 31, 1998 the actual capitalization
of the Company and the capitalization of the Company as adjusted to reflect the
sale by the Company of the 2,000,000 shares of Common Stock offered hereby at an
assumed public offering price of $19.50 per share (the last sale price on May
22, 1998) after deducting underwriting discounts and commissions and estimated
offering expenses payable by the Company.

<TABLE>
<CAPTION>
MARCH 31, 1998
----------------------------
ACTUAL AS ADJUSTED
------------ ------------
(UNAUDITED)
<S> <C> <C>
Stockholders' equity:
Preferred Stock, $0.01 par value, 5,000,000 shares
authorized, none issued or outstanding.................... $ -- $ --
Common Stock, $0.01 par value, 30,000,000 shares authorized;
issued and outstanding -- 7,601,273 actual and 9,601,273
as adjusted(1)............................................ 76,013 96,013
Additional paid-in capital.................................. 53,377,810 89,510,310
Deficit accumulated during the development stage............ (44,206,479) (44,206,479)
------------ ------------
Total stockholders' equity................................ 9,247,344 45,399,844
------------ ------------
Total capitalization...................................... $ 9,247,344 $ 45,399,844
============ ============
</TABLE>

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

(1) Excludes an aggregate of 1,107,175 shares of Common Stock issuable upon
exercise of stock options outstanding at March 31, 1998, at a weighted
average exercise price of $7.54 per share, granted under the Company's stock
option plans. An additional 20,000 shares of Common Stock have been reserved
for issuance upon the exercise of warrants at an exercise price of $7.50 per
warrant, subject to certain adjustments.

DILUTION

The net tangible book value of the Company at March 31, 1998 was
$8,442,916, or approximately $1.11 per share of Common Stock. Net tangible book
value per share represents the amount of the Company's tangible assets less
total liabilities, divided by the total number of shares of Common Stock
outstanding. Dilution per share represents the difference between the amount per
share paid by investors in this offering and the pro forma net tangible book
value per share upon completion of this offering. After giving effect to the
sale of shares of Common Stock offered by the Company hereby at an assumed
offering price of $19.50 per share (the last sale price on May 22, 1998) and
after receipt of the estimated net proceeds therefrom of $36,152,500 (after
deducting the underwriting discounts and commissions and estimated offering
expenses payable by the Company), the pro forma net tangible book value of the
Company as of March 31, 1998 would have been $44,595,416, or $4.64 per share of
Common Stock. This represents an immediate increase in net tangible book value
of $3.53 per share to existing stockholders and an immediate dilution of $14.86
per share to purchasers in this offering.

The following table illustrates the dilution per share as described above:

<TABLE>
<S> <C> <C>
Assumed public offering price per share..................... $19.50
Net tangible book value per share prior to the offering... $1.11
Increase per share attributable to new investors.......... 3.53
-----
Pro forma net tangible book value per share after the
offering(1)............................................... 4.64
------
Dilution per share to new investors......................... $14.86
======
</TABLE>

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

18
<PAGE> 20

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data of the Company for the
years ended December 31, 1993 through 1997, the three months ended March 31,
1997 and 1998, and the period from inception of operations (August 31, 1988)
through March 31, 1998 are derived from the consolidated financial statements of
the Company. The information presented below should be read in conjunction with
the Company's Consolidated Financial Statements and related Notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.

(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION OF
THREE MONTHS OPERATIONS
YEAR ENDED DECEMBER 31, ENDED MARCH 31, (AUGUST 31, 1988)
----------------------------------------------------- --------------------- THROUGH MARCH 31,
1993 1994 1995 1996 1997 1997 1998 1998
------- ------- --------- --------- --------- --------- --------- -----------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues
Research contracts and
licensing fees........... $ -- $ 918 $ 2,217 $ 2,855 $ 2,954 $ 739 $ 739 $ 9,682
Product sales.............. -- 86 182 901 1,536 345 512 3,217
Government grants.......... 302 141 255 122 410 50 150 1,651
------- ------- --------- --------- --------- --------- --------- --------
Total revenues........... 302 1,145 2,654 3,878 4,900 1,134 1,401 14,550
Operating costs and expenses
Research and development... 4,441 4,600 5,107 6,120 6,952 1,855 2,253 36,251
Selling, general and
administrative........... 1,674 2,365 2,599 4,070 4,401 1,070 1,233 19,813
Depreciation and
amortization............. 312 272 170 166 293 65 87 1,824
Cost of product sales...... -- 58 123 342 614 125 167 1,303
------- ------- --------- --------- --------- --------- --------- --------
Total operating costs and
expenses............... 6,427 7,295 7,999 10,698 12,260 3,115 3,740 59,191
------- ------- --------- --------- --------- --------- --------- --------
Loss from operations......... (6,125) (6,150) (5,345) (6,820) (7,360) (1,981) (2,339) (44,641)
Settlement of claim.......... (2,025) (2,025)
Interest income, net......... 211 98 360 1,120 824 237 147 3,399
------- ------- --------- --------- --------- --------- --------- --------
Net loss..................... $(5,914) $(6,052) $ (4,985) $ (5,700) $ (8,561) $ (1,744) $ (2,192) $(43,267)
======= ======= ========= ========= ========= ========= ========= ========
Basic and diluted net loss
per common share........... $(35.14) $ (3.28) $ (0.78) $ (1.16) $ (0.24) $ (0.29)
======= ========= ========= ========= ========= =========
Shares used for purposes of
computing basic and diluted
net loss per common
share...................... 172 1,519 7,313 7,354 7,333 7,451
</TABLE>

<TABLE>
<CAPTION>
AT DECEMBER 31, AT
-------------------------------------------------------- MARCH 31,
1993 1994 1995 1996 1997 1998
-------- -------- -------- -------- -------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments................................ $ 4,321 $ 4,671 $ 23,023 $ 17,996 $ 11,542 $ 8,042
Working capital.............................. 2,860 1,511 21,762 15,821 9,370 7,136
Total assets................................. 6,148 6,716 25,346 20,804 14,805 11,659
Deficit accumulated during the development
stage...................................... (16,716) (22,768) (27,754) (33,454) (42,014) (44,206)
Total stockholders' equity................... 4,177 3,122 23,182 17,627 11,440 9,247
</TABLE>

19
<PAGE> 21

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

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

OVERVIEW

Since commencing operations in 1988, the Company has been a development
stage company. The Company is engaged in the research, development and
commercialization of its ADCON family of products, which are proprietary,
resorbable, carbohydrate polymer medical devices designed to inhibit surgical
scarring and adhesions. Based on European pivotal clinical studies and other
compliance efforts and submission of data, the Company obtained regulatory
clearance to affix CE Marking on ADCON-L and ADCON-T/N in August 1995 and
January 1996, respectively, thereby allowing ADCON-L and ADCON-T/N to be
marketed in the 19 European countries which recognize CE Marking. ADCON-L and
ADCON-T/N are currently being marketed in 29 countries outside the U.S. through
independent medical device distributors for lumbar disc surgery and tendon and
peripheral nerve surgeries, respectively. In addition, the Company signed a
development and exclusive license agreement in December 1996 with Chugai for the
sale of ADCON-L and ADCON-T/N in Japan. Further, the Company is pursuing the
development of small molecule drug candidates for the treatment of several
nervous system disorders, including ADHD, sleep disorders, obesity, anxiety and
AD. In October 1994, the Company entered into a strategic alliance with Janssen
to collaborate on the discovery and development of therapeutic products to treat
AD. In September 1995, the scope of the alliance was expanded and the current
arrangement extends through October 1998. Since inception, the Company's
revenues have been derived primarily from contract research payments relating to
its strategic alliance with Janssen. The Company has also received revenues from
product sales of ADCON-L and ADCON-T/N as well as from various government grants
awarded to the Company. The Company anticipates that a significant portion of
revenue from product sales will be derived from its ADCON family of products,
primarily ADCON-L. See "Business -- Janssen Agreement."

The Company is a development stage company that has not generated any
material revenues from operations. As a result, the Company has had net
operating losses since its inception and expects such losses to continue unless
and until such time as revenues are sufficient to fund its current operations.
The Company has accumulated a deficit of $44.2 million for the period from
inception of operations (August 31, 1988) through March 31, 1998. The Company
expects to continue to incur a loss over at least the next several years and the
amount of future net losses and time required by the Company to reach
profitability are uncertain. See "Risk Factors -- History of Operating Losses
and Accumulated Deficit; Uncertainty of Future Profitability; Fluctuating
Results of Operations."

RESULTS OF OPERATIONS

For the three months ended March 31, 1998 and 1997

Total revenues increased approximately 23.5% to $1.4 million in the first
quarter of 1998 from $1.1 million in the first quarter of 1997. The increase in
total revenues was primarily a result of a 48.4% increase in product sales to
$512,000 in the first quarter of 1998 from $345,000 in the first quarter of
1997. This increase in product sales primarily resulted from increased sales of
the Company's ADCON-L product, and to a lesser extent, the Company's ADCON-T/N
product in certain European countries, as well as other countries outside the
U.S.

The Company's government-funded grant revenues increased to $150,000 in the
first quarter of 1998 from $50,000 in the first quarter of 1997. This increase
was primarily due to the award in February 1997 of a Phase II Small Business
Innovation Research ("SBIR") Program two year grant from the National Institute
of Neurological Disorders and Stroke ("NINDS") for research to evaluate the use
of histamine H(3) receptor antagonists in treating ADHD. The increase also
resulted from an award in the fourth quarter of 1997 of two $100,000 Phase I
SBIR Program grants: (i) from NINDS for research to evaluate the molecular
characterization

20
<PAGE> 22

of the histamine receptor subtype and (ii) from the National Institute of
Nursing Research ("NINR") for research to evaluate the inhibition of
postoperative gynecological adhesions.

Total operating expenses increased by approximately 20.1% to $3.7 million
in the first quarter of 1998, compared to $3.1 million in the first quarter of
1997. Cost of products sold increased to $167,000 in the first quarter of 1998
compared to $125,000 in the first quarter of 1997, but decreased as a percentage
of product sales in the first quarter of 1998 to 32.6% from 36.2% in the first
quarter of 1997. This decrease as a percentage of sales was primarily due to
improved efficiencies and the absorption of manufacturing overhead costs as a
result of increased production volumes.

Research and development expenses increased by approximately 21.5% to $2.3
million in the first quarter of 1998 from $1.9 million in the first quarter of
1997. This increase was primarily due to: (i) increased research contract
expenses and purchases of materials for animal toxicology and other preclinical
studies for the lead compound which is being developed by the Company for its
Cognition Modulation program; and (ii) increased staffing and clinical research
costs associated with preclinical and clinical development of ADCON-P.

Selling, general and administrative expenses increased 15.2% to $1.2
million in the first quarter of 1998 compared to $1.1 million in the first
quarter of 1997. This increase was primarily due to an increase in sales and
marketing expenses resulting from the Company's preparations in anticipation of
final approval by the FDA for ADCON-L.

Depreciation and amortization expense was $87,000 in the first quarter of
1998 compared to $65,000 in the first quarter of 1997. The increase was
primarily due to increased amortization resulting from leasehold improvements
made in 1997 and 1996.

Net interest income decreased to $147,000 in the first quarter of 1998 from
$237,000 in the first quarter of 1997. This decrease was due to lower cash and
cash equivalents and short-term investment balances during the first quarter of
1998 as compared to the first quarter of 1997.

The Company's net loss increased 25.7% to $2.2 million in the first quarter
of 1998, compared to $1.7 million in the first quarter of 1997. The increase in
net loss was a result of increased total expenses, which were slightly offset by
increased revenues as discussed above. The basic and diluted net loss per common
share was $0.29 in the first quarter of 1998, compared to $0.24 in the first
quarter of 1997.

Fiscal Years ended December 31, 1997 and 1996

Total revenues increased approximately 26.4% to $4.9 million in 1997 from
$3.9 million in 1996. The increase in total revenues was primarily a result of a
70.5% increase in product sales to $1.5 million in 1997 from $901,000 in 1996.
This increase in product sales primarily resulted from increased sales of the
Company's ADCON-L and ADCON-T/N products in certain European countries, as well
as other countries outside the U.S. In addition, research contract revenues
increased slightly to $3.0 million in 1997 from $2.9 million in 1996. These
research contract revenues were from the Company's research contract with
Janssen.

The Company's government-funded grant revenues increased to $410,000 in
1997 from $122,000 in 1996. This increase was primarily due to the award in
February 1997 of a Phase II SBIR Program two year grant from the NINDS for
research to evaluate the histamine H(3) receptor antagonists to treat ADHD. In
addition, in the fourth quarter of 1997, the Company was awarded two $100,000
Phase I SBIR Program grants: (i) from NINDS for research to evaluate the
molecular characterization of the histamine receptor subtype and (ii) from the
NINR for research to evaluate the inhibition of postoperative gynecological
adhesions.

Total operating expenses increased by approximately 14.6%, to $12.3 million
in 1997 compared to $10.7 million in 1996. Cost of products sold increased to
$614,000 in 1997 compared to $342,000 in 1996 and increased as a percentage of
product sales in 1997 to 40.0% from 37.9% in 1996. This increase was primarily
due to slightly increased manufacturing overhead costs which were added in
anticipation of larger planned production volumes which were not obtained in
1997.

Research and development expenses increased by approximately 13.6% to $7.0
million in 1997 from $6.1 million in 1996. This increase was primarily due to:
(i) increased research contract expenses and purchases
21
<PAGE> 23

of materials for preclinical and animal toxicology studies for the lead compound
which is being developed by the Company for the treatment of ADHD; (ii)
increased staffing and clinical consulting costs associated with the PMA filed
with the FDA for ADCON-L; (iii) increased costs associated with the development
of a new delivery system for ADCON-L and (iv) increased staffing and clinical
research costs associated with preclinical and clinical development of ADCON-P.

Selling, general and administrative expenses increased 8.1% to $4.4 million
in 1997, compared to $4.1 million in 1996. The increase was primarily due to
increases in expenses resulting from the Company's sales and marketing efforts
for ADCON-L and ADCON-T/N in certain European markets and other selected
countries outside of the U.S.

Depreciation and amortization expense was $293,000 in 1997 compared to
$166,000 in 1996. The increase was primarily due to increased amortization
resulting from leasehold improvements made in 1996 and 1997.

Net interest income decreased 26.4% to $824,000 in 1997 from $1.1 million
in 1996. This decrease was due to lower cash and cash equivalents and short-term
investment balances throughout 1997 as compared to 1996.

In the fourth quarter of 1997, the Company incurred a one-time non-cash
charge of $2.0 million relating to the Company's settlement of litigation
involving the Company.

The Company's net loss increased 50.2% to $8.6 million in 1997, compared to
$5.7 million in 1996. The net loss, excluding a one-time non-cash charge of $2.0
million for settlement of the litigation, increased 14.7% to $6.5 million in
1997 from $5.7 million in 1996. The increase in net loss was a result of
increased total expenses, which were slightly offset by increased revenues as
discussed above. The net loss per share was $1.16 in 1997, compared to $0.78 in
1996 and, excluding the one-time non-cash charge for settlement of the
litigation, $0.89 in 1997.

Fiscal Years ended December 31, 1996 and 1995

Total revenues increased approximately 46.1% to $3.9 million in 1996 from
$2.7 million in 1995. The increase in total revenues was primarily the result of
an increase in product sales to $901,000 in 1996 from $182,000 in 1995. The
increase in product sales in 1996 resulted from sales of the Company's ADCON-L
and ADCON-T/N products in certain European countries, as well as Australia and
New Zealand.

The Company had research contract revenues in 1996 of $2.9 million from its
research contract with Janssen compared to research revenues of $2.2 million in
1995. In September 1995, the Company entered into an addendum to the Janssen
Agreement in order to expand the scope of the collaboration with Janssen on AD
to include research and development relating to inhibitors of complement
activation. This addendum to the Janssen Agreement added approximately $875,000
to research contract revenues in 1996 and $290,000 to research contract revenues
in 1995. Under the terms of the expanded agreement, Janssen increased its
research funding and milestone payments by 50% beginning in September 1995.

The Company's government-funded research grant revenues were $122,000 in
1996 and $255,000 in 1995. The level of grant revenues were a direct result of
the number of government-funded research grants awarded the Company in each
year.

Total operating expenses were $10.7 million in 1996 compared to $8.0
million in 1995. Cost of products sold increased 178.6% to $342,000 in 1996 from
$123,000 in 1995. The increase in cost of products sold was due primarily to the
increases in product sales for the corresponding period. However, cost of
products sold decreased as a percentage of product sales in 1996 to 37.9% from
67.3% in 1995. This decrease was primarily due to improved absorption of
manufacturing overhead costs as a result of increased production volumes in
1996. In both periods, cost of products sold included costs associated with the
start-up of manufacturing processes with EMCM, a third party manufacturer of
ADCON-L and ADCON-T/N.

Expenses for research and development increased 19.8% to $6.1 million in
1996 from $5.1 million in 1995. This increase was due primarily to increased
staffing and clinical contract expenses resulting from the initiation of pivotal
clinical trials in the U.S. for both ADCON-L and ADCON-T/N beginning in the
fourth quarter of 1995 and continuing throughout 1996. Additionally, the
increase is a result of additions in staffing and purchases of
22
<PAGE> 24

laboratory supplies and services relating to increased research activities
beginning in the first quarter of 1996 with respect to AD and Cognition
Modulation programs as well as write-offs of costs associated with patents which
were abandoned due to changes in the technology pursuits of the Company.
Increased expenses associated with the Company's AD program are funded under the
Company's research agreement with Janssen.

Selling, general and administrative expenses increased 56.6% to $4.1
million in 1996 from $2.6 million in 1995. This increase was primarily due to an
increase in sales and marketing expenses as the Company continued to expand its
sales and marketing efforts for its ADCON-L and ADCON-T/N products in Europe and
in other countries outside the U.S. Additionally, the Company incurred increased
general and administrative expenses of $230,000 in 1996 associated with the
filing of a registration statement with the Securities and Exchange Commission
(the "Commission") for an offering of Common Stock which was subsequently
withdrawn due to unfavorable market conditions. The Company also incurred
increased general and administrative expenses in 1996 associated with its first
full year of reporting as a publicly traded company.

Depreciation and amortization expense was $166,000 in 1996 compared to
$170,000 in 1995. This expense decreased because several Company assets had
become fully depreciated.

Net interest income increased 211.2% to $1.1 million in 1996 from $360,000
in 1995. The increase in 1996 was due primarily to the interest earned on the
cash received on the October 1995 initial public offering of Common Stock. In
addition, interest expense decreased in both periods as the Company paid down
its line of credit and fully repaid its capital leases.

The Company's net loss increased 14.3% to $5.7 million in 1996, compared to
$5.0 million in 1995. The increase in net loss was a result of increased total
expenses, which were slightly offset by increased revenues as discussed above.
The net loss per share was $0.78 in 1996, compared to $3.28 in 1995.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the Company has financed its operations primarily through
the private placement and public offering of its equity securities, research
contract licensing fees, and, to a lesser extent, through federally-sponsored
research grants. Since its inception, the Company has received $49.3 million in
net proceeds from equity financings. In addition, from its inception through
March 31, 1998, the Company has recognized revenue of $9.7 million from its
research agreement with Janssen, $3.2 million from product sales and $1.7
million from several federally-sponsored research grants. The Company has also
established a $1.5 million line of credit with a bank, secured by certain assets
of the Company. As of March 31, 1998, the Company had no borrowings against the
line of credit.

In order to preserve principal and maintain liquidity, the Company's funds
are invested in commercial paper and other short-term investments. As of March
31, 1998, December 31, 1997 and December 31, 1996, the Company's cash and cash
equivalents and short-term investments totaled $8.0 million, $11.5 million and
$18.0 million, respectively. The Company is currently evaluating possible
alternative facilities in Ohio, Massachusetts and North Carolina for its
operations; however, no definitive plans have been made as of the date hereof.
The Company expects that its existing capital resources, together with the net
proceeds of this offering and interest earned thereon, will enable the Company
to maintain its current and planned operations for at least the next two years.
The Company may need to raise substantial additional capital to fund its
operations prior to such time. The Company's future capital requirements will
depend on, and could increase as a result of, many factors, including, but not
limited to, the costs of commercialization of ADCON-L, the commercial success of
its ADCON family of products, the progress of the Company's research and
development, including the costs related to its Cognition Modulation and AD
programs, the scope, timing and results of preclinical studies and clinical
trials, the cost and timing of obtaining regulatory approvals, its success in
obtaining the strategic alliances required to fund certain of its programs, the
rate of technological advances, determinations as to the commercial potential of
certain of the Company's product candidates, the status of competitive products,
the establishment of additional manufacturing capacity and the possible
relocation of the Company's facilities.

In 1995 and 1996, the Company received revenues from two Phase I SBIR
grants for up to $100,000 each from the NINDS division of the National Institute
of Health relating to the development of histamine H(3) receptor

23
<PAGE> 25

agents. In February 1997, the Company was awarded a Phase II SBIR Program grant
from the NINDS for research evaluating histamine H(3) receptor antagonists to
treat ADHD. The grant has a two-year term and may provide as much as $750,000 in
funding. If the Company is successful in other Phase I research, additional
Phase II awards may be sought for funding to aid in further development of
pharmaceutical compounds; however, there is no assurance that such Phase I
research will be successful or that additional funding will be obtained. In
addition, in the fourth quarter of 1997, the Company was awarded two Phase I
SBIR grants for up to $100,000 each from the NINDS and the NINR divisions of the
National Institute of Health.

The Company does not expect to generate a positive cash flow from
operations for several years due to the substantial costs for commercialization
of its ADCON family of products, additional research and development costs for
ADCON-A, ADCON-I and ADCON-C and for costs related to its Cognition Modulation
and AD programs, preclinical testing, clinical trials and operating expenses
associated with supporting such activities.

The Company may raise additional funds through additional equity or debt
financing, government grants, further corporate alliances, collaborative
relationships, or otherwise. The Company may engage in these capital raising
activities even if it does not have an immediate need for additional capital at
that time. There can be no assurance that any such additional funding will be
available to the Company or, if available, that it will be on acceptable terms.
If additional funds are raised by issuing equity securities, further dilution to
existing shareholders may result. If adequate funds are not available, the
Company may be required to delay, reduce the scope of, or eliminate one or more
of its research, development or clinical trials. If the Company seeks to obtain
funds through arrangements with collaborative partners or others, such partners
may require the Company to relinquish rights to certain of its technologies,
product candidates or products that the Company would otherwise seek to develop
or commercialize itself.

As of December 31, 1997, the Company has available for Federal income tax
purposes net operating loss carryforwards of approximately $17.5 million and
research and development credit carryforwards of approximately $2.2 million.
These carryforwards expire at various dates between 2003 and 2012. Pursuant to
the Tax Reform Act of 1986, the utilization of net operating loss and research
and development tax credit carryforwards for tax purposes may be subject to an
annual limitation if a cumulative change in ownership of more than 50% occurs
over a three-year period. The issuance of securities by the Company and/or sales
of securities by the Company's principal stockholders could result in such a
change in ownership. The Company has offset the tax benefit of the net operating
loss and tax credit carryforwards with a valuation allowance as realization of
the benefit is not assured. See Note F of Notes to Consolidated Financial
Statements incorporated herein by reference.

YEAR 2000

The Company has conducted a review of its information system to identify
any issues that could be affected by the year 2000. Although the Company
believes that its information systems are able to process year and date
information beyond the year 1999, the Company is unable to determine the extent
to which year 2000 issues will affect its independent distributors or EMCM in
tracking sales, orders or shipments of the Company's devices or drugs, as the
case may be. Any interruption in the manufacturing or marketing of the Company's
products could have a material adverse effect on the Company's business,
prospects, financial condition or results of operations.

FORWARD-LOOKING STATEMENTS

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<PAGE> 26

funding, the ability of the Company to establish and maintain collaborative
arrangements with others, the potential market size for ADCON products, the
ability to renew research collaborations, the productivity of distributors of
the ADCON products, shortages of supply of ADCON products from the Company's
sole manufacturer, the lack of supply of raw materials for the Company's
products, particularly from the sole source supplier of certain key components
for its ADCON products, uncertainty of future profitability, uncertainties
related to the Company's proprietary rights in its products, the loss of key
management personnel, and technological change. These statements are based on
certain assumptions and analysis made by the Company in light of its experience
and its perception of historical trends, current conditions, expected future
developments and other factors it believes are appropriate in the circumstances.
Such statements are subject to a number of other assumptions, risks,
uncertainties, general economic and business conditions, and the business
opportunities (or lack thereof) that may be presented to and pursued by the
Company. Prospective investors are cautioned that any such statements are not
indicative of future performance and that actual results or developments may
differ materially from those projected in the forward-looking statements. The
accompanying information contained in this Prospectus, including, without
limitation, the information set forth in this section and under the headings
"Risk Factors" and "Business" identifies important factors that could cause such
differences.

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<PAGE> 27

BUSINESS

OVERVIEW

Gliatech is a leader in the research, development and commercialization of
proprietary, resorbable, carbohydrate polymer medical devices designed to
inhibit surgical scarring and adhesions. The Company has developed its family of
ADCON medical devices to be used prophylactically as a physical barrier between
tissues to inhibit scarring and adhesions in all patients undergoing certain
surgical procedures. The Company's most developmentally advanced product,
ADCON-L, a proprietary, resorbable, carbohydrate polymer gel, is designed to
inhibit surgical scarring and adhesions and to reduce postsurgical pain
following lumbar surgeries. On April 6, 1998, the Company received a letter from
the FDA stating that the PMA for ADCON-L is approvable subject to the
satisfactory completion of an FDA inspection of the ADCON-L manufacturing
facilities, methods and controls. The Company expects to receive a final
decision regarding the approval of ADCON-L from the FDA in mid-1998; however,
there can be no assurance as to the satisfactory completion of the manufacturing
review process or the decision of the FDA to approve ADCON-L for marketing in
the U.S. ADCON-L is currently being marketed in 29 countries outside the U.S.,
including the 19 countries which recognize CE Marking. See "Risk
Factors -- Uncertainty of Regulatory Approval for ADCON-L," "-- Reliance on
Third Party for Manufacturing; Comprehensive Regulation of Manufacturing of
Products" and " -- Government Regulation." In addition to the ADCON family of
medical devices, the Company is pursuing the development of small molecule drug
candidates for the treatment of several central nervous system disorders,
including ADHD, sleep disorders, obesity, anxiety and AD. The Company is
pursuing its AD program through its strategic alliance with Janssen, a
wholly-owned subsidiary of Johnson & Johnson.

Surgical scarring is a significant medical problem often resulting in
adhesions at the surgical site, thereby binding together tissues, nerves and
organs following either open incision or minimally invasive surgery. Scarring
and adhesions may lead to many significant postsurgical complications, including
recurrent pain and impairment of function following lumbar surgery, infertility
following pelvic surgery and limited range of motion following tendon and
peripheral nerve surgery of the hand. Excessive scarring also can obstruct
access to the surgical site when reoperation is necessary making additional
surgery difficult. Due to the differences in the surgical environments in which
each of these products would be used, each ADCON product is designed to be
adapted for use at the different surgical sites. ADCON-L is designed to inhibit
scarring and adhesions and reduce postsurgical pain following lumbar surgery. In
1995, approximately 450,000 lumbar surgeries were performed in the U.S. The
Company's European clinical trial has shown that approximately 90% of lumbar
surgery patients experience a certain amount of scarring following such surgery.
This clinical trial also demonstrated that 8% to 44% of patients who received
ADCON-L experienced a lower incidence of activity-related pain in the
performance of all evaluated activities of daily living.

The Company is also developing ADCON-P, a proprietary, resorbable,
carbohydrate polymer solution, which is designed to inhibit pelvic and
gynecological postsurgical scarring and adhesions, which may lead to infertility
or difficulty in conceiving. In 1994, approximately 1.3 million gynecological
surgeries related to infertility were performed in the U.S. Independent studies
have shown that more than 55% of patients undergoing such surgeries experience
some postsurgical scarring and adhesions. The Company has initiated a
double-blind, controlled, clinical trial and has completed enrollment of 41
patients; 23 patients for evaluation in reoperations to remove adhesions and 18
patients for evaluation in uterine tumor surgeries. Upon completion of the pilot
trial, which is currently anticipated to occur in the second half of 1998, the
Company intends to submit a request to the FDA to conduct a pivotal clinical
trial for ADCON-P. See "Risk Factors -- Early Commercialization; Uncertainty of
Market Acceptance of ADCON Family of Products," "-- Uncertainty Related to
Development of ADCON Products" and "-- Government Regulation."

26
<PAGE> 28

following carpal tunnel release, the surgical procedure to treat carpal tunnel
syndrome after the first surgery has failed.

The Company is currently marketing ADCON-L and ADCON-T/N outside the U.S.
through independent medical device distributors in 29 countries, including the
major countries in the European Union. Upon receipt of regulatory approval from
the FDA, the Company intends to market ADCON-L in the U.S. through a network of
independent manufacturers' agents with an aggregate sales force of approximately
175 sales representatives who serve the orthopaedic and neurosurgical markets.
In addition, the Company signed a development and exclusive license agreement in
December 1996 with Chugai for the sale of ADCON-L and ADCON-T/N in Japan. Chugai
has filed applications requesting regulatory approval to market ADCON-L and
ADCON-T/N in Japan. The Company is also in the early stages of development of
several other ADCON products, including: ADCON-A, for use in abdominal
surgeries; ADCON-I for use in implant/prosthetic surgeries; and ADCON-C for use
in cardiac surgeries. In 1994, approximately 2.5 million abdominal surgeries,
approximately 1.4 million implant/prosthetic surgeries and approximately 1.0
million cardiac surgeries were performed in the U.S.

The Company is also engaged in the research and development of therapeutic
products for the treatment of AD. In October 1994, the Company entered into an
agreement with Janssen to collaborate on the research and development of
therapeutic products to treat AD. Pursuant to the Janssen Agreement, the Company
has developed a number of high throughput in vitro assay systems that have been
used to screen Janssen's pharmaceutical library and has identified several lead
compounds. The Company anticipates that lead compounds will be selected for
preclinical testing in late 1998. See "Risk Factors -- Early Stage of
Development for Therapeutic Programs," "-- The Janssen Agreement" and
"-- Government Regulation."

BUSINESS STRATEGY

Gliatech's strategic objective is to utilize its core glial cell-derived
technology to: (i) develop and commercialize its family of ADCON site-specific
products and (ii) identify drug candidates and develop therapies for central
nervous system disorders, including ADHD and AD. The key elements of the
Company's business strategy include:

Establishing ADCON-L as a Standard of Care for Lumbar Surgery. The Company
seeks to establish ADCON-L as the standard of care for inhibiting scarring and
adhesions following lumbar surgery. Gliatech will seek to educate the surgical
community regarding ADCON-L's key advantages and benefits, which include a
reduction in scarring, a reduction in the incidence of pain associated with the
performance of activities of daily living and easier access to the surgical site
when reoperation is necessary. To date, ADCON-L has been used in approximately
12,000 surgeries outside the U.S. without significant complications. The Company
expects the decision of the FDA regarding marketing approval for ADCON-L in the
U.S. in mid-1998. Upon receipt of FDA approval, the Company intends to market
ADCON-L in the U.S. through a network of independent manufacturers' agents with
an aggregate sales force of approximately 175 sales representatives who serve
the orthopaedic and neurosurgical markets. Currently, ADCON-L is being marketed
in 29 countries outside the U.S. through independent medical device
distributors.

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<PAGE> 29

Developing and Commercializing a Broad Range of ADCON Products. Surgical
scarring is a significant medical problem often resulting in adhesions at the
surgical site, which may lead to significant complications, such as pain,
infertility, limited range of motion and impairment of gastrointestinal
function. Gliatech's ADCON proprietary, resorbable, carbohydrate polymer
technology is highly adaptable to meet the needs of many different types of
surgery through modification of its carbohydrate polymers and their formulation
into gels and solutions of variable viscosities and resorption times. Each
member of the ADCON family of products is being developed and commercialized to
address the site-specific problems of excessive postsurgical scarring and
adhesions. For example, in addition to ADCON-L and ADCON-T/N which are
carbohydrate polymer gels, Gliatech is developing ADCON-P, a low-viscosity
solution which can be administered directly through the surgical instrument used
in minimally invasive pelvic and gynecological procedures, thereby enabling its
use with minimal disruption of the surgical site and without enlargement of the
surgical opening. Gliatech's objective is to bring to market a family of
differentiated ADCON products for specific surgical procedures.

Capitalizing on Surgeons' Recognition of ADCON Technology. As a result of
the Company's sales of ADCON-L and ADCON-T/N outside the U.S. and the various
multi-center clinical trials conducted in the U.S. and Europe for ADCON-L,
ADCON-T/N and ADCON-P to date, an aggregate of approximately 1,000 neurologic,
orthopaedic, gynecologic and hand surgeons have used the appropriate ADCON
product in over 13,000 procedures. As a result, the Company believes that it has
developed and is expanding upon a reputation for providing high-quality, safe
and effective medical devices. The Company intends to use its reputation to
increase market acceptance of its existing products and to assist in introducing
new products currently under development. Initiatives to support product
marketing, enhance physician awareness and obtain support from key opinion
leaders include publishing results of clinical trials in peer reviewed surgeon
journals, providing packages of sales tools, videos, brochures and clinical
papers to its independent distributors, and exhibiting at major surgeons'
meetings, such as the American Association of Orthopaedic Surgeons and the
Federation of European Societies of Surgeries of the Hand.

Utilizing its Core Glial Cell-Derived Technology for Treatment of Central
Nervous System Disorders. To complement its near-term focus on its ADCON family
of products, the Company is pursuing the development of small molecule drug
candidates based on the Company's knowledge of glial cell function for the
treatment of central nervous system disorders. Through its Cognition Modulation
program, the Company has discovered and developed highly selective histamine
H(3) receptor antagonists which have been shown in in vivo studies to (i)
penetrate the blood-brain barrier after oral administration, (ii) selectively
block the histamine H(3) receptor in the brain, and (iii) modulate levels of
arousal and alertness. The Company is conducting preclinical studies on
compounds designed for use in the treatment of certain central nervous system
disorders, such as ADHD, obesity and narcolepsy. The Company has also discovered
and developed an agonist to the histamine H(3) receptor, which may be developed
for use in the treatment of anxiety and insomnia. In addition, the Company has a
collaborative agreement with Janssen relating to the research and development of
therapeutic products for use in the treatment of AD. The Company's research and
development activities have identified several potential lead compounds for each
of these programs.

Pursuing and Expanding Strategic Alliances. Gliatech's approach to
development and commercialization centers on selective retention of key
commercial rights complemented by partnership with third parties at appropriate
times. The Company has licensed marketing rights in Japan for ADCON-L and
ADCON-T/N to Chugai through an agreement under which Chugai is responsible for
obtaining applicable regulatory approval. For ADCON products other than ADCON-L,
Gliatech may seek a strategic marketing partner, possibly prior to seeking
regulatory approval, in order to facilitate product introduction and
commercialization. In the field of pharmaceutical development, Gliatech's
strategy is to seek development partners early in the development phase, as
exemplified by the collaboration with Janssen for the research and development
of a product for the treatment of AD.

GLIAL CELL-DERIVED TECHNOLOGIES

The human central nervous system is composed of two interrelated networks
of cells, neurons and glial cells. Neurons transfer and process information from
within and around the body, enabling motor and sensory

28
<PAGE> 30

functions. Glial cells, which outnumber neurons by approximately nine to one and
are the major cellular component of the brain, support, protect and repair the
neurons and maintain the environment necessary for proper neuronal activity.
Additionally, glial cells release biological mediators which, among other
processes, regulate the inflammatory and immune responses within the brain.

The Company's ADCON family of products and the Company's two therapeutic
programs, Cognition Modulation and AD, are based on the Company's research of
glial cells. The ADCON family of products is based on research relating to the
manner in which glial cells respond to scarring following damage to the central
nervous system. The Company identified glial cell-derived substances which act
as barriers to neuronal scarring. The Company utilized this technology to
develop carbohydrate polymers which mimic such actions. These carbohydrate
polymers are the basis for the Company's family of ADCON products. The Cognition
Modulation program is based on controlling the levels of the neurotransmitter,
histamine, within the brain. The Company has determined that the level of
histamine can be modulated by the neuronal histamine H(3) receptor, which
controls the release of histamine, and glial cells, which are responsible for
removal of histamine. The Company is conducting research to discover and develop
small molecule drug candidates which interact with these neuronal histamine H(3)
receptors to modulate the levels of histamine in the brain. For the AD program,
the Company identified that, in the AD-affected brain, glial cells release
pro-inflammatory molecules which can cause neuronal death. The Company is also
engaged in the discovery and development of small molecule drug candidates which
are designed to inhibit the release of these pro-inflammatory molecules. The
Company believes that research into the function of glial cells will continue to
provide opportunities for the discovery and development of additional products
and product candidates.

SURGICAL ADHESIONS AND THE GLIATECH SOLUTION

As a result of the natural cellular processes of healing following surgery,
scarring and adhesions develop at the surgical site. Scarring and adhesions may
cause tissues and organs, which under normal conditions remain separate, to bind
and tether to each other and surrounding tissues. Scarring and adhesions may
occur following either open incision or minimally invasive surgery and may lead
to such postoperative complications as pain and impairment of function in the
performance of activities of daily living following lumbar surgeries,
infertility following pelvic surgeries, limited range of joint motion following
tendon surgeries, and more difficult access to the surgical site when
reoperation is necessary. Inhibition of postoperative scarring and adhesions is
a concern for surgeons. The preferred product to inhibit scarring and adhesions
would be (i) safe and effective in inhibiting scarring and adhesions, (ii)
resorbable so that a second surgery to remove the product would not be
necessary, (iii) adaptable to the particular surgical site and (iv) useable in
either open incision or minimally invasive surgeries. Additionally, such a
product would be used prophylactically because it is not possible to predict
prior to surgery which patients are likely to develop adhesion-related problems.

The Company's ADCON family of proprietary, resorbable, carbohydrate polymer
gels and solutions possess the characteristics described above. ADCON products
are specifically designed as free-flowing resorbable gels and solutions of
varying viscosities and are designed for use at the appropriate surgical site.
For example, in both lumbar and tendon surgeries, the respective surgical sites
are small and ADCON-L and ADCON-T/N, which are formulated as free-flowing gels,
are designed to remain at the surgical site and coat both the surgical site and
the surrounding area. In contrast, in pelvic surgeries where the surgical site
is larger with many organs to coat, a less viscous product, such as ADCON-P, as
opposed to a film or gel, is needed to permit coating of the larger surgical
site. In addition, because ADCON-P is a solution, it is designed to be used in
both open incision and minimally invasive surgeries using a laparoscope. Because
scarring and adhesion formation typically occurs within a few weeks following
surgery, ADCON gels and solutions are designed to be present at the surgical
site during the time of scarring and adhesion formation and then to be gradually
and fully resorbed by the body. Further, ADCON-L and ADCON-T/N have been
demonstrated to be both safe and effective in multi-center European clinical
trials. Given their ease of use, and because it is not possible to predict prior
to surgery which patients are likely to develop adhesion-related problems, the
ADCON products are designed to be used prophylactically in all applicable
surgeries.

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<PAGE> 31

ADCON FAMILY OF PRODUCTS

The following table summarizes the ADCON family of products, which are
designed to inhibit scarring and adhesions in applicable surgeries:

<TABLE>
<CAPTION>
APPROXIMATE NUMBER OF
SURGERIES PERFORMED
PRODUCT SURGICAL APPLICATION STATUS(1) ANNUALLY IN THE U.S.
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ADCON-L Lumbar surgeries Approvable letter received from 450,000
the FDA in April 1998

Marketed in 29 countries outside
the U.S.

ADCON-P Pelvic/gynecological U.S. pilot clinical trials 1,300,000
surgeries underway

ADCON-T/N Tendon and peripheral U.S. pivotal clinical trials 260,000
nerve surgeries of the underway
hand

Marketed in 29 countries outside
the U.S.

ADCON-A Abdominal surgeries Preclinical research 2,500,000

ADCON-I Implant/prosthetic Preclinical research 1,400,000
surgeries

ADCON-C Cardiac surgeries Preclinical research 1,000,000
</TABLE>

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

(1) "Preclinical" refers to activities involving testing of defined lead
product candidates in animals prior to Investigational Device Exemption
("IDE") application with the FDA or similar regulatory approvals with
non-U.S. agencies. "Pilot clinical trial" refers to human clinical testing
of product functionality. "Pivotal clinical trial" refers to human
clinical testing of safety and effectiveness. The results of the pivotal
trials, if successful, may be adequate to allow the Company to file for
regulatory approval of a product candidate in the U.S. or make similar
filings for regulatory approvals with non-U.S. agencies. See
"-- Government Regulation."

ADCON-L

ADCON-L is a proprietary, resorbable, carbohydrate polymer gel which is
applied directly to the surgical site during lumbar surgery. ADCON-L is designed
to provide a physical barrier between the membranes covering the spinal cord and
the back muscles, and between the spinal nerve roots and the inner surface of
the vertebral body. This physical barrier inhibits excess scarring and adhesions
at the surgical site. Because it is not possible to predict prior to surgery
which patients are likely to develop adhesion-related problems, ADCON-L is
designed to be used prophylactically in all patients undergoing lumbar
surgeries. To date, ADCON-L has been used in approximately 12,000 surgeries.

In 1994, approximately 450,000 lumbar surgeries were performed in the U.S.
Patients undergoing any lumbar surgeries often require additional medical
treatment which may include physical therapy, pain medication and, in certain
cases, reoperation to remove adhesions. The majority of lumbar surgeries are
performed to remove herniated lumbar spinal discs while others are performed to
decompress the spinal cord and nerve roots. The Company's European clinical
trial has shown that 8% to 44% of patients who received ADCON-L experienced a
lower incidence of activity-related pain in the performance of all evaluated
activities of daily living. The Company is not aware of any competitive products
that are being developed or marketed to inhibit scarring and adhesions following
lumbar surgery.

Clinical Results. To date, the Company has conducted clinical trials in
the U.S. and in Europe. The Company's European pivotal, double-blind,
controlled, clinical trial of ADCON-L was designed to test its safety and
effectiveness in inhibiting excessive scarring and adhesions, as well as
associated pain and other symptoms, following lumbar disc surgery. The clinical
trial was conducted at nine academic neurosurgical centers in

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<PAGE> 32

Switzerland, The Netherlands and Belgium and enrolled 298 patients. The
parameters used to evaluate patients at one, three and six months following
surgery were: (i) recurrence of postoperative pain, (ii) pain associated with
the performance of activities of daily living, such as lifting objects, riding
in or driving a car and sitting; (iii) sensory and motor function and (iv)
safety. At six months following surgery, patients were also evaluated as to the
amount of extensive scarring as assessed by Magnetic Resonance Imaging and as to
the association between scarring and the recurrence of postoperative pain.

The results of this clinical trial indicated that the use of ADCON-L
resulted in a statistically significant reduction in the incidence of extensive
scarring, and that there is a statistically significant correlation between the
presence of scarring and the recurrence of postoperative pain. In addition, this
trial revealed a statistically significant reduction in the incidence of
activity-related pain associated with the performance of all evaluated
activities of daily living in ADCON-L treated patients, as compared to control
patients. The reduction of scarring in patients treated with ADCON-L was also
observed by surgeons who performed second surgical procedures necessitated by
reherniation of the disc. The Company also conducted a post-study surveillance
that evaluated these same patients at approximately 12 months after surgery. The
results of such surveillance supported the conclusion of the pivotal clinical
study that ADCON-L reduced scarring.

The Company also is conducting a double-blind, controlled clinical trial of
ADCON-L in the U.S. at 16 centers. The Company has enrolled 371 patients in this
trial. Interim results on 165 patients indicated that ADCON-L reduced scarring.
The Company is analyzing the data for the remaining evaluable patients enrolled
in the study. The Company expects to complete the analysis of data from this
trial by the end of 1998. There can be no assurance that the results of the
completed analysis will be consistent with the interim results of such trial or
the results of the European trial. See "Risk Factors -- Early Commercialization;
Uncertainty of Market Acceptance of ADCON Family of Products," and
"-- Uncertainty Related to Development of ADCON Products."

Development and Regulatory Status. In August 1995, the Company obtained
regulatory clearances to affix CE Marking for ADCON-L. The CE Marking for
ADCON-L allows the Company to market ADCON-L for lumbar surgery patients in 19
countries, which include (i) the European Union countries (Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The
Netherlands, Portugal, Spain, Sweden and the United Kingdom); (ii) Switzerland
and (iii) the three European Economic Area countries (Iceland, Liechtenstein and
Norway). The Company has also satisfied all the necessary regulatory
requirements to market ADCON-L in Argentina, Australia, Canada and Israel and is
also able to market ADCON-L in New Zealand and the Republic of South Africa.

In December 1996, the Company submitted a PMA to the FDA for ADCON-L, which
was granted expedited review in February 1997. Based on the results of the
Company's pivotal European clinical trial and interim data of the U.S. clinical
trial currently underway, the Advisory Panel of the FDA recommended in December
1997 that ADCON-L be approved for marketing in the U.S. subject to certain
conditions and labeling requirements. The Company believes that the FDA will
approve labeling indicating that based on the six month pivotal European
clinical trial patients treated with ADCON-L had a statistically significant
reduction of scarring and of activity-related pain at six months and that with
regard to adverse safety events, the European trial showed no statistically
significant difference between the ADCON-L and control groups. The Company
believes that the FDA will approve labeling indicating that based on the
12-month post-study surveillance of the European clinical trial of available
patients, patients treated with ADCON-L had a statistically significant
reduction of scarring at 12 months, but there was no statistically significant
difference between patients treated with ADCON-L and the control group for
activity-related pain at 12 months. The European pivotal clinical trial had a
six-month end-point. In addition, the Company believes that the approved
labeling will reflect interim six month results from the U.S. clinical trial,
which showed that ADCON-L patients had a statistically significant reduction in
scarring and adhesions and a lower incidence of pain while performing certain
daily living activities. Based on discussions with the FDA, the Company believes
that labeling presenting this information will be approved by the FDA; however,
there can be no assurance that this labeling will ultimately be approved. In
addition, there can be no assurance that FDA will not require changes in any
approved labeling to reflect the final U.S. clinical trial results if they are
not consistent with the interim results or the European clinical trial. On April
6, 1998, the Company received a letter from the FDA stating that the PMA for
ADCON-L is approvable subject to the satisfactory

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<PAGE> 33

completion of an FDA inspection of the ADCON-L manufacturing facilities, methods
and controls. The Company anticipates receiving a final decision regarding the
approval of ADCON-L from the FDA in mid-1998; however, there can be no assurance
as to the satisfactory completion of the manufacturing review process or the
decision of the FDA to approve ADCON-L for marketing in the U.S. See "Risk
Factors -- Uncertainty of Regulatory Approval for ADCON-L," "-- Reliance on
Third Party for Manufacturing; Comprehensive Regulation of Manufacturing of
Products" and "-- Government Regulation."

Marketing and Sales. The Company currently markets ADCON-L in 29 countries
outside the U.S. through independent medical device distributors. The Company
has entered into distribution agreements for the sale of ADCON-L in certain
countries, including Argentina, Australia, Austria, Belgium, Canada, Denmark,
Egypt, Finland, France, Germany, Greece, Iceland, Italy, Korea, Luxemburg,
Mexico, The Netherlands, New Zealand, Norway, Portugal, the Republic of South
Africa, Slovakia, Spain, Sweden, Switzerland and the United Kingdom
(collectively, the "Distributing Countries"). In the U.S., the Company intends
to market ADCON-L through a network of independent manufacturers' agents with an
aggregate sales force of approximately 175 sales representatives who serve the
orthopaedic and neurosurgical markets. The sales representatives of these
organizations will be trained and managed by the sales personnel of the Company.
In the U.S., the Company will establish the price of its products for sale to
hospitals and the independent manufacturers' agents will be reimbursed on a
commissioned basis.

In order to support its distribution network, the Company provides ongoing
technical and marketing support through its Area Sales Managers, Marketing and
Medical departments. In 1997, the Company provided initial product training for
all distributor representatives and subsequent field training for individual
sales representatives. The Company also participated in 12 surgeons' meetings in
1997 relating to ADCON-L and provided support for distributors at key meetings
with various surgeons in the distributor's territory. In addition, distributors
were provided with a package of sales tools, videos, brochures and clinical
papers supporting the introduction and use of ADCON-L. During 1997, the Company
exhibited at several major surgeons' meetings which were attended by orthopaedic
and neurosurgeons whose practices involve spinal surgery, including the American
Association of Orthopaedic Surgeons, the American Association of Neurological
Surgeons, the North American Spine Society and the International Congress of
Neurosurgery.

ADCON-P

ADCON-P is a proprietary, resorbable, carbohydrate polymer solution which
is applied directly into the pelvic cavity during pelvic and gynecologic
surgeries, such as reoperations to remove adhesions and uterine tumor surgeries.
ADCON-P is designed to provide a physical barrier to inhibit scarring and
adhesions which may bind the uterus, fallopian tubes or ovaries to the
surrounding pelvic cavity.

In 1994, approximately 1.3 million gynecological surgeries were performed
in the U.S. Independent studies have shown that more than 55% of patients
undergoing such surgeries experience some scarring and adhesions following
pelvic and gynecological surgeries. Such postsurgical scarring and adhesions may
form on the ovaries, fallopian tubes and uterus thereby causing infertility or
difficulty in conceiving. In preclinical studies conducted by the Company, it
was demonstrated that ADCON-P: (i) significantly inhibited the incidence and
extent of uterine adhesions, (ii) was resorbable and (iii) was safe. ADCON-P is
designed for use in both open incision surgeries and minimally invasive
surgeries using a laparoscope. Two existing competitive products used in pelvic
surgeries are both "films" and as a result may not be used in minimally invasive
surgeries. In addition, ADCON-P can be applied directly to the surgical site,
which minimizes the handling of the product during surgery. See
"-- Competition."

Development and Regulatory Status. The Company has initiated a
double-blind, controlled clinical trial and has completed enrollment of 41
patients; 23 patients for evaluation in reoperations to remove adhesions and 18
patients for evaluation in uterine tumor surgeries. This trial evaluates
patients between one to three months after surgery to assess the incidence and
extent of postsurgical scarring and adhesions. Upon completion of the pilot
trial, which is currently anticipated to occur in the second half of 1998, the
Company intends to submit a request to the FDA to conduct a pivotal clinical
trial for ADCON-P. See "Risk Factors -- Early Commercializa-

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<PAGE> 34

tion; Uncertainty of Market Acceptance of ADCON Family of Products," and
"-- Uncertainty Related to Development of ADCON Products."

Marketing and Sales. To date, the Company has funded the development of
ADCON-P independently of strategic partners and retains all worldwide commercial
rights to ADCON-P. Due to the relatively large number of pelvic and
gynecological procedures performed and the large number of surgeons performing
such surgeries, the Company may seek to enter into agreements with strategic
partners for commercialization of ADCON-P, and as a result may relinquish
certain rights to ADCON-P to such strategic partners. No assurances can be given
that the Company will be able to enter into such a strategic partnership or that
in the event the Company does enter into such a strategic partnership that such
partnership will be successful. See "Risk Factors -- Reliance on Third Party for
Manufacturing; Comprehensive Regulation of Manufacturing of Products,"
" -- Dependence on Strategic Alliances," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."

ADCON-T/N

ADCON-T/N is a proprietary, resorbable, carbohydrate polymer gel which is
applied directly to the surgical site following tendon and peripheral nerve
surgeries such as primary tendon repair and reoperations to remove adhesions on
tendons or peripheral nerves. ADCON-T/N is designed to act as a physical barrier
between the peripheral nerve and the surrounding tissue.

In 1994, approximately 260,000 tendon and peripheral nerve surgeries were
performed in the U.S. The formation of adhesions may bind the tendon to
surrounding tissues, which results in a reduction of the tendon's ability to
glide, thus limiting the range of motion of the affected joint. In the
peripheral nervous system, adhesions may tether nerves to surrounding tissues
and may cause compression of nerves, which results in pain or numbness due to
loss of nerve function in the hand.

Clinical Results. In November 1995, the Company completed open label
clinical trials involving approximately 68 patients in France and Switzerland to
evaluate the use of ADCON-T/N in inhibiting postsurgical scarring and adhesions
following various surgical procedures involving tendons and nerves. These trials
evaluated range of motion as well as safety. The results of these trials showed
that ADCON-T/N was safe and enabled improved range of motion of the affected
joint.

Development and Regulatory Status. In January 1996, the Company obtained
regulatory clearances to affix CE Marking for ADCON-T/N. The CE Marking allows
the Company to market ADCON-T/N for use in tendon and peripheral nerve surgeries
in the 19 European countries that recognize CE Marking. The Company has also
obtained all the necessary regulatory requirements to market ADCON-T/N in the
same countries it markets ADCON-L. See "-- Government Regulation." In February
1995, the Company received approval to conduct a U.S. pilot clinical trial for
ADCON-T/N. The Company is conducting a multi-center, double-blind, controlled
clinical trial to test the safety and effectiveness of ADCON-T/N in inhibiting
excessive scarring and adhesions following peripheral nerve surgery of the hand.
The study has commenced at 14 clinical centers and will enroll up to 230
patients. To date, the Company has enrolled approximately one-third of the
patients necessary to conduct this trial. Because the trial is directed toward a
specific patient population and because most of such surgeries are performed at
local or regional hospitals, thereby dispersing the patient population, the
Company has experienced delays in completing enrollment. The Company has taken
certain measures to enhance enrollment of this trial. Further delays in
completing enrollment, however, may delay the regulatory approval process of
ADCON-T/N in the U.S. There can be no assurance, however, as to the timing of
completion of such trial, or, upon such completion, the regulatory approval, if
at all, in the U.S. See "Risk Factors -- Early Commercialization; Uncertainty of
Market Acceptance of ADCON Family of Products" and "-- Uncertainty Related to
Development of ADCON Products."

Marketing and Sales. The Company is currently marketing ADCON-T/N in the
29 Distributing Countries. The Company provides ongoing technical and marketing
support through its Area Sales Managers, Marketing and Medical departments. In
1997, the Company provided initial product training for all distributor
representatives and subsequent field training for individual sales
representatives. The Company also

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participated in eight surgeons' meetings relating to ADCON-T/N in 1997 and
provided support for distributors at key meetings with various surgeons in the
distributor's territory. In addition, distributors were provided with a package
of sales tools, videos, brochures and clinical papers supporting the
introduction and use of ADCON-T/N. During 1997, the Company exhibited at several
major surgeons meetings, including American Society for Surgery of the Hand and
Federation of European Societies of Surgeries of the Hand.

To date, the Company has funded the development of ADCON-T/N independently
of strategic partners and retains all worldwide commercial rights to ADCON-T/N,
except in Japan with respect to Chugai. The Company is exploring marketing
alternatives for ADCON-T/N and may continue marketing through independent
distributors or the Company may enter into agreements with strategic partners
for ADCON-T/N, and as a result may relinquish certain rights to ADCON-T/N to
such strategic partners. No assurances can be given that the Company will enter
into such a strategic partnership or that in the event the Company does enter
into such a strategic partnership that such partnership will be successful. See
"Risk Factors -- Reliance on Third Party for Manufacturing; Comprehensive
Regulation of Manufacturing of Products," " -- Dependence on Strategic
Alliances," and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."

Other ADCON Products

The Company is also currently conducting preclinical studies relating to
applications of its ADCON technology in other propriety, resorbable,
carbohydrate polymer medical devices designed to inhibit scarring and adhesions
in certain additional surgical procedures. Due to the differences in the body
environments in which each of the products would be used, each of the Company's
ADCON products is being designed to be adapted for use at the specific surgical
site. Examples of other types of surgery where adhesions are common and are
known to create troublesome postsurgical complications include (i) abdominal
surgery, where peritoneal adhesions between organs and/or the abdominal wall may
seriously impair gastrointestinal function; (ii) implant/prosthetic surgery,
where adhesions may compromise the effective performance of the implanted
medical device; and (iii) cardiac surgery, where adhesions may significantly
increase the risk of injury during reoperation. The Company is developing
ADCON-A for use in abdominal surgery, ADCON-I for use in implant/prosthetic
surgery, and ADCON-C for use in cardiac surgery. In 1994, approximately 2.5
million abdominal surgeries, approximately 1.4 million implant/prosthetic
surgeries and approximately 1.0 million cardiac surgeries were performed in the
U.S. The Company currently intends to formulate its ADCON family of products as
solutions and gels, which will permit their use in both open incision and
minimally invasive surgeries. In contrast, the presently developed and marketed
film products cannot be used in minimally invasive surgeries. Additionally, the
ADCON gels and solutions are applied directly to the surgical site, which
minimizes the handling of the products during surgery. See "-- Competition." The
Company may seek one or more strategic partners to collaborate on the
development and commercialization of these additional ADCON products. See "Risk
Factors -- Early Commercialization; Uncertainty of Market Acceptance of ADCON
Family of Products," and "-- Uncertainty Related to Development of ADCON
Products."

NEUROLOGIC DRUG DEVELOPMENT PROGRAMS

The Company is engaged in the discovery and development of therapeutic
products for use in the treatment of certain central nervous system disorders
for which the Company believes existing therapies are inadequate. The Company is
focusing its therapeutic research and development efforts on the discovery and
development of small molecules for the treatment of ADHD, sleep disorders,
obesity, anxiety and AD. The Company's AD research and development efforts are
being pursued through its strategic alliance with Janssen. See "-- The Janssen
Agreement."

Cognition Modulation Program

The Company is conducting research to discover and develop a class of small
molecules designed to act on the histamine H(3) receptor in the brain. Histamine
is a chemical messenger released from certain neurons in the brain which
regulates sleep/wake states and modulates levels of arousal and alertness in the
conscious state. The histamine H(3) receptor is predominantly found in the brain
and regulates the synthesis and release of histamine in
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the brain. An antagonist to this receptor would lead to enhanced states of
arousal and alertness. The histamine H(3) receptor antagonists may be useful in
treating disorders in which central nervous system arousal is desirable, such as
ADHD or narcolepsy. An agonist to the receptor may prove useful in treating
disorders in which suppression of the central nervous system is desirable, such
as anxiety and insomnia.

Histamine H(3) Receptor Antagonists. The Company believes histamine H(3)
receptor antagonists could provide a therapeutic approach for enhancing
cognition and positive behavior in patients with disorders characterized by
memory and learning deficiencies such as AD and ADHD. Such an agent could also
be useful in arousing patients with various forms of depressed activity of the
central nervous system, such as narcolepsy. In addition, the compounds may be
used in the treatment of obesity. The Company has discovered and developed
highly selective histamine H(3) receptor antagonists, which have been shown in
in vivo studies to (i) penetrate the blood-brain barrier after oral
administration, (ii) selectively block the histamine H(3) receptor in the brain
and (iii) modulate levels of arousal and alertness. The Company has demonstrated
in preclinical studies that the histamine H(3) antagonists improve learning and
memory and have potential advantages in both safety and abuse potential and have
a prolonged duration of action. The Company anticipates that a lead compound for
its H(3) antagonist will be identified in the second half of 1998 and that it
will begin human clinical trials with respect to such compound in late 1998. See
"Risk Factors -- Early Stage of Development for Therapeutic Programs" and
"-- Government Regulation."

While there are currently available products for the treatment of the
conditions mentioned above, the Company is not aware of any such products based
on the histamine H(3) receptor antagonists. The histamine H(3) receptor is a
member of a family of histamine receptors which has been demonstrated to have
significant pharmaceutical uses and has proven to be useful in developing drug
candidates. For example, antagonists to the histamine H(1) receptor are used as
"antihistamines" for treating symptoms of the common cold, and include products
such as Benadryl and Claritin, and antagonists to the histamine H(2) receptor
are used as anti-ulcer agents, and include products such as Tagamet and Zantac.
The Company has obtained a U.S. patent and filed several additional patent
applications covering the histamine H(3) receptor antagonists currently being
developed by the Company. See "Risk Factors -- Patents, Licenses and Proprietary
Rights" and "-- Patents, Trademarks and Trade Secrets."

Histamine H(3) Receptor Agonists. The Company has also begun research and
development of histamine H(3) receptor agonists to reduce levels of wakefulness
and arousal for use in the treatment of anxiety and insomnia. To date, the
Company has developed several compounds which have high affinity for the
histamine H(3) receptor and in animal models have been shown to penetrate the
blood-brain barrier and occupy histamine H(3) receptors. The Company continues
to synthesize and screen new compounds as potential selective agonists of the
histamine H(3) receptor.

To date, the Company has pursued the development of its Cognition
Modulation technology independently of strategic partners and retains all of
worldwide commercial rights to all of the products it may develop. In the
future, the Company may seek one or more strategic partners for the development
of its Cognition Modulation technology. No assurances can be given that the
Company will be able to enter into such a strategic alliance or partnership, or
that in the event the Company does enter into such a strategic alliance or
partnership, that such alliance or partnership will be successful. See "Risk
Factors -- Dependence on Strategic Alliances."

Alzheimer's Disease Program

AD is characterized by progressive dementia due to degeneration and death
of neuronal cells. The cause of AD is unknown, and there are no proven means of
prevention or cure. Research in AD has been directed primarily at providing
replacement therapy for neurotransmitter deficiencies in order to alleviate the
symptoms and has focused on the role of beta-amyloid, which is the major
component of the brain deposits called senile plaques that accumulate in the
brain of a patient with AD. The Company has demonstrated that the presence of
beta-amyloid plaques results in the release of pro-inflammatory molecules which
can result in neuronal death. The Company believes glial cells play a causative
role in neuronal death associated with AD. The Company is developing small
molecular weight compounds to block the release of these pro-inflammatory
molecules.

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The Company is engaged in two programs for the discovery and development of
compounds to inhibit these unwanted glial cell associated events. These two
programs, which the Company is pursuing through its strategic alliance with
Janssen, are as follows:

Inhibitors of Beta-Amyloid Induced Inflammation. The Company has
discovered that the presence of beta-amyloid plaques results in a specific
metabolic response in glial cells, including the release of pro-inflammatory
molecules, which has been reported to occur in the brain of patients with AD.
These pro-inflammatory molecules are believed to cause neuronal death. The
Company is working with Janssen on the development of compounds that would block
the affects of beta-amyloid plaques on glial cells and thus block or reduce the
release of inflammatory agents, thereby reducing the incidence of neuronal
death. The Company has developed a number of high throughput in vitro assay
systems that have been used to screen Janssen's pharmaceutical library for
inhibitors of these beta-amyloid-induced actions. As a result of the Company's
efforts, several potential lead compounds that block or reduce the release of
inflammatory agents have been identified.

Inhibitors of Complement Activation. The Company is also pursuing research
relating to activated proteins of an immune response system known as the
"complement cascade." Activated complement proteins are associated with
beta-amyloid in AD senile plaques. The complement cascade is part of the immune
response typically invoked to fight systemic infections, resulting in the death
of pathogenic cells, but is not usually found in the brain. The Company has
discovered that beta-amyloid can bind one of the complement proteins and
activate the entire complement cascade, providing an explanation for the
presence of activated complement proteins in patients with AD. The activation of
the complement cascade may result in neuronal death. The Company is working with
Janssen on the development of compounds that would block the complement
activation. The Company has developed a number of high throughput in vitro assay
systems that have been used to screen Janssen's pharmaceutical library for
inhibitors of beta-amyloid induced activation of the complement cascade. As a
result of the Company's efforts, several potential lead compounds that block
beta-amyloid induced activation of the complement cascade have been identified.

Development Status. Janssen is currently utilizing chemistry to advance
the development of the lead compounds identified for both the beta-amyloid
induced inflammatory molecule and the inhibitors of complement activation
programs. In addition, Janssen is funding the development by the Company of in
vivo animal models to further evaluate the efficacy of selected potential lead
compounds for each of these programs. A joint committee consisting of members of
management of the Company and Janssen will evaluate each of the lead compounds
identified for the inhibitors of beta-amyloid induced inflammation and
inhibitors of complement activation. This committee will identify compounds for
further preclinical studies and development, including clinical studies. The
Company anticipates that a lead compound will be identified for preclinical
testing in late 1998. See "Risk Factors -- Early Stage of Development for
Therapeutic Programs."

The Janssen Agreement. In October 1994, under the terms of the Janssen
Agreement, Johnson & Johnson Development Corporation, a subsidiary of Johnson &
Johnson, made an equity investment in the Company and Janssen, a wholly-owned
subsidiary of Johnson & Johnson, paid the Company an initial licensing fee. The
initial Janssen Agreement provided funding by Janssen to the Company for AD
research through October 1997. In September 1995, the Company entered into an
addendum to the Janssen Agreement in order to expand the scope of the
collaboration on AD to include research relating to inhibitors of complement
activation. In October 1997, Janssen exercised its option to extend the Janssen
Agreement for a period of one year through October 1998 and has retained the
right to extend it for an additional period of one year. The Janssen Agreement
provides for total funding and milestone payments of up to approximately $30.0
million. As of March 31, 1998, the Company has received approximately $9.7
million in revenues under the Janssen Agreement. Janssen is required to make
additional payments to the Company upon the attainment of certain clinical and
developmental milestones. Janssen is also responsible for all development costs,
including the cost associated with clinical trials and obtaining regulatory
approval. Technology developed pursuant to the Janssen Agreement will be the
property of Janssen. Janssen's parent, Johnson & Johnson, has worldwide
distribution rights for all products developed as a result of this
collaboration. The Company will receive a royalty from Janssen on any sales of
such products. There can be no assurance that development of the AD program will
be successfully completed or that Janssen or Johnson & Johnson will be able to
successfully commercialize the products developed as part of any collaborative

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<PAGE> 38

efforts pursuant to the Janssen Agreement. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Note I to
Consolidated Financial Statements.

MARKETING AND SALES

The Company is marketing its ADCON products outside the U.S. through
independent medical device distributors. The Company has entered into agreements
with independent distributors regarding country specific sales and distribution
rights for ADCON-L and ADCON-T/N in the 29 Distributing Countries. The
distributors in Europe are managed by the Company's European sales organization,
which consists of four Area Sales Managers, located in The Netherlands, Germany,
France and Italy. The non-European distributors are managed by an international
sales manager located at the Company's executive offices in Cleveland, Ohio. In
addition, the Company signed a development and exclusive license agreement in
December 1996 with Chugai for the exclusive sale of ADCON-L and ADCON-T/N in
Japan. Chugai has filed applications requesting regulatory approval to market
ADCON-L and ADCON-T/N in Japan. Unless terminated earlier by either the Company
or Chugai, the agreement with Chugai shall remain in effect until the date on
which the last Japanese patent issued in connection with the agreement expires.

These distributor agreements provide the distributors with exclusive
distribution rights in their assigned territory. The agreements require the
distributors to meet specified minimum annual purchase targets and to provide
the Company with periodic reports on their sales to hospitals. In the event such
targets are not achieved, the Company may, upon the expiration of applicable
notice periods, terminate the exclusivity of such arrangement. The Company
currently establishes the price of its products for sale to distributors and
each distributor then sets the price, including any discounts at which the
product is sold to the hospital. The Company's distributors are independent
third parties, are not employees of the Company and are not under the direct
control or supervision of the Company, except that they are subject to the terms
and conditions of their respective distribution agreements. See "Risk
Factors -- Dependence on Independent Distributors; No Direct Sales Force."

Although the Company does not have approval to market any of its products
in the U.S., the Company intends to market ADCON-L, subject to and upon receipt
of final approval from the FDA, through a network of independent manufacturers'
agents with an aggregate sales force of approximately 175 sales representatives
who serve the orthopaedic and neurosurgical markets. The sales representatives
of these organizations will be trained and managed by the sales personnel of the
Company. These manufacturers' agents agreements provide the agents with
exclusive distribution rights in their assigned territory. The agreements
require the agents to meet certain sales targets. In the event such targets are
not achieved, the Company may, upon the expiration of applicable notice periods,
terminate the exclusivity of such arrangement. In the U.S., the Company will
establish the price of its products for sale to hospitals and the independent
manufacturers' agents will be reimbursed on a commissioned basis.

MANUFACTURING AND SUPPLIERS

The Company does not have any manufacturing facilities and presently
utilizes a sole third-party manufacturer, EMCM, located in Nijmegen, The
Netherlands, for the manufacture of its commercial and clinical requirements of
ADCON-L, ADCON-P and ADCON-T/N. The Company believes that the manufacturer has
the ability to supply sufficient products to satisfy the Company's existing and
future requirements for the development and commercialization of its ADCON
products. The Company maintains an inventory of its products in warehouses
located in the U.S. and The Netherlands. The Company currently purchases the key
components for ADCON-L, ADCON-P and ADCON-T/N from suppliers and provides such
components to the contract manufacturer who formulates these components into
ADCON-L, ADCON-P and ADCON-T/N. The contract manufacturer is registered as a
subcontractor for the manufacture of pharmaceutical products by The Netherlands
designated agency and is certified to ISO requirements for manufacture of such
products. ISO Certification is an internationally recognized standard of quality
manufacturing. The Company intends to identify additional manufacturers in the
future, including a U.S.-based contract manufacturer. The manufacture of the
Company's products is subject to QSR or other requirements prescribed by the
appropriate regulatory agency in the country of use. There can be no assurance
that the Company's current manufacturer will continue to comply
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with all applicable regulatory requirements or that such manufacturer will be
able to supply the Company with such products or that the Company will be able
to identify additional manufacturers of its products on terms acceptable to the
Company. See "Risk Factors -- Reliance on Third Parties for Manufacturing;
Comprehensive Regulation of Manufacturing of Products" and "-- Reliance on a
Single Source Supplier."

The Company currently obtains one of the key components for its ADCON
products from a single supplier. The Company also has developed its own
proprietary process to manufacture this key component and is currently
manufacturing it on a pilot basis through a contract manufacturer according to
QSR requirements. The Company intends to have this proprietary process qualified
under applicable regulatory requirements in the first half of 1999 in order to
have an alternate source of supply. In addition, the Company is pursuing
qualification of additional suppliers. There can be no assurance that the
Company will be successful in developing such a proprietary process or that such
proprietary process will be qualified or alternative sources will be located or
that the current supply of raw materials will continue to be provided on terms
and conditions acceptable to the Company, if at all. See "Risk
Factors -- Reliance on Third Party for Manufacturing; Comprehensive Regulation
of Manufacturing of Products."

COMPETITION

There is substantial competition in the medical device and pharmaceutical
industries, both from specialized firms and from major pharmaceutical, chemical,
medical device and surgical supply companies. Furthermore, academic
institutions, governmental agencies, and other public and private research
organizations also continue to conduct research, seek patent protection, and
establish collaborative arrangements with commercial entities for product
development and marketing. Products resulting from these activities may compete
directly with any products developed by the Company. These companies and
institutions also compete with the Company in recruiting and retaining highly
qualified scientific personnel.

Although the Company is not aware of any products on the market that would
directly compete with ADCON-L or ADCON-T/N, there are products on the market
which would compete with ADCON-P. These products include Interceed, a film
comprised of oxidized regenerated cellulose which has been marketed for several
years by Johnson & Johnson to prevent surgical adhesions following pelvic
surgeries and Seprafilm, a film comprised of sodium hyaluronic acid and
carboxymethyl cellulose which is marketed by Genzyme Corporation to inhibit
surgical adhesions following both pelvic and abdominal surgeries. There are
significant efforts by others, including many large pharmaceutical companies and
academic institutions, to develop products which may compete with products that
are developed by the Company relating to its ADCON family of products, the
Cognition Modulation program and the AD program. Some of these products may be
at a more advanced stage of development than the Company's products. In
addition, there may be substantial competition in the biopharmaceutical and
medical industries, both from specialized firms and from major pharmaceutical,
chemical, medical device and surgical supply companies. Many of the Company's
potential competitors have product development capabilities and financial and
human resources greater than the Company, and have manufacturing, marketing,
sales and distribution capabilities that the Company does not have. Universities
and other research institutions may develop similar technologies and processes
which, in some instances, may be utilized by others to compete with the
Company's products.

The Company expects to encounter significant competition for each of its
product candidates. To compete successfully, the Company will be required to
develop and maintain scientifically advanced technology, develop proprietary
products, attract and retain highly qualified personnel, obtain patent or other
protection for its products, obtain required regulatory approvals and
manufacture and successfully market its products, either alone or through
collaboration with third parties. See "Risk Factors -- Technological Change" and
"-- Dependence on Key Management and Qualified Personnel."

GOVERNMENT REGULATION

The manufacture and sale of the Company's products are subject to
regulation by numerous authorities, principally the FDA, and corresponding state
and foreign authorities. The regulatory process is lengthy, expensive and
uncertain. Prior to commercial sale in the United States, most medical devices
and new drugs, including the

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Company's products under development, must be cleared or approved by the FDA. In
addition, certain material changes or modifications to medical devices and drugs
also are subject to FDA review and approval. Securing the FDA clearances and
approvals may require the submission of extensive clinical data and supporting
information to the FDA. Product clearances and approvals can be withdrawn for
failure to comply with regulatory standards or the occurrence of unforeseen
problems following initial marketing. The FDA and other agency requirements for
manufacturing, product testing, and marketing also can vary depending upon
whether the product is a medical device or drug. Failure to comply with
applicable FDA regulatory requirements could result in sanctions being imposed
on the Company or the manufacturer of its products, including warning letters,
fines, injunctions, civil penalties, failure of the FDA to grant premarket
clearance or premarket approval of medical devices and drugs, operating
restrictions and criminal prosecution. Sales of the Company's products outside
of the United States are subject to foreign regulatory requirements that may
vary widely from country to country. The time required to obtain clearance from
a foreign country may be longer or shorter than that required by the FDA or
other such agencies, and clearance or approval or other product requirements may
differ. There can be no assurance that the Company will be able to obtain
necessary regulatory clearances or approvals on a timely basis, if at all, for
any of its products under development, and delays in receipt or failure to
receive such clearances or approvals, the loss of previously received clearances
or approvals or failure to comply with existing or future regulatory
requirements could have a material adverse effect on the Company's business,
financial condition and results of operations.

There is no certainty that the clinical studies involving ADCON-T/N and
ADCON-P will be completed in a timely manner or that the data and information
obtained will be sufficient to support the filing of a premarket approval
application. There can be no assurance that the Company will be able to obtain
necessary approvals to market ADCON-L, ADCON-T/N or ADCON-P or any other
products under development on a timely basis, if at all, and delays in receipt
or failure to receive such approvals, the loss of previously received approvals,
or failure to comply with existing or future regulatory requirements could have
a material adverse effect on the Company's business, financial condition and
results of operations.

Any products manufactured or distributed pursuant to clearance of a
premarket notification submission or an approved premarket approval application
are subject to pervasive and continuing regulation by the FDA, including record
keeping requirements and reporting of adverse experience with the use of the
device. The Federal Food, Drug and Cosmetic Act ("FDC Act") requires that
medical devices be manufactured in registered establishments and in accordance
with the QSR requirements for medical devices. Such manufacturing facilities are
subject to periodic inspections by the FDA.

Regulation of Medical Devices -- United States. The FDC Act requires
premarket clearance or premarket approval by the FDA prior to commercialization
of medical devices. Pursuant to the FDC Act, the FDA regulates the manufacture,
distribution and production of medical devices in the United States. Medical
devices are classified into class I, II or III on the basis of the controls
deemed by the FDA to be reasonably necessary to ensure their safety and
effectiveness. Class I devices are subject to general controls (e.g., labeling
and adherence to QSR) and class II devices are subject to premarket clearance
and special controls (e.g., performance standards, postmarket surveillance,
patient registries and FDA guidelines). Generally, class III devices are those
which require premarket approval by the FDA to ensure their safety and
effectiveness (e.g., life-sustaining, life-supporting and implantable devices
which have been found not to be substantially equivalent to legally marketed
devices). The FDA regulates the Company's ADCON-L, ADCON-P and ADCON-T/N
products as class III medical devices.

Before a new device can be introduced into the market, the manufacturer or
distributor generally must obtain FDA clearance or approval through either a
510(k) premarket notification or a PMA. A 510(k) clearance will be granted if
the submitted data establish that the proposed device is "substantially
equivalent" to a legally marketed class I or II medical device, or to a
preamendment class III medical device (i.e., one that has been marketed since a
date prior to May 28, 1976) for which the FDA has not called for premarket
approvals. A PMA must be filed if the proposed device is not substantially
equivalent to a legally marketed device or if it is a preamendment class III
device for which the FDA has called for premarket approvals. A PMA must be
supported by extensive data, including preclinical and clinical trial data to
demonstrate the safety and efficacy of the device. If human clinical

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trials of a device are required and if the device presents a "significant risk,"
the manufacturer or the distributor of the device is required to obtain FDA
approval of an IDE application prior to commencing human clinical trials.

The IDE application must be supported by data, typically including the
results of animal and, possibly, mechanical testing. If the IDE application is
approved by the FDA, human clinical trials may begin at a specific number of
investigational sites with a maximum specific number of patients, as approved by
the agency. The clinical trials must be conducted under the auspices of an
independent institutional review board ("IRB") established pursuant to FDA
regulations. In August 1995, the Company received FDA approval for an IDE
application permitting the initiation of a U.S. multi-center clinical trial of
ADCON-L. This clinical trial for ADCON-L was initiated in January 1996. In April
1995, the Company received FDA approval of an IDE application to conduct
multi-center clinical trials of ADCON-T/N. The ADCON-T/N multi-center clinical
trials are ongoing. The Company also received FDA conditional approval of its
IDE application to conduct a clinical pilot trial of ADCON-P on September 3,
1997 and final approval to conduct such clinical pilot trial of ADCON-P on
November 19, 1997.

Following receipt of the PMA, if the FDA determines that the PMA is
sufficiently complete to permit a substantive review, the FDA will "file" the
application. Once the submission is filed, the FDA begins a review of the PMA.
The PMA process can be expensive, uncertain and lengthy, frequently requiring
one to several years from the date the premarket approval application is
accepted for filing. A number of devices for which premarket approval has been
sought by other companies have never been approved for marketing. The review
time is often significantly extended by the FDA, which may require more
information or clarification of information already provided in the submission.
During the review period, an advisory committee likely will be convened to
review and evaluate the application and provide recommendations to the FDA as to
whether the device should be approved. In addition, the FDA will inspect the
manufacturing facility to ensure compliance with QSR requirements prior to
approval of a PMA. If granted, the premarket approval may include significant
limitations on the indicated uses for which a product may be marketed. The FDA
prohibits promoting products for unapproved or "off-label" uses. The Company
submitted a PMA application for ADCON-L in December 1996. This application was
deemed filed in February 1997 and granted expedited review by the FDA. Based on
the results of the European pivotal clinical trials for ADCON-L and interim data
of the U.S. clinical study currently underway, the Advisory Panel of the FDA
recommended in December 1997 that ADCON-L be approved by the FDA for marketing
in the U.S. subject to certain conditions and labeling requirements. On April 6,
1998, the Company received a letter from the FDA stating that the PMA for
ADCON-L is approvable subject to satisfactory completion of an FDA inspection of
the ADCON-L manufacturing facilities, methods and controls. The Company expects
to receive a final decision regarding the approval of ADCON-L from the FDA in
mid-1998; however, there can be no assurance as to the satisfactory completion
of the manufacturing inspection or the decision of the FDA to approve ADCON-L
for marketing in the U.S. See "Risk Factors -- Uncertainty of Regulatory
Approval for ADCON-L."

There is no certainty that the clinical studies involving ADCON-P and
ADCON-T/N will be completed in a timely manner or that the data and information
obtained will be sufficient to support the filing of a PMA. There can be no
assurance that the Company will be able to obtain necessary approvals to market
ADCON-L, ADCON-P or ADCON-T/N or any other products under development on a
timely basis, if at all, and delays in receipt or failure to receive such
approvals, the loss of previously received approvals, or failure to comply with
existing or future regulatory requirements could have a material adverse effect
on the Company's business, financial condition and results of operations.

Modifications to a device that is the subject of an approved PMA, its
labeling, or manufacturing process may require approval by the FDA of PMA
supplements or new PMAs. Supplements to a PMA often require the submission of
the same type of information required for an initial PMA, except that the
supplement is generally limited to that information needed to support the
proposed change from the product covered by the original PMA.

Any products manufactured or distributed pursuant to clearance of a
premarket notification submission or an approved premarket approval application
are subject to pervasive and continuing regulation by the FDA, including
recordkeeping requirements and reporting of adverse experience with the use of
the device. The FDC Act requires that medical devices be manufactured in
registered establishments and in accordance with the QSR

40
<PAGE> 42

requirements for medical devices. Such manufacturing facilities are subject to
periodic inspections by the FDA. The manufacturing facility utilized by EMCM in
manufacturing the Company's ADCON family of products must undergo a review and
inspection by the FDA for QSR requirements before ADCON-L can be approved by the
FDA for marketing in the U.S. In February-March 1998, the FDA inspected the
Company's headquarters and EMCM's manufacturing facility. In connection with
these inspections, the FDA issued a Form 483 listing a number of observations
relating to the Company's headquarters and second Form 483 listing additional
observations relating to the EMCM manufacturing facility. The Company is in the
process of addressing these conditions to the FDA's satisfaction. There can be
no assurance that the FDA upon reinspection will agree that the Company has
corrected all observed conditions or that the Company's compliance with QSR
requirements is sufficient to permit approval of ADCON-L or other products in
its ADCON family. There can be no assurance as to the timing or extent of such
review by the FDA. Further, there can be no assurance that the FDA will declare
such facility to be in compliance with QSR requirements.

The President recently signed into law the Food and Drug Administration
Modernization Act of 1997 ("FDAMA"). This legislation makes changes in the
provisions of the FDC Act affecting the regulation of devices, drugs and
biological products. With respect to devices, the changes will affect the IDE,
510(k) and PMA processes, and also will affect device standards and data
requirements, procedures relating to humanitarian and breakthrough devices,
tracking and postmarket surveillance, accredited third party review, and the
dissemination of off-label information. The Company cannot predict how or when
these changes will be implemented or what effect the changes will have on the
regulation of the Company's products.

Regulations of Drugs -- United States. Drugs are a category of products
that can include biologics, such as vaccines, and prescription or
over-the-counter medications. Each of these classes of products is often
regulated differently and, therefore, approval requirements, if any, can vary
significantly. Before a new drug may be commercially sold in the United States,
clinical trials and other tests on the product must be conducted and the results
submitted to the appropriate regulatory agencies as part of the approval
process. Drug products that the Company may develop are subject to FDA
regulation under the FDC Act. Drug products also would be subject to regulation
under the Public Health Service Act if they are classified as biologics. The
Company believes that its AD and other nervous system disorder products would be
regulated as new drugs.

The steps required before a new drug product may be marketed in the United
States include (i) preclinical laboratory and animal tests conducted in
accordance with Good Laboratory Practices, (ii) submission to the FDA of an
application for an investigational new drug ("IND"), which must become effective
before human clinical trials may commence, (iii) well-controlled human clinical
trials to establish the safety and efficacy of the new drug product, (iv)
submission of a new drug application ("NDA") to the FDA for nonbiological drugs,
and (v) FDA approval of the NDA prior to any commercial sale or shipment of the
drug. Approval by the FDA must be obtained for each product and for each
indication to be treated with each product. The filing of an NDA and the
marketing of approved prescription drugs also requires the payment of certain
user fees to the FDA.

Preclinical tests include formulation development, laboratory evaluation of
product chemistry and animal studies to assess the potential safety and efficacy
of a product formulation. Preclinical tests are submitted to the FDA as part of
the IND. Unless the FDA issues a clinical hold, the IND will become effective 30
days following its receipt by the FDA. There is no certainty that submission of
an IND will result in the ability to conduct one phase of a clinical trial or
that the lack of the issuance of a clinical hold on one phase of a clinical
trial will result in other phases or that the completion of clinical trials will
result in FDA approval. Clinical trials may be placed on hold by the FDA at any
time for a variety of reasons, particularly if safety concerns exist.

Clinical trials involving the administration of the investigational drug
product to humans typically are conducted in three phases and are subject to
specific protocols that are particularly detailed in Phases II and III. Each
protocol indicating how the clinical trial will be conducted must be submitted
for review to the FDA as part of the IND. Further, each clinical study must be
conducted under the auspices of an IRB and in accordance with informed consent
requirement. The IRB considers, among other factors, ethical concerns, informed
consent requirements and protection of human subjects. The IRB or the FDA may
require changes in a protocol both prior to and after commencement of a trial.
There is no assurance that the IRB or the FDA will permit a study to go

41
<PAGE> 43

forward or, once started, to be completed. The FDA's review of a study protocol
does not necessarily mean that if the study is successful it will constitute
proof of safety or efficacy.

The three phases of clinical trials are generally conducted sequentially,
but they may overlap. Phase I testing generally involves the initial
introduction of the drug into humans for testing the safety, side effects,
dosage tolerance, metabolism and clinical pharmacology of the drug. In the case
of drugs for life-threatening diseases, the initial human testing is generally
done in patients rather than in healthy volunteers. Because these patients are
already afflicted with the target disease, it is possible that such studies may
provide results traditionally obtained in Phase II trials. These trials are
referred to as Phase I/II trials. Phase II testing generally involves
well-controlled tests in a larger but still limited patient population to
determine the efficacy of the drug for specific indications, to determine
optimal dosage and to identify possible side effects and safety risks. If a drug
is found to be effective in Phase II evaluations, expanded Phase III trials are
undertaken to evaluate the overall risks and benefits of the drug in relation to
the treated disease in light of other available therapies. Phase III studies can
include significant numbers of patients. Phase III clinical studies may be
avoided under certain circumstances. For example, under the FDA's expedited
approval interim regulations, the FDA may determine that the study is not
necessary, especially where no adequate alternative therapy exists, and if the
disease under examination is life-threatening or seriously debilitating. The FDA
may suspend clinical trials at any time if the patients are believed to be
exposed to a significant health risk.

Reports of results of preclinical studies and clinical trials for
nonbiological drugs, such as those likely to be developed by the Company, are
submitted to the FDA in the form of an NDA for approval for marketing and
commercial shipment. The NDA also includes information pertaining to the
preparation of drug substances, analytical methods, drug product formulation,
details on the manufacture of finished product as well as proposed product
packaging and labeling. Submission of an NDA does not assure FDA approval for
marketing. The application review process generally takes one to three years to
complete, although reviews of treatments for cancer and other severely
debilitating or life-threatening diseases may be accelerated. However, the
process may take substantially longer if, among other things, the FDA has
questions or concerns about the safety and/or efficacy of a product. No
assurance exists that the Company's drug products will qualify for expedited or
accelerated review procedures.

In general, the FDA traditionally has required at least two adequate and
well-controlled clinical studies demonstrating efficacy with sufficient levels
of statistical assurance. The recently enacted FDAMA now allows the
consideration of one such study. However, additional information may be
required. For example, the FDA also may require long-term toxicity studies or
other studies relating to product safety or efficacy. Notwithstanding the
submission of such data, the FDA ultimately may decide that the application does
not satisfy its regulatory criteria for approval. Finally, the FDA may require
additional clinical tests following NDA approval to confirm safety and efficacy
(Phase IV clinical tests). Less extensive approval requirements can apply to
generic and other types of drugs, but no assurance exists that the Company's AD
and other nervous system disorder products, or any other drug products which the
Company may develop, will qualify for such abbreviated requirements.

Prospective manufacturers must also conform to the GMP requirements, permit
FDA inspection, and register and list drug products with the FDA. In complying
with GMP, manufacturers must continue to expend time, money and effort in
production, recordkeeping and quality assurance to ensure that the product meets
applicable specifications and other requirements. Failure to comply subjects the
manufacturer to possible FDA action, such as the suspension of manufacturing,
seizure of the product or voluntary recall of the product.

The product testing and approval process is likely to take a substantial
number of years and involves the expenditure of substantial resources. The FDA
also may require postmarket testing and surveillance to monitor the use of the
product and continued compliance with regulatory requirements. Upon approval, a
drug only may be marketed for the approved indications in the approved dosage
forms and at the approved dosages. Adverse experiences with the product must be
reported to the FDA. Product approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems concerning safety or
efficacy of the product occur following approval.

42
<PAGE> 44

Foreign manufacturers of drug products intended for importation into the
United States also must comply with relevant registration and listing
requirements of the GMP regulations and are subject to periodic inspection by
the FDA or by local authorities under agreement with the FDA.

Other Regulation. The advertising of FDA-regulated products may be subject
to Federal Trade Commission jurisdiction. The Company also is subject to
regulations by the Occupational Safety and Health Administration and by the U.S.
Environmental Protection Agency under such statutes as the Toxic Substances
Control Act, the Resource Conservation and Recovery Act and other laws. Various
states and other foreign governments often have comparable health and
environmental laws.

Foreign Regulation. The Company is subject in many countries to regulatory
requirements concerning drugs and devices and relating to human clinical trials,
marketing approvals and product testing. See "Risk Factors -- Uncertainty of
Health Care Reimbursement."

For medical devices, from January 1, 1995, member countries of the European
Union are required to put in effect the Medical Devices Directive ("MDD"). This
new legislation includes, among others, requirements with respect to the design,
safety, performance and manufacture of products. Under the system established by
the MDD, all medical devices other than active implants and in vitro diagnostic
products must qualify for CE Marking by June 14, 1998. During the transitional
period (from January 1, 1995 to June 14, 1998) medical devices can be placed on
the market and put into service if they comply with the requirements of the MDD
or national requirements that were in force on December 31, 1994.

In order to qualify for CE Marking, the manufacturer must comply with the
Essential Requirements of the MDD. These relate to safety and performance. In
order to demonstrate compliance with these requirements of the MDD, the
manufacturer must undergo conformity assessment which depends on the class of
the product. The Company has chosen as its conformity assessment EC
type-examination of the product by a Notified Body and assessment of the
manufacturer's quality system used in production by a Notified Body. The
Notified Body chosen by the Company is a Dutch non-governmental entity which,
after an accreditation proceeding, has been notified by the Dutch Competent
Authority to the European Commission that it may carry out conformity assessment
tasks under the MDD. Once all the necessary conformity assessment tasks have
been completed to the satisfaction of the Notified Body and the manufacturer is
convinced that it is in full compliance with the MDD, CE Marking may be affixed
on the products concerned.

Although member countries must accept for marketing medical devices bearing
a CE Marking without imposing further requirements related to product safety and
performance, each country may require the use of its own language on labels and
instructions for use. National Competent Authorities, who are required to
enforce compliance with the requirements of the MDD, can restrict, prohibit and
recall CE Marked products if they are considered to be unsafe. Such a decision
must be confirmed by the European Commission in order to be valid. Member
countries can impose additional requirements as long as they do not violate the
MDD or constitute technical barriers to trade. There can be no assurances,
however, that member countries will continue to recognize the restrictions on
such countries to impose additional requirements for CE Marked products.

Within the European Union, premarket compliance for devices must be
supported by clinical data of a type and extent set out by European Union
directives, standards as interpreted by Competent Authorities and Notified
Bodies. The regulatory compliance process for the commencement of clinical
trials varies currently from country to country.

The new post-1994 regimes for medical devices are based on directives.
Devices will be subject to, in addition to other future European Union or other
countries legislation, continued national regulation on pricing and
reimbursement, which may vary from country to country. Certain other
requirements such as clinical investigations and post marketing surveillance,
will probably be subject to significant variation among countries. The
regulation of drugs in the European Union is subject to a separate and different
regulatory framework which requires, among other things, premarket approval by
the applicable regulatory agencies before sale of such products.

43
<PAGE> 45

PATENTS, TRADEMARKS AND TRADE SECRETS

Proprietary protection for the Company's product candidates, processes and
know-how is important to the Company's business. The Company's policy is to file
patent applications to protect technology, inventions and improvements that are
considered important to the development of its business. The Company also relies
upon trade secrets, know-how and continuing technological innovation to develop
and maintain its competitive position. The Company plans to aggressively
prosecute and defend its patents and proprietary technology.

The Company has been approached by a third-party regarding the potential
infringement, by the ADCON line of products, of two U.S. patents for which the
third-party is the licensee. Based upon its investigation, the Company believes
that the claims of such issued patents are invalid or not infringed by the ADCON
products. There can, however, be no assurance that the Company will not be sued
by such third party, and the Company could incur substantial costs and diversion
of management resources with respect to the defense of any such lawsuit, which
costs and diversion could have a material adverse effect on the Company's
business, prospects, financial condition and results of operations. Further,
there can be no assurance that infringement of these two patents will not be
found to exist, that the Company will not be enjoined from making, using and
selling its ADCON products, or that the Company will not be ordered to pay
damages that would have a material adverse effect on the Company's ability to
conduct its business. Moreover, there can be no assurance that a sublicense
under these patents, if necessary, will be available on reasonable terms, if at
all.

As a result of allegations made by Dr. Jerry Silver, an employee of Case
Western Reserve University ("CWRU"), and CWRU, that Dr. Silver is a co-inventor
of the Company's issued U.S. Patent No. 5,605,938, which is one of the Company's
three issued patents relating to its ADCON technology, and which covers certain
of the Company's ADCON products, the Company filed a civil action in the United
States District Court for the Northern District of Ohio, Eastern Division,
entitled Gliatech Inc. v. Dr. Jerry Silver and Case Western Reserve University,
Civil Action No. 1:97CV 2306, requesting, inter alia, a declaration that Dr.
Silver is not a co-inventor of the patent. On March 17, 1998, the suit was
dismissed pursuant to the terms and conditions of a Settlement Agreement,
effective as of February 20, 1998 by and among the Company, Dr. Silver and CWRU.

A U.S. patent application, filed solely by the Company, has been issued
covering the composition of matter for a series of synthetic H(3) receptor
antagonist compounds, which is due to expire in 2015. Several additional U.S.
patent applications and their corresponding foreign applications for additional
series of H(3) receptor antagonists and one series of H(3) receptor agonist
compounds, their methods of medical use and pharmaceutical compositions, are
pending. No assurance can be given that any claims relating to these products
and methods will be issued.

The Company is prosecuting its patent applications with the USPTO but the
Company does not know whether any of its applications will result in the
issuance of any patents or, if any patents are issued, whether any issued patent
will provide significant proprietary protection or will be circumvented or
invalidated. During the course of patent prosecution, patent applications are
evaluated, inter alia, for utility, novelty, nonobviousness and enablement. The
USPTO may require that the claims of an initially filed patent application be
amended if it is determined that the scope of the claims includes subject matter
that is not useful, novel, nonobvious or enabled. Furthermore, in certain
instances, the practice of a patentable invention may require a license from the
holder of dominant patent rights. In cases where one party believes that it has
a claim to an invention covered by a patent application or patent of a second
party, the first party may institute an interference proceeding in the USPTO or
such a proceeding may otherwise be declared by the USPTO. In general, in an
interference proceeding, the USPTO would review the competing patents and/or
patent applications to determine the validity of the competing claims, including
but not limited to determining priority of invention. Any such determination
would be subject to appeal in the appropriate U.S. federal courts.

44
<PAGE> 46

There can be no assurance that additional patents will be obtained by the
Company or that issued patents will provide substantial protection or be of
commercial benefit to the Company. The issuance of a patent is not conclusive as
to its validity or enforceability, nor does it provide the patent holder with
freedom to operate without infringing the patent rights of others. A patent
could be challenged by litigation and, if the outcome of such litigation were
adverse to the patent holder, competitors could be free to use the subject
matter covered by the patent, or the patent holder may license the technology to
others in settlement of such litigation. The invalidation of key patents owned
by or licensed to the Company or non-approval of pending patent applications
could create increased competition, with potential adverse effects on the
Company and its business prospects. In addition, there can be no assurance that
any patents on, or applications of, the Company's technology will not infringe
patents or proprietary rights of others or that licenses that might be required
as a result of such infringement for the Company's processes or products would
be available on commercially reasonable terms, if at all.

The Company cannot predict whether its or its competitors' patent
applications will result in valid patents being issued. Litigation, which could
result in substantial cost to the Company, may also be necessary to enforce the
Company's patent and proprietary rights and/or to determine the scope and
validity of others' proprietary rights. The Company may participate in
interference proceedings that may in the future be declared by the U.S. Patent
and Trademark Office to determine priority of invention, which could result in
substantial cost to the Company. There can be no assurance that the outcome of
any such litigation or interference proceedings will be favorable to the Company
or that the Company will be able to obtain licenses to technology that it may
require or that, if obtainable, such technology can be licensed at a reasonable
cost.

The patent position of biotechnology and biopharmaceutical firms generally
is highly uncertain and involves complex legal and factual questions. To date,
no consistent policy has emerged regarding the breadth of claims allowed in
biotechnology and biopharmaceutical patents. Accordingly, there can be no
assurance that patent applications owned or licensed by the Company will result
in patents being issued or that the patents will afford protection against
competitors with similar technology.

The Company also attempts to protect its proprietary compounds, products
and processes by relying on trade secret laws, and on non-disclosure and
confidentiality agreements. The Company requires its employees, consultants,
outside scientific collaborators and sponsored researchers, and other advisors
to execute confidentiality agreements upon the commencement of employment or
consulting relationships with the Company. These agreements generally provide
that all confidential information developed or made known to the individual
during the course of the relationships is to be kept confidential and not
disclosed to third parties except in specific circumstances. In the case of
employees, the agreements provide that any inventions conceived by the
individual within the scope of his employment shall be the exclusive property of
the Company. There can be no assurance, however, that these agreements will
provide meaningful protection for any of the Company's trade secrets in the
event of unauthorized use or disclosure of such information. See "Risk
Factors -- Patents, Licenses and Proprietary Rights."

The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. There can be no assurance that the Company will not
become subject to patent infringement claims or litigation or interference
proceedings declared by the USPTO to determine the priority of invention. The
defense and prosecution of intellectual property suits, USPTO interference
proceedings and related legal and administrative proceedings are both costly and
time-consuming. Litigation may be necessary to enforce patents issued to the
Company, to protect trade secrets or know-how owned by the Company or to
determine the enforceability, scope and validity of the proprietary rights of
others. Any litigation or interference proceedings will result in substantial
expense to the Company and significant diversion of effort by the Company's
technical and management personnel. An adverse determination in litigation or
interference proceedings to which the Company may become a party, including any
litigation that may arise against the Company could subject the Company to
significant liabilities to third parties or require the Company to seek licenses
from third parties or prevent the Company from marketing its products in certain
areas, or at all. Although patent and intellectual property disputes regarding
medical devices have often been settled through licensing or similar
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can
45
<PAGE> 47

be no assurance that the necessary licenses would be available to the Company on
satisfactory terms, if at all. Adverse determinations in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
the Company from marketing its products, which would have a material adverse
effect on the Company's business, prospects, financial condition and results of
operation.

EMPLOYEES

As of March 31, 1998, the Company had 62 full-time employees, 21 of whom
hold a Ph.D. or M.D. degree; 40 employees are engaged in, or directly support,
research and development; 11 employees are engaged in the sales and marketing of
the ADCON family of products and the remaining employees perform executive or
administrative functions.

FACILITIES

The Company's personnel conduct the Company's operations at a 50,925 square
foot leased facility in Beachwood, Ohio, a suburb of Cleveland, which expires on
December 31, 2001. The Company currently subleases a 4,600 square foot portion
of this space. The Company believes its current facilities are adequate for its
existing product development programs. The Company is currently evaluating
possible alternative sites in Ohio, Massachusetts and North Carolina for its
operations; however, no definitive plans have been made as of the date hereof.

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<PAGE> 48

MANAGEMENT

The executive officers, key employees and Directors of the Company consist
of the following individuals:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Thomas O. Oesterling, Ph.D................. 60 President, Chief Executive Officer and
Director
Kurt R. Brunden, Ph.D...................... 40 Vice President, Research
Rodney E. Dausch........................... 53 Vice President, Chief Financial Officer and
Secretary
Jon D. Schoeler............................ 48 Vice President, Worldwide Sales and
Marketing
Raymond P. Silkaitis, Ph.D................. 48 Vice President, Medical and Regulatory
Affairs
Michael A. Zupon, Ph.D..................... 43 Vice President, Product Development and
Operations
Robert P. Pinkas (*)....................... 44 Chairman of the Board and Treasurer
William A. Clarke.......................... 59 Director
Theodore E. Haigler, Jr. (+)............... 73 Director
Ronald D. Henriksen (*).................... 58 Director
Irving S. Shapiro (+)...................... 81 Director
John L. Ufheil (*)......................... 64 Director
</TABLE>

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

(*) Member of the Compensation Committee.
(+) Member of the Audit Committee.

THOMAS O. OESTERLING, PH.D. has served as President, Chief Executive
Officer and a Director of the Company since June 1989. From 1984 to 1986, he was
Senior Vice President, Research and Development of Collaborative Research,
Incorporated, a manufacturer of diagnostic reagents for genetic research and
testing, and from 1986 to 1989, he was President. Prior to 1984, Dr. Oesterling
had 18 years of experience in pharmaceutical and medical management and research
and development for the Upjohn Company, Johnson & Johnson, and Mallinckrodt Inc.
Dr. Oesterling received his Ph.D. in Pharmaceutical Chemistry from the Ohio
State University.

KURT R. BRUNDEN, PH.D. has served as Vice President, Research since January
1997. Dr. Brunden joined the Company in July 1991 as Head of Biomolecular
Research. He was subsequently promoted to the position of Director, Exploratory
Research in 1992 and Senior Director, Exploratory Research in 1995. Prior to
joining the Company, Dr. Brunden was a faculty member in the Department of
Biochemistry at the University of Mississippi Medical Center. He received his
Ph.D. in Biochemistry from Purdue University in 1985, and obtained post-
doctoral training in the Departments of Neurology and Biochemistry/Molecular
Biology at the Mayo Clinic.

RODNEY E. DAUSCH joined the Company as Vice President and Chief Financial
Officer in March 1995. In August 1995, Mr. Dausch was elected Secretary of the
Company. Prior to joining the Company and since February 1994, Mr. Dausch was
Vice President of Finance and Administration of Oncologix, Inc., a
biopharmaceutical company. From May 1987 to January 1994, he was Vice President
of Finance and Administration of Oncor, Inc., a manufacturer of diagnostic
products for detection of cancer diseases. Prior to 1987 he held the position of
Vice President of Finance and Administration with CPM Group, Inc., a real estate
development company, and Bethesda Research Laboratories, Inc., a biotechnology
company. Mr. Dausch holds a B.S. in Accounting from Loyola College and is a
Certified Public Accountant in the State of Maryland.

JON D. SCHOELER has served as Vice President, Worldwide Sales and Marketing
since July 1996. Prior to joining the Company, from August 1995 to July 1996,
Mr. Schoeler was Director, Worldwide Sales and Marketing at St. Jude Medical
Inc., a biopharmaceutical company. From July 1991 to January 1995, he was Vice
President of Sales and Marketing of American Cyanamid, a manufacturer of medical
devices. Mr. Schoeler holds a B.S. in Industrial Engineering from the University
of Toronto.

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<PAGE> 49

RAYMOND P. SILKAITIS, PH.D. joined the Company as Director, Regulatory
Affairs in April 1994. In January 1996, Dr. Silkaitis was promoted to Vice
President, Regulatory Affairs. In April 1996, he became the Vice President of
Medical and Regulatory Affairs. Prior to joining the Company, Dr. Silkaitis held
the position of Director, Clinical Affairs, Director, Regulatory Affairs and
Biologics Project Manager at Zimmer Inc. a division of Bristol-Myers Squibb
Company, a pharmaceutical company. Dr. Silkaitis also serves as the industry
representative for the Orthopaedic and Rehabilitation Devices Advisory Panel for
the FDA.

MICHAEL A. ZUPON, PH.D. has served as Vice President, Product Development
and Operations since June 1993. Prior to joining the Company, Dr. Zupon had 12
years of experience in a variety of product development positions at
Schering-Plough Corporation, a pharmaceutical company, most recently as
Director, Drug Delivery and Technology Assessment from January 1991 to June 1993
and as Director, Pharmaceutical Process Development from April 1988 to January
1991. Dr. Zupon received his B.S. and Ph.D. from the University of Utah College
of Pharmacy and also received his M.B.A. from the University of Utah Graduate
School of Business.

ROBERT P. PINKAS has served as Chairman of the Board of Directors and
Treasurer of the Company since 1988. He is a Director of Pediatric Services of
America Inc., Quad Systems Corporation, Brantley Capital Corporation, Waterlink,
Inc. and Medirisk, Inc. Mr. Pinkas is the founding general partner of Brantley
Venture Partners LP, a venture capital firm formed in 1987.

WILLIAM A. CLARKE became a Director of the Company in May 1998. Mr. Clarke
has been retired since 1996. Prior to his retirement, Mr. Clarke served as
President of Johnson & Johnson Medical Inc., a medical supplier. Mr. Clarke is
also a Director of Medical Device Technologies.

THOMAS E. HAIGLER, JR. has served as a Director of the Company since May
1996. Mr. Haigler has been an independent management consultant since his
retirement in 1989. From 1986 until his retirement in 1989, he served as
President, Chief Executive Officer and Director of Burroughs Wellcome Co., a
pharmaceutical company, and Director of Glaxo Wellcome PLC, England. Mr. Haigler
is also a Director of FAC Realty Trust, Inc.

RONALD D. HENRIKSEN has served as a Director of the Company since May 1997.
In April 1996, Mr. Henriksen became Chief Executive Officer of Itasca Ventures
LLC, a medical technology company. From March 1993 through December 1995, he was
the President and Chief Executive Officer of Khepri Pharmaceuticals, a
development stage biotechnology company. From 1970 to March 1993, he held a
series of managerial and executive positions at Eli Lilly and Company, a
pharmaceutical company. In addition until March 1993, he was Director of
Business Development for Eli Lilly and Company. Mr. Henriksen currently serves
as a Director of QLT PhotoTherapeutics, Inc.

IRVING S. SHAPIRO has served as a Director since December 1993. Mr. Shapiro
has been Of Counsel to the law firm of Skadden, Arps, Slate, Meagher & Flom LLP
in Wilmington, Delaware since 1990 and from 1981 to 1989 was a Partner of that
firm. Mr. Shapiro currently serves as Director of J.P. Morgan Florida, FSB,
Pediatric Services of America Inc. and Sola International Inc.

JOHN L. UFHEIL has served as a Director of the Company since May 1993. From
April 1990 until his retirement in May 1994, he served as Chairman, President,
and Chief Executive Officer of Celgene Corporation, a biotechnology company.

48
<PAGE> 50

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information with respect to
beneficial ownership of the Company's Common Stock as of May 1, 1998 by (i) each
person (or affiliated group of persons) known by the Company to own beneficially
more than 5% of the Company's Common Stock, (ii) each Director of the Company,
(iii) each of the executive officers and (iv) all Directors and executive
officers of the Company as a group.

<TABLE>
<CAPTION>
AMOUNT AND NATURE PERCENT OWNERSHIP
OF BENEFICIAL ---------------------------------
NAME OF BENEFICIAL OWNER OWNERSHIP(1) BEFORE OFFERING AFTER OFFERING
- ------------------------ ----------------- --------------- --------------
<S> <C> <C> <C>
State of Wisconsin Investment Board (2)........ 685,500 9.0% 7.1%
Thomas O. Oesterling, Ph.D. (3)................ 233,069 3.0 2.4
Robert P. Pinkas (4)........................... 342,420 4.5 3.6
William A. Clarke.............................. -- * *
Ronald D. Henriksen (5)........................ 1,333 * *
Irving S. Shapiro (6).......................... 13,867 * *
John L. Ufheil (7)............................. 15,867 * *
Theodore E. Haigler, Jr. (8)................... 4,000 * *
Rodney E. Dausch (9)........................... 58,316 * *
Jon D. Schoeler (10)........................... 16,977 * *
Michael A. Zupon, Ph.D. (11)................... 80,728 1.1 *
All executive officers and directors as a group
(10 persons)(12)............................. 766,577 9.6% 7.7%
</TABLE>

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

* Less than one percent of the outstanding shares.

(1) Beneficial ownership is determined in accordance with rules of the
Commission. Shares of Common Stock subject to options currently exercisable
or exercisable within 60 days of the date of this Prospectus are deemed
outstanding for computing the percentage beneficially owned by such holder
but are not deemed outstanding for purposes of computing the percentage
beneficially owned by any other person. Except as otherwise indicated, the
Company believes that the beneficial owners of the Common Stock listed
above, based on information furnished by such owners, have sole investment
and voting power with respect to such shares, subject to community property
laws where applicable, and that there are no other affiliations among the
stockholders listed in the table.

(2) The address of the State of Wisconsin Investment Board is P.O. Box 7842,
Madison, Wisconsin 53707.

(3) Includes 201,750 shares of Common Stock purchasable upon the exercise of
stock options.

(4) Includes (i) 11,667 shares of Common Stock purchasable upon exercise of
stock options, (ii) 33,911 shares of Common Stock owned by Brantley Venture
Partners, L.P. and (iii) 296,842 shares of Common Stock owned by Brantley
Venture Partners II, L.P. Mr. Pinkas is a general partner of Pinkas Family
Partners, L.P., the general partner of each of Brantley Venture Management,
L.P., Brantley Venture Management II, the general partners, respectively,
of Brantley Venture Partners L.P. and Brantley Venture Partners II, L.P.

(5) Consists of 1,333 shares of Common Stock purchasable upon the exercise of
stock options.

(6) Consists of 13,867 shares of Common Stock purchasable upon the exercise of
stock options.

(7) Consists of 15,867 shares of Common Stock purchasable upon the exercise of
stock options.

(8) Consists of 4,000 shares of Common Stock purchasable upon the exercise of
stock options.

(9) Includes 56,250 shares of Common Stock purchasable upon the exercise of
stock options.

(10) Includes 16,250 shares of Common Stock purchasable upon the exercise of
stock options.

(11) Includes 64,750 shares of Common Stock purchasable upon the exercise of
stock options.

(12) Includes 385,734 shares of Common Stock purchasable upon the exercise of
stock options.

49
<PAGE> 51

UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters"), through their representatives,
Cowen & Company, Furman Selz LLC and Vector Securities International, Inc. (the
"Representatives"), have severally agreed to purchase from the Company the
following respective number of shares of Common Stock at the public offering
price less the underwriting discounts and commissions set forth on the cover
page of this Prospectus:

<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITER OF COMMON STOCK
- ----------- ----------------
<S> <C>
Cowen & Company.............................................
Furman Selz LLC.............................................
Vector Securities International, Inc. ......................
----------
Total............................................. 2,000,000
==========
</TABLE>

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

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

The Company has granted to the Underwriters an option, exercisable no later
than 30 days after the date of this Prospectus, to purchase up to 300,000
additional shares of Common Stock at the public offering price less the
underwriting discounts and commissions set forth on the cover page of this
Prospectus. To the extent that the Underwriters exercise such option, each of
the Underwriters will have a firm commitment to purchase approximately the same
percentage thereof that the number of shares of Common Stock to be purchased by
it shown in the above table bears to 2,000,000, and the Company will be
obligated, pursuant to the option, to sell such shares to the Underwriters. The
Underwriters may exercise such option only to cover over-allotments made in
connection with the sale of Common Stock offered hereby. If purchased, the
Underwriters will offer such additional shares on the same terms as those on
which the 2,000,000 shares are being offered.

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

The Directors, officers and certain stockholders of the Company, holding in
the aggregate approximately 427,841 shares of Common Stock outstanding prior to
this offering and 395,401 shares of Common Stock subject to exercisable stock
options, and the Company have agreed that, for a period of 90 days after the
effective date of the Registration Statement, they will not, without the prior
written consent of Cowen & Company, offer, sell or otherwise dispose of any
shares of Common Stock or any securities convertible into, or exchangeable for,
or warrants to purchase, any shares of Common Stock, or grant any option to
purchase, any shares of Common Stock, except that the Company may issue (i)
shares or options to purchase Common Stock pursuant to the Company's employee
and director stock plans and (ii) shares of Common Stock upon the exercise of
outstanding warrants.

In order to facilitate this offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Stock. Specifically, the Underwriters may over-allot in connection with
this offering, creating a short position in the Common Stock for their own
account. In addition, to cover over-allotments or to stabilize the price of the
Common Stock, the Underwriters may bid for, and purchase, shares of the Common
Stock in the open market. The Underwriters may also reclaim selling concessions
allowed to an underwriter or a dealer for distributing the Common Stock in this
offering, if the Underwriters repurchase previously distributed Common Stock in
transactions to cover their short positions, in stabilization transactions or
50
<PAGE> 52

otherwise. Finally, the Underwriters may bid for and purchase shares of the
Common Stock in market making transactions and impose penalty bids. These
activities may stabilize or maintain the market price of the Common Stock above
market levels that may otherwise prevail. The Underwriters are not required to
engage in these activities and may end passive market making activities at any
time.

The Underwriters and dealers may engage in passive market making
transactions in the Common Stock in accordance with Rule 103 of Regulation M
promulgated by the Commission. In general, a passive market maker may not bid
for, or purchase, the Common Stock at a price that exceeds the highest
independent bid. In addition, the net daily purchases made by any passive market
maker generally may not exceed 30% of its average daily trading volume in the
Common Stock during a specified two-month prior period or 200 shares, whichever
is greater. A passive market maker must identify passive market making bids as
such on the Nasdaq electronic inter-dealer reporting system. Passive market
making may stabilize or maintain the market price of the Common Stock above
independent market levels.

The Underwriters have advised the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority in excess of five percent of the number of shares of Common Stock
offered hereby.

LEGAL OPINIONS

The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Jones, Day, Reavis & Pogue, Cleveland, Ohio. Certain
legal matters in connection with this offering will be passed upon for the
Underwriters by Brobeck, Phleger & Harrison LLP, New York, New York.

EXPERTS

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

The consolidated financial statements of Gliatech Inc. appearing in
Gliatech Inc.'s Annual Report (Form 10-K) for the year ended December 31, 1997
and for the period from inception of operations (August 31, 1998) through
December 31, 1997, have been audited by Ernst & Young LLP, independent auditors,
as set forth in their report thereon included therein and incorporated herein by
reference. Such consolidated financial statements are incorporated herein by
reference in reliance upon such report given upon the authority of such firm as
experts in accounting and auditing.

The statements in this Registration Statement, in the sections captioned
"Risk Factors -- Patents, Licenses and Proprietary Rights" and
"Business -- Patents, Trademarks and Trade Secrets," relating to United States
patent matters, other than those statements relating to histamine H(3)
compounds, have been reviewed and approved by Pennie & Edmonds LLP, New York,
New York, patent counsel to the Company, and have been included herein in
reliance upon the review and approval by such firm as experts in United States
patent law.

51
<PAGE> 53

AVAILABLE INFORMATION

The Company has filed a Registration Statement on Form S-3, of which this
Prospectus is a part (the "Registration Statement"), with the Commission under
the Securities Act with respect to the shares of Common Stock offered hereby.
This Prospectus does not contain all the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement, including the financial
statements and exhibits filed therewith. Statements made in this Prospectus as
to the contents of any contract, agreement or other document that is filed as an
exhibit to the Registration Statement or otherwise with the Commission are not
necessarily complete, and, in each instance, reference is made to the copy of
such document filed with the Commission. Each such statement shall be deemed
qualified in its entirety by such reference. Copies of the Registration
Statement, including all exhibits and schedules thereto, may be examined or
obtained from the Commission as described below.

The Company is subject to the reporting requirements of the Exchange Act
and, in accordance therewith, files reports and other information with the
Commission. Reports and other information filed by the Company can be inspected
and copied at the public reference facilities maintained by the Commission at
Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the following
Regional Offices of the Commission: Midwest Regional Office, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661-2511 and Northeast Regional Office,
Seven World Trade Center, Suite 1300, New York, New York 10048. Copies of such
material can be obtained from the Public Reference Section of the Commission at
450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. The
Commission also maintains a Website that contains reports, proxy and information
statements and other information regarding the Company filed electronically with
the Commission. The address of such site is: http://www.sec.gov. The Company's
Common Stock is quoted on the Nasdaq National Market and in connection
therewith, reports and other information concerning the Company may also be
inspected at the offices of The Nasdaq Stock Market, Inc. at 1735 K Street,
N.W., Washington, D.C. 20006-1500.

INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

The following documents filed by the Company with the Commission (File No.
0-20096) are hereby incorporated by reference in this Prospectus pursuant to the
Exchange Act:

(1) The Annual Report of the Company on Form 10-K for the fiscal year ended
December 31, 1997;

(2) The Quarterly Report of the Company on Form 10-Q for the quarterly
period ended March 31, 1998;

(3) The description of the Common Stock of the Company contained in its
Registration Statement on Form 8-A filed with the Commission on October
3, 1995; and

(4) The description of the Rights attached to the Common Stock of the
Company contained in its Registration Statement on Form 8-A/A filed
with the Commission on July 2, 1997.

All reports and other documents subsequently filed by the Company pursuant
to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this
Prospectus and prior to the termination of this offering shall be deemed to be
incorporated by reference herein and to be a part hereof from the date of filing
of such reports and documents. Any statement contained in a document all or a
portion of which is incorporated or deemed to be incorporated by reference
herein shall be deemed to be modified or superseded for purposes of this
Prospectus to the extent that a statement contained herein or in any other
subsequently filed document which also is or is deemed to be incorporated by
reference herein modifies or supersedes such statement. Any statement so
modified will not be deemed to constitute a part of this Prospectus, except as
so modified, and any statement so superseded will not be deemed to constitute a
part of this Prospectus.

The Company will provide without charge to each person to whom this
Prospectus is delivered, on the written or oral request of such person, a copy
(without exhibits other than exhibits specifically incorporated by reference) of
any or all documents incorporated by reference into this Prospectus. Requests
for such copies should be directed to Rodney E. Dausch, Vice President and Chief
Financial Officer, 23420 Commerce Park Road, Cleveland, Ohio 44122, telephone
(216) 831-3200.
52
<PAGE> 54

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... F-2

Consolidated Balance Sheets at December 31, 1996 and 1997
and March 31, 1998 (unaudited)............................ F-3

Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997 and for the period from
inception of operations (August 31, 1988) through March
31, 1998 (unaudited) and for the three months ended March
31, 1997 and 1998 (unaudited)............................. F-4

Consolidated Statements of Changes in Stockholders' Equity
for the period from inception of operations (August 31,
1988) through December 31, 1988 and for the years ended
December 31, 1989, 1990, 1991, 1992, 1993, 1994, 1995,
1996 and 1997 and for the three months ended March 31,
1998 (unaudited).......................................... F-5

Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997 and for the period from
inception of operations (August 31, 1988) through March
31, 1998 (unaudited) and for the three months ended March
31, 1997 and 1998 (unaudited)............................. F-7

Notes to Consolidated Financial Statements.................. F-8
</TABLE>

F-1
<PAGE> 55

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

Board of Directors and Stockholders
Gliatech Inc.

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

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

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

/S/ ERNST & YOUNG LLP

Cleveland, Ohio
March 10, 1998

F-2
<PAGE> 56

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- MARCH 31,
1996 1997 1998
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................... $ 9,120,547 $ 5,601,398 $ 2,697,037
Short-term investments............................ 8,875,222 5,940,476 5,345,077
Accounts receivable............................... 331,157 544,051 489,801
Government grants receivable...................... 7,290 207,080 206,574
Inventories....................................... 387,118 164,078 560,486
Prepaid expenses and other........................ 277,276 278,714 248,122
----------- ----------- -----------
Total current assets................................ 18,998,610 12,735,797 9,547,097
Property and equipment, net......................... 1,129,671 1,277,519 1,293,814
Other assets, net................................... 675,959 792,072 817,925
----------- ----------- -----------
Total assets........................................ $20,804,240 $14,805,388 $11,658,836
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued expenses....... $ 1,369,583 $ 1,686,356 $ 1,440,673
Accrued compensation.............................. 204,328 179,018 89,815
Accrued clinical trial costs...................... 796,861 690,885 810,144
Deferred research contract revenue................ 806,359 809,359 70,860
----------- ----------- -----------
Total current liabilities........................... 3,177,131 3,365,618 2,411,492
Stockholders' equity:
Common Stock, $0.01 par value:
Authorized shares -- 30,000,000 at December 31,
1996 and 1997 and March 31, 1998
Issued and outstanding shares -- 7,320,089 at
December 31, 1996, 7,401,273 at December 31,
1997 and 7,601,273 at March 31, 1998......... 73,201 74,013 76,013
Additional paid-in capital........................ 51,007,673 53,379,810 53,377,810
Deficit accumulated during the development
stage.......................................... (33,453,765) (42,014,053) (44,206,479)
----------- ----------- -----------
Total stockholders' equity.......................... 17,627,109 11,439,770 9,247,344
----------- ----------- -----------
Total liabilities and stockholders' equity.......... $20,804,240 $14,805,388 $11,658,836
=========== =========== ===========
</TABLE>

See notes to consolidated financial statements.
F-3
<PAGE> 57

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to consolidated financial statements.
F-4
<PAGE> 58

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED CONVERTIBLE CLASS A
STOCK COMMON STOCK COMMON STOCK
----------------------- ---------------------------- --------------------- ADDITIONAL
NUMBER OF NUMBER OF PAR CONTRA NUMBER OF PAID-IN
SHARES PAR VALUE SHARES VALUE ACCOUNT SHARES PAR VALUE CAPITAL
----------- --------- --------- ------ ------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at August 31, 1988........ 0 $ 0 0 $ 0 $ 0 0 $ 0 $ 0
Issuance of Redeemable Convertible
Series A Preferred Stock at
$1.44 per share................. 1,806,667 18,067 2,583,535
Stock award of Convertible Class A
Common Stock.................... 450,000 4,500 (1,683)
Accretion of Redeemable
Convertible Series A Preferred
Stock........................... 111,200
Amortization of contra account.... 140
Net loss -- 1988..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1988...... 1,806,667 18,067 450,000 4,500 (1,543) 0 0 2,694,735
Accretion of Redeemable
Convertible Series A Preferred
Stock........................... 448,422
Amortization of contra account.... 561
Net loss -- 1989..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1989...... 1,806,667 18,067 450,000 4,500 (982) 0 0 3,143,157
Issuance of Redeemable Convertible
Series B Preferred Stock at
$2.16 per share................. 1,467,593 14,676 3,155,324
Accretion of Redeemable
Convertible Series A Preferred
Stock........................... 379,400
Amortization of contra account.... 561
Net loss -- 1990..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1990...... 3,274,260 32,743 450,000 4,500 (421) 0 0 6,677,881
Issuance of Convertible Series B
Preferred Stock at $2.16 per
share, net of expense........... 615,741 6,157 1,309,630
Exercise of stock options......... 12,700 127 4,318
Amortization of contra account.... 421
Compensation related to grant of
stock options................... 130,250
Net loss -- 1991..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1991...... 3,890,001 38,900 450,000 4,500 0 12,700 127 8,122,079
Issuance of Convertible Series C
Preferred Stock at $1.50 per
share, net of expense........... 8,245,784 82,459 12,237,689
Exercise of stock options......... 2,000 20 680
Issuance of stock bonus........... 18,000 180 67,320
Compensation related to grant of
stock options................... 116,740
Net loss -- 1992..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1992...... 12,135,785 121,359 450,000 4,500 0 32,700 327 20,544,508
Exercise of stock options......... 2,630 26 3,295
Issuance of stock bonus........... 18,200 182 136,318
Issuance of Common Stock.......... 22,000 220 164,780
Compensation related to grant of
stock options................... (3,987)
Net loss -- 1993..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1993...... 12,135,785 121,359 450,000 4,500 0 75,530 755 20,844,914

<CAPTION>
DEFICIT
ACCUMULATED
DURING THE TOTAL
DEFERRED DEVELOPMENT STOCKHOLDERS'
COMPENSATION STAGE EQUITY
------------ ------------ -------------
<S> <C> <C> <C>
Balance at August 31, 1988........ $ 0 $ 0 $ 0
Issuance of Redeemable Convertible
Series A Preferred Stock at
$1.44 per share................. 2,601,602
Stock award of Convertible Class A
Common Stock.................... 2,817
Accretion of Redeemable
Convertible Series A Preferred
Stock........................... (111,200) 0
Amortization of contra account.... 140
Net loss -- 1988.................. (294,123) (294,123)
--------- ------------ -----------
Balance at December 31, 1988...... 0 (405,323) 2,310,436
Accretion of Redeemable
Convertible Series A Preferred
Stock........................... (448,422) 0
Amortization of contra account.... 561
Net loss -- 1989.................. (802,926) (802,926)
--------- ------------ -----------
Balance at December 31, 1989...... 0 (1,656,671) 1,508,071
Issuance of Redeemable Convertible
Series B Preferred Stock at
$2.16 per share................. 3,170,000
Accretion of Redeemable
Convertible Series A Preferred
Stock........................... (379,400) 0
Amortization of contra account.... 561
Net loss -- 1990.................. (1,855,903) (1,855,903)
--------- ------------ -----------
Balance at December 31, 1990...... 0 (3,891,974) 2,822,729
Issuance of Convertible Series B
Preferred Stock at $2.16 per
share, net of expense........... 1,315,787
Exercise of stock options......... 4,445
Amortization of contra account.... 421
Compensation related to grant of
stock options................... (81,250) 49,000
Net loss -- 1991.................. (2,829,868) (2,829,868)
--------- ------------ -----------
Balance at December 31, 1991...... (81,250) (6,721,842) 1,362,514
Issuance of Convertible Series C
Preferred Stock at $1.50 per
share, net of expense........... 12,320,148
Exercise of stock options......... 700
Issuance of stock bonus........... 67,500
Compensation related to grant of
stock options................... (29,413) 87,327
Net loss -- 1992.................. (4,080,101) (4,080,101)
--------- ------------ -----------
Balance at December 31, 1992...... (110,663) (10,801,943) 9,758,088
Exercise of stock options......... 3,321
Issuance of stock bonus........... 136,500
Issuance of Common Stock.......... 165,000
Compensation related to grant of
stock options................... 31,961 27,974
Net loss -- 1993.................. (5,913,836) (5,913,836)
--------- ------------ -----------
Balance at December 31, 1993...... (78,702) (16,715,779) 4,177,047
</TABLE>

F-5
<PAGE> 59

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY -- (CONTINUED)

<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED CONVERTIBLE CLASS A
STOCK COMMON STOCK COMMON STOCK
----------------------- ---------------------------- --------------------- ADDITIONAL
NUMBER OF NUMBER OF PAR CONTRA NUMBER OF PAID-IN
SHARES PAR VALUE SHARES VALUE ACCOUNT SHARES PAR VALUE CAPITAL
----------- --------- --------- ------ ------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Exercise of stock options......... 135 1 289
Issuance of Convertible Series D
Preferred Stock and warrants at
$1.50 per share, net of
expense......................... 2,420,001 24,200 3,402,228
Issuance of stock bonus........... 6,598 66 49,434
Issuance of Common Stock.......... 680 7 5,093
Issuance of Convertible Series E
Preferred Stock and warrants at
$1.50 per share, net of
expense......................... 1,000,000 10,000 1,479,500
Compensation related to grant of
stock options................... (805)
Net loss -- 1994..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1994...... 15,555,786 155,559 450,000 4,500 0 82,943 829 25,780,653
Exercise of stock options......... 13,850 139 34,499
Redemption of Common Stock........ (4,040) (40) (30,295)
Issuance of Convertible Series F
Preferred Stock at $1.85 per
share, net of expense........... 2,702,703 27,027 4,626,062
Issuance of stock bonus......... 12,092 120 90,567
Issuance of Common Stock.......... 12,061 121 102,390
Issuance of Common Stock in
initial public offering, net of
expenses........................ 2,300,000 23,000 19,646,134
Conversion of Preferred Stock and
Class A Common Stock............ (18,258,489) (182,586) (450,000) (4,500) 4,718,015 47,180 139,906
Exercise of stock warrants........ 162,944 1,629 498,372
Compensation related to grant of
stock options................... (1,500)
Net loss -- 1995..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1995...... 0 0 0 0 0 7,297,865 72,978 50,886,788
Exercise of stock options......... 12,175 122 91,191
Issuance of stock bonus........... 6,088 61 51,688
Expenses of issuance of common
stock........................... (21,954)
Exercise of stock warrants........ 3,961 40 (40)
Compensation related to grant of
stock options...................
Net loss -- 1996..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1996...... 0 0 0 0 0 7,320,089 73,201 51,007,673
Exercise of stock options......... 76,000 760 306,365
Issuance of stock bonus........... 5,184 52 40,772
Settlement of claim............... 2,025,000
Net loss -- 1997..................
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at December 31, 1997...... 0 0 0 0 0 7,401,273 74,013 53,379,810
Issuance of stock for settlement
of claim (Unaudited)............ 200,000 2,000 (2,000)
Net loss (Unaudited)..............
----------- --------- -------- ------ ------- --------- ------- -----------
Balance at March 31, 1998
(Unaudited)..................... 0 $ 0 0 $ 0 $ 0 7,601,273 $76,013 $53,377,810
=========== ========= ======== ====== ======= ========= ======= ===========

<CAPTION>
DEFICIT
ACCUMULATED
DURING THE TOTAL
DEFERRED DEVELOPMENT STOCKHOLDERS'
COMPENSATION STAGE EQUITY
------------ ------------ -------------
<S> <C> <C> <C>
Exercise of stock options......... 290
Issuance of Convertible Series D
Preferred Stock and warrants at
$1.50 per share, net of
expense......................... 3,426,428
Issuance of stock bonus........... 49,500
Issuance of Common Stock.......... 5,100
Issuance of Convertible Series E
Preferred Stock and warrants at
$1.50 per share, net of
expense......................... 1,489,500
Compensation related to grant of
stock options................... 27,699 26,894
Net loss -- 1994.................. (6,052,570) (6,052,570)
--------- ------------ -----------
Balance at December 31, 1994...... (51,003) (22,768,349) 3,122,189
Exercise of stock options......... 34,638
Redemption of Common Stock........ (30,335)
Issuance of Convertible Series F
Preferred Stock at $1.85 per
share, net of expense........... 4,653,089
Issuance of stock bonus......... 90,687
Issuance of Common Stock.......... 102,511
Issuance of Common Stock in
initial public offering, net of
expenses........................ 19,669,134
Conversion of Preferred Stock and
Class A Common Stock............ 0
Exercise of stock warrants........ 500,001
Compensation related to grant of
stock options................... 27,892 26,392
Net loss -- 1995.................. (4,985,861) (4,985,861)
--------- ------------ -----------
Balance at December 31, 1995...... (23,111) (27,754,210) 23,182,445
Exercise of stock options......... 91,313
Issuance of stock bonus........... 51,749
Expenses of issuance of common
stock........................... (21,954)
Exercise of stock warrants........ 0
Compensation related to grant of
stock options................... 23,111 23,111
Net loss -- 1996.................. (5,699,555) (5,699,555)
--------- ------------ -----------
Balance at December 31, 1996...... 0 (33,453,765) 17,627,109
Exercise of stock options......... 307,125
Issuance of stock bonus........... 40,824
Settlement of claim............... 2,025,000
Net loss -- 1997.................. (8,560,288) (8,560,288)
--------- ------------ -----------
Balance at December 31, 1997...... 0 (42,014,053) 11,439,770
Issuance of stock for settlement
of claim (Unaudited)............
Net loss (Unaudited).............. (2,192,426) (2,192,426)
--------- ------------ -----------
Balance at March 31, 1998
(Unaudited)..................... $ 0 $(44,206,479) $ 9,247,344
========= ============ ===========
</TABLE>

See notes to consolidated financial statements.

F-6
<PAGE> 60

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION OF
THREE MONTHS ENDED OPERATIONS
YEAR ENDED DECEMBER 31, MARCH 31, (AUGUST 31, 1988)
---------------------------------------- ------------------------- THROUGH MARCH 31,
1995 1996 1997 1997 1998 1998
----------- ------------ ----------- ----------- ----------- -----------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss............................ $(4,985,861) $ (5,699,555) $(8,560,288) $(1,744,180) $(2,192,426) $(43,267,457)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation and amortization..... 170,395 166,411 292,746 64,913 86,848 1,824,383
Patent cost write-off............. 27,000 277,889 48,668 50,000 24,998 532,740
Loss on disposal of equipment..... 102,000
Compensation from issuance of
stock and stock options......... 72,303 23,111 286,609
Settlement of claim............... 2,025,000 2,025,000
Changes in operating assets and
liabilities:
Accounts receivable............. (52,088) (192,729) (212,894) (27,658) 54,250 (489,801)
Inventories..................... 22,596 30,541 223,040 9,685 (396,408) (560,486)
Government grants receivable and
other assets.................. (148,809) 61,834 (201,228) (71,138) 31,098 (464,695)
Accounts payable and other
accrued expenses.............. 152,491 327,822 316,773 302,412 (334,886) 1,344,799
Deferred contract research
revenue....................... (1,235,414) 527,264 3,000 (738,500) (738,499) 70,860
Other liabilities............... (213,808) 610,303 (90,462) 88,273 119,259 1,432,593
----------- ------------ ----------- ----------- ----------- ------------
Net cash used in operating
activities........................ (6,191,195) (3,867,109) (6,155,645) (2,066,193) (3,345,766) (37,163,455)
INVESTING ACTIVITIES
Sale (purchase) of short-term
investments, net.................. 1,708,221 (6,632,281) 2,934,746 2,857,461 595,399 (5,345,077)
Payment for patent rights and
trademarks........................ (144,622) (114,629) (186,812) (49,002) (56,926) (1,429,483)
Payment of organization costs....... (139,779)
Purchase of property and
equipment......................... (151,609) (715,153) (418,563) (69,471) (97,068) (2,496,631)
----------- ------------ ----------- ----------- ----------- ------------
Net cash provided by (used in)
investing activities.............. 1,411,990 (7,462,063) 2,329,371 2,738,988 441,405 (9,410,970)
FINANCING ACTIVITIES
Payment of demand note from bank.... (400,000)
Principal payments on capital lease
obligations....................... (43,228) (565,601)
Proceeds from sale and leaseback.... 75,131
Proceeds from issuance of Preferred
Stock, net........................ 4,653,089 28,976,554
Proceeds from issuance of Common
Stock, net........................ 19,669,134 (21,954) 19,817,280
Proceeds from exercise of stock
options........................... 60,903 91,313 307,125 157,750 468,097
Proceeds from exercise of
warrants.......................... 500,001 500,001
----------- ------------ ----------- ----------- ----------- ------------
Net cash provided by (used in)
financing activities.............. 24,839,899 (330,641) 307,125 157,750 49,271,462
----------- ------------ ----------- ----------- ----------- ------------
Increase (decrease) in cash and cash
equivalents....................... 20,060,694 (11,659,813) (3,519,149) 830,545 (2,904,361) 2,697,037
Cash and cash equivalents at
beginning of year/period.......... 719,666 20,780,360 9,120,547 9,120,547 5,601,398
----------- ------------ ----------- ----------- ----------- ------------
CASH AND CASH EQUIVALENTS AT END OF
YEAR/PERIOD....................... $20,780,360 $ 9,120,547 $ 5,601,398 $ 9,951,092 $ 2,697,037 $ 2,697,037
=========== ============ =========== =========== =========== ============
</TABLE>

See notes to consolidated financial statements.
F-7
<PAGE> 61

GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED)
A. BACKGROUND AND ACCOUNTING POLICIES

BACKGROUND

Gliatech Inc. and its wholly-owned subsidiaries (the "Company" or
"Gliatech") are engaged in the research, development and commercialization of
proprietary, resorbable, carbohydrate, polymer medical devices designed to
inhibit surgical scarring and adhesions. In addition, Gliatech is pursuing the
development of small molecule drug candidates for the treatment of certain
central nervous system disorders, including Attention Deficit Hyperactive
Disorder, sleep disorders, obesity, anxiety and Alzheimer's Disease. Gliatech
began operations on August 31, 1988 and is currently in the development stage,
as operations consist primarily of research and development expenditures, and
significant revenues from planned principal operations have not yet been
realized. Product sales consist of sales of Gliatech's first two medical device
products, ADCON-L and ADCON-T/N, primarily to independent distributors in
Europe, Australia and New Zealand. The Company recognizes revenue from product
sales upon shipment.

The consolidated financial statements reflect the financial position and
results of operations of Gliatech and its wholly-owned subsidiaries.
Intercompany balances and transactions have been eliminated.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The carrying amount
of the Company's cash equivalents approximates fair value due to the short
maturity of those investments. Cash equivalents are primarily in commercial
paper.

SHORT-TERM INVESTMENTS

The Company's short-term investments, all of which are classified as
available-for-sale, consist primarily of corporate bonds. Such investments are
stated at cost, which approximates fair value due to the short-term maturities
of these securities.

INVENTORIES

Inventories are stated at the lower of cost or market and are valued using
the first-in, first-out method.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Laboratory and office equipment
and leasehold improvements are depreciated on the straight-line basis over the
shorter of the lease period or the estimated useful lives (5 to 10 years).

PATENT RIGHTS AND TRADEMARKS

Patent rights are amortized on the straight-line basis over the shorter of
the estimated useful life of the patented technology or the useful life of the
patent, beginning at the time the patent is granted. Costs associated with
patents that are abandoned are expensed at the date of abandonment. Trademark
costs are amortized on the straight-line basis over the estimated useful life of
the trademark, beginning at the time the trademark is granted.

GOVERNMENT GRANTS

Revenues from government grants are recognized ratably over the period of
the grant.

F-8
<PAGE> 62
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

A. BACKGROUND AND ACCOUNTING POLICIES -- CONTINUED
RESEARCH CONTRACTS AND LICENSING FEE REVENUE

Revenue from the research collaboration agreements are recorded when earned
as defined under the terms of the agreements. Periodic research funding payments
received which are related to future performance are deferred and recognized as
income when earned. Licensing fees and other milestone payments are recognized
as income when earned.

INCOME TAXES

Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. Under SFAS
No. 109, the liability method is used in accounting for income taxes. Under this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the currently enacted tax rates and laws that will be in effect
when the differences are expected to reverse. Prior to the adoption of SFAS No.
109, income tax expense was determined using the deferred method prescribed by
Accounting Principles Board Opinion ("APBO") No. 11, Accounting for Income
Taxes.

BASIC AND DILUTED NET LOSS PER COMMON SHARE

In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
128, Earnings per Share. SFAS No. 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options and warrants. Diluted earnings per share is very
similar to the previously reported fully diluted earnings per share. On February
3, 1998, the Securities and Exchange Commission issued Staff Accounting Bulletin
("SAB") No. 98 which, among other things, supersedes SAB No. 83 regarding the
computation of earnings per share in connection with a company's initial public
offering (the "IPO") of common stock and requires conformity with SFAS No. 128.
SAB No. 83 was used by the Company in computing its pro forma net loss per share
prior to its IPO that occurred in October 1995, whereby common and common
equivalent shares, including preferred stock (all of which converted upon the
completion of the IPO) issued by the Company prior to the IPO were included in
the calculation of the shares used in computing pro forma net loss per share,
even if they were anti-dilutive, which differs from the requirement of SFAS No.
128.

Basic and diluted net loss per common share for 1995 and 1996 have been
restated to conform to SFAS No. 128 and SAB No. 98 requirements. Basic and
diluted net loss per common share is based on the weighted average number of
common shares outstanding. For 1995, 90,000 common equivalent shares relating to
convertible Class A common stock were assumed to be outstanding for the entire
year since such shares were issued for a nominal amount. Outstanding common
equivalent shares relating to stock options and warrants and convertible
preferred stock outstanding prior to the IPO are excluded as their effect is
anti-dilutive.

STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation in accordance with APBO
No. 25, Accounting for Stock Issued to Employees.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

F-9
<PAGE> 63
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

A. BACKGROUND AND ACCOUNTING POLICIES -- CONTINUED
NEW PRONOUNCEMENTS

In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. This statement establishes standards for
reporting financial and descriptive information about operating segments. Under
SFAS No. 131, information pertaining to the Company's operating segments will be
reported on the basis that is used internally for evaluating segment performance
and making resource allocation determinations. Management is currently studying
the potential effects of adoption of this statement, which is required in 1998.

B. INVENTORIES

Inventories consist of:

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------------- -----------
1996 1997 1998
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Raw materials....................................... $129,095 $ 36,755 $448,129
Work in process..................................... 196,502 71,572 39,755
Finished goods...................................... 61,521 55,751 72,602
-------- -------- --------
$387,118 $164,078 $560,486
======== ======== ========
</TABLE>

As of December 31, 1997, the Company had purchase commitments of $387,000
for inventory.

C. PROPERTY AND EQUIPMENT

Property and equipment consist of:

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
----------------------- -----------
1996 1997 1998
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Laboratory equipment.......................... $1,138,398 $1,213,267 $ 1,258,354
Office equipment.............................. 410,583 485,674 537,655
Leasehold improvements........................ 782,782 1,051,385 1,051,385
---------- ---------- -----------
2,331,763 2,750,326 2,847,394
Accumulated depreciation and amortization..... (1,202,092) (1,472,807) (1,553,580)
---------- ---------- -----------
Property and equipment, net................... $1,129,671 $1,277,519 $ 1,293,814
========== ========== ===========
</TABLE>

F-10
<PAGE> 64
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

D. OTHER ASSETS

Other assets consist of:

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------------- -----------
1996 1997 1998
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Patent rights, net of accumulated amortization of
$60,712 at December 31, 1996, $82,744 at December
31, 1997 and $88,819 at March 31, 1998............ $605,385 $718,973 $744,898
Trademark costs, net................................ 56,810 59,503 59,530
Other............................................... 13,764 13,596 13,497
-------- -------- --------
$675,959 $792,072 $817,925
======== ======== ========
</TABLE>

E. FINANCING ARRANGEMENTS

The Company has an unsecured line of credit that provides for borrowings up
to $1,500,000 at an interest rate of 1% above the bank's insured money market
savings account rate. No borrowings were outstanding at December 31, 1996 and
1997.

Rent expense relating to the operating lease of office space was
approximately $234,000, $297,000 and $318,000 in 1995, 1996 and 1997,
respectively. Future annual minimum lease commitments at December 31, 1997 are
as follows:

<TABLE>
<S> <C>
1998........................................................ $ 385,239
1999........................................................ 416,498
2000........................................................ 416,498
2001........................................................ 416,498
----------
Total $1,634,733
==========
</TABLE>

F. INCOME TAXES

At December 31, 1997, the Company has net operating loss carryforwards of
approximately $17.5 million for income tax purposes. In addition, the Company
has approximately $2.2 million in research and development tax credit
carryforwards. Such losses and credit carryforwards may be used to reduce future
tax liabilities and expire at various dates between 2003 and 2012. The Company
has offset the tax benefit of the net operating loss and tax credit
carryforwards and other deferred tax assets with a valuation allowance as
realization of the benefits is not assured. The valuation allowance increased by
$2,203,000 and $3,088,000 during the years ended December 31, 1996 and 1997,
respectively.

F-11
<PAGE> 65
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

F. INCOME TAXES -- CONTINUED
The Company's net deferred tax assets and liabilities consist of the
following:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ ------------
<S> <C> <C>
Deferred tax liabilities................................ $ (217,000) $ (232,000)
Deferred tax assets:
Amortization of capitalized research and development
expenses for tax................................... 5,100,000 6,256,000
Research and development tax credit carryforwards..... 1,883,000 2,170,000
Net operating tax loss carryforwards.................. 5,038,000 5,966,000
Other................................................. 271,000 1,003,000
------------ ------------
Total deferred tax assets............................... 12,292,000 15,395,000
Valuation allowance..................................... (12,075,000) (15,163,000)
------------ ------------
Net deferred taxes...................................... $ 0 $ 0
============ ============
</TABLE>

Pursuant to the Tax Reform Act of 1986, the utilization of net operating
loss and research and development tax credit carryforwards for tax purposes may
be subject to an annual limitation if a cumulative change in ownership of more
than 50% occurs over a three-year period.

G. CAPITALIZATION

On October 24, 1995, the Company consummated an IPO of 2,300,000 shares of
common stock at an initial public offering price of $9.50 per share (the
"Offering"). The Company received net proceeds from the Offering of
approximately $19,669,000. In connection with the Offering, an amendment to the
Company's Certificate of Incorporation was filed to effect a five-for-one
reverse stock split of each share of common stock. All share and per share
information in the accompanying financial statements and conversion ratios of
all series of Preferred Stock and Class A Common Stock were adjusted to reflect
the reverse split. Immediately prior to the consummation of the Offering, all
shares of Class A Common Stock and all series of Preferred Stock automatically
converted pursuant to the Company's Certificate of Incorporation at applicable
conversion rates into a total of 4,718,015 shares of common stock.

After the conversion and immediately prior to the consummation of the
Offering, the Company filed a Restated Certificate of Incorporation which
authorized the issuance of 30,000,000 shares of common stock and 5,000,000
shares of Preferred Stock at $.01 par value.

On July 1, 1997, the Company declared a dividend distribution of one right
(a "Right") for each outstanding share of Common Stock. The terms of the Rights
are set forth in a Rights Agreement, dated July 1, 1997, between the Company and
a rights agent. The Rights generally will become exercisable and allow a holder
to acquire Common Stock at a discounted price if a person or group acquires 15%
or more of the outstanding shares of Common Stock of the Company. The Company is
also subject to provisions of state law which will prohibit the Company from
engaging in any "business combination" with a person who, together with
affiliates and associates, owns 15% or more of the Company's Common Stock (an
"Interested Stockholder") for a period of three years following the date that
such person became an Interested Stockholder, unless the business combination is
approved in a prescribed manner or certain other requirements are satisfied.

At December 31, 1997, 1,340,510 shares of common stock are reserved for
issuance under the stock option plans and 20,000 shares are reserved for
issuance under common stock warrants outstanding for $7.50 per share.

F-12
<PAGE> 66
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

G. CAPITALIZATION -- CONTINUED
Prior to April 1991 certain preferred stock issuances were mandatorily
redeemable, and accordingly, periodic accretion to the redemption price was
charged to the deficit accumulated during the development stage.

H. STOCK OPTION PLANS

The Company has three stock-based compensation plans. The Company applies
APBO No. 25, Accounting for Stock Issued to Employees and related
Interpretations in accounting for its plans, which requires that for certain
options granted, the Company recognize as compensation expense the excess of the
deemed fair value for accounting purposes of the common stock over the exercise
price of the options. For the majority of options, no compensation cost has been
recognized. Had compensation cost for the Company's three stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans consistent with the method of SFAS No. 123,
Accounting for Stock-Based Compensation, the Company's net loss and net loss per
share would have increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C> <C>
Net loss As reported...... $(4,985,861) $(5,699,555) $(8,560,288)
Pro forma........ $(5,124,584) $(6,351,247) $(9,166,993)
Basic and diluted net
loss As reported...... $ (3.28) $ (.78) $ (1.16)
per common share Pro forma........ $ (3.37) $ (.87) $ (1.25)
</TABLE>

The Company has a 1989 Stock Option Plan for employees and 1992 and 1995
Stock Option Plans for members of the Company's Board of Directors. These plans
provide for 1,270,000 shares to be issued to employees and 190,000 shares to be
issued to Directors. These options generally vest over a three or four year
period and become exercisable in part one year after date of grant and expire at
the end of ten years.

For pro forma calculations, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants in 1995, 1996 and
1997:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
------------ ------------ -------------
<S> <C> <C> <C>
Expected volatility.......................... 67% 67% 75%
Risk-free interest rates..................... 5.27-5.32% 5.32-6.49% 5.71-6.48%
Average expected life........................ 4 or 5 years 4 or 5 years 4 or 5 years
</TABLE>

At December 31, 1997, there were 230,335 options available for future
grant.

F-13
<PAGE> 67
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

H. STOCK OPTION PLANS -- CONTINUED
A summary of the status of the Company's three stock option plans as of
December 31, 1995, 1996 and 1997 and changes during the years then ended is
presented below:

<TABLE>
<CAPTION>
1995 1996 1997
------------------- ------------------- ---------------------
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...... 326,700 $3.43 765,700 $6.34 978,375 $6.85
Granted............................... 464,700 8.22 247,800 8.53 225,300 9.46
Exercised............................. (13,850) 2.50 (12,175) 7.50 (76,000) 4.04
Canceled.............................. (11,850) 3.87 (22,950) 7.75 (17,500) 8.14
------- ------- ---------
Outstanding at end of year............ 765,700 6.34 978,375 6.85 1,110,175 7.56
======= ======= =========
Options exercisable at year-end....... 227,205 362,650 491,692
Weighted-average fair value of
options granted during the
year............................. $4.92 $5.15 $6.12
</TABLE>

The following table summarizes information about options outstanding at
December 31, 1997:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ----------------------------
WEIGHTED-
AVERAGE WEIGHTED-
RANGE OF NUMBER REMAINING AVERAGE NUMBER WEIGHTED-
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE AVERAGE
PRICES AT 12/31/97 LIFE (YRS) PRICE AT 12/31/97 EXERCISE PRICE
- -------- ----------- ----------- --------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$0-5 146,500 2.14 $ 1.00 146,500 $ 1.00
5-10 804,475 8.05 8.10 334,672 8.05
10-15 159,200 9.58 10.82 10,520 13.13
--------- -------
1,110,175 491,692
========= =======
</TABLE>

In May 1991, all previously issued options with an exercise price of $0.70
were canceled and reissued at an exercise price of $0.35.

I. RESEARCH COLLABORATION AGREEMENTS

In October 1994, the Company established a research and development
collaboration with Janssen Pharmaceutica, N.V. ("Janssen"), a wholly owned
subsidiary of Johnson & Johnson, for the discovery and development of compounds
suitable for the treatment of Alzheimer's Disease and other neurodegenerative
diseases. Under the terms of the agreements, the Company received an initial
licensing fee and Janssen will provide research funding over a three-year
research period, renewable for a fourth and fifth year. In addition, Janssen
will make milestone payments to the Company upon the achievement of development
and clinical benchmarks. The Company will receive a royalty on sales of marketed
products and Janssen will be responsible for all development costs, including
clinical trials and obtaining regulatory approval. Deferred revenue related to
these agreements was $806,359 and $809,359 at December 31, 1996 and 1997,
respectively. In October 1994, Johnson & Johnson Development Corporation made an
equity investment in the Company.

J. RESEARCH, CLINICAL TRIAL, CONSULTING AND LICENSE AGREEMENTS

Since beginning operations, the Company has entered into research
agreements and clinical trial agreements with universities and third parties and
consulting agreements with scientific advisors. The research agreements

F-14
<PAGE> 68
GLIATECH INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

J. RESEARCH, CLINICAL TRIAL, CONSULTING AND LICENSE AGREEMENTS -- CONTINUED
require the Company to fund certain research activities, and are generally
renewable on an annual basis. In return, the Company has rights to obtain and
use exclusive licenses for the results of the research. Under license agreements
with various universities, ownership of all patents resulting from research
agreements will remain with the universities or researchers. The Company is
required to incur all costs associated with applying for and maintaining the
patents. The Company generally will obtain exclusive worldwide licensing rights
and is required to remit fixed percentages, as defined, of the net selling price
of licensed products and royalties received from sublicensees to the
universities and researchers. The clinical trial agreements require the Company
to fund the performance of specific clinical procedures and the cost of
administering the clinical trials.

As of December 31, 1997, minimum commitments under research, clinical trial
and consulting agreements are $453,703 for 1998 ($1,162,827 at December 31,
1996).

K. LEGAL MATTERS

In 1995, a dispute regarding inventorship of the ADCON products and the
rights of Case Western Reserve University ("CWRU") to receive royalties from
sales of ADCON products arose between the Company and CWRU. After extensive
discussions between the Company and CWRU, a complaint was filed by the Company
on September 8, 1997 in the United States District Court Northern District of
Ohio, Eastern Division ("Court") against CWRU and one of its employees,
requesting the Court to confirm that there was no error in the omission of the
employee as a named inventor of the Company's patents. The complaint was filed
in response to repeated statements to the Company and the general public made by
the employee and CWRU alleging that the inventorship of the patent was in error
because the employee was not named. The complaint did not seek monetary damages.
In March 1998, the suit was dismissed pursuant to the terms and conditions of a
Settlement Agreement between the Company and CWRU. As part of the Settlement
Agreement, the Company agreed to issue a total of 200,000 shares of common stock
to CWRU and the employee.

As an agreement in principle had been reached between the Company and CWRU
in 1997, the Company recorded a charge of $2,025,000 based on the fair value of
the Company's common stock at that time. Since the dispute will be settled with
shares (issued in 1998), the Company has recorded the offset to the charge as a
component of stockholders' equity.

The Company may from time to time be subject to various legal actions,
including patent and product liability related matters, arising in the normal
course of business. These matters are subject to various uncertainties, and it
is always possible that some of these matters may be decided unfavorably to the
Company.

NOTE L. INTERIM FINANCIAL INFORMATION (UNAUDITED)

The consolidated balance sheet as of March 31, 1998, the related
consolidated statements of operations and cash flows for the three months ended
March 31, 1997 and 1998, and the statement of stockholders' equity for the three
months ended March 31, 1998 (interim financial statements) have been prepared by
the Company and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments necessary for a
fair statement of the results of the interim periods. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted from the interim financial statements. The interim financial statements
should be read in conjunction with the Company's December 31, 1997 audited
consolidated financial statements appearing herein. The results for the three
months ended March 31, 1998 may not be indicative of operating results for the
full year.

F-15
<PAGE> 69

======================================================

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OFFERED HEREBY BY
ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED
OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO
SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT
AS OF ANY TIME SUBSEQUENT TO THE DATE OF THIS PROSPECTUS OR THAT THERE HAS BEEN
NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 6
Use of Proceeds....................... 17
Price Range of Common Stock and
Dividend Policy..................... 17
Capitalization........................ 18
Dilution.............................. 18
Selected Consolidated Financial
Data................................ 19
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 20
Business.............................. 26
Management............................ 47
Principal Stockholders................ 49
Underwriting.......................... 50
Legal Opinions........................ 51
Experts............................... 51
Available Information................. 52
Incorporation of Certain Documents by
Reference........................... 52
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>

======================================================
======================================================
2,000,000 SHARES

GLIATECH LOGO

COMMON STOCK
---------------------------

PROSPECTUS
---------------------------
COWEN & COMPANY

FURMAN SELZ

VECTOR SECURITIES INTERNATIONAL,

INC.

, 1998
======================================================
<PAGE> 70

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following is a list of the estimated expenses to be incurred by the
Company in connection with the issuance and distribution of the Common Stock
being registered hereby, other than underwriting discounts and commissions.

<TABLE>
<S> <C>
Securities and Exchange Commission registration fee......... $ 10,984
National Association of Securities Dealers, Inc. filing
fee....................................................... 3,724
Nasdaq National Market subsequent listing fee............... 17,500
Printing costs.............................................. 130,000*
Accounting fees and expenses................................ 85,000*
Legal fees and expenses (not including Blue Sky)............ 150,000*
Blue Sky fees and expenses.................................. 5,000*
Miscellaneous expenses...................................... 7,792*
--------
Total.................................................. $410,000
========
</TABLE>

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

* Reflects estimates made by the Company.

ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.

The Company's Second Restated Certificate of Incorporation ("Second
Restated Certificate") provides in Article Seventh that the Company will
indemnify its officers, directors and each person who is or was serving or who
had agreed to serve at the request of the Board of Directors or an officer of
the Company as an employee or agent of the Company or as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise to the full extent permitted by the General Corporation Law of
the State of Delaware (the "DGCL") or any other applicable laws as from time to
time may be in effect and that the Company may enter into agreements which
provide for indemnification greater or different from that provided in the
Second Restated Certificate. In addition, the Company has provided in Article
Eighth of its Second Restated Certificate that no director will be personally
liable to the Company or its stockholders for or with respect to any acts or
omissions in the performance of his or her duty as a director, to the full
extent permitted by the DGCL or any other applicable laws as from time to time
may be in effect. The Second Restated Certificate further provides that any
repeal or modification of Article Seventh or Article Eighth will not adversely
affect the right or protection existing under such provision prior to such
repeal or modification.

Subsection (a) of Section 145 of the DGCL empowers a corporation to
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative, or investigative (other than an action by or in
the right of the corporation) by reason of the fact that such person is or was a
director, officer, employee or agent of the corporation, or is or was serving at
the request of the corporation as a director, officer, employee or agent of
another corporation or enterprise, against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by such person in connection with such action, suit or proceeding if such person
acted in good faith and in a manner reasonably believed to be in or not opposed
to the best interests of the corporation, and, with respect to any criminal
action or proceeding, had no reasonable cause to believe such person's conduct
was unlawful.

Subsection (b) of Section 145 of the DGCL empowers a corporation to
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending or completed action or suit by or in the right of the
corporation to procure a judgment in its favor, by reason of the fact that such
person acted in any of the capacities set forth above, against expenses
(including attorneys' fees) actually and reasonably incurred by such person in
connection with the defense or settlement of such action or suit if such person
acted under standards similar to those set forth in the paragraph above, except
that no indemnification may be made in respect of any claim, issue or matter as
to which such person shall have been adjudged to be liable to the corporation,
unless and only to the extent that the Court of Chancery of the State of
Delaware or the court in which such action or suit

II-1
<PAGE> 71

was brought shall determine that despite the adjudication of liability but in
view of all the circumstances of the case, such person is fairly and reasonably
entitled to be indemnified for such expenses which the court shall deem proper.

Section 145 further provides that, to the extent that a director or officer
of a corporation has been successful on the merits or otherwise in defense of
any action, suit or proceeding referred to in subsections (a) and (b) of Section
145, or in defense of any claim, issue or matter therein, such person will be
indemnified against expenses (including attorneys' fees) actually and reasonably
incurred by such person in connection therewith; that any indemnification under
subsections (a) and (b) of Section 145 (unless ordered by a court) will be made
by a corporation only as authorized in the specific case upon a determination
that indemnification of the director, officer, employee or agent is proper in
the circumstances because such person has met the applicable standard of conduct
set forth in subsections (a) and (b) of Section 145; that expenses (including
attorney's fees) incurred by an officer or director in defending any civil,
criminal, administrative or investigative action, suit or proceeding may be paid
by the corporation in advance of the final disposition of such action, suit or
proceeding upon receipt of an undertaking by or on behalf of such director or
officer to repay such amount if it shall ultimately be determined that such
person is not entitled to be indemnified by the corporation; that
indemnification provided for by Section 145 will not be deemed exclusive of any
other rights to which the indemnified party may be entitled; and that a
corporation is empowered to purchase and maintain insurance on behalf of a
director or officer of the corporation against any liability asserted against
him and incurred by him in such capacity, or arising out of his status as such,
whether or not the corporation would have the power to indemnify him against
such liability under Section 145.

The Company has entered into indemnity agreements (the "Indemnity
Agreements") with the current Directors and executive officers of the Company
and expects to enter into similar agreements with any Director or those
executive officers designed by the Board of Directors of the Company which may,
from time to time, be elected or appointed.

Pursuant to the Indemnity Agreements, the Company will indemnify a Director
or officer of the Company (the "Indemnitee") if the Indemnitee is a party or is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative, by
reason of the fact that the Indemnitee is or was a Director or officer of the
Company, or is or was serving at the request of the Company in certain
capacities with another entity, against any and all costs, charges and expenses,
judgments, fines and amounts paid in settlement actually and reasonably incurred
by the Indemnitee in connection with the defense or settlement of such
proceeding. Indemnity is available to the Indemnitee unless it is proved by
clear and convincing evidence that the Indemnitee's action or failure to act was
not in good faith and in a manner he reasonably believed to be in or not opposed
to the best interests of the Company.

The Indemnity Agreements provide for advancement of expenses to the
Indemnitee if the Indemnitee provides the Company with a written undertaking
that (i) he has reasonably incurred or will reasonably incur actual expenses in
defending an actual civil, criminal, administrative or investigative action,
suit, proceeding or claim and (ii) he will repay such amount if it is ultimately
determined that he is not entitled to be indemnified by the Company.

Reference is made to Section 6 of the Underwriting Agreement (Exhibit 1.1
to this Registration Statement) which provides for indemnification of the
Company's Directors and Officers by the Underwriters and Selling Stockholders
against certain civil liabilities, including liabilities under the Securities
Act of 1933.

II-2
<PAGE> 72

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(a) Exhibits. The following Exhibits are filed herewith and made a part
hereof:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
<C> <S>
*1.1 Form of Underwriting Agreement.
4.1 Rights Agreement, dated as of July 1, 1997, by and between
the Company and American Stock Transfer & Trust Company, as
rights agent, is incorporated by reference to Exhibit 1 of
the Company's Current report on Form 8-K as filed on July 2,
1997 (File No. 0-20096).
*5.1 Opinion of Jones, Day, Reavis & Pogue as to the validity of
the securities being offered.
*23.1 Consent of Jones, Day, Reavis & Pogue (included in Exhibit
5.1).
23.2 Consent of Ernst & Young LLP.
23.3 Consent of Pennie & Edmonds.
**24.1 Powers of Attorneys.
24.2 Power of Attorney of William A. Clarke.
</TABLE>

* To be filed by amendment.

** Previously filed.

(b) Financial Statement Schedules

None

ITEM 17. UNDERTAKINGS.

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

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

The undersigned registrant hereby undertakes that:

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

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

The undersigned registrant hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person to whom the prospectus is sent or
given, the latest annual report, to security holders that is incorporated by

II-3
<PAGE> 73

reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X is not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly report that is specifically incorporated by reference in
the prospectus to provide such interim financial information.

II-4
<PAGE> 74

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE
REQUIREMENTS FOR FILING ON FORM S-3 AND HAS DULY CAUSED THIS AMENDMENT NO. 1 TO
THE REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED,
THEREUNTO DULY AUTHORIZED, IN THE CITY OF CLEVELAND, STATE OF OHIO, ON MAY 26,
1998.

GLIATECH INC.

By: /s/ THOMAS O. OESTERLING
------------------------------------
Thomas O. Oesterling, Ph.D.
President and Chief Executive
Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 1 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES AND ON THE DATES INDICATED.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>

/s/ THOMAS O. OESTERLING President and Chief Executive May 26, 1998
- --------------------------------------------- Officer (Principal Executive
Thomas O. Oesterling, Ph.D. Officer) and Director

* Vice President and Chief May 26, 1998
- --------------------------------------------- Financial
Rodney E. Dausch Officer (Principal Financial and
Accounting Officer)

* Chairman of the Board May 26, 1998
- ---------------------------------------------
Robert P. Pinkas

* Director May 26, 1998
- ---------------------------------------------
William A. Clarke

* Director May 26, 1998
- ---------------------------------------------
Thomas E. Haigler, Jr.

* Director May 26, 1998
- ---------------------------------------------
Ronald D. Henriksen

* Director May 26, 1998
- ---------------------------------------------
Irving S. Shapiro

* Director May 26, 1998
- ---------------------------------------------
John L. Ufheil
</TABLE>

* The undersigned by signing his name hereto, does sign and execute this
Amendment No. 1 to the Registration Statement pursuant to the Powers of
Attorney executed by the above-named officers and directors of the Company,
which are being filed herewith with the Securities and Exchange Commission on
behalf of such officers and directors.

By: /s/ THOMAS O. OESTERLING

--------------------------------
Thomas O. Oesterling, Ph.D.
Attorney-in-Fact
<PAGE> 75

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
<C> <S>
*1.1 Form of Underwriting Agreement.
4.1 Rights Agreement, dated as of July 1, 1997, by and between
the Company and American Stock Transfer & Trust Company, as
rights agent, is incorporated by reference to Exhibit 1 of
the Company's Current report on Form 8-K as filed on July 2,
1997 (File No. 0-20096).
*5.1 Opinion of Jones, Day, Reavis & Pogue as to the validity of
the securities being offered.
*23.1 Consent of Jones, Day, Reavis & Pogue (included in Exhibit
5.1).
23.2 Consent of Ernst & Young LLP.
23.3 Consent of Pennie & Edmonds.
**24.1 Powers of Attorney.
24.2 Power of Attorney of William A. Clarke.
</TABLE>

* To be filed by amendment.

** Previously filed.

<PAGE> 1
Exhibit 23.2

Consent of Ernst & Young LLP

We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated March 10, 1998, in Amendment No. 1 to the Registration
Statement (Form S-3 No. 333-52825) and related Prospectus of Gliatech Inc. for
the registration of 2,300,000 shares of its common stock.

We also consent to the incorporation by reference in Amendment No. 1 to the
Registration Statement (Form S-3 No. 333-52825) and related Prospectus of
Gliatech Inc. for the registration of 2,300,000 shares of its common stock of
our report dated March 10, 1998, with respect to the consolidated financial
statements of Gliatech Inc. included in its Annual Report (Form 10-K) for the
year ended December 31, 1997 and for the period from inception of operations
(August 31, 1988) through December 31, 1997, filed with the Securities and
Exchange Commission.

/s/ERNST & YOUNG LLP

Cleveland, Ohio
May 26, 1998

<PAGE> 1
Exhibit 23.3

CONSENT OF COUNSEL

The undersigned hereby consents to the use of our name and the statement
with respect to us appearing under the heading "Experts" in Amendment No. 1 to
the Registration Statement on Form S-3 of Gliatech Inc.

/s/ PENNIE & EDMONDS LLP

New York, New York
May 26, 1998

<PAGE> 1
Exhibit 24.2

DIRECTOR AND/OR OFFICER OF
GLIATECH INC.

REGISTRATION STATEMENT ON FORM S-3

POWER OF ATTORNEY

The undersigned director of Gliatech Inc., a Delaware
corporation (the "Company"), hereby constitutes and appoints Thomas O.
Oesterling, Ph.D., Rodney E. Dausch, Michael A. Zupon, Ph.D. and Thomas C.
Daniels, and each of them, with full power of substitution and resubstitution,
as attorneys-in-fact or attorney-in-fact of the undersigned, for him and in his
name, place and stead, to sign and file with the Securities and Exchange
Commission under the Securities Act of 1933 (the "Securities Act") one or more
Registration Statement(s) on Form S-3 relating to the registration for sale of
the Common Stock, $0.01 par value per share, of the Company, with any and all
amendments, supplements and exhibits thereto, including pre-effective and
post-effective amendments or supplements or any additional registration
statement filed pursuant to Rule 462 promulgated under the Securities Act, with
full power and authority to do and perform any and all acts and things
whatsoever required, necessary or desirable to be done in the premises, hereby
ratifying and approving the act of said attorneys and any of them and any such
substitute.

EXECUTED as of May 20, 1998.

/s/ William A. Clarke
- -----------------------------
William A. Clarke
Director