SURMODICS INC, 424B4, 1998-03-04

SURMODICS INC
424B4, 1998-03-04
ADHESIVES & SEALANTS

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<PAGE>
FILED PURSUANT TO RULE 424B4
FILE NO: 333-43217
2,000,000 SHARES

[LOGO]

COMMON STOCK

All of the shares of Common Stock offered hereby are being sold by
SurModics, Inc. Prior to this offering, there has been no public market for the
Common Stock. See "Underwriting" for the factors considered in determining the
initial public offering price. The Company's Common Stock has been approved for
quotation on the Nasdaq National Market under the symbol "SRDX."

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

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 5.

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

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 DISCOUNT AND PROCEEDS TO
PUBLIC COMMISSIONS (1) COMPANY (2)
<S> <C> <C> <C>
Per Share................................................ $7.50 $0.5625 $6.9375
Total (3)................................................ $15,000,000 $1,125,000 $13,875,000
</TABLE>

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

(2) Before deducting expenses payable by the Company estimated at $350,000.

(3) The Company has granted the Underwriters a 30-day option to purchase up to
300,000 additional shares solely to cover over-allotments, if any. If such
option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions, and Proceeds to Company will be $17,250,000,
$1,293,750 and $15,956,250, respectively. See "Underwriting."

The shares of Common Stock are offered by the several Underwriters subject
to prior sale, when, as and if delivered to and accepted by them, and are
subject to the right of the Underwriters to withdraw, cancel or modify such
offer and to reject any order in whole or in part. It is expected that delivery
of the shares of Common Stock will be made on or about March 9, 1998.

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

JOHN G. KINNARD AND COMPANY, INCORPORATED
------------

The date of this Prospectus is March 3, 1998
<PAGE>
[LOGO]

Providing surface modification solutions
to optimize medical device
performance

[ANATOMICAL DEPICTION OF HUMAN BODY]

<TABLE>
<S> <C>
NEUROLOGICAL
guide catheters
infusion catheters
guidewires
hydrocephalic shunts

CARDIOVASCULAR CARDIAC RHYTHM MANAGMENT
stents pacemaker leads
guidewires electrophysiology catheters
guide catheters
angioplasty catheters
heart valves
vascular grafts

SURGICAL DEVICES
endoscopy devices
chest wound drains

UROGENITAL PERIPHERAL VASCULAR
urinary catheters vascular grafts
penile implants stents
incontinence devices catheters
ureteral stents guidewires

ORTHOPEDIC
bone repair
cartilage repair
</TABLE>

The following are registered trademarks of the Company:
"PhotoLink-Registered Trademark-", "StabilCoat-Registered Trademark-",
"StabilZyme-Registered Trademark-" and "StabilZyme SELECT-Registered
Trademark-". The Company's applications for the federal registration of its
trademarks "SurModics-TM-" and "StabilGuard-TM-" are pending.

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 AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES, AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
PhotoLink-Registered Trademark-

[ILLUSTRATION OF PHOTOLINK COATING PROCESS
BONDING BIOMOLECULES TO A SURFACE]
BIOMOLECULE
IMMOBILIZATION

PhotoLink is a versatile, easily applied light-activated coating technology that
can impart a variety of performance-enhancing characteristics to the surface of
medical devices.

[PHOTOGRAPH OF UNCOATED MATERIAL WITH NON-ABSORBED LIQUID
AND COATED MATERIAL WITH ABSORBED LIQUID]
WETTABILITY

[PHOTOGRAPH OF UNCOATED MATERIAL WITH BLOOD CELL ATTACHMENT
AND COATED MATERIAL WITHOUT SUCH ATTACHMENT]
HEMOCOMPATIBILITY
<PAGE>
[MICROSCOPIC PHOTOGRAPH OF BONE
REGENERATION]
TISSUE ENGINEERING SURFACES

[ILLUSTRATION OF DRUG MOLECULES TRAPPED WITHIN A MATRIX OF POLYMERS BONDED
TO A SURFACE OF A STENT]
DRUG DELIVERY

[PHOTOGRAPH OF LIQUID BEADS ON AN UNCOATED SURFACE
AND NO LIQUID BEADS ON A COATED SURFACE]
LUBRICITY

[MICROSCOPIC PHOTOGRAPHS OF UNCOATED MATERIAL COVERED WITH BACTERIA
AND COATED MATERIAL WITH ALMOST NO BACTERIA]

INFECTION RESISTANCE
<PAGE>
PROSPECTUS SUMMARY

THIS SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS AND THE
NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE
INDICATED, THE INFORMATION IN THIS PROSPECTUS (I) ASSUMES NO EXERCISE OF THE
UNDERWRITERS' OVER-ALLOTMENT OPTION, (II) ASSUMES PRO FORMA CONVERSION OF ALL
OUTSTANDING SHARES OF SERIES A CONVERTIBLE PREFERRED STOCK INTO 1,507,312 SHARES
OF COMMON STOCK TO BE EFFECTED UPON THE CLOSING OF THIS OFFERING AND (III)
REFLECTS A 4-FOR-1 STOCK SPLIT OF THE COMMON STOCK EFFECTED ON DECEMBER 22,
1997. SEE "DESCRIPTION OF CAPITAL STOCK" AND "UNDERWRITING."

THE COMPANY

SurModics, Inc. ("SurModics" or the "Company") is a leading provider of
surface modification solutions to the medical device industry. The Company's
primary focus is the commercialization of its patented PhotoLink process through
third-party licensing arrangements. PhotoLink is a versatile, easily applied,
light-activated coating technology that modifies medical device surfaces by
creating covalent bonds between those surfaces and a variety of chemical agents.
Through the PhotoLink process, these chemical agents can impart many
performance-enhancing characteristics, such as lubricity, hemocompatibility,
infection resistance and drug delivery, onto the surface of a medical device
without materially changing the dimensions or physical properties of the device.
The Company believes that medical device manufacturers who utilize the Company's
technology are able to significantly improve the performance of their products
and, in many cases, differentiate their products in a highly competitive
marketplace.

The Company focuses on providing high value-added surface modification
solutions to a variety of medical device markets and product categories.
Examples of products in the market or under development that incorporate the
PhotoLink technology include interventional cardiology catheters, vascular
stents, interventional neurology catheters, guide wires and shunts, cardiac
rhythm management devices, and urological and gynecological devices. The surface
properties created by the PhotoLink technology have greatly reduced treatment
times in catheter-based vascular procedures and have shown the potential to
enhance the long-term performance of implantable devices by improving infection
resistance and promoting host cell attachment, growth and subsequent tissue
integration. The Company believes further opportunities exist to commercialize
its PhotoLink technology for other market applications, such as biomolecule
immobilization for use in the emerging field of DNA-based diagnostics.

SurModics believes its PhotoLink technology has many advantages over other
competing surface modification technologies. First, the PhotoLink technology can
be applied to many different kinds of surfaces, which allows manufacturers a
high degree of flexibility in designing their products. Second, the PhotoLink
technology can immobilize a variety of chemical, pharmaceutical and biological
agents, thereby imparting many different performance-enhancing characteristics
to the device being coated. Third, the PhotoLink technology provides the medical
device manufacturer with the ability to combine multiple surface-enhancing
characteristics on the same device. Finally, the PhotoLink process is relatively
simple and does not subject the medical devices to harsh chemical, pressure or
temperature conditions during the coating process as is the case with some
competing technologies. PhotoLink coatings are compatible with all generally
accepted sterilization processes and the PhotoLink process does not require
expensive, specialized manufacturing equipment. In addition, SurModics' customer
service includes free proof-of-concept studies for potential applications,
coating optimization for specific licensee applications, transfer of the
technology to licensee manufacturing facilities, and assistance during the FDA
approval process for PhotoLink coated devices.

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<PAGE>
capabilities of its licensees. Revenues from these arrangements include initial
license fees, minimum royalties and earned royalties based on a percentage of
licensees' product sales. As of February 5, 1998, the Company had license
agreements with 32 companies covering 105 different applications, of which 59
were generating royalty revenues for the Company. Licensees of the PhotoLink
technology include Cook Incorporated, Cordis Corporation (a Johnson & Johnson
company), Medtronic PS Medical, Pacesetter, Inc. (a St. Jude Medical, Inc.
company), Perclose, Inc., Sulzer Carbomedics (a division of Sulzer Medica USA
Inc.) and Target Therapeutics, Inc. (a subsidiary of Boston Scientific
Corporation).

In addition to licensing its PhotoLink technology, the Company also licenses
certain diagnostic technology to Abbott Laboratories for use with rapid
point-of-care diagnostic tests, such as pregnancy and strep tests. The Company
also manufactures and sells the chemical reagents used in the PhotoLink process
and stabilization products used to extend the shelf-life of immunoassay
diagnostic tests.

The Company was incorporated under the laws of the State of Minnesota in
June 1979. The Company changed its name from BSI Corporation to SurModics, Inc.
in June 1997. The Company's executive offices are located at 9924 West 74th
Street, Eden Prairie, Minnesota 55344, its telephone number is (612) 829-2700
and its Internet address is www.surmodics.com.

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered......................... 2,000,000 shares

Common Stock to be outstanding after this
offering................................... 6,916,420 shares (1)

Use of Proceeds.............................. The Company intends to use proceeds from this
offering for research and development, sales
and marketing and upgrades to its
manufacturing equipment, to strengthen its
patent protection and for working capital and
general corporate purposes. See "Use of
Proceeds."

Nasdaq National Market symbol................ SRDX
</TABLE>

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

(1) Includes 84,000 shares of Common Stock issuable pursuant to restricted stock
agreements as of the date of this Prospectus. Excludes, as of the date of
this Prospectus, 1,226,880 shares of Common Stock issuable upon exercise of
outstanding stock options at a weighted average exercise price of $4.61 per
share. See "Management--Stock Options" and "Description of Capital Stock."

3
<PAGE>
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND LICENSE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
FISCAL YEAR ENDED SEPTEMBER 30, DECEMBER 31,
----------------------------------------------------- --------------------
1993 1994 1995 1996 1997 1996 1997
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Total revenues............................ $ 4,630 $ 4,618 $ 5,956 $ 6,182 $ 7,582 $ 1,655 $ 1,909
Operating costs and expenses.............. 5,391 5,703 6,411 6,597 7,545 1,668 1,808
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from operations............. (761) (1,085) (455) (415) 37 (13) 101
Other income (expense), net............... 244 (17) 133 221 199 39 50
--------- --------- --------- --------- --------- --------- ---------
Net income (loss)......................... $ (517) $ (1,102) $ (322) $ (194) $ 236 $ 26 $ 151
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) per share (pro forma)
(1)
Basic................................... $ (.13) $ (.26) $ (.07) $ (.04) $ .05 $ .01 $ .03
Diluted................................. (.13) (.26) (.07) (.04) .04 .00 .03
Weighted average shares outstanding (pro
forma) (1)
Basic................................... 4,009 4,228 4,713 4,776 4,854 4,819 4,904
Diluted................................. 4,009 4,228 4,713 4,776 5,385 5,334 5,413
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------------------------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
SELECTED LICENSE DATA:
Number of licensees............................................ 15 19 26 28 32
Number of licensed applications................................ 34 44 77 101 106
Number of licensed applications generating royalties........... 14 20 23 45 58

DECEMBER 31,
1997
-----------------
<S> <C>
SELECTED LICENSE DATA:
Number of licensees............................................ 32
Number of licensed applications................................ 105
Number of licensed applications generating royalties........... 59
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------
ACTUAL AS ADJUSTED(2)
--------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments................................................ $ 3,637 $ 17,162
Total assets.......................................................................... 6,341 19,866
Total liabilities..................................................................... 1,073 1,073
Total stockholders' equity............................................................ 5,268 18,793
</TABLE>

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

(1) See Note 2 to Financial Statements for an explanation of the determination
of weighted average shares outstanding (pro forma).

(2) Adjusted to reflect the sale of the 2,000,000 shares of Common Stock offered
by the Company hereby and the application of the estimated net proceeds
therefrom. See "Use of Proceeds."

4
<PAGE>
RISK FACTORS

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. THIS
PROSPECTUS INCLUDES CERTAIN FORWARD-LOOKING STATEMENTS WHICH REFLECT THE
COMPANY'S PLANS, ESTIMATES AND BELIEFS. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED IN THE
FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS. IN EVALUATING AN
INVESTMENT IN THE COMMON STOCK, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER
THE FOLLOWING RISK FACTORS AND OTHER INFORMATION CONTAINED IN THIS PROSPECTUS.

DEPENDENCE ON ROYALTY REVENUES; LICENSEES' REGULATORY BARRIERS; TERMINATION OF
LICENSE AGREEMENTS

The principal element of the Company's strategy is to enter into licensing
arrangements with medical device companies that manufacture products
incorporating the Company's technology. For the three months ended December 31,
1997 and for the fiscal year ended September 30, 1997, the Company derived
approximately 49.3% and 38.4% of its revenues, respectively, from royalties. The
Company does not currently manufacture, market or sell its own medical devices
nor does it intend to do so in the foreseeable future. Thus, the Company's
prospects are substantially dependent on the receipt of royalties from licensees
of its technology. The amount and timing of such royalties are, in turn,
dependent on the ability of the Company's licensees to successfully gain
regulatory approval for, market and sell products incorporating the Company's
technology. Failure of certain licensees to gain regulatory approval or market
acceptance for such products could have a material adverse effect on the
Company's business, financial condition and results of operations. Although the
Company believes that its licensees have an economic motivation to market
products containing the Company's technology, the amount and timing of resources
to be devoted by them to marketing and the ultimate commercial success of such
medical devices are not within the control of the Company. Hence, the amount and
timing of royalty payments received by the Company will fluctuate, and such
fluctuations could have a material adverse effect on the Company's business,
financial condition and results of operations.

Under the Company's standard license agreements, licensees can abandon the
Company's technology for any reason upon prior written notice, typically
required at least 90 days before termination. Existing and potential licensees
have no obligation to deal exclusively with the Company in obtaining surface
modification technology and may pursue parallel development or licensing of
competing surface modifications, on their own or with third parties. A decision
by a licensee to abandon or terminate one or more of its products coated through
the PhotoLink process or to otherwise terminate its relationship with the
Company could materially adversely affect the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business--Current
Licensing Arrangements."

NEED TO EXPAND LICENSING BASE; UNCERTAINTY OF MARKET ACCEPTANCE

The Company intends to continue pursuing a strategy of licensing its
technology to a diversified base of medical device manufacturers, thereby
expanding its licensing base for the PhotoLink technology. The Company's success
will depend, in part, on its ability to attract new licensees and to enter into
agreements for additional applications with existing licensees. There can be no
assurance that the Company can successfully expand its licensing base or that
such expansion will result in increased commercialization of licensed
applications. While certain applications of SurModics' PhotoLink technology have
gained acceptance in some segments of the medical device industry, the Company
is in the early stages of adapting the technology for a broader base of medical
applications with additional performance-enhancing characteristics. The
Company's ability to expand its licensing base will depend, in part, on its
ability to develop and market new applications for its PhotoLink technology in
its target markets. However, certain of the Company's existing licenses are
exclusive with respect to certain medical devices, which could restrict the
Company's ability to license the same technology to another entity for a similar
or competitive purpose. There can be no assurance that the Company will be able
to identify, develop and adapt its PhotoLink

5
<PAGE>
technology for new applications in a timely and cost effective manner, that new
applications will be licensed by the Company on favorable terms, that such
applications will be accepted by manufacturers in the Company's target markets,
or that products incorporating new applications will gain regulatory approval,
be commercialized or gain market acceptance. Delays in developing new or
enhancing existing PhotoLink applications or the failure of such applications or
potential licensees' products to gain market acceptance could have an adverse
effect on the Company's business, financial condition and results of operations.
See "Business--Strategy," "Business--Research and Development" and
"Business--Government Regulation."

COMPETITION AND RISK OF TECHNOLOGICAL OBSOLESCENCE

The Company operates in a highly competitive and rapidly evolving field and
new developments are expected to continue at a rapid pace. The Company's success
depends, in part, upon its ability to maintain a competitive position in the
development of technologies and products in its areas of focus. The Company's
PhotoLink technology competes with technologies developed by Biocompatibles
International plc, Carmeda (a division of Norsk Hydro USA, Inc.), Specialty
Coatings Systems, Spire Corporation and STS Biopolymers Inc., among others. In
addition, many medical device manufacturers have developed or are engaged in
efforts to develop surface modification technologies generally for use on their
own products. Competition may also result from development efforts by existing
and potential licensees who have no obligation to deal exclusively with the
Company in utilizing or developing surface modification technologies. Many of
the Company's existing and potential competitors (including medical device
manufacturers pursuing coating solutions through their own research and
development efforts) have substantially greater financial and technical
resources and production and marketing capabilities than the Company. There can
be no assurance that the Company will be able to compete effectively with such
competitors. Furthermore, there can be no assurance that new products or
technologies developed by others, or the emergence of new industry standards,
will not render the Company's products or technologies or licensees' products
incorporating the Company's technologies noncompetitive or obsolete. Any new
technologies which make the Company's PhotoLink technology less competitive or
obsolete would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Competition."

HISTORY OF LOSSES AND ACCUMULATED DEFICIT

The Company has incurred net losses in each year since inception, except for
the year ended September 30, 1997, during which the Company recorded operating
income of $37,000 and net income of $236,000. As of December 31, 1997, the
Company had an accumulated deficit of $8.0 million. Losses have resulted
principally from costs incurred in connection with the Company's research and
development activities and from general and administrative costs associated with
the Company's operations. Historically, operations have been predominately
funded with government grants and equity offerings. The Company's revenues may
fluctuate from quarter to quarter and year to year primarily as a result of
fluctuations in the recognition of initial license fees and royalty revenue. The
Company's ability to generate significant revenues and maintain profitability
will depend, in large part, on the ability of the Company to enter into
additional license agreements and on the ability of its licensees to
successfully commercialize products incorporating the Company's technologies. No
assurance can be given that the Company will generate significant revenue growth
or maintain profitability. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

DEPENDENCE ON PATENTS AND PROPRIETARY RIGHTS

The Company's success depends, in large part, on its ability to obtain and
maintain patents, maintain trade secret protection, operate without infringing
on the proprietary rights of third parties and protect its proprietary rights
against infringement by third parties. The Company has been granted U.S. and
foreign

6
<PAGE>
patents and has U.S. and foreign patent applications pending related to its
PhotoLink technology. There can be no assurance that any pending patent
application will be approved, that the Company will develop additional
proprietary technology that is patentable, that any patents issued to the
Company will provide the Company with competitive advantages or will not be
challenged or invalidated by any third parties or that the patents of others
will not prevent the commercialization of products incorporating the Company's
technology. Furthermore, there can be no assurance that others will not
independently develop similar technology, duplicate any of the Company's
technology or design around the Company's patents. There can also be no
assurance that the Company's trade secrets or confidentiality agreements with
potential licensees or other parties will provide meaningful protection for the
Company's unpatented proprietary information.

The commercial success of the Company also will depend, in part, on its
ability to avoid infringing patent or other intellectual property rights of
third parties. There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry, and intellectual
property litigation may be used against the Company as a means of gaining a
competitive advantage. Intellectual property litigation is complex,
time-consuming and expensive, and the outcome of such litigation is difficult to
predict. If the Company were found to be infringing any third-party patent or
other intellectual property right, the Company could be required to pay
significant damages, alter its products or processes, obtain licenses from
others or cease commercialization of its products and processes. If the Company
is required to obtain any licenses, there can be no assurance that the Company
will be able to do so on commercially favorable terms, if at all. The Company's
failure to obtain any such license on commercially favorable terms could have a
material adverse effect on the Company's business, financial condition and
results of operations.

Patent litigation may also be necessary to enforce any patents issued or
licensed to the Company or to determine the scope and validity of third-party
proprietary rights. If patent applications are filed in the U.S. that claim
technology also claimed by the Company, the U.S. Patent and Trademark office may
declare an interference proceeding to determine priority of invention which
could result in substantial cost to the Company, even if the eventual outcome is
favorable to the Company. An adverse outcome of any such litigation or
interference proceeding could subject the Company to significant liabilities to
third parties, require disputed rights to be licensed from third parties or
require the Company to cease using its technology. Any action to defend or
prosecute intellectual property would be costly and result in significant
diversion of the efforts of the Company's management and technical personnel,
regardless of outcome, and could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--Patents
and Proprietary Rights" and "Use of Proceeds."

DEPENDENCE ON KEY LICENSEE AND GOVERNMENT FUNDING

Abbott Laboratories ("Abbott") and certain U.S. government agencies
accounted for 28% and 12% of the Company's revenues, respectively, for the three
months ended December 31, 1997 and 21% and 16% of the Company's revenues,
respectively, for fiscal 1997. The revenues from Abbott primarily represent
royalties received by SurModics in connection with an exclusive license granted
to Abbott of the Company's patent rights in a particular diagnostic format. This
license currently expires in 2008, subject to extension or renewals of the life
of the licensed patents, but can be terminated earlier at any time by Abbott
upon 90 days' prior written notice. However, Abbott would then have no right to
use such technology in any of its diagnostic tests. There can be no assurance
that revenues from Abbott or any customer will continue at their historical
levels. Loss of one or more of the Company's current customers, particularly
Abbott, could have a material adverse effect on the Company's business,
financial condition and results of operations.

The revenues from government agencies represent grants from such agencies
under the federal government's Small Business Innovative Research ("SBIR")
program. While the Company intends to continue to seek government grants to fund
some of its research and development efforts, there can be no

7
<PAGE>
assurance that the Company will be successful in obtaining any future government
grants. Although government grants have represented a significant percentage of
revenues in the past, the Company believes that these revenues will decline
slightly as an absolute number and more significantly as a percentage of total
revenue as the Company continues its focus on commercializing its technology.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business--Other Products" and "Business--Research and
Development."

PRODUCT LIABILITY AND INSURANCE

The development and sale of medical devices and component products involves
an inherent risk of product liability claims. Although the Company expects that
devices incorporating its technologies and products will be manufactured by
others and sold under their own labels, there can be no assurance that product
liability claims will not be filed against the Company for such devices or that
such manufacturers will not seek indemnification or other relief from the
Company for any such claims. In addition, there can be no assurance that product
liability claims will not be filed directly against the Company with respect to
its own products. The Company currently maintains product liability insurance in
amounts which management believes are appropriate. There can be no assurance,
however, that product liability insurance will continue to be available to the
Company in the future on acceptable terms, if at all, or that, if available, the
coverages will be adequate to protect the Company against any future product
liability claims. Furthermore, the Company does not expect to be able to obtain
insurance covering its costs and losses as a result of any recall of its
products or devices incorporating the Company's technology due to alleged
defects, whether such recall is instituted by a device manufacturer or the
Company or required by a regulatory agency. A product liability claim, recall or
other claim with respect to uninsured liabilities or in excess of insured
liabilities could have a material adverse effect on the Company's business,
financial condition or results of operations.

DEPENDENCE UPON KEY PERSONNEL AND ABILITY TO ATTRACT QUALIFIED PERSONNEL

The Company is highly dependent upon a number of key management and
technical personnel. The Company is also dependent upon its ability to attract
and retain additional highly qualified management and technical personnel. The
Company faces intense competition for qualified personnel, many of whom could be
subject to competing employment offers, and there can be no assurance that the
Company will be able to attract and retain such personnel. The Company does not
maintain key person insurance on any of its employees. The loss of the services
of one or more key employees or the failure to attract and retain additional
qualified personnel could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company does not
have employment agreements with any of its employees. Although the Company has
non-compete agreements with certain employees, there can be no assurance that
such agreements will be enforceable. See "Business--Employees" and "Management."

GOVERNMENT REGULATION

Although PhotoLink technology itself is not directly regulated by the U.S.
Food and Drug Administration ("FDA"), the medical devices incorporating this
technology are subject to FDA regulation. The burden of securing FDA approval
for these medical devices rests with the Company's licensees (the medical device
manufacturers). However, the Company has prepared Device Master Files which may
be accessed by the FDA to assist it in its review of the applications filed by
the Company's licensees. Historically, most medical devices incorporating the
PhotoLink process have been subject to the FDA's 510(k) marketing approval
process, which typically lasts about six to nine months. Supplemental or full
pre-market approval ("PMA") reviews require a significantly longer period. Thus,
significantly more time will be required to commercialize applications subjected
to PMA review. Furthermore, sales of medical devices outside the U.S. are
subject to international regulatory requirements that vary from country to
country. The time required to obtain approval for sale internationally may be
longer or shorter than that

8
<PAGE>
required for FDA approval. There can be no assurance that the Company's
licensees will be able to obtain regulatory approval for devices incorporating
PhotoLink technology on a timely basis, or at all. Regulatory approvals, if
granted, may include significant limitations of the indicated uses for which the
product may be marketed. In addition, product approval could be withdrawn for
failure to comply with regulatory standards or the occurrence of unforeseen
problems following initial marketing. Changes in existing regulations or
adoption of new governmental regulations or policies could prevent or delay
regulatory approval of products incorporating PhotoLink technology or subject
the Company to additional regulation. Failure or delay of licensees in obtaining
FDA and other necessary regulatory approval or clearance or the loss of
previously obtained approvals could have a material adverse effect on the
Company's business, financial condition and results of operations.

Certain of the Company's activities are regulated by federal and state
agencies in addition to the FDA. For example, activities in connection with
industrial applications of PhotoLink technology and waste disposal are subject
to regulation by the U.S. Environmental Protection Agency. Some PhotoLink
reagents must be registered with the agency with basic information filed related
to toxicity during the manufacturing process as well as the toxicity of the
final product. 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. See "Business--Government Regulation."

HAZARDOUS MATERIALS

The Company's research activities sometimes involve the controlled use of
various hazardous materials. Although the Company believes that its safety
procedures for handling and disposing of such materials comply with the
standards prescribed by state and federal regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated.
While the Company currently maintains insurance in amounts which it believes are
appropriate in light of the risk of accident, the Company could be held liable
for any damages that might result from any such event. Any such liability could
exceed the Company's insurance and available resources and could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business--Government Regulation."

NO PRIOR PUBLIC MARKET FOR COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICE

Prior to this offering, there has been no public market for the Common Stock
and there can be no assurance that an active public market for the Common Stock
will develop or be sustained after the offering. The initial public offering
price was determined by negotiations between the Company and the Underwriters
and is not necessarily indicative of the market price at which the Common Stock
of the Company will trade after this offering. Market prices for securities of
medical technology companies can be highly volatile, and the market has
experienced significant price and volume fluctuations that are unrelated to the
operating performance of particular companies. Announcements of the status or
results of licensing agreements, development projects or technological
innovations by the Company or its competitors, developments concerning
proprietary rights, including patents and litigation matters, government
regulation, general market conditions, as well as quarterly fluctuations in the
Company's revenues and financial results and other factors, may have a
significant impact on the market price of the Common Stock. In particular, the
realization of any of the risks described in the "Risk Factors" set forth in
this Prospectus could have a dramatic and adverse impact on such market price.
See "Underwriting."

POTENTIAL ADVERSE MARKET IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE

Sales of substantial amounts of Common Stock (including shares issued upon
the exercise of outstanding options) in the public market following this
offering could have an adverse effect on the price of the Common Stock. Such
sales may also make it more difficult for the Company to sell equity or equity-
related securities in the future at a time and price that the Company would deem
appropriate. Upon completion of this offering, the Company will have 6,916,420
shares of Common Stock issued and

9
<PAGE>
outstanding. The 2,000,000 shares offered hereby will be freely tradable
following this offering, except for any shares purchased by an "affiliate" of
the Company, which will be subject to the limitations of Rule 144 promulgated
under the Securities Act of 1933, as amended ("Rule 144"). All officers and
directors and certain stockholders of the Company, owning an aggregate of
4,101,212 shares, have entered into "lock-up" agreements, agreeing not to sell,
transfer or otherwise dispose of any shares of Common Stock without the consent
of John G. Kinnard and Company, Incorporated, as the representative of the
several Underwriters (the "Representative"), for a period of 180 days after the
date of this Prospectus. The Representative may waive these restrictions at any
time in its discretion. In considering any waiver request, the Representative
may take into account prevailing market conditions, the number of shares subject
to the requested waiver, the extent to which other waivers have been granted and
other factors that the Representative may deem relevant. Taking such
restrictions into account, in addition to the 2,000,000 shares of Common Stock
offered hereby, (i) approximately 676,552 shares will be eligible for immediate
sale on the date of this Prospectus in accordance with Rule 144; (ii)
approximately 21,600 shares will be eligible for sale on April 1, 1998 upon
expiration of certain restrictions under restricted stock awards; (iii)
approximately 17,428 additional shares will become eligible for sale in the
public market beginning 90 days after the date of this Prospectus in accordance
with Rule 144; and (iv) approximately 4,067,212 additional shares will be
eligible for sale beginning 180 days after the date of this Prospectus upon the
expiration of the lock-up agreements, subject, in certain cases, to volume and
manner of sale limitations under Rule 144. As of the date of this Prospectus,
options to purchase an aggregate of 1,226,880 shares of Common Stock are
outstanding, with 531,520 of the shares issuable upon exercise of such options
subject to vesting requirements and lock-up agreements. The remaining 695,360
shares issuable upon exercise of outstanding options will become available for
exercise and sale upon vesting and effectiveness of Registration Statements on
Form S-8, which the Company intends to file following the expiration of the
lock-up agreements referenced above. Following the completion of this offering,
the holders of Series A Convertible Preferred Stock, which automatically
converts into an aggregate of 1,507,312 shares of Common Stock upon the closing
of this offering, are entitled to participatory or "piggyback" and demand
registration rights with respect to such Common Stock. The piggyback
registration rights relate to certain public offerings of the Company, if any,
occurring during a three-year period beginning on the closing of this offering.
The demand registration rights provide that on a one-time basis only, during a
two and one-half year period beginning six months after the effective date of
this offering, upon the request of the holders of a majority of interest
thereof, the Company will promptly take all necessary action to register such
shares of Common Stock. See "Shares Eligible for Future Sale."

MANAGEMENT DISCRETION IN THE USE OF PROCEEDS

While the Company intends to use a portion of the proceeds of this offering
for research and development, sales and marketing and upgrades of its
manufacturing equipment and to strengthen its patent protection, approximately
thirty percent of the proceeds are expected to be used for working capital and
other general corporate purposes. Accordingly, the Company's management will
have broad discretion to allocate a significant amount of the proceeds of this
offering and to determine the timing of expenditures. See "Use of Proceeds."

ADVERSE EFFECT OF UNDESIGNATED STOCK AND ANTI-TAKEOVER PROVISIONS

The authorized capital of the Company includes 5,000,000 shares of
undesignated stock. The Company's Board of Directors has the power to issue any
or all of the shares of undesignated stock, including the authority to establish
one or more series and to fix the powers, preferences, rights and limitations of
such class or series, without seeking stockholder approval. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any preferred stock that may be created and issued
in the future. Furthermore, as a Minnesota corporation, the Company is subject
to provisions of the Minnesota Business Corporations Act ("MBCA") that could
have an anti-takeover effect on the Company. The Company may also consider
adopting additional anti-

10
<PAGE>
takeover measures. The authority of the Board to issue undesignated stock and
the anti-takeover provisions of the MBCA, as well as any future anti-takeover
measures adopted by the Company, may, in certain circumstances, delay, deter or
prevent takeover attempts and other changes in control of the Company not
approved by management and the Board of Directors. As a result, the Company's
stockholders may lose opportunities to dispose of their shares at a premium over
prevailing prices in the event of a change in control, and the market price,
voting and other rights of the holders of Common Stock may also be affected. See
"Description of Capital Stock."

DILUTION

Purchasers of shares in this offering will incur immediate and substantial
dilution in the pro forma net tangible book value per share of $4.82 or 64% from
the initial public offering price of $7.50 per share. Investors may also
experience additional dilution as a result of the exercise of outstanding stock
options, or the issuance by the Company of additional equity securities. See
"Dilution."

ABSENCE OF DIVIDENDS

The Company has not declared or paid any cash dividends on its Common Stock
since its inception and does not anticipate declaring or paying any such cash
dividends in the foreseeable future. See "Dividend Policy."

11
<PAGE>
USE OF PROCEEDS

The net proceeds to the Company from the sale of the 2,000,000 shares of
Common Stock offered to the public hereby are estimated to be $13.5 million
($15.6 million if the Underwriters' over-allotment option is exercised in full)
after deducting estimated underwriting discounts and commissions and estimated
offering expenses payable by the Company. The Company intends to apply such net
proceeds substantially as follows:

<TABLE>
<CAPTION>
AMOUNT PERCENTAGE
------------- -------------
<S> <C> <C>
Research and development........................................... $ 5,500,000 41%
Sales and marketing................................................ 2,000,000 15%
Equipment upgrades................................................. 1,500,000 11%
Patent protection.................................................. 1,000,000 7%
Working capital and general corporate purposes..................... 3,500,000 26%
------------- ---
Total.............................................................. $ 13,500,000 100%
------------- ---
------------- ---
</TABLE>

The Company currently intends to use approximately $5.5 million of such
proceeds to fund research and development including improvements to existing
PhotoLink applications and the development of new technological initiatives,
primarily focused on additional PhotoLink applications, including the hiring of
additional technical personnel to support such initiatives. The Company plans to
use approximately $2.0 million of the net proceeds to expand its sales and
marketing capabilities by hiring additional marketing personnel, and to support
market development of new PhotoLink applications. An additional $1.5 million of
the net proceeds is intended to be used to upgrade its technical and production
equipment over the next two years. Finally, an estimated $1.0 million will be
reserved to strengthen SurModics' patent protection in additional worldwide
markets and to seek patent protection for new technology.

The balance of the net proceeds will be used for working capital and general
corporate purposes. A portion of the net proceeds may also be used to acquire
technologies or products that complement the Company's current business. The
Company does not currently have any agreements, arrangements or understandings,
and is not involved in any negotiations, with respect to any such acquisitions,
and no portion of the net proceeds has been allocated for any specific
acquisition.

Pending their use, the net proceeds will be invested in investment grade,
interest-bearing securities.

DIVIDEND POLICY

The Company has not declared or paid cash dividends on its Common Stock
since its inception. The Company currently intends to retain any earnings for
use in the operation and expansion of its business and therefore does not
anticipate declaring or paying any cash dividends in the foreseeable future.

12
<PAGE>
CAPITALIZATION

The following table sets forth as of December 31, 1997 (i) the
capitalization of the Company, (ii) the pro forma capitalization of the Company
giving effect to the conversion of all outstanding shares of Series A
Convertible Preferred Stock into 1,507,312 shares of Common Stock and (iii) such
pro forma capitalization as adjusted to reflect the sale by the Company of the
2,000,000 shares offered hereby and the anticipated receipt and application of
the estimated net proceeds therefrom, after deducting underwriting discounts and
commissions and estimated offering expenses payable by the Company. The
information set forth below should be read in conjunction with the Financial
Statements and Notes thereto included elsewhere in this Prospectus. See "Use of
Proceeds."

<TABLE>
<CAPTION>
DECEMBER 31, 1997(1)
-------------------------------------
ACTUAL PRO FORMA AS ADJUSTED
--------- ------------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
STOCKHOLDERS' EQUITY:
Series A Convertible Preferred Stock, $0.05 per share par value;
convertible into Common Stock upon the closing of an initial public
offering; 450,000 shares authorized and 376,828 shares issued and
outstanding (actual); no shares authorized, issued and outstanding
(pro forma and as adjusted)........................................... $ 19 $ -- $ --
Common Stock, $0.05 per share par value; 15,000,000 shares authorized;
3,396,868 shares issued and outstanding (actual); 4,904,180 shares
issued and outstanding (pro forma); 6,904,180 shares issued and
outstanding (as adjusted)............................................. 170 245 345
Additional paid-in capital.............................................. 13,491 13,435 26,860
Unearned compensation................................................... (243) (243) (243)
Stock purchase notes receivable......................................... (160) (160) (160)
Accumulated deficit..................................................... (8,009) (8,009) (8,009)
--------- ------------- -----------
Total stockholders' equity and capitalization......................... $ 5,268 $ 5,268 $ 18,793
--------- ------------- -----------
--------- ------------- -----------
</TABLE>

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

(1) Includes 80,000 shares of Common Stock issuable pursuant to restricted stock
agreements. Excludes 1,240,400 shares of Common Stock issuable upon exercise
of outstanding stock options at a weighted average exercise price of $4.61
per share. See "Management--Stock Options" and "Description of Capital
Stock."

13
<PAGE>
DILUTION

The pro forma net tangible book value of the Company's Common Stock at
December 31, 1997 was $5.0 million or $1.01 per share. "Net tangible book value"
represents the tangible assets less total liabilities of the Company, and "pro
forma net tangible book value per share" was determined by dividing the net
tangible book value of the Company by the pro forma number of shares of Common
Stock outstanding on December 31, 1997. See "Capitalization." "Pro forma net
tangible book value dilution per share" represents the difference between the
initial public offering price per share and the pro forma net tangible book
value per share after this offering. Without taking into account any changes in
the Company's pro forma net tangible book value per share after December 31,
1997, other than to give effect to the sale of the 2,000,000 shares offered
hereby (net of underwriting discounts and commissions and estimated offering
expenses), the pro forma net tangible book value of the Company at December 31,
1997 would have been $18.5 million or $2.68 per share. This represents an
immediate increase in pro forma net tangible book value to the existing
stockholders of $1.67 per share and an immediate pro forma net tangible book
value dilution to purchasers of the shares of $4.82 per share, as illustrated by
the following table:

<TABLE>
<CAPTION>
Initial public offering price per share....................... $ 7.50

<S> <C> <C>
Pro forma net tangible book value per share at December 31,
1997...................................................... $ 1.01

Increase per share attributable to new investors............ 1.67
---------
Pro forma net tangible book value per share after this
offering.................................................... 2.68
---------
Pro forma net tangible book value dilution per share to new
investors................................................... $ 4.82
---------
---------
</TABLE>

The following table summarizes as of December 31, 1997, on a pro forma
basis, the difference between the number of shares of Common Stock purchased
from the Company by existing stockholders and by new investors in this offering,
the total consideration paid to the Company and the average price paid per
share. The table assumes that no shares are purchased in this offering by
existing stockholders. To the extent existing stockholders purchase shares in
this offering, their percentage ownership, total consideration and average
consideration per share will be greater than is shown.

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION(1) AVERAGE
----------------------- -------------------------- CONSIDERATION
NUMBER PERCENT AMOUNT PERCENT PER SHARE(1)
---------- ----------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............................... 4,904,180 71.0% $ 13,890,861 48.1% $ 2.83
New investors....................................... 2,000,000 29.0% 15,000,000 51.9% 7.50
---------- ----- ------------- -----
Total............................................. 6,904,180 100.0% $ 28,890,861 100.0%
---------- ----- ------------- -----
---------- ----- ------------- -----
</TABLE>

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

(1) Does not reflect any deductions for commissions or expenses paid or incurred
in connection with the issuance of such shares.

The foregoing tables and calculations, as of December 31, 1997, include
80,000 shares of Common Stock issuable pursuant to restricted stock agreements,
assume pro forma conversion of all outstanding shares of Series A Convertible
Preferred Stock into 1,507,312 shares of Common Stock upon the closing of this
offering and exclude 1,240,400 shares of Common Stock issuable upon exercise of
outstanding stock options at a weighted average exercise price of $4.61 per
share. See "Management--Stock Options," "Description of Capital Stock" and Note
4 to the Financial Statements.

14
<PAGE>
SELECTED FINANCIAL DATA

The statement of operations data for the years ended September 30, 1995,
1996 and 1997 and the balance sheet data at September 30, 1996 and 1997 which
are derived from and are qualified by reference to, and should be read in
conjunction with the more detailed Financial Statements of the Company and the
Notes thereto, which have been audited by Arthur Andersen LLP, independent
public accountants, whose report is included elsewhere in this Prospectus, and
the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" which follows this section. The statement
of operations data for the years ended September 30, 1993 and 1994 and the
balance sheet data at September 30, 1993, 1994 and 1995 are derived from audited
financial statements not included in this Prospectus. The statement of
operations data for the three months ended December 31, 1996 and 1997 and the
balance sheet data at December 31, 1997 have been derived from the Company's
unaudited financial statements for such periods included elsewhere in this
Prospectus. The results of operations for the three months ended December 31,
1997 are not necessarily indicative of results to be expected for the entire
fiscal year or for other interim periods.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FISCAL YEAR ENDED SEPTEMBER 30, DECEMBER 31,
----------------------------------------------------- ------------------------
1993 1994 1995 1996 1997 1996 1997
--------- --------- --------- --------- --------- ------------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues:
Royalties...................................... $ 1,123 $ 1,697 $ 2,082 $ 2,340 $ 2,913 $ 603 $ 942
License fees................................... 606 350 857 382 540 232 --
Product sales.................................. 573 898 1,429 1,641 2,159 490 497
Research and development....................... 2,328 1,673 1,588 1,819 1,970 330 470
--------- --------- --------- --------- --------- ------------- ---------
Total revenues............................... 4,630 4,618 5,956 6,182 7,582 1,655 1,909
--------- --------- --------- --------- --------- ------------- ---------
Operating costs and expenses:
Product........................................ 415 562 1,258 1,214 1,432 329 250
Research and development....................... 3,229 3,043 2,966 3,317 3,597 812 958
Sales and marketing............................ 588 951 1,061 912 1,098 222 303
General and administrative..................... 1,159 1,147 1,126 1,154 1,418 305 297
--------- --------- --------- --------- --------- ------------- ---------
Total operating costs and expenses........... 5,391 5,703 6,411 6,597 7,545 1,668 1,808
--------- --------- --------- --------- --------- ------------- ---------
Income (loss) from operations.................... (761) (1,085) (455) (415) 37 (13) 101
Other income (expense), net...................... 244 (17) 133 221 199 39 50
--------- --------- --------- --------- --------- ------------- ---------
Net income (loss)................................ $ (517) $ (1,102) $ (322) $ (194) $ 236 $ 26 $ 151
--------- --------- --------- --------- --------- ------------- ---------
--------- --------- --------- --------- --------- ------------- ---------
Net income (loss) per share
(pro forma) (1)
Basic.......................................... $ (.13) $ (.26) $ (.07) $ (.04) $ .05 $ .01 $ .03
Diluted........................................ (.13) (.26) (.07) (.04) .04 .00 .03
Weighted average shares outstanding (pro forma)
(1)
Basic.......................................... 4,009 4,228 4,713 4,776 4,854 4,819 4,904
Diluted........................................ 4,009 4,228 4,713 4,776 5,385 5,334 5,413

SEPTEMBER 30,
----------------------------------------------------- DECEMBER 31,
1993 1994 1995 1996 1997 1997
--------- --------- --------- --------- --------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments........... $ 2,866 $ 4,730 $ 3,192 $ 3,845 $ 3,822 $ 3,637
Total assets..................................... 4,654 7,169 5,849 6,046 6,450 6,341
Total liabilities................................ 2,041 2,580 1,192 1,306 1,348 1,073
Accumulated deficit.............................. (6,777) (7,879) (8,201) (8,395) (8,160) (8,009)
Total stockholders' equity....................... 2,613 4,589 4,657 4,740 5,102 5,268
</TABLE>

- --------------------------
(1) See Note 2 to Financial Statements for determination of weighted average
shares outstanding.

15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

SurModics, Inc. was formed in 1979 to conduct biomedical research for
government agencies and private industry. Historically, the Company relied
heavily on revenues from research grants from U.S. government agencies to fund
its operations. Since 1990, SurModics has focused its efforts on commercializing
its technologies.

As indicated in the table below, the Company's revenues come from four
primary sources: fees from licensing its patented technology to customers;
royalties received from licensees; the sale of photo-reactive chemical compounds
to licensees and stabilization products to the diagnostics industry; and
research and development fees generated on projects for commercial customers and
pursuant to government grants. The Company expects that revenue generated from
government grants will continue to decline slightly as an absolute number but
more significantly as a percentage of total revenue in the future. The table
below reports each revenue category as a percentage of total revenues.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
FISCAL YEAR ENDED SEPTEMBER 30, DECEMBER 31,
------------------------------------- ------------------------
1995 1996 1997 1996 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Royalties......................................... 35.0% 37.9% 38.4% 36.4% 49.3%
License fees...................................... 14.4% 6.2% 7.1% 14.0% --%
Product sales..................................... 24.0% 26.5% 28.5% 29.6% 26.1%
Research and development.......................... 26.6% 29.4% 26.0% 20.0% 24.6%
----- ----- ----- ----- -----
Total........................................... 100.0% 100.0% 100.0% 100.0% 100.0%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</TABLE>

As indicated above, a significant portion of the Company's revenues are
derived from license fees and royalties. Generally, the Company's license
agreements provide for a term of 15 years or the life of the Company's patents
covering the licensed applications, whichever is longer, although the agreement
may be terminated earlier upon notice. These worldwide licenses can be either
exclusive or nonexclusive for a particular device, but over 75% of the Company's
licensed applications are nonexclusive. SurModics requires the payment of a
non-refundable license fee which has historically ranged from $25,000 to
$500,000 and quarterly royalties of 2% to 6% on sales of products incorporating
SurModics' technology. The amount of license fees and royalties are based on
whether the arrangement is exclusive or nonexclusive and the perceived value of
the PhotoLink application to the device. Certain nonrefundable license and
research and development fees are recoverable by the licensees as offsets
against a percentage of future earned royalties.

The Company has attempted to diversify its revenue base by entering into
license agreements with many companies covering multiple product applications.
As of February 5, 1998, SurModics had license agreements with 32 companies
covering 105 applications, of which 59 were generating royalty revenues for the
Company. Most of SurModics' agreements provide for the quarterly payment of the
greater of a minimum royalty or an "earned" royalty based on actual product
sales. Many of the licensed products incorporating SurModics' technology are
still in the early phase of their development, and the Company will not receive
earned royalties on these products until the licensees receive the necessary
regulatory approvals and commercialize these products, if at all. SurModics
anticipates that the Company's royalty revenues will continue to grow in the
future as its licensees succeed in bringing their licensed products to market.

With the exception of the most recently completed fiscal year, the Company
has reported annual losses since inception. During fiscal 1997, the Company
recorded operating income of $37,000 and net income of $236,000. The Company's
accumulated deficit was $8.0 million as of December 31, 1997.

16
<PAGE>
Historically, most of the Company's expenses were incurred in connection
with its research and development activities. As additional products
incorporating the PhotoLink technology are commercialized by the manufacturers
of such products and consequently generate earned royalties for the Company,
management anticipates that the Company will be able to leverage its expense
base into increased profitability. The Company's licensing strategy should allow
it to grow its revenue without corresponding expense growth. However, as stated
in "Use of Proceeds," the Company does intend to further invest in sales,
marketing and technical resources in order to further penetrate its target
markets and to develop additional PhotoLink applications.

RESULTS OF OPERATIONS

THREE MONTHS ENDED DECEMBER 31, 1997 AND 1996

REVENUES. The Company's revenues were $1.9 million for the first quarter of
fiscal 1998, an increase of $254,000, or 15.3%, over the same period of fiscal
1997. The revenue increases were primarily due to an increase in royalty revenue
of 56.2% and an increase in research and development revenue of 42.4%. Two-
thirds of the royalty increase was due to increased royalty payments from Abbott
due to the impact of additional patent rights issued to the Company. All other
royalty revenue increased 32.2% between periods. The research and development
revenue increase consisted of a 105.1% increase in customer-funded research and
development revenue and a 6.9% increase in government-sponsored research and
development revenue. The increase in customer-funded research and development
revenue was due to greater customer development activity. Increases in the above
revenue categories offset the impact of signing no new licenses during the first
quarter of fiscal 1998, compared to revenues of $233,000 from new licenses in
the first quarter of fiscal 1997.

PRODUCT COSTS. The Company's product costs were $250,000 for the first
quarter of fiscal 1998, a decrease of $79,000, or 24.0%, over the same period of
fiscal 1997. Overall product margins increased to 49.7% in the first quarter of
fiscal 1998 from 32.9% in the same period of fiscal 1997. These improvements
were achieved due to a formulation change in certain of the stabilization
products combined with continued increases in the efficiency of reagent chemical
production.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$958,000 for the first quarter of fiscal 1998, an increase of $147,000, or
18.1%, over the same period of fiscal 1997. The change was primarily due to the
added compensation and benefit costs associated with the additional technical
personnel added to the Company over the past year.

SALES AND MARKETING EXPENSES. Sales and marketing expenses were $303,000
for the first quarter of fiscal 1998, an increase of $81,000, or 36.5%, over the
same period of fiscal 1997. This increase was primarily due to additional
marketing personnel and a related increase in travel costs.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $297,000 for the first quarter of fiscal 1998, a decrease of $9,000, or
3.0%, over the same period of fiscal 1997. The decrease was due to lower legal
costs and a reduction in certain other general business expenses offset by
higher compensation costs.

OTHER INCOME (EXPENSE), NET. The Company's net other income was $50,000 for
the first quarter of fiscal 1998, an increase of $11,000, or 26.9%, over the
same period of fiscal 1997 due primarily to increased interest income from
investments.

YEARS ENDED SEPTEMBER 30, 1997 AND 1996

REVENUES. The Company's revenues were $7.6 million for fiscal 1997, an
increase of $1.4 million, or 22.6%, over fiscal 1996. Between years, royalty
revenue increased 24.5%, product sales increased 31.6% and license fees
increased 41.1%. Research and development revenue increased 8.3%, with a 41.0%

17
<PAGE>
increase in customer-funded research and development revenue, partially offset
by a 5.0% decrease in government-sponsored research and development revenue. In
general, these increases were due to greater customer development activity and
increased market penetration of products incorporating SurModics' technology.

PRODUCT COSTS. The Company's product costs were $1.4 million in fiscal
1997, an increase of $217,000, or 17.9%, compared to fiscal 1996. Product
margins increased to 33.7% in fiscal 1997 from 26.0% in fiscal 1996, primarily
due to manufacturing efficiencies achieved in producing reagent chemicals.

RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense was $3.6
million in fiscal 1997, an increase of $280,000, or 8.5%, over fiscal 1996. The
change was primarily due to increased patent-related costs, additional research
studies at external laboratories and additional technical personnel.

SALES AND MARKETING EXPENSE. Sales and marketing expense was $1.1 million
in fiscal 1997, an increase of $186,000, or 20.5%, over fiscal 1996. This
increase was primarily due to additional marketing personnel and increased
customer activities, which resulted in more travel and promotional spending.

GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense was
$1.4 million in fiscal 1997, an increase of $263,000, or 22.8%, compared to
fiscal 1996. The increase was primarily due to incentive compensation.

OTHER INCOME (EXPENSE), NET. The Company's net other income was $198,000 in
fiscal 1997, a decrease of $23,000 or 10.2% from fiscal 1996. This decrease was
due primarily to a reduced level of interest income from investments.

YEARS ENDED SEPTEMBER 30, 1996 AND 1995

REVENUES. The Company's revenues were $6.2 million for fiscal 1996, an
increase of $227,000, or 3.8%, over fiscal 1995. Due to an overall increase in
customer activity, royalty revenue increased 12.4%, product sales increased
14.8% and research and development revenue increased 14.5%, which was comprised
of a 28.9% increase in customer-funded research and development revenue and a
9.6% increase in government-sponsored research and development revenue. License
fees declined $475,000, or 55.4%, to $383,000 in fiscal 1996 due to the timing
of finalizing new license arrangements. Fiscal 1995 included large fees
associated with two license agreements.

PRODUCT COSTS. The Company's product costs were $1.2 million for fiscal
1996, a decrease of $43,000, or 3.4%, compared to fiscal 1995. Product margins
increased to 26.0% in fiscal 1996 from 12.0% in fiscal 1995. This improvement
was primarily due to manufacturing efficiencies achieved in producing reagent
chemicals.

RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense was $3.3
million for fiscal 1996, an increase of $351,000, or 11.8%, over fiscal 1995.
The increase was primarily due to additional compensation-related expense and
research studies at external laboratories, offset by lower patent-related costs.

SALES AND MARKETING EXPENSE. Sales and marketing expense was $912,000 for
fiscal 1996, a decrease of $149,000, or 14.0%, compared to fiscal 1995. This
decrease was primarily attributable to lower compensation costs due to personnel
turnover and lower legal fees associated with the review of new license
agreements.

GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense was
$1.2 million for fiscal 1996, an increase of $29,000, or 2.6%, over fiscal 1995.
The increase was primarily due to higher compensation costs offset by slightly
lower general legal costs.

18
<PAGE>
OTHER INCOME (EXPENSE), NET. The Company's net other income was $221,000
for fiscal 1996, an increase of $88,000, or 66.2%, compared to fiscal 1995. The
primary reason for the increase was the improved performance of the Company's
investment portfolio. Performance of the Company's investment portfolio in
fiscal 1996 included losses of $55,000 on certain investments compared to losses
of $218,000 on these same investments in fiscal 1995. The Company completely
liquidated these investments in the second quarter of fiscal 1996.

NEW ACCOUNTING PRONOUNCEMENTS

See Notes 2 and 4 of Notes to Financial Statements for a discussion of
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," SFAS No. 128, "Earnings Per Share," SFAS No. 130,
"Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information."

NET OPERATING LOSS CARRYFORWARDS

In accordance with Section 382 of the Internal Revenue Code of 1986, as
amended, a change in equity ownership of the Company of greater than 50% within
a three-year period results in an annual limitation on the Company's ability to
utilize its net operating loss ("NOL") carryforwards which accrued during the
tax periods prior to the change in ownership. As of September 30, 1997, the
Company had an NOL carryforward of approximately $6.4 million, which expires in
varying amounts through 2011. The sale of the shares of Common Stock in this
offering will not directly result in such limitation; however, the NOL
carryforwards may become subject to such a limitation due to subsequent changes
in the equity ownership of the Company.

YEAR 2000 COMPLIANCE

The Company has evaluated its information technology infrastructure for Year
2000 compliance and does not expect that the cost to modify its information
technology infrastructure to be Year 2000 compliant will be material to its
financial condition or results of operations. The Company does not anticipate
any material disruption in its operations as a result of any failure by the
Company, or its suppliers or customers to be in compliance.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 1997, the Company had working capital of approximately
$2.5 million. Historically, the Company has primarily funded its operations
through government research grants and equity offerings, the most recent of
which occurred in the third quarter of fiscal 1994. For the last three fiscal
years, the Company has generated positive cash flow from operations.

As of December 31, 1997, the Company had cash, cash equivalents and
investments totaling approximately $3.6 million. The Company's funds are
currently invested in short-term money market funds and investment grade,
interest-bearing securities with maturity dates of less than two years. As of
December 31, 1997, the Company had no debt, nor did it have any credit
agreements. The Company believes that its existing capital resources, including
the net proceeds from this offering, will be adequate to fund the Company's
operations into the foreseeable future.

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<PAGE>
BUSINESS

GENERAL

SurModics is a leading provider of surface modification solutions to the
medical device industry. The Company's primary focus is the commercialization of
its patented PhotoLink process through third-party licensing arrangements.
PhotoLink is a versatile, easily applied, light-activated coating technology
that modifies medical device surfaces by creating covalent bonds between those
surfaces and a variety of chemical agents. Through the PhotoLink process, these
chemical agents can impart many performance-enhancing characteristics, such as
lubricity, hemocompatibility, infection resistance and drug delivery, onto the
surface of a medical device without materially changing the dimensions or
physical properties of the device. The Company believes that medical device
manufacturers who utilize the Company's technology are able to significantly
improve the performance of their products and, in many cases, differentiate
their products in a highly competitive marketplace.

The Company has commercialized its PhotoLink technology through licensing
arrangements with medical device manufacturers which apply the PhotoLink
coatings to their own products. The Company believes this approach allows it to
focus its resources on further development of its technology and expansion of
its licensing activities, while leveraging the established manufacturing, sales
and marketing capabilities of its licensees. Revenues from these arrangements
include initial license fees, minimum royalties and earned royalties based on a
percentage of licensees' product sales. As of February 5, 1998, the Company had
license agreements with 32 companies covering 105 different applications, of
which 59 were generating royalty revenues for the Company. In addition to
licensing its PhotoLink technology, the Company also licenses certain diagnostic
technology to Abbott Laboratories for use with rapid point-of-care diagnostic
tests, such as pregnancy and strep tests. The Company also manufactures and
sells the chemical reagents used in the PhotoLink process and stabilization
products used to extend the shelf-life of immunoassay diagnostic tests.

MARKETS AND NEED FOR SURFACE MODIFICATION

Recent trends in healthcare toward improved patient outcomes and reduced
total costs have resulted in intense competition for the development of medical
devices that demonstrate superior product performance, reduced procedure times,
improved outcomes and overall cost effectiveness. In the highly competitive
medical device industry, many medical device manufacturers may offer similar
competing products for a single medical application. As a result, product
differentiation is critical to marketing success, and medical device
manufacturers are continually seeking new methods of distinguishing their
products from those of their competitors.

Medical device manufacturers have attempted to address these competitive
pressures by developing innovative medical devices manufactured from a wide
variety of synthetic materials, including many new, expensive and exotic
materials. In an effort to further differentiate their products through improved
product performance, a growing number of medical device manufacturers are
turning to the emerging field of surface modification technology. Surface
modification technology enables device manufacturers to

20
<PAGE>
provide medical devices with desired surface characteristics including improved
lubricity, hemocompatibility and infection resistance, as well as the ability to
deliver drugs and promote cell growth and tissue integration.

Although it is an emerging field, surface modification technology has been
used to improve medical devices in many different industry segments. The table
below identifies several of these market segments and the surface properties the
Company believes are desired by each segment.

<TABLE>
<CAPTION>
MARKET SEGMENT SERVED DESIRED SURFACE PROPERTY AND EXAMPLES OF APPLICATIONS
- ---------------------------- -------------------------------------------------------------
<S> <C>
Interventional cardiology LUBRICITY: catheters, guide wires
and vascular access HEMOCOMPATIBILITY: vascular stents, catheters, guide wires
THERAPEUTIC DRUG DELIVERY AND RELEASE: vascular stents,
catheters
INFECTION RESISTANCE: catheters, implantable ports

Cardiac rhythm management LUBRICITY: pacemaker and defibrillator leads,
electrophysiology devices
HEMOCOMPATIBILITY: electrophysiology devices

Cardiothoracic surgery INFECTION RESISTANCE: heart valves
HEMOCOMPATIBILITY: minimally invasive bypass devices,
vascular grafts, ventricular assist devices
CELL GROWTH AND TISSUE INTEGRATION: heart valves, vascular
grafts

Interventional neurology LUBRICITY: catheters, guide wires
and neurosurgery INFECTION RESISTANCE: catheters, shunts

Urology and gynecology LUBRICITY: urinary catheters, incontinence devices, ureteral
stents, fertility devices
INFECTION RESISTANCE: urinary catheters, incontinence
devices, ureteral stents, fertility devices, penile
implants

Orthopedics CELL GROWTH AND TISSUE INTEGRATION: bone regeneration
</TABLE>

In addition to the above-identified market segments, the Company believes
that one of the next areas of growth for surface modification technology will be
the diagnostic test market. Diagnostic tests utilizing biomolecules, such as
DNA, can be used to screen for new drugs, to sequence unknown portions of the
human genome, or to search for signs of viruses. The Company believes
manufacturers of these diagnostic tests may benefit from surface modification
technology to provide biomolecule immobilization and wettability properties.

THE PHOTOLINK SOLUTION

PhotoLink is a versatile, easily applied, light-activated coating technology
that modifies medical device surfaces by creating covalent bonds between those
surfaces and a variety of chemical agents. The PhotoLink process can impart many
performance-enhancing characteristics, such as lubricity, hemocompatibility,
infection resistance and drug delivery, onto the surface of a wide variety of
medical devices without significantly changing the dimensions or physical
properties of the device.

21
<PAGE>
The PhotoLink solution to surface modification involves the utilization of
proprietary, light sensitive (photochemical) reagents. These reagents can
consist of advanced polymers or active biomolecules having desired surface
characteristics and an attached light-reactive chemical compound (photogroup).
As illustrated in the following diagram, when the reagent is exposed to a direct
light source, typically ultraviolet, a photochemical reaction creates a covalent
bond between the photogroup and the surface of the medical device, thereby
imparting the desired property to the surface. A covalent bond is a very strong
chemical bond which results from the sharing of electrons between carbon
molecules of the substrate and the applied coating.

[illustration of the PhotoLink coating process in which a polymer attached
to a photogroup is bonded to a surface when exposed to ultraviolet light]

SurModics' proprietary PhotoLink reagents work on most polymer-based (E.G.,
plastic) substrates, biological substrates (latex rubber, cellulose, tissue and
natural fibers), and metal and glass substrates. Metal and glass substrates
generally require pretreating with polymers to make a carbon-molecule available
for bonding prior to the application of the PhotoLink reagents. The reagents are
easily applied to a clean material surface by dipping, spraying, roll coating,
ink jetting or brushing. SurModics continues to develop proprietary
photochemical reagents providing new product features while expanding the number
and type of substrates on which the reagents can be applied.

ADVANTAGES

The Company believes that its proprietary PhotoLink process provides its
licensees with a number of benefits.

- FLEXIBILITY. PhotoLink coatings can be applied to many different kinds of
surfaces and can immobilize a variety of chemical, pharmaceutical and
biological agents, which allows licensees to be innovative in the design
of their products without significantly changing their dimensions or
physical properties.

- VARIETY OF SURFACE PROPERTIES. The PhotoLink process can be tailored to
provide SurModics' licensees with the ability to improve the performance
of their devices by choosing the specific coating properties desired for
particular applications. The PhotoLink technology also provides the
medical device manufacturer with the ability to combine multiple
surface-enhancing characteristics on the same device.

- EASE OF USE. The PhotoLink coating process is a relatively simple process
that does not require expensive special equipment or the use of hazardous
materials and does not subject the coated products to harsh chemical,
pressure or temperature conditions. Further, PhotoLink coatings are
compatible with all the generally accepted sterilization processes, so the
surface attributes are not lost when the medical device is sterilized
prior to usage.

SURFACE PROPERTIES

SurModics' PhotoLink process has been used by manufacturers of pacemaker
leads, drug infusion catheters, laser and balloon angioplasty catheters, urinary
drainage catheters, vascular closure devices, wound drains, guide wires,
angiography catheters, ureteral stents and hydrocephalic shunts, among other
devices. The PhotoLink process can be used to provide medical device
manufacturers with the following surface properties to improve product
performance:

- LUBRICITY. Low friction or lubricious coatings reduce the force and time
required for insertion, navigation and removal of devices in vascular,
neurological and urogenital applications. Lubricity also reduces tissue
irritation and damage caused by products such as catheters, guide wires
and endoscopy devices. Based on Company and licensee testing, when
compared to uncoated surfaces, the PhotoLink process has reduced the
friction on surfaces by as much as 85% to 95%, depending on the substrate
being coated.

22
<PAGE>
- HEMOCOMPATIBILITY. Hemocompatible coatings help reduce adverse reactions
that may be created when a device is inserted into the body and comes in
contact with blood. Heparin has been used for decades as an injectable
drug to reduce blood clotting in patients. SurModics can immobilize
heparin on the surface of blood-contacting medical devices thereby
inhibiting blood clotting on the device surface, minimizing patient risk
and enhancing the performance of the device. PhotoLink heparin coatings
have been shown in Company and licensee testing to reduce blood clotting
by greater than 90% compared to uncoated surfaces. SurModics has
immobilized several other chemical agents in addition to heparin that have
also demonstrated improved hemocompatibility.

- INFECTION RESISTANCE. Antimicrobial coatings are advantageous for most
implantable medical devices where risk of infection is a concern.
PhotoLink technology can apply passive coatings which significantly reduce
bacterial adhesion to the device or active coatings incorporating
antimicrobial agents which kill bacteria around the device. Testing by the
Company has demonstrated that the PhotoLink process reduces the adherence
of microorganisms to biomaterial surfaces by 97% to over 99% depending on
the base material of the device. In addition, when compared to uncoated
products, the PhotoLink process has been shown to increase the uptake of
antimicrobial agents applied to the device just prior to implantation and
prolong the release of these agents.

- DRUG DELIVERY. PhotoLink technology can be used to crosslink polymers and
create reservoirs to entrap drugs on the surface of medical devices. These
drugs can then be released from the surface on a controlled basis by
tailoring the polymers, by adjusting the extent of crosslinking, or by
using a barrier coating to control diffusion. For example, SurModics has
developed a PhotoLink coating that would allow a coronary stent
manufacturer to incorporate a drug onto the stent directed at reducing the
incidence of restenosis (the re-narrowing of the artery).

- WETTABILITY. PhotoLink hydrophilic coatings have been shown in tests by
the Company and its licensees to accelerate liquid flow rates on normally
hydrophobic (water repelling) materials by 75%. Rapid point-of-care
diagnostic tests, such as home monitoring or physician monitoring of
glucose levels in diabetics, are currently done by pricking a patient's
finger and carefully placing a drop of blood onto a polymer strip which is
then inserted into a blood glucose reader. The Company believes that the
time it takes for the blood to flow up the strip to provide the patient
with a readout can be dramatically reduced and the consistency can be
greatly improved with PhotoLink technology.

- CELL GROWTH, TISSUE INTEGRATION AND OTHER TISSUE ENGINEERING. Studies have
shown that attachment of extracellular matrix proteins and peptides onto
surfaces of implantable medical devices improves host cell attachment,
growth and subsequent tissue integration. PhotoLink technology has been
used to coat biomedical devices with photoreactive collagens and other
proteins upon which cells normally grow within the body. Company studies
have shown that biomedical devices (such as vascular grafts and ocular
implants) coated with such proteins, have improved attachment, growth of
cells and acceptance by surrounding tissues. In addition, the Company is
also using its PhotoLink technology to produce three-dimensional scaffolds
to promote bone regeneration.

- BIOMOLECULE IMMOBILIZATION. During a DNA gene analysis, typically hundreds
of different probes need to be placed in a pattern on a surface, called a
DNA array. These arrays can be used by the pharmaceutical industry to
screen for new drugs, by genome mappers to sequence unknown portions of
the human genome, or by diagnostic companies to search a patient sample
for disease-causing bacteria or viruses. However, DNA does not readily
adhere to most surfaces that are important for DNA assays. The Company has
demonstrated a versatile method for the immobilization of DNA on various
surfaces.

23
<PAGE>
STRATEGY

The Company's goal is to be the leading provider of surface modification
solutions to companies in the medical device industry. To achieve this goal,
SurModics intends to implement the following key strategies:

- FURTHER PENETRATE AND EXPAND ITS LICENSING BASE. The Company intends to
continue to focus on commercializing its technology through
application-by-application licensing agreements with medical device
manufacturers. Under this strategy, SurModics intends to continue to
license its PhotoLink technology to multiple licensees within the same
market, thereby increasing SurModics' revenue potential.

- FURTHER DEVELOP APPLICATIONS FOR THE PHOTOLINK TECHNOLOGY. The PhotoLink
process is extremely flexible, which provides the Company with many
potential useful applications in the medical device industry. The Company
intends to devote research and development efforts to further enhance the
lubricious, hemocompatible and infection resistant properties of its
existing PhotoLink applications, and to further develop applications
involving controlled drug delivery and release, DNA immobilization and
cell growth and tissue integration.

- EXPAND SALES AND MARKETING RESOURCES. Because of the technical nature of
the Company's operations, SurModics' marketing strategy is to utilize a
technically sophisticated direct sales force, which works closely with
both the Company's and its customers' development staff. The Company
intends to increase its direct sales resources to increase market
awareness of the Company's technological capabilities and developments.
The Company also intends to improve its market research capabilities to
investigate new PhotoLink applications.

- SEEK JOINT DEVELOPMENT PROGRAMS. The Company intends to aggressively
pursue opportunities with medical device companies to expand its
technology, internal expertise and revenue base while reducing
developmental risks by sharing them with others. SurModics is engaged in
several such joint development programs, including one regarding
controlled drug delivery and release and another involving DNA
immobilization.

- EXPAND THE COMPANY'S PRODUCT PORTFOLIO. SurModics believes that it can
utilize its know-how and expertise in surface modified devices,
photoreactive crosslinking and bonding, and reagent chemistry to develop
additional proprietary products that SurModics can directly sell, rather
than license, to the medical marketplace. The Company may acquire
technologies and products which are closely related to or utilize its
technology, thereby allowing the Company to leverage its existing presence
in the medical marketplace.

CURRENT LICENSING ARRANGEMENTS

The Company has commercialized its PhotoLink technology through licensing
arrangements with medical device manufacturers who apply the PhotoLink coatings
to their own products. The Company believes this approach allows it to focus its
resources on further developing its technology and expanding its licensing
activities, while leveraging the established manufacturing, sales and marketing
capabilities of its licensees for the marketing of the specific medical device
utilizing the PhotoLink technology. The Company believes its licensees generally
find the licensing arrangement to be beneficial for them because it is designed
to allow manufacturers to incorporate the PhotoLink process into their own
manufacturing processes without the need to send product outside their facility,
resulting in tighter quality control and reduced investment in work-in-process
inventory.

As of February 5, 1998, SurModics had license agreements with 32 companies
covering 105 applications. The following table identifies selected licensees of
SurModics' PhotoLink technology, some of the

24
<PAGE>
medical devices that incorporate SurModics' technology and the surface
characteristics sought by the licensee.

<TABLE>
<CAPTION>
SELECTED LICENSEES SELECTED MEDICAL DEVICE(1) DESIRED SURFACE PROPERTY
- -------------------------------- ---------------------------------------- ----------------------------
<S> <C> <C>
Cook Incorporated Angiography catheters* Hemocompatibility
Urinary catheters* Lubricity
Guide catheters
Intravascular stents
Guide wires
Balloon dilitation catheters

Cordis Corporation Intravascular stents Hemocompatibility
(a Johnson & Johnson company) Therapeutic drug release

Medtronic PS Medical Hydrocephalic shunts* Lubricity
Central venus access catheter*

Pacesetter, Inc. Implantable pacemaker Infection resistance
(a St. Jude Medical, Inc. components* Lubricity
company) Implantable defibrillator
components

Perclose, Inc. Vascular closure device* Lubricity

Sulzer Carbomedics Sewing rings for biologically derived Hemocompatibility
(a division of Sulzer Medica and synthetic heart valves
USA, Inc.) Synthetic heart valve components

Target Therapeutics, Inc. Neurovascular infusion catheters* Lubricity
(a subsidiary of Boston Neurovascular guide wires*
Scientific Corporation) Neurovascular guide catheters*
</TABLE>

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

(1) The devices marked with an asterisk are currently generating earned
royalties for SurModics based on the respective licensee's sale of the
medical device incorporating SurModics' technology. The devices not marked
with an asterisk are in the development stage and may never generate earned
royalties for the Company.

The licensing process begins with the medical device manufacturer specifying
the surface characteristics it desires. Because each surface is unique, the
Company routinely conducts a feasibility study at no charge to the customer to
qualify each new potential product application. Once the feasibility has been
proven, the customer typically funds further development by SurModics to
optimize the coating formulation to meet the customer's technical and financial
needs. A license agreement is then executed granting the licensee the rights to
use the technology. SurModics' technical personnel are then available to provide
services in the transfer of the PhotoLink technology into the licensee's
manufacturing process. Such services can include further coating optimization,
process control and trouble shooting which are billable to the licensee. The
Company also manufactures and sells the chemical reagents used in the PhotoLink
process, thus creating another source of revenue.

The term of a license agreement is generally for a period of 15 years or the
life of SurModics' patents covering the licensed application, whichever is
longer, although an agreement may be terminated for any reason upon prior
written notice, typically required at least 90 days before termination. The
worldwide license can be either exclusive or nonexclusive for a particular
medical device, but over 75% of the Company's licensed applications are
nonexclusive. SurModics requires the payment of a non-refundable

25
<PAGE>
license fee which has historically ranged from $25,000 to $500,000 and quarterly
"earned" royalties of 2% to 6% on the sales of products incorporating SurModics'
technology. The amount of license fees and royalties are based on whether the
arrangement is exclusive or nonexclusive and the perceived value of the
PhotoLink application to the device. Certain nonrefundable license and research
and development fees are recoverable by the licensees as offsets against a
percentage of future earned royalties. Most of SurModics' agreements incorporate
a minimum royalty to be paid by the licensee while the medical devices are
developed, tested and commercialized. In certain cases, payment of these minimum
royalties may not commence until several months after the execution of an
agreement for a particular application.

OTHER PRODUCTS

STABILIZATION PRODUCTS

Although the primary focus of the Company is the development and marketing
of its PhotoLink technology, the Company also develops and markets stabilization
products for use by manufacturers of immunoassay diagnostic tests. SurModics'
StabilCoat and StabilZyme Stabilizers are designed to maintain the activity of
biological components of the immunoassays, resulting in a longer shelf-life.
These products offer SurModics' customers the benefit of product differentiation
and improvement while providing the ultimate end users the benefit of a faster
test with fewer steps and fewer errors. In fiscal 1997, SurModics generated $1.7
million of revenue from its stabilization products.

DIAGNOSTIC FORMATS

The Company also licenses a format for IN VITRO diagnostic tests developed
during the early years of the Company. This format has found broad application
in the expanding area of rapid point-of-care diagnostic testing, such as
pregnancy and strep tests, and generated $1.5 million of royalty revenue for the
Company in fiscal 1997 pursuant to the license agreement with Abbott. Although
this revenue is expected to grow in the future with the increased sales of
licensed products, limited additional SurModics-funded research and development
is being undertaken in this area.

INDUSTRIAL APPLICATIONS

While it is not the Company's primary focus, the Company occasionally
pursues industrial applications for its PhotoLink technology. The Company only
pursues those applications that are perceived to be high-value applications in a
market that is not considered to be price sensitive. To date, revenue associated
with industrial applications has been immaterial and is not expected to be
significant in the foreseeable future.

RESEARCH AND DEVELOPMENT

SurModics' research and development department supports the marketing staff
in performing feasibility studies, providing technical assistance to potential
licensees, optimizing the coating methodologies for specific licensee
applications, assisting in training licensees and integrating the Company's
technology and know-how into licensee manufacturing processes. In addition, the
research and development department works to enhance and expand the PhotoLink
technology through the development of new reagents and new applications.

As medical devices become more sophisticated and complex, the Company
believes the requirements for optimized surface properties will grow. The
Company intends to continue its development efforts to allow its PhotoLink
technology to provide additional optimized surface properties to meet these
needs. The Company's technical strategy is to target selected coating
characteristics for further development prior to licensing, in order to
facilitate and shorten the license cycle. The Company has begun to perform
research into applications for future products both on its own and in
conjunction with some of its licensees. Some of the identified research and
development opportunities include coatings designed to improve the
characteristics of long-term implants, site-specific drug release, orthopedic
repair materials and devices, long-term blood compatibility and DNA
immobilization methods. In addition to expanding the number of medical
applications that may use PhotoLink technology, the Company intends to broaden
the spectrum of surfaces on which reagents can be applied, improve the coating
process for metals and glass, develop a

26
<PAGE>
process for coating the interior diameter of medical devices, expand the
portfolio of PhotoLink reagents, and develop additional proprietary products in
which PhotoLink reagents serve as the end product.

The technical staff of the Company consists of 45 scientists, including
eight with Ph.D. degrees, four with Masters degrees and 30 with Bachelor
degrees, with expertise in chemistry, biomedical engineering, biology,
microbiology, cell biology and biochemistry. The technical staff is organized
into five areas of specialization: hydrophilicity, microbiology,
hemocompatibility, biochemistry and tissue engineering. In addition, a chemistry
group supports the synthesis of new reagents needed by the other five groups.
SurModics intends to use a portion of the net proceeds from this offering to
hire additional technical personnel.

In fiscal 1996 and 1997, the Company's research and development expenses
were $3.3 million and $3.6 million, respectively. The Company's research and
development efforts are often funded by commercial licensees and government
agencies. Such research and development revenues during these periods were $1.8
million and $2.0 million, respectively.

Since its founding, the Company has actively participated in the federal
government's Small Business Innovative Research ("SBIR") program to fund
development efforts. Since 1979, 136 research contracts resulting in revenues of
over $23 million have been awarded to SurModics, primarily under the SBIR
program. Grant proposals are generally directed toward the commercial strategies
of the Company. The Company retains commercial rights to discoveries and
technologies resulting from the research and development efforts funded by these
grants. Where possible, licensees' products or substrates are used when
performing research under the grant; thus the results are often directly
applicable to SurModics' licensees. Grant funding has also allowed SurModics to
maintain a larger and more technologically diverse employee base than would
otherwise be possible.

PATENTS AND PROPRIETARY RIGHTS

The Company has taken steps intended to protect certain PhotoLink related
inventions through a series of patents covering a variety of coating reagents
and formulations, as well as particular medical device applications, based on or
employing the Company's proprietary photoreactive chemistry. The patents related
to the PhotoLink technology include 13 issued U.S. patents, nine pending U.S.
patent applications, eight issued foreign patents, 27 pending foreign patent
applications and two pending international patent applications. The Company
generally files international patent applications in parallel with its U.S.
applications. The Company generally files national or regional applications in
Australia, Canada, Europe, Japan, and Mexico. In addition to the patents related
to the PhotoLink technology, SurModics has four issued U.S. patents, two pending
U.S. patent applications, 13 issued foreign patents and nine pending foreign
patent applications related to its diagnostic technology. There can be no
assurance that any of the pending patent applications will be allowed.

The commercial success of the Company will depend, in part, on its ability
to successfully assert its patents against infringers, to continue to obtain
patent protection for newly developed technology, and to avoid infringing
patents issued to others, all of which there can be no assurance. Furthermore,
there can be no assurance that others will not independently develop similar
products, duplicate any of the Company's products or, if patents are issued to
the Company, design around, circumvent or challenge the Company's patents. There
can also be no assurance that the Company's trade secrets or confidentiality
agreements with potential licensees or other parties will provide meaningful
protection for the Company's unpatented proprietary information. Litigation,
which could result in substantial costs to the Company and substantial diversion
of the efforts of its management and technical personnel, may be necessary to
protect the Company's intellectual property rights or to determine the scope and
validity of third-party proprietary rights.

The Company also relies heavily upon trade secrets and unpatented
proprietary technology. The Company seeks to maintain the confidentiality of
such information by requiring employees, consultants and other parties to sign
confidentiality agreements and by limiting access by parties outside the Company

27
<PAGE>
to such information. There can be no assurance, however, that these measures
will prevent the unauthorized disclosure or use of this information or that
others will not be able to independently develop such information. Additionally,
there can be no assurance that any agreements regarding confidentiality and
non-disclosure will not be breached, or, in the event of any breach, that
adequate remedies would be available to the Company.

MARKETING AND SALES

The Company markets its PhotoLink technology throughout the world using a
direct sales force consisting of four licensing managers who focus on specific
markets such as cardiology devices, diagnostic products and urology products.
This specialization fosters an in-depth knowledge of the issues faced by
SurModics' licensees within these markets such as technology changes,
biomaterial changes and the regulatory environment.

Because the sales cycle can take several months from feasibility
demonstration to the execution of a license agreement, the Company focuses its
sales efforts on potential licensees with established market positions rather
than those with only development stage products which may never come to market.
Generally, the PhotoLink technology is licensed to medical device manufacturers
for use on specific products. This strategy enables the Company to license the
PhotoLink technology to multiple licensees in the same market. SurModics also
targets selling new applications to existing licensees. The Company believes the
sales cycle is much faster in these situations because the licensee is already
familiar with the technology and the general terms of the license have already
been negotiated. The Company intends to use a portion of the net proceeds from
this offering to increase the size of its direct sales staff and to expand its
market research capabilities to investigate new PhotoLink applications.

As part of its marketing strategy, the Company publishes technical
literature on each surface capability of the PhotoLink technology (I.E.,
lubricity, hemocompatibility, etc.). In addition, the Company participates at
major trade shows and technical meetings, advertises in trade journals and
through its website, and conducts direct mailings to appropriate target markets.

The Company also offers ongoing customer service and technical support
throughout a licensee's relationship with SurModics. This service and support
includes a coating feasibility study at no charge to the licensee as well as
services in connection with the transfer of the technology to the licensee,
which can include billable services such as further coating optimization,
process control and trouble shooting. SurModics also generally assists the
licensee at no charge with FDA submissions for coated product approval.

COMPETITION

Competition in the medical device industry has resulted in an increase in
competition in the surface modification market. The Company's PhotoLink
technology competes with technologies developed by Biocompatibles International
plc, Carmeda (a division of Norsk Hydro, Inc.), Specialty Coatings Systems,
Spire Corporation and STS Biopolymers Inc., among others. In addition, many
medical device manufacturers have developed or are engaged in efforts to develop
surface modification technologies for use on their own products. Most
competitors marketing surface modification to the outside marketplace are
divisions of organizations with businesses in addition to surface modification.
Overall, the Company believes the worldwide market is very fragmented with no
competitor marketing to third parties having more than a 10% market share. Many
of the Company's existing and potential competitors (including medical device
manufacturers pursuing coating solutions through their own research and
development efforts) have substantially greater financial, technical and
marketing resources than the Company.

SurModics attempts to differentiate itself from its competition by providing
what it believes is a high value-added solution to surface modification. The
Company believes that the primary factors customers consider in choosing a
particular surface modification technology are performance, ease of
manufacturing, ability to produce multiple properties from a single process,
compliance with manufacturing regulations, customer service and pricing. The
Company believes that its PhotoLink process competes favorably with respect to
these factors, enabling it to charge a premium price. The Company believes that
the cost and

28
<PAGE>
time required to obtain the necessary regulatory approvals significantly reduces
the likelihood of a manufacturer changing the coating process it uses once a
device has been approved for marketing.

Because a significant portion of the Company's revenue is dependent on the
receipt of royalties based on sales of medical devices incorporating PhotoLink
coatings, the Company is also affected by competition within the markets for
such devices. The Company believes that the intense competition within the
medical device markets creates opportunities for the Company's coating
technology as medical device manufacturers seek to differentiate their products
through new enhancements or to remain competitive with enhancements offered by
other manufacturers. Because the Company seeks to license its technology on a
non-exclusive basis, the Company may further benefit from competition within the
medical device markets by offering its PhotoLink technology to multiple
competing manufacturers of a device. However, competition in the medical device
markets could also have an adverse affect on the Company. While the Company
seeks to license its products to established manufacturers, in certain cases the
Company's licensees may compete directly with larger, dominant manufacturers
with extensive product lines and greater sales, marketing and distribution
capabilities. The Company also is unable to control other factors that may
impact commercialization of PhotoLink-coated devices, such as the marketing and
sales efforts of its licensees or competitive pricing pressures within the
particular device market. There can be no assurance that products coated with
the PhotoLink technology will be successfully commercialized by the Company's
licensees or that such licensees will otherwise be able to effectively compete.

The primary competition for SurModics' stabilization products is its
customers' internally developed formulations. The consolidation of the
diagnostic industry increases the availability of internally developed
stabilizers to the market. There are several direct competitors that have
recently emerged, of which Pierce Medical Products, Inc. and Medix, Inc. are the
two largest. The Company believes that quick market penetration is the best
strategy for addressing these threats. As in the coating market, the Company
also believes that once its stabilization products are accepted in an
FDA-approved diagnostic test, the likelihood of change is reduced because of the
cost and time required to qualify a new component. SurModics' marketing strategy
for its stabilization products is to develop a strong market presence by
offering superior product performance and technical service.

MANUFACTURING

In accordance with its licensing strategy, the Company does not perform the
actual coating of its licensees' medical devices, nor does it manufacture any of
these devices. The Company has, however, adopted a strategy of developing and
manufacturing the reagents itself, allowing it to maintain the quality of the
reagents and their proprietary nature, while providing an additional source of
revenue. PhotoLink reagents are specialty photoreactive chemicals that are
prepared using a proprietary formula in small batch processes (as contrasted
with commodity chemicals prepared by large continuous methods). Generally, all
PhotoLink reagents share a similar production process: a water soluble polymer
is synthesized in a glass reactor; reactive photochemical groups are attached to
the polymer; the solution is purified and freeze-dried, thus removing the water
and creating a solid; and the PhotoLink reagents are packaged in standard
quantities in light- and moisture-proof packaging. The reagents are sold dry,
requiring the licensee, in most cases, to simply add water or a water and
isopropyl alcohol mix before application. The Company has developed proprietary
testing and quality assurance standards for manufacturing the reagents and does
not disclose the reagent formulas or manufacturing methods. Although licensees
may purchase the requisite chemical reagents from any source, all have elected
to purchase them from the Company.

29
<PAGE>
The Company also manufactures its stabilization products. These products are
a group of sterile-filtered liquids that generally share a three-step production
process. A standard recipe of chemicals is mixed in high purity water, these
liquids are sterile-filtered into specific container sizes under aseptic
conditions, and the resultant finished goods are packaged and labeled.

The Company maintains multiple sources of supply for the key raw materials
used to manufacture reagents and stabilization products. The Company does,
however, purchase some raw materials from single sources, but it believes that
additional sources of supply are readily available.

Although not required to follow Good Manufacturing Practice quality
procedures, SurModics does follow such procedures in part to respond to requests
of licensees to establish compliance with their criteria. The Company has not
yet sought ISO 9001 certification but may do so in the future.

GOVERNMENT REGULATION

Although PhotoLink technology itself is not directly regulated by the FDA,
the medical devices incorporating this technology are subject to FDA regulation.
The burden of demonstrating safety and efficacy of such medical devices, the
ultimate criteria applied by the FDA, rests with the Company's licensees (the
medical device manufacturers). Medical products incorporating the PhotoLink
technology may generally be marketed only after 510(k) or PMA applications have
been submitted and approved by the FDA, which process can take anywhere from six
months for a 510(k) application and to two or three years for a PMA application.
These applications are prepared by the manufacturer and contain results of
extensive laboratory toxicity, mutagenicity and clinical evaluations on animals
and humans conducted by the manufacturer.

The Company maintains confidential Device Master Files at the FDA regarding
the nature, chemical structure and biocompatibility of the PhotoLink reagents.
Although the Company's licensees do not have access to these files, the
licensees may, with the permission of the Company, reference these files in any
medical device submission to the FDA. This process allows the FDA to understand
in confidence the details of the PhotoLink technology without the Company having
to share this highly confidential information with its licensees.

Recent U.S. legislation allows device manufacturers, prior to obtaining FDA
approval to market a medical device in the U.S., to manufacture such medical
device in the U.S. and export it for sale in international markets, which could
allow SurModics to realize earned royalties sooner. However, sales of medical
devices outside the U.S. are subject to international requirements that vary
from country to country. The time required to obtain approval for sale
internationally may be longer or shorter than that required by the FDA.

EMPLOYEES

As of February 1, 1998, SurModics had 76 full-time and seven part-time
employees of whom 51 were engaged in development or manufacturing positions,
with the remainder in marketing, quality or administrative positions. Of
SurModics' employees, eight hold Ph.D. degrees and eight hold Masters degrees.
The Company is not a party to any collective bargaining agreements and believes
that its employee relations are good.

Management believes that the future success of the Company will depend in
part on its ability to attract and retain qualified technical, management and
marketing personnel. Such experienced personnel are in high demand, and the
Company must compete for their services with other firms which may be able to
offer more favorable benefits.

30
<PAGE>
FACILITIES

SurModics leases approximately 35,000 square feet of office/warehouse space
in Eden Prairie, Minnesota under a lease that expires at the end of 1999.
SurModics has an option to extend this lease through the end of 2001. The lease
commitment for fiscal 1998 is approximately $210,000. Of the total leased space,
approximately 15,000 square feet is office space, 13,000 square feet is
laboratory space and 7,000 square feet is manufacturing space. Approximately
6,000 square feet of the manufacturing space is a HEPA-filtered, highly
controlled environment, but not certified as a "clean room" under FDA standards.
The Company believes that projected capacity of the manufacturing area is
adequate to service the needs of its licensees for the foreseeable future.

LEGAL PROCEEDINGS

The Company is not a party to nor is any of its property subject to any
material pending legal proceedings.

31
<PAGE>
MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- -------------------------------------------------
<S> <C> <C>
Dale R. Olseth................ 67 Chairman of the Board, President and Chief
Executive Officer

Stephen C. Hathaway........... 42 Vice President and Chief Financial Officer

Patrick E. Guire, Ph.D........ 61 Senior Vice President of Research and Technology
and Director

James C. Powell............... 48 Vice President of Technical Operations

Andrew B. Summerville......... 52 Vice President of Marketing

Walter H. Diers, Jr........... 46 Vice President of Corporate Development

Marie J. Versen............... 36 Vice President of Quality Management and
Regulatory Compliance

Donald S. Fredrickson, M.D. 73 Director
(2).........................

James J. Grierson (1)......... 55 Director

Kenneth H. Keller, Ph.D. 63 Director
(1)(2)......................

David A. Koch (1)(2).......... 67 Director

Kendrick B. Melrose (1)(2).... 57 Director
</TABLE>

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

(1) Member of Audit Committee

(2) Member of Compensation Committee

DALE R. OLSETH joined the Company in 1986 as its President, Chief Executive
Officer and a director of the Company and has served as Chairman of the Board
since 1988. Mr. Olseth also serves on the Board of Directors of The Toro Company
and Graco, Inc. He served as Chairman or President and Chief Executive Officer
of Medtronic, Inc. from 1976 to 1986. From 1971 to 1976, Mr. Olseth served as
President and Chief Executive Officer of Tonka Corporation. Mr. Olseth received
a B.B.A. degree from the University of Minnesota in 1952 and an M.B.A. degree
from Dartmouth College in 1956.

STEPHEN C. HATHAWAY joined the Company as its Vice President and Chief
Financial Officer in September 1996. Prior to joining SurModics, he served as
Director of Finance for Ceridian Employer Services, Ceridian Corporation from
1995 to 1996. Prior to that, Mr. Hathaway was Vice President-- Finance &
Operations for Wilson Learning Corporation from 1988 to 1995. He also spent ten
years with Arthur Andersen LLP. Mr. Hathaway received a B.S. degree in
accounting in 1977 from Miami University and became a Certified Public
Accountant in 1980.

PATRICK E. GUIRE, PH.D. is a co-founder of the Company and has served as
Senior Vice President of Research and Technology and a director since 1980. Dr.
Guire is responsible for the research affairs of the Company. Prior to founding
SurModics, Dr. Guire was employed by Kallestad Laboratories, Inc. as a senior
scientist from 1978 to 1979 and was a researcher at the Midwest Research
Institute, Inc. in Kansas City, Missouri from 1972 to 1978. He received a B.S.
degree in Chemistry from the University of Arkansas, Fayetteville in 1958 and a
Ph.D. in biochemistry from the University of Illinois in 1963.

JAMES C. POWELL joined the Company in 1987, and in 1992 became its Vice
President of Technical Operations. He was employed at Precision-Cosmet Company,
Inc., a manufacturer of contact and intraocular lenses, from 1978 until he
joined SurModics. Mr. Powell received a B.S. degree in wood

32
<PAGE>
sciences from Texas A&M University in 1972 and an M.S. degree in polymer science
in 1975 from the University of Washington.

ANDREW B. SUMMERVILLE joined the Company in 1994, and in 1995 became its
Vice President of Marketing. He held various sales and marketing positions with
Graco, Inc. from 1986 until joining SurModics. Prior to that, Mr. Summerville
held similar positions with 3M Company. Mr. Summerville received a B.A. degree
in applied science and a B.S. degree in material science from Lehigh University
in 1968 and an M.B.A. degree from Dartmouth College in 1970.

WALTER H. DIERS, JR. joined the Company in 1988 and currently serves as Vice
President of Corporate Development. He served as a consultant to several small,
high technology companies from 1984 until he joined SurModics. Prior to that, he
was the Controller of the Laserdyne division of Data Card Corporation. Mr. Diers
received a B.S. degree in economics and a B.S. degree in business in 1977 and an
M.B.A. degree in finance in 1979 from the University of Minnesota.

MARIE J. VERSEN joined the Company in 1987, and in 1996 became its Vice
President of Quality Management and Regulatory Compliance. She was previously
employed at Precision-Cosmet Company, Inc. from 1983 to 1986. Ms. Versen
received a B.S. degree in chemical engineering from the University of Minnesota
in 1983.

DONALD S. FREDRICKSON, M.D. was elected a director of the Company in
February 1991. He has served as President and Chief Executive Officer of D.S.
Fredrickson Associates, Inc., an international medical research and biomedical
consulting firm since 1987. Dr. Fredrickson served as Vice President, President
and Chief Executive Officer during his tenure at the Howard Hughes Medical
Institute in Washington D.C. from 1983 to 1987. During 1982 and 1983, he served
as a scholar-in-residence at the National Academy of Sciences of the United
States of America. From 1975 to 1981, he served as the Director of the National
Institutes of Health. Dr. Fredrickson received his medical degree from the
University of Michigan.

JAMES J. GRIERSON was elected a director of the Company in 1988. He served
as Vice President of Business Development for Honeywell, Inc. from 1992 until
his retirement in 1996. He was Vice President of Finance of Honeywell from 1987
to 1992 and its Vice President and Treasurer from 1982 to 1987.

KENNETH H. KELLER, PH.D. was elected a director of the Company in 1997. He
has served as Professor of Science and Technology Policy in the Hubert H.
Humphrey Institute of Public Affairs at the University of Minnesota since 1996.
Dr. Keller was a Senior Fellow at the Council on Foreign Relations from 1989 to
1997. Dr. Keller joined the Chemical Engineering and Materials Science faculty
of the University of Minnesota in 1964, and through the years assumed increasing
administrative responsibilities, including serving as the twelfth President of
the University in 1985, a position he held until 1988, when he moved to
Princeton University as a Visiting Fellow. Dr. Keller received a B.A. degree in
liberal arts and a B.S. degree in chemical engineering from Columbia University
in 1956 and 1957, respectively, and his M.S.E. and Ph.D. degrees in 1963 and
1964, respectively, from The Johns Hopkins University.

DAVID A. KOCH was elected a director of the Company in 1988. He has served
as the Chairman of Graco, Inc. since 1985, as its Chief Executive Officer from
1962 to 1996 and as its President and Chief Executive Officer from 1962 to 1985.
Mr. Koch is also a director of ReliaStar Financial Corporation and is Chair of
the Federal Reserve Bank of Minneapolis.

KENDRICK B. MELROSE was elected a director of the Company in 1988. He has
served as Chairman of the Board and Chief Executive Officer of The Toro Company
since 1987, served as its Chief Executive Officer from 1983 to 1987 and as its
President from 1981 to 1983. Mr. Melrose is also a director of Donaldson
Company, Inc., Valspar Corporation and Jostens, Inc.

The number of directors is determined by the stockholders at their annual
meeting, subject to the right of the stockholders to change such number between
annual meetings and to the right of the Board to increase such number between
annual meetings. All directors hold office until the next annual meeting of

33
<PAGE>
stockholders or until their successors have been duly elected and qualified.
Executive officers of the Company are appointed by and serve at the discretion
of the Board of Directors. The Board of Directors has a Compensation Committee
which provides recommendations concerning salaries and other compensation to be
paid to executive officers of the Company and administers the Company's employee
stock plans. The Board also has an Audit Committee which is responsible for
reviewing the Company's audit process.

The Company does not pay any directors' fees. Non-employee directors are
generally compensated with non-qualified options as determined by the Board of
Directors from time to time. The non-employee directors currently hold
non-qualified options to purchase an aggregate of 200,000 shares of Common
Stock. All such options have an exercise price equal to the fair market value of
a share of Common Stock on the day of grant and expire five to ten years after
the date of grant. Such options vest over five year periods commencing on the
date of grant. In addition, Messrs. Grierson and Fredrickson are reimbursed for
their expenses incurred in attending meetings of the Board of Directors. See
"Principal Stockholders."

EXECUTIVE COMPENSATION

COMPENSATION SUMMARY. The following table sets forth certain information
regarding compensation earned or awarded to the President and Chief Executive
Officer and each of the other four most highly compensated executive officers
(the "Named Executive Officers") during the Company's fiscal year ended
September 30, 1997.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
----------------------- ALL OTHER
NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY($) BONUS($)(1) COMPENSATION($)(2)
- ------------------------------------------------------------ ----------- ---------- ----------- -------------------
<S> <C> <C> <C> <C>
Dale R. Olseth,
President and Chief Executive Officer..................... 1997 $ 109,598 $ 20,408 $ 2,100
Stephen C. Hathaway,
Vice President and Chief Financial Officer................ 1997 $ 90,000 $ 22,493 $ 618
Patrick E. Guire, Ph.D.,
Senior Vice President of Research and Technology.......... 1997 $ 86,250 $ 16,327 $ 1,680
James C. Powell,
Vice President of Technical Operations.................... 1997 $ 96,246 $ 18,463 $ 1,830
Andrew B. Summerville,
Vice President of Marketing............................... 1997 $ 89,160 $ 16,523 $ 1,675
</TABLE>

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

(1) Represents amounts earned under a bonus plan established in fiscal 1997 for
the Company's officers enabling them to receive a payout of up to 24% of
their base salary. The amount of the bonus was determined based on the
achievement of certain revenue and profit goals for the year. The plan was
reviewed and approved by the Board of Directors. Mr. Hathaway's bonus
includes an additional bonus paid upon commencement of employment with the
Company.

(2) Represents contributions made by the Company under its 401(k) plan.

34
<PAGE>
OPTION GRANTS. The following table sets forth information regarding stock
options granted during the fiscal year ended September 30, 1997 to the Named
Executive Officers.

OPTION GRANTS
(INDIVIDUAL GRANTS)

<TABLE>
<CAPTION>
NUMBER OF PERCENT OF TOTAL
SECURITIES OPTIONS GRANTED TO EXERCISE OR
UNDERLYING OPTIONS EMPLOYEES IN FISCAL BASE PRICE EXPIRATION
NAME GRANTED(#) 1997 ($/SH) DATE
- ------------------------------------------- ------------------- ----------------------- ------------- -----------
<S> <C> <C> <C> <C>
Dale R. Olseth............................. -- -- -- --
14,000 9.2% $ 5.00 1/1/02
30,000 19.8% $ 5.00 11/18/01
30,000 19.8% $ 5.00 11/18/03
Stephen C. Hathaway........................
Patrick E. Guire, Ph.D..................... 20,000 13.2% $ 5.00 1/1/02
James C. Powell............................ -- -- -- --
Andrew B. Summerville...................... 16,000 10.6% $ 5.00 1/1/02
</TABLE>

AGGREGATE OPTION EXERCISES AND YEAR-END OPTION VALUES. The following table
sets forth certain information regarding options exercised and the number and
value of exercisable and unexercisable options to purchase shares of Common
Stock held as of the end of the Company's 1997 fiscal year by the Named
Executive Officers.

AGGREGATE OPTION EXERCISES AND YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
SHARES ACQUIRED VALUE OPTIONS AT FY-END(#) AT FY-END($)
NAME ON EXERCISE(#) REALIZED(1) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(1)
- -------------------------------- --------------- ---------------- ----------------------- --------------------------
<S> <C> <C> <C> <C>
Dale R. Olseth.................. -- -- 112,000/128,000 $96,000/$64,000
Stephen C. Hathaway............. -- -- 8,800/65,200 $0/$0
Patrick E. Guire, Ph.D.......... -- -- 24,400/49,600 $14,400/$9,600
James C. Powell................. 14,000 $ 14,000 38,000/56,000 $7,200/$4,800
Andrew B. Summerville........... -- -- 31,600/42,400 $0/$0
</TABLE>

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

(1) Based on the difference between the fair market value as of September 30,
1997 ($5.00 per share as determined by the Board of Directors) and the
option exercise price.

STOCK OPTIONS

On January 27, 1997, the Board of Directors and stockholders of the Company
adopted the 1997 Incentive Stock Option Plan (the "Plan") in order to provide
for the granting of stock purchase options to employees and officers of the
Company. The Plan permits the granting of incentive stock options meeting the
requirements of Section 422A of the Internal Revenue Code of 1986. The Company
has reserved 600,000 shares of its Common Stock for issuance upon exercise of
options granted under the Plan. As of the date of this Prospectus, the Company
has outstanding options to purchase an aggregate of 30,800 shares under the
Plan. The Company also has outstanding options, granted pursuant to the
Company's 1987 Incentive Stock Option Plan, which plan expired on January 18,
1997, to purchase an aggregate of 294,080 shares. In addition, the Company has
outstanding non-qualified options, granted outside of either of the foregoing
plans, to purchase an aggregate of 902,000 shares of Common Stock.

35
<PAGE>
CERTAIN TRANSACTIONS

In August 1997, the Company adopted a plan pursuant to which an employee of
the Company could borrow amounts from the Company to fund option exercises. Any
loan made pursuant to this plan is required to provide for: a five-year term,
subject to automatic acceleration to the earlier of three months after
termination of employment or six months after the shares purchased become
eligible for sale in the public market; interest payable annually at the prime
rate in effect at the time of the loan, paid annually; principal payable at
maturity; and a pledge of the shares of Common Stock acquired with the proceeds
of the loan as security. The Board has the authority to terminate this plan at
any time and will do so upon completion of this offering. Under the terms of
this loan program, (i) Walter H. Diers, Jr., Vice President of Corporate
Development for the Company, borrowed an aggregate of $80,000 on September 19,
1997, at an interest rate of 8.5%, to exercise an option to purchase an
aggregate of 20,000 shares of Common Stock at $4.00 per share and (ii) James C.
Powell, Vice President of Technical Operations for the Company, borrowed an
aggregate of $56,000 on September 19, 1997, at an interest rate of 8.5% to
exercise an option to purchase an aggregate of 14,000 shares of Common Stock at
$4.00 per share.

36
<PAGE>
PRINCIPAL STOCKHOLDERS

The following table sets forth as of February 1, 1998, and as adjusted to
reflect the sale of the shares offered hereby, certain information regarding
beneficial ownership of the Company's Common Stock by (i) each person known by
the Company to be the beneficial owner of more than 5% of the outstanding Common
Stock, (ii) each director of the Company, (iii) each of the Named Executive
Officers and (iv) all executive officers and directors of the Company as a
group.

<TABLE>
<CAPTION>
PERCENTAGE OF OUTSTANDING SHARES
NUMBER OF SHARES
BENEFICIALLY -----------------------------------
NAME OF BENEFICIAL OWNER OWNED(1) BEFORE OFFERING AFTER OFFERING
- ------------------------------------------------------------ -------------------- ----------------- ----------------
<S> <C> <C> <C>
Dale R. Olseth (2)(3)....................................... 546,000 10.8% 7.7%
Stephen C. Hathaway (2)(4).................................. 17,600 * *
Patrick E. Guire, Ph.D. (2)(5).............................. 207,867 4.2% 3.0%
James C. Powell (2)(6)...................................... 87,600 1.8% 1.3%
Andrew B. Summerville (2)(4)................................ 34,800 * *
Donald S. Fredrickson, M.D. (2)(4).......................... 52,000 1.1% *
James J. Grierson (2)(7).................................... 75,000 1.5% 1.1%
Kenneth H. Keller, Ph.D. (2)(4)............................. 4,000 * *
David A. Koch (2)(8)........................................ 441,400 8.9% 6.4%
Kendrick B. Melrose (2)(7).................................. 142,000 2.9% 2.0%
Seven Hundred Company (9)................................... 522,000 10.6% 7.6%
All executive officers and directors 1,692,547
as a group (12 persons) (10).............................. 34.0% 24.3%
</TABLE>

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

* Less than one percent.

(1) Shares not outstanding but deemed beneficially owned by virtue of the
individual's right to acquire them as of February 1, 1998, or within 60
days of such date, are treated as outstanding when determining the percent
of the class owned by such individual and when determining the percent
owned by the group. For purposes of calculating the percent of class owned
after this offering, it was assumed that the officers, directors and
principal stockholders will not be purchasing shares in this offering.
Unless otherwise indicated, each person named or included in the group has
sole voting and investment power with respect to the shares of Common Stock
set forth opposite his name.

(2) The address of the directors and executive officers of the Company is 9924
West 74th Street, Eden Prairie, Minnesota 55344.

(3) Includes 144,000 shares purchasable upon exercise of options.

(4) Represents shares purchasable upon exercise of options.

(5) Includes 33,200 shares purchasable upon exercise of options.

(6) Includes 47,600 shares purchasable upon exercise of options.

(7) Includes 32,000 shares purchasable upon exercise of options.

(8) Includes 32,000 shares purchasable upon exercise of options and 16,000
shares held of record by an affiliate of Mr. Koch's wife.

(9) The address of the Seven Hundred Company is 5140 Norwest Center, 90 South
Seventh Street, Minneapolis, MN 55402.

(10) Includes 462,480 shares purchasable upon exercise of options.

37
<PAGE>
DESCRIPTION OF CAPITAL STOCK

Upon completion of this offering, the authorized capital stock of the
Company will consist of 20,000,000 shares of capital stock, $0.05 per share par
value, of which 15,000,000 shares are Common Stock and 5,000,000 shares are
undesignated.

COMMON STOCK

As of February 1, 1998, the Company had approximately 200 shareholders of
record holding 3,402,788 shares of issued and outstanding Common Stock,
including 84,000 shares issuable pursuant to restricted stock agreements. The
holders of the Common Stock: (i) have equal ratable rights to dividends from
funds legally available therefor, when, as and if declared by the Board of
Directors of the Company; (ii) are entitled to share ratably in all the assets
of the Company available for distribution to holders of the Common Stock upon
liquidation, dissolution or winding up of the affairs of the Company; and (iii)
are entitled to one vote per share on all matters which stockholders may vote on
at all meetings of stockholders. All shares of Common Stock now outstanding are
fully paid and nonassessable and the shares of Common Stock to be issued upon
completion of this offering will be fully paid and nonassessable. There are no
redemption, sinking fund, conversion or preemptive rights with respect to the
shares of Common Stock.

The holders of the Common Stock do not have cumulative voting rights.
Subject to the rights of any future series of preferred stock, the holders of
more than 50 percent of such outstanding shares voting for the election of
directors can elect all of the directors of the Company to be elected, if they
so choose. In such event, the holders of the remaining shares will not be able
to elect any of the Company's directors.

SERIES A CONVERTIBLE PREFERRED STOCK

Upon the closing of this offering, the 376,828 shares of outstanding Series
A Convertible Preferred Stock, held of record by approximately 60 shareholders,
will be converted automatically into an aggregate of 1,507,312 shares of Common
Stock. The Company's Restated Articles of Incorporation, as amended, provide for
the automatic cancellation and elimination of the shares authorized as Series A
Convertible Preferred Stock upon conversion of all such shares.

UNDESIGNATED STOCK

Under governing Minnesota law and the Company's Restated Articles of
Incorporation, as amended, no action by the Company's stockholders is necessary,
and only action of the Board of Directors is required, to authorize the issuance
of any of the undesignated stock. The Board of Directors is empowered to
establish and to designate each class or series of the undesignated shares and
to set the terms of such shares (including terms with respect to redemption,
sinking fund, dividend, liquidation, preemptive, conversion and voting rights
and preferences). Accordingly, the Board of Directors, without stockholder
approval, may issue such undesignated shares in one or more series of preferred
stock having rights, preferences, privileges or restrictions, including voting
rights, that may be greater than the rights of holders of Common Stock.

It is not possible to state the actual effect of the issuance of any shares
of preferred stock upon the rights of holders of the Common Stock until the
Board of Directors determines the specific rights of the holders of such
preferred stock. However, the effects might include, among other things,
restricting dividends on the Common Stock, diluting the voting power of the
Common Stock, impairing the liquidation rights of the Common Stock and delaying
or preventing a change in control of the Company without further action by the
stockholders. The Company has no present plans to issue any shares of preferred
stock.

38
<PAGE>
MINNESOTA BUSINESS CORPORATION ACT

Certain provisions of Minnesota law described below could have an
anti-takeover effect. These provisions are intended to provide management
flexibility and to enhance the likelihood of continuity and stability in the
composition of the Company's Board of Directors and in the policies formulated
by the Board and to discourage an unsolicited takeover of the Company, if the
Board determines that such a takeover is not in the best interests of the
Company and its stockholders. However, these provisions could have the effect of
discouraging certain attempts to acquire the Company which could deprive the
Company's stockholders of opportunities to sell their shares of Common Stock at
prices higher than prevailing market prices.

Section 302A.671 of the Minnesota Statutes applies, with certain exceptions,
to any acquisition of voting stock of the Company (from a person other than the
Company, and other than in connection with certain mergers and exchanges to
which the Company is a party) resulting in the beneficial ownership of 20
percent or more of the voting stock then outstanding. Section 302A.671 requires
approval of any such acquisitions by a majority vote of the stockholders of the
Company prior to its consummation. In general, shares acquired in the absence of
such approval are denied voting rights and are redeemable at their then fair
market value by the Company within 30 days after the acquiring person has failed
to give a timely information statement to the Company or the date the
stockholders voted not to grant voting rights to the acquiring person's shares.

Section 302A.673 of the Minnesota Statutes generally prohibits any business
combination by the Company, or any subsidiary of the Company, with any
stockholder which purchases 10 percent or more of the Company's voting shares
(an "interested stockholder") within four years following such interested
stockholder's share acquisition date, unless the business combination is
approved by a committee of all of the disinterested members of the Board of
Directors of the Company serving before the interested stockholder's share
acquisition date.

CERTAIN LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS

The Company's Restated Articles of Incorporation, as amended, limit the
personal liability of its directors. Specifically, directors of the Company will
not be personally liable to the Company or its stockholders for monetary damages
for any breach of their fiduciary duty as directors, except to the extent that
the elimination or limitation of liability is in contravention of the MBCA, as
amended. This provision will generally not limit liability under state or
federal securities law.

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

Section 5.1 of the Company's Bylaws provides that each director, officer and
employee of the Company shall be indemnified by the Company in accordance with,
and to the fullest extent permissible by, applicable law.

The Company is in the process of obtaining an insurance policy covering
director and officer liability.

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

39
<PAGE>
TRANSFER AGENT AND REGISTRAR

The Transfer Agent and Registrar with respect to the Company's Common Stock
will be Firstar Trust Company.

SHARES ELIGIBLE FOR FUTURE SALE

Prior to this offering, there has been no public market for the Common
Stock. Future sales of substantial amounts of Common Stock in the open market
may adversely affect the market price of the Common Stock offered hereby and the
ability of the Company to raise equity capital in the future.

Upon consummation of the offering, the Company will have outstanding an
aggregate of 6,916,420 shares of Common Stock (assuming no exercise of the
Underwriters' over-allotment option). Of the aggregate number of outstanding
shares of Common Stock, the 2,000,000 shares of Common Stock sold in this
offering will be freely tradable without restriction or further registration
under the Securities Act, unless purchased by an "affiliate" of the Company, as
that term is defined by Rule 144 promulgated under the Securities Act (an
"Affiliate"), whose sales would be subject to certain volume limitations and
other restrictions described below. The remaining 4,916,420 shares of Common
Stock originally issued and sold by the Company in private transactions in
reliance upon exemptions from the Securities Act held by stockholders upon the
consummation of this offering will be "restricted securities" as that term is
defined in Rule 144 under the Securities Act, and may be sold in the public
market only if registered or if they qualify for an exemption from registration
under Rule 144, 144(k) or 701 or otherwise.

All officers and directors and certain stockholders of the Company, owning
an aggregate of 4,101,212 shares, have entered into "lock-up" agreements,
agreeing not to, directly or indirectly, sell, assign, transfer, encumber, offer
to sell, grant any option for the sale of, or otherwise dispose of, any shares
of Common Stock without the consent of the Representative for a period of 180
days after the date of this Prospectus. The Representative may waive these
restrictions at any time in its discretion. In considering any waiver request,
the Representative may take into account prevailing market conditions, the
number of shares subject to the requested waiver, the extent to which other
waivers have been granted and other factors that the Representative may deem
relevant. Taking such restrictions into account, in addition to the 2,000,000
shares of Common Stock offered hereby, (i) approximately 676,552 shares will be
eligible for immediate sale on the date of this Prospectus in accordance with
Rule 144; (ii) approximately 21,600 shares will be eligible for sale on April 1,
1998 upon expiration of certain restrictions under restricted stock awards;
(iii) approximately 17,428 additional shares will become eligible for sale in
the public market beginning 90 days after the date of this Prospectus in
accordance with Rule 144; and (iv) approximately 4,067,212 additional shares
will be eligible for sale beginning 180 days after the date of this Prospectus
upon the expiration of the lock-up agreements, subject, in the case of
Affiliates, to volume and manner of sale limitations under Rule 144.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who beneficially owns shares last acquired
privately from the Company or an Affiliate at least one year previously is
entitled to sell, in "brokers' transactions" or to market makers, within any
three-month period commencing 90 days after the date of this Prospectus, a
number of shares that does not exceed the greater of (i) 1% of the then
outstanding shares of Common Stock (approximately 69,000 shares immediately
after the offering); or (ii) the average weekly trading volume in the Common
Stock during the four calendar weeks preceding the required filing of a Form 144
with respect to such sale. Sales under Rule 144 are generally subject to the
availability of current public information about the Company. Under Rule 144(k),
a person who is not deemed to have been an Affiliate of the Company at any time
during the 90 days preceding a sale, and who beneficially owns shares last
acquired from the Company or an Affiliate at least two years previously, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144. Unless
otherwise restricted, "144(k) shares" may therefore be sold immediately upon the
consummation of this offering.

40
<PAGE>
Any employee, officer or director of or consultant to the Company who
purchased his or her shares pursuant to a written compensatory plan or contract
is entitled to rely on the resale provisions of Rule 701, which permits
non-Affiliates to sell their Rule 701 shares without complying with the public
information, holding period, volume limitation or notice provisions of Rule 144
and which permits Affiliates to sell their Rule 701 shares without complying
with the Rule 144 holding period restrictions, in each case commencing 90 days
after the date of this Prospectus.

The Company intends to file, after expiration of the lockup agreements
referenced above, Registration Statements on Form S-8 under the Securities Act
to register shares of Common Stock reserved for issuance upon exercise of stock
options, thus permitting the resale of such shares by non-Affiliates in the
public market without restrictions under the Securities Act and by Affiliates
subject to volume and manner of sale limitations under Rule 144. As of the date
of this Prospectus, options to purchase 1,226,880 shares of Common Stock were
outstanding, with 531,520 of the shares issuable upon exercise of such options
subject to vesting requirements extending beyond the terms of the lock-up
agreements. The remaining 695,360 shares issuable upon exercise of such options
will become available for exercise and sale upon vesting and effectiveness of
such Registration Statements on Form S-8.

REGISTRATION RIGHTS

The Company has entered into Registration Rights Agreements with all holders
of Series A Convertible Preferred Stock granting them participatory and demand
registration rights with respect to the shares of Common Stock issuable to them
upon conversion of their shares of Series A Convertible Preferred Stock. The
participatory or "piggyback" rights provide that if the Company determines to
register for public sale with the U.S. Securities and Exchange Commission any of
the Company's securities, the Company will use its best efforts to cause the
Common Stock acquired upon conversion of the Series A Convertible Preferred
Stock by such stockholders to be included in the offering for the benefit of the
investors desiring to sell such shares. The piggyback registration rights relate
to certain public offerings of the Company, if any, occurring during a
three-year period beginning on the closing of this offering. Such registration
rights are subject to various limitations, including the right of the managing
underwriter of a subsequent offering to determine that marketing factors require
a limitation on the number of shares of Common Stock that can be sold by the
selling stockholders participating in the registered sales. In connection with
any exercise of these piggyback rights, the Registration Rights Agreements
provide that the selling stockholders pay their own selling expenses (including
selling commissions and stock transfer taxes), as well as a proportionate share
of offering and registration fees and expenses.

The demand registration rights provide that on a one-time basis only, during
a two and one-half year period beginning six months after the effective date of
this offering, upon the request of the holders of a majority in interest
thereof, the Company will promptly take all necessary action to register or
qualify for immediate sale, under the Securities Act and the securities laws of
such states as the holders may reasonably request, the Common Stock obtained
upon conversion. In connection with these demand rights, the Company will bear
all offering and registration fees and expenses other than blue sky fees, fees
and disbursements of underwriter's counsel and selling stockholders' selling
expenses (including selling commissions and stock transfer taxes), which will be
the responsibility of the selling stockholder. Any request for demand
registration made within the period beginning six months and ending twelve
months after the date of this Prospectus may be limited in the event that John
G. Kinnard and Company, Incorporated determines that any such demand
registration would have an adverse effect on the market price of Common Stock.
In the event of any such determination, the Company may delay filing of a
registration statement for such demand registration for up to 180 days.

41
<PAGE>
The registration rights granted under the Registration Rights Agreements may
not be transferred or assigned to any subsequent holder of Series A Convertible
Preferred Stock or shares of Common Stock issuable upon conversion thereof
without the prior written consent of the Company. All registration rights
granted under the Registration Rights Agreements terminate upon the subsequent
transfer of 75% or more of the shares of Common Stock issued upon conversion of
the Series A Convertible Preferred Stock.

UNDERWRITING

The Underwriters named below, for which John G. Kinnard and Company,
Incorporated is acting as representative (the "Representative"), have severally
agreed, subject to the terms and conditions of the Underwriting Agreement with
the Company to purchase from the Company the 2,000,000 shares of Common Stock
offered hereby. The number of shares that each Underwriter has agreed to
purchase is set forth opposite its name below:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- --------------------------------------------------------------------------------- ----------
<S> <C>
John G. Kinnard and Company, Incorporated........................................ 1,160,000
Cowen & Company.................................................................. 90,000
Dain Rauscher Incorporated....................................................... 90,000
EVEREN Securities, Inc........................................................... 90,000
NationsBanc Montgomery Securities LLC............................................ 90,000
Robert W. Baird & Co., Inc....................................................... 40,000
Cleary Gull Reiland & McDevitt Inc............................................... 40,000
Cruttenden Roth Incorporated..................................................... 40,000
Hanifen, Imhoff Inc.............................................................. 40,000
Kirkpatrick, Pettis, Smith, Polian Inc........................................... 40,000
Miller, Johnson & Kuehn, Inc..................................................... 40,000
Pacific Crest Securities Inc..................................................... 40,000
R. J. Steichen & Company......................................................... 40,000
Tucker Anthony Incorporated...................................................... 40,000
Van Kasper & Company............................................................. 40,000
Vector Securities International, Inc............................................. 40,000
Wedbush Morgan Securities........................................................ 40,000
----------
Total........................................................................ 2,000,000
----------
----------
</TABLE>

The Underwriting Agreement provides that the several Underwriters will be
obligated to purchase all of the shares offered hereby, if any are purchased.
The obligation of the Underwriters to purchase the shares is several and not
joint meaning that, subject to the terms of the Underwriting Agreement, each
Underwriter is obligated to purchase only the number of shares set forth
opposite its name.

The Underwriters propose to offer the shares to the public at the Price to
Public set forth on the cover page of this Prospectus and to dealers at such
price less a concession not in excess of $0.33 per share. The Underwriters may
allow, and such dealers may reallow, a concession not in excess of $0.10 per
share to certain other brokers and dealers. The Price to Public, concession and
reallowance will not be changed by the Representative until the initial public
offering has been completed.

The Company has granted the Underwriters an option, exercisable within 30
days after the date of this Prospectus, to purchase up to an additional 300,000
shares at the Price to Public, less the Underwriting Discount and Commission
shown on the cover page of this Prospectus. The Underwriters may exercise such
option only for the purpose of covering any over-allotments in the sale of the
shares offered hereby.

The Representative has informed the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.

42
<PAGE>
The Underwriting Agreement provides for reciprocal indemnification between
the Company, the Underwriters and their controlling persons against civil
liabilities in connection with the offering, including liabilities under the
Securities Act. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted pursuant to the foregoing provisions, the
Company has been informed that, in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as expressed in such
Act and is therefore unenforceable.

In order to facilitate the offering of Common Stock, the Underwriters may
engage in transactions that stabilize, maintain or otherwise affect the price of
Common Stock. Specifically, the Underwriters may over-allot Common Stock in
connection with the offering, creating a short position in Common Stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of Common Stock, the Underwriters may bid for, and purchase, shares of
Common Stock in the open market. The Underwriters may also reclaim selling
concessions allowed to an underwriter or dealer for distributing Common Stock in
the offering, if the Underwriters repurchase previously distributed Common Stock
in transactions to cover their short positions, in stabilization transactions or
otherwise. Finally, the Underwriters may bid for, and purchase, shares of Common
Stock in market making transactions and impose penalty bids. These activities
may stabilize or maintain the market price of Common Stock above the market
level that may otherwise prevail. The Underwriters are not required to engage in
these activities and may end any of these activities at any time. Any such
activities will be undertaken in accordance with Regulation M under the
Securities Exchange Act of 1934 (the "Exchange Act"), if at all.

Prior to this offering, there has been no public trading market for the
Common Stock. The initial public offering price of the shares has been
determined by negotiations between the Company and the Representative. Among the
factors considered in such negotiations were the prevailing market conditions,
estimates of the business potential of the Company, the results of operations of
the Company in recent periods and other factors deemed to be relevant.

The foregoing is a brief summary of the material provisions of the
Underwriting Agreement and does not purport to be a complete statement of their
terms and conditions. The Underwriting Agreement has been filed as an exhibit to
the Registration Statement of which this Prospectus is a part.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Fredrikson & Byron, P.A., Minneapolis, Minnesota. Certain legal
matters for the Underwriters will be passed upon by Oppenheimer Wolff & Donnelly
LLP, Minneapolis, Minnesota.

EXPERTS

The audited financial statements of SurModics, Inc. as of September 30, 1996
and 1997 and for each of the three years in the period ended September 30, 1997,
included in this Prospectus and elsewhere in the registration statement, have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said report.

AVAILABLE INFORMATION

The Company has filed with the Commission a Registration Statement under the
Securities Act with respect to the sale of the shares. This Prospectus does not
contain all of the information set forth in the Registration Statement, certain
portions of which have been omitted as permitted by the rules and regulations of
the Commission. For further information with respect to the Company and the
shares being offered hereby, reference is made to the Registration Statement,
including the exhibits thereto. Statements contained in this Prospectus as to
the contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of such contract or
other

43
<PAGE>
document filed as an exhibit to the Registration Statement. The Registration
Statement may be inspected by anyone without charge at the principal office of
the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, or at one of
the Commission's regional offices: 500 West Madison, Suite 1400, Chicago,
Illinois 60661-2511 and 7 World Trade Center, 13th Floor, New York, New York,
10048. Copies of all or any part of such material may be obtained upon payment
of the prescribed fees from the Public Reference Section of the Commission at
450 Fifth Street, N.W. Washington, D.C. The Commission maintains a World Wide
Website at http://www.sec.gov containing reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission, including the Company.

Prior to this offering, the Company has not been subject to the reporting
requirements of the Exchange Act. After completion of this offering, the Company
intends to comply with such requirements, including distributing to its
stockholders an annual report containing audited financial statements.

44
<PAGE>
SURMODICS, INC.

FINANCIAL STATEMENTS

INDEX

Report of Independent Public Accountants................................................................... F-2

Balance Sheets as of September 30, 1996 and 1997, December 31, 1997 (unaudited) and Pro Forma as of
December 31, 1997 (unaudited)............................................................................ F-3

Statements of Operations for the Years Ended September 30, 1995, 1996 and 1997, and for the Three Months
Ended December 31, 1996 and 1997 (unaudited)............................................................. F-4

Statements of Stockholders' Equity for the Years Ended September 30, 1995, 1996 and 1997, for the Three
Months Ended December 31, 1997 (unaudited) and Pro Forma as of September 30, 1997 (unaudited)............ F-5

Statements of Cash Flows for the Years Ended September 30, 1995, 1996 and 1997, and for the Three Months
Ended December 31, 1996 and 1997 (unaudited)............................................................. F-6

Notes to Financial Statements.............................................................................. F-7
</TABLE>

F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To SurModics, Inc.:

We have audited the accompanying balance sheets of SurModics, Inc. (a
Minnesota corporation) as of September 30, 1996 and 1997, and the related
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended September 30, 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 financial statements referred to above present fairly,
in all material respects, the financial position of SurModics, Inc. as of
September 30, 1996 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended September 30, 1997, in
conformity with generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Minneapolis, Minnesota,
November 14, 1997 (except for
Note 3, as to which the date
is December 22, 1997)

F-2
<PAGE>
SURMODICS, INC.

BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------- DECEMBER 31, PRO FORMA
1996 1997 1997 DECEMBER 31, 1997
------------ ------------ ------------ -----------------
<S> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED;
SEE NOTE 8)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................... $ 2,012,906 $ 491,624 $ 566,385 $ 566,385
Short-term investments............................. 1,831,910 1,455,976 1,685,099 1,685,099
Accounts receivable, less allowance of $5,000, 712,873 712,873
$29,000 and $15,000.............................. 627,819 922,466
Inventories........................................ 260,768 264,008 258,985 258,985
Prepaids and other................................. 61,423 74,124 167,140 167,140
------------ ------------ ------------ -----------------
Total current assets........................... 4,794,826 3,208,198 3,390,482 3,390,482
------------ ------------ ------------ -----------------
PROPERTY AND EQUIPMENT:
Laboratory fixtures and equipment.................. 1,901,828 2,027,940 2,090,159 2,090,159
Office furniture and equipment..................... 727,563 815,602 878,827 878,827
Leasehold improvements............................. 1,038,609 1,049,802 1,049,802 1,049,802
Construction in progress........................... -- 18,620 193,875 193,875
Less--Accumulated depreciation and amortization.... (2,452,609) (2,846,954) (2,959,654 ) (2,959,654 )
------------ ------------ ------------ -----------------
Property and equipment, net.................... 1,215,391 1,065,010 1,253,009 1,253,009
LONG-TERM INVESTMENTS................................ -- 1,874,118 1,385,312 1,385,312
OTHER ASSETS, net.................................... 36,265 302,930 312,217 312,217
------------ ------------ ------------ -----------------
$ 6,046,482 $ 6,450,256 $ 6,341,020 $ 6,341,020
------------ ------------ ------------ -----------------
------------ ------------ ------------ -----------------

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................... $ 52,663 $ 280,467 $ 144,723 $ 144,723
Accrued liabilities--
Compensation..................................... 162,108 400,861 294,966 294,966
Other............................................ 111,635 91,807 129,114 129,114
Deferred revenues.................................. 518,786 308,143 272,347 272,347
------------ ------------ ------------ -----------------
Total current liabilities...................... 845,192 1,081,278 841,150 841,150
DEFERRED REVENUES AND OTHER, less current portion.... 460,850 266,973 231,841 231,841
------------ ------------ ------------ -----------------
Total liabilities.............................. 1,306,042 1,348,251 1,072,991 1,072,991
------------ ------------ ------------ -----------------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY:
Series A Convertible Preferred Stock--
$.05 par value, 450,000 shares authorized; 18,841 --
376,828 shares issued and outstanding (none pro
forma)......................................... 18,841 18,841
Voting Common Stock--
$.05 par value, 15,000,000 shares authorized; 169,844 245,208
3,311,480, 3,400,868 and 3,396,868 shares
issued and outstanding (4,904,180 pro forma)... 165,576 170,044
Additional paid-in capital......................... 13,093,961 13,491,665 13,490,865 13,434,342
Unearned compensation.............................. (142,720) (259,000) (243,000 ) (243,000 )
Stock purchase notes receivable.................... -- (160,000) (160,000 ) (160,000 )
Accumulated deficit................................ (8,395,218) (8,159,545) (8,008,521 ) (8,008,521 )
------------ ------------ ------------ -----------------
Total stockholders' equity..................... 4,740,440 5,102,005 5,268,029 5,268,029
------------ ------------ ------------ -----------------
$ 6,046,482 $ 6,450,256 $ 6,341,020 $ 6,341,020
------------ ------------ ------------ -----------------
------------ ------------ ------------ -----------------
</TABLE>

The accompanying notes are an integral part of these balance sheets.

F-3
<PAGE>
SURMODICS, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED SEPTEMBER 30, ENDED DECEMBER 31,
---------------------------------------- --------------------------
1995 1996 1997 1996 1997
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES:
Royalties................................ $ 2,082,176 $ 2,340,187 $ 2,913,119 $ 603,141 $ 941,768
License fees............................. 857,500 382,500 540,000 232,500 --
Product sales............................ 1,428,951 1,641,226 2,158,572 489,652 497,225
Research and development................. 1,587,607 1,818,739 1,970,174 330,063 470,443
------------ ------------ ------------ ------------ ------------
Total revenues......................... 5,956,234 6,182,652 7,581,865 1,655,356 1,909,436
------------ ------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Product.................................. 1,258,327 1,214,526 1,431,675 328,497 249,818
Research and development................. 2,966,489 3,316,767 3,597,061 811,740 958,449
Sales and marketing...................... 1,060,728 911,622 1,098,316 222,140 302,886
General and administrative............... 1,125,494 1,154,412 1,417,524 305,807 296,829
------------ ------------ ------------ ------------ ------------
Total operating costs and
expenses............................. 6,411,038 6,597,327 7,544,576 1,668,184 1,807,982
------------ ------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS.............. (454,804) (414,675) 37,289 (12,828) 101,454
------------ ------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Investment income and other, net......... 350,465 275,849 198,384 39,063 49,570
Loss on investments...................... (217,840) (54,901) -- -- --
------------ ------------ ------------ ------------ ------------
Other income, net...................... 132,625 220,948 198,384 39,063 49,570
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS).......................... $ (322,179) $ (193,727) $ 235,673 $ 26,235 $ 151,024
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS) PER SHARE (PRO FORMA)
(Note 2)
Basic.................................... $ (.07) $ (.04) $ .05 $ .01 $ .03
Diluted.................................. (.07) (.04) .04 .00 .03
WEIGHTED AVERAGE SHARES OUTSTANDING (PRO
FORMA) (Note 2)
Basic.................................... 4,713,438 4,775,598 4,853,558 4,818,792 4,904,267
Diluted.................................. 4,713,438 4,775,598 5,385,338 5,333,971 5,413,078
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-4
<PAGE>
SURMODICS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE VOTING NONVOTING COMMON
PREFERRED STOCK COMMON STOCK STOCK ADDITIONAL
-------------------- -------------------- -------------------- PAID-IN UNEARNED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION
--------- --------- --------- --------- --------- --------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, September 30, 1994........ 376,828 $ 18,841 3,158,380 $ 157,920 26,232 $ 1,312 $12,688,813 $(151,680)
Common stock options exercised... -- -- 36,040 1,800 -- -- 90,860 --
Restricted stock granted......... -- -- 24,000 1,200 -- -- 118,800 (120,000)
Amortization of unearned
compensation................... -- -- -- -- -- -- -- 50,560
Net realized loss on
investments.................... -- -- -- -- -- -- -- --
Unrealized gain on investments... -- -- -- -- -- -- -- --
Net loss......................... -- -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------- -------------
BALANCE, September 30, 1995........ 376,828 18,841 3,218,420 160,920 26,232 1,312 12,898,473 (221,120)
Common stock options exercised... -- -- 71,628 3,584 -- -- 199,088 --
Conversion of nonvoting common
stock to voting common stock... -- -- 26,232 1,312 (26,232) (1,312) -- --
Restricted stock canceled........ -- -- (4,800) (240) -- -- (3,600) 3,840
Amortization of unearned
compensation................... -- -- -- -- -- -- -- 74,560
Unrealized loss on investments... -- -- -- -- -- -- -- --
Realized loss on investments..... -- -- -- -- -- -- -- --
Net loss......................... -- -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------- -------------
BALANCE, September 30, 1996........ 376,828 18,841 3,311,480 165,576 -- -- 13,093,961 (142,720)
Common stock options exercised... -- -- 45,388 2,268 -- -- 179,904 --
Restricted stock granted......... -- -- 44,000 2,200 -- -- 217,800 (220,000)
Amortization of unearned
compensation................... -- -- -- -- -- -- -- 103,720
Net income....................... -- -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------- -------------
BALANCE, September 30, 1997........ 376,828 18,841 3,400,868 170,044 -- -- 13,491,665 (259,000)
Restricted stock
canceled (unaudited)........... -- -- (4,000) (200) -- -- (16,800) 17,000
Restricted stock
extension (unaudited).......... -- -- -- -- -- -- 16,000 (16,000)
Amortization of unearned
compensation (unaudited)....... -- -- -- -- -- -- -- 15,000
Net income (unaudited)........... -- -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------- -------------
BALANCE, December 31, 1997......... 376,828 18,841 3,396,868 169,844 -- -- 13,490,865 (243,000)
Effects of conversion of Series A
Convertible Preferred Stock to
common stock (Note 8)
(unaudited).................... (376,828) (18,841) 1,507,312 75,364 -- -- (56,523) --
--------- --------- --------- --------- --------- --------- ---------- -------------
BALANCE, pro forma, December 31,
1997 (unaudited)................. -- $ -- 4,904,180 $ 245,208 -- $ -- $13,434,342 $(243,000)
--------- --------- --------- --------- --------- --------- ---------- -------------
--------- --------- --------- --------- --------- --------- ---------- -------------

STOCK
PURCHASE UNREALIZED TOTAL
NOTES INVESTMENT ACCUMULATED STOCKHOLDERS'
RECEIVABLE LOSS DEFICIT EQUITY
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
BALANCE, September 30, 1994........ $ -- $(246,390) $(7,879,312) $4,589,504
Common stock options exercised... -- -- -- 92,660
Restricted stock granted......... -- -- -- --
Amortization of unearned
compensation................... -- -- -- 50,560
Net realized loss on
investments.................... -- 217,840 -- 217,840
Unrealized gain on investments... -- 28,550 -- 28,550
Net loss......................... -- -- (322,179) (322,179)
----------- ----------- ------------ ------------
BALANCE, September 30, 1995........ -- -- (8,201,491) 4,656,935
Common stock options exercised... -- -- -- 202,672
Conversion of nonvoting common
stock to voting common stock... -- -- -- --
Restricted stock canceled........ -- -- -- --
Amortization of unearned
compensation................... -- -- -- 74,560
Unrealized loss on investments... -- (54,901) -- (54,901)
Realized loss on investments..... -- 54,901 -- 54,901
Net loss......................... -- -- (193,727) (193,727)
----------- ----------- ------------ ------------
BALANCE, September 30, 1996........ -- -- (8,395,218) 4,740,440
Common stock options exercised... (160,000) -- -- 22,172
Restricted stock granted......... -- -- -- --
Amortization of unearned
compensation................... -- -- -- 103,720
Net income....................... -- -- 235,673 235,673
----------- ----------- ------------ ------------
BALANCE, September 30, 1997........ (160,000) -- (8,159,545) 5,102,005
Restricted stock
canceled (unaudited)........... -- -- -- --
Restricted stock
extension (unaudited).......... -- -- -- --
Amortization of unearned
compensation (unaudited)....... -- -- -- 15,000
Net income (unaudited)........... -- -- 151,024 151,024
----------- ----------- ------------ ------------
BALANCE, December 31, 1997......... (160,000) -- (8,008,521) 5,268,029
Effects of conversion of Series A
Convertible Preferred Stock to
common stock (Note 8)
(unaudited).................... -- -- -- --
----------- ----------- ------------ ------------
BALANCE, pro forma, December 31,
1997 (unaudited)................. $(160,000) $ -- $(8,008,521) $5,268,029
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-5
<PAGE>
SURMODICS, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED SEPTEMBER 30, DECEMBER 31,
---------------------------------------- -----------------------
1995 1996 1997 1996 1997
------------ ------------ ------------ ----------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss).................................. $ (322,179) $ (193,727) $ 235,673 $ 26,235 $ 151,024
Adjustments to reconcile net income (loss) to net
cash provided by operating activities--
Depreciation and amortization.................... 449,746 427,274 460,039 119,278 116,707
Realized loss on investments..................... 217,840 54,901 -- -- --
Amortization of unearned compensation, net....... 50,560 59,200 103,720 17,680 15,000
Change in deferred rent.......................... 8,812 2,174 (11,104) (1,811) (3,882)
Change in assets and liabilities:
Accounts receivable............................ (29,250) (67,849) (294,647) 98,778 209,593
Inventories.................................... (100,318) (3,945) (3,240) 13,598 5,023
Accounts payable and accrued liabilities....... 113,170 (9,962) 446,729 (29,481) (204,332)
Deferred revenue............................... (311,968) 138,268 (393,416) (57,971) (67,046)
Prepaids and other............................. 2,230 (33,303) (12,701) (35,613) (93,016)
------------ ------------ ------------ ----------- ----------
Net cash provided by operating activities.... 78,643 373,031 531,053 150,693 129,071
------------ ------------ ------------ ----------- ----------
INVESTING ACTIVITIES:
Purchases of property and equipment, net........... (190,323) (201,580) (298,388) (50,591) (300,701)
Purchases of short-term investments................ (933,428) (1,497,290) (2,049,066) (597,165) --
Sales of short-term investments.................... -- 2,659,520 2,425,000 725,000 250,000
Purchases of long-term investments................. (334,620) -- (1,874,118) (971,903) --
Other.............................................. (15,000) -- (277,935) -- (3,609)
------------ ------------ ------------ ----------- ----------
Net cash provided by (used in) investing
activities................................. (1,473,371) 960,650 (2,074,507) (894,659) (54,310)
------------ ------------ ------------ ----------- ----------
FINANCING ACTIVITIES:
Issuance of common stock, net of offering costs.... 92,660 218,032 22,172 -- --
Borrowings (repayments) under line of credit,
net.............................................. (1,151,263) -- -- -- --
Repayment of long-term debt and capital lease
obligations...................................... (46,206) (16,917) -- -- --
------------ ------------ ------------ ----------- ----------
Net cash provided by (used in) financing
activities................................. (1,104,809) 201,115 22,172 -- --
------------ ------------ ------------ ----------- ----------
Net increase (decrease) in cash and cash
equivalents................................ (2,499,537) 1,534,796 (1,521,282) (743,966) 74,761
CASH AND CASH EQUIVALENTS:
Beginning of period................................ 2,977,647 478,110 2,012,906 2,012,906 491,624
------------ ------------ ------------ ----------- ----------
End of period...................................... $ 478,110 $ 2,012,906 $ 491,624 $ 1,268,940 $ 566,385
------------ ------------ ------------ ----------- ----------
------------ ------------ ------------ ----------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid...................................... $ 13,462 $ 2,254 $ 1,700 $ 1,700 $ --
Noncash investing and financing activity-- Issuance
of stock purchase notes receivable from exercised
stock options.................................... -- -- 160,000 -- --
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-6
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO THE UNAUDITED PERIODS)

1. DESCRIPTION:

SurModics, Inc. (the Company) (formerly BSI Corporation) develops,
manufactures and markets innovative surface modifications for medical,
industrial and diagnostic products. The Company also produces and markets a line
of proprietary biomolecule stabilization products. Its revenues are derived from
the following: the licensing of its surface modification and diagnostic
technologies to major manufacturers, resulting in both license fees and ongoing
royalty streams; the sale of reagents and diagnostic products; and contracts
with the United States government and private industry to conduct biomedical
research.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist principally of money market instruments
with original maturities of three months or less and are stated at cost which
approximates fair value.

INVESTMENTS

Short-term and long-term investments consist of corporate debt securities
and are classified as available-for-sale as of September 30, 1996 and 1997 and
December 31, 1997. Investments classified as available-for-sale are reported at
fair value with unrealized gains and losses excluded from operations and
reported as a separate component of stockholders' equity, except for
other-than-temporary impairments, which are reported as a charge to current
operations and result in a new cost basis for the investment. As of September
30, 1996 and 1997 and December 31, 1997, the investments' amortized cost
approximated fair value.

INVENTORIES

Inventories are stated at the lower of cost or market using the specific
identification method and include direct labor, materials and overhead.
Inventories consisted of the following:

<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------- DECEMBER 31,
1996 1997 1997
------------- ------------- ------------
<S> <C> <C> <C>
Raw materials.................................... $ 85,197 $ 67,099 $ 110,313
Finished products................................ 175,571 196,909 148,672
------------- ------------- ------------
Total........................................ $ 260,768 $ 264,008 $ 258,985
------------- ------------- ------------
------------- ------------- ------------
</TABLE>

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost and are depreciated using the
straight-line method over five years, the estimated useful lives of the assets.
Amortization of leasehold improvements is recorded on a straight-line basis over
the estimated useful lives of the assets or the lease term, whichever is
shorter.

F-7
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
OTHER ASSETS

Other assets consist principally of patents, which are amortized over seven
to twelve years. Accumulated amortization is $12,000, $23,000 and $27,000 as of
September 30, 1996 and 1997 and December 31, 1997, respectively.

REVENUE RECOGNITION

Royalties are recognized as third-party licensees report sales of the
product or as minimum royalties become due. Initial nonrefundable license fees
are recognized as revenue upon execution of the license agreement. Certain
nonrefundable license and research and development fees are recoverable by the
licensees as offsets against a percentage of future earned royalties. Revenues
on product sales are recognized as products are shipped and for research and
development as performance progresses under the applicable government contract
or commercial development agreement.

Cash received prior to performance is recorded as deferred revenues in the
accompanying balance sheets. Deferred revenues also include advance payments
from a third-party licensee to the Company. The advance payments are being
applied as a reduction of amounts otherwise due for earned royalties up to
$75,000 per quarter and were fully absorbed during the first quarter of fiscal
1998.

As of December 31, 1997, the Company had approximately $2.1 million of
signed government contracts on which work is yet to be performed and revenue has
yet to be earned.

MAJOR CUSTOMERS

Revenues from customers which exceed 10% of total revenues are as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED SEPTEMBER 30,
DECEMBER 31,
------------------------------- --------------------
1995 1996 1997 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Government agencies.............................................. 20% 21% 16% 13% 12%
Commercial:
Company A...................................................... 23 24 21 19 28
Company B...................................................... 12 -- -- -- --
</TABLE>

Accounts receivable from these customers were as follows:

<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------- DECEMBER 31,
1996 1997 1997
------------- ------------- -------------
<S> <C> <C> <C>
Government agencies.............................. $ 59,000 $ 78,000 $ --
Commercial:
Company A...................................... 73,000 5,000 5,000
</TABLE>

INCOME TAXES

The Company utilizes the liability method to account for income taxes, and
deferred taxes are based on the estimated future tax effects of differences
between the financial statement and tax bases of assets and liabilities given
the provisions of the enacted tax laws.

F-8
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
NET INCOME (LOSS) PER SHARE (PRO FORMA)

Net income (loss) per share (pro forma) was computed by dividing net income
(loss) by the weighted average shares outstanding (pro forma). Basic weighted
average shares outstanding includes common shares outstanding and the conversion
of Series A Convertible Preferred Stock into common stock. Diluted weighted
average shares outstanding includes the basic weighted average shares
outstanding and dilutive common stock equivalents.

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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Ultimate results could differ from those estimates.

NEW ACCOUNTING PRONOUNCEMENTS

In March 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share," which changed the way companies calculated their earnings per share
(EPS). SFAS No. 128 replaced primary EPS with basic EPS. Basic EPS is computed
by dividing reported earnings by weighted average shares outstanding, excluding
potentially dilutive securities. Fully diluted EPS, termed diluted EPS under
SFAS No. 128, is also to be disclosed. The Company adopted SFAS No. 128 in
fiscal 1998, at which time all prior year EPS was restated in accordance with
SFAS No. 128.

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and displaying comprehensive
income and its components in financial statements. The Company will adopt the
provisions of SFAS No. 130 in fiscal 1999.

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes a new model for
segment reporting, called the "management approach" and requires certain
disclosures for each segment. The management approach is based on the way the
chief operating decision maker organizes segments within a company for making
operating decisions and assessing performance. The Company will be required to
adopt the provisions of SFAS No. 131 in fiscal 1999.

INTERIM FINANCIAL INFORMATION (UNAUDITED)

The accompanying balance sheet as of December 31, 1997, the statements of
operations and cash flows for the three months ended December 31, 1996 and 1997
and the statement of stockholders' equity for the three months ended December
31, 1997 are unaudited but, in the opinion of management, include all
adjustments, consisting solely of normal recurring adjustments necessary for a
fair presentation of results for these interim periods. The results of
operations for the three months ended December 31, 1997 are not necessarily
indicative of results to be expected for the entire fiscal year.

F-9
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

3. STOCKHOLDERS' EQUITY:

AUTHORIZED SHARES

The authorized capital stock of the Company consists of 20,450,000 shares of
capital stock, $0.05 per share par value, of which 15,000,000 shares are common
stock, 450,000 shares are Series A Convertible Preferred Stock and 5,000,000
shares are undesignated.

STOCK SPLIT

On December 22, 1997, the Company's board of directors approved a 4-for-1
stock split of all the Company's outstanding common stock. All share and per
share data have been restated for all periods presented to reflect the common
stock split.

PREFERRED STOCK RIGHTS

The Series A Convertible Preferred Stock has certain preferential
liquidation, conversion and dividend rights as follows:

a. In the event of liquidation of the Company, the holders of these shares are
entitled to receive $13.50 per share unless a greater amount would be
distributed or paid with respect to each common share assuming the
conversion of all outstanding preferred shares.

b. Each preferred share is convertible, at the option of the holder, at any
time into four shares of voting common stock, subject to adjustment, with
automatic conversion upon the closing of a registered public offering
meeting certain minimum parameters.

c. Holders of preferred stock are entitled to receive dividends if, as and when
declared by the board of directors.

RESTRICTED STOCK AWARDS

The Company has entered into restricted stock agreements with certain key
employees, covering the issuance of voting common stock (the Restricted Stock).
The Restricted Stock will be released to the key employees if they are employed
by the Company at the end of a five-year waiting period. Unearned compensation
has been recognized for the estimated fair value of the applicable common
shares, reflected as a reduction of stockholders' equity, and is being charged
to operations over the five-year waiting period.

F-10
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

3. STOCKHOLDERS' EQUITY: (CONTINUED)
Transactions in restricted stock are as follows:

<TABLE>
<CAPTION>
SHARES
---------
<S> <C>
Outstanding at September 30, 1994.................................................. 63,200
Granted.......................................................................... 24,000
---------
Outstanding at September 30, 1995.................................................. 87,200
Canceled......................................................................... (4,800)
---------
Outstanding at September 30, 1996.................................................. 82,400
Granted.......................................................................... 44,000
---------
Outstanding at September 30, 1997.................................................. 126,400
Issued........................................................................... (42,400)
Canceled......................................................................... (4,000)
---------
Outstanding at December 31, 1997................................................... 80,000
---------
---------
</TABLE>

STOCK PURCHASE NOTES RECEIVABLE

The Company established a loan program during fiscal 1997 to assist
employees in purchasing shares of the Company's stock. The loans are
collateralized by the employees' purchased shares and require annual interest
payments at a rate equal to prime at the date of issuance, with principal and
any unpaid interest due at the earlier of five years after the date of issuance,
three months after termination of employment, or six months after the Company's
common stock becomes available to the public. Employees may borrow up to 100% of
the option price for the shares purchased or up to 100% of their previous
investment in the Company's stock.

4. STOCK-BASED COMPENSATION PLANS:

Upon adoption of the Company's 1997 Incentive Stock Option Plan (the Plan),
which replaced the 1987 Incentive Stock Option Plan, 600,000 shares of voting
common stock were reserved for issuance to employees and officers. The Plan
requires that the option price per share cannot be less than 100% of the fair
market value of the common stock (as determined by the board of directors) on
the date of the grant of the option or 110% with respect to optionees who own
more than 10% of the total combined voting power of all classes of stock.
Options expire in five years or upon termination of employment and are
exercisable at a rate of 20% per year from the date of grant.

Nonqualified options have been granted to outside directors, employees and
officers. The options have been granted at fair market value, as determined by
the board of directors at the date of grant. Options expire in five to ten years
and are exercisable at a rate of 20% per year from the date of grant or 20% per
year commencing two years after the date of grant.

F-11
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

4. STOCK-BASED COMPENSATION PLANS: (CONTINUED)
Information regarding stock options under all plans is summarized as
follows:
<TABLE>
<CAPTION>
THREE
YEARS ENDED SEPTEMBER 30, MONTHS
------------------------------------------------------------------------- ENDED
DECEMBER
1995 1996 1997 31, 1997
----------------------- ----------------------- ----------------------- ----------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE SHARES
- --------------------------------- ---------- ----------- ---------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of
period......................... 856,000 $ 3.81 1,396,280 $ 4.35 1,163,600 $ 4.52 1,204,800
Granted........................ 592,400 5.00 5,400 5.00 157,400 5.00 38,200
Exercised...................... (36,040) 2.57 (71,628) 3.04 (45,388) 4.01 --
Canceled....................... (16,080) 3.55 (166,452) 3.78 (70,812) 4.51 (2,600)
---------- ----- ---------- ----- ---------- ----- ----------
Outstanding, end of period....... 1,396,280 $ 4.35 1,163,600 $ 4.52 1,204,800 $ 4.60 1,240,400
---------- ----- ---------- ----- ---------- ----- ----------
---------- ----- ---------- ----- ---------- ----- ----------
Exercisable, end of period....... 448,880 $ 3.84 436,760 $ 4.26 589,320 $ 4.42 670,880
---------- ----- ---------- ----- ---------- ----- ----------
---------- ----- ---------- ----- ---------- ----- ----------
Weighted average fair value of
options granted................ $ 3.23 $ 3.30 $ 2.93
---------- ---------- ----------
---------- ---------- ----------

<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
- --------------------------------- -----------
<S> <C>
Outstanding, beginning of
period......................... $ 4.60
Granted........................ 5.00
Exercised...................... --
Canceled....................... 5.00
-----
Outstanding, end of period....... $ 4.61
-----
-----
Exercisable, end of period....... $ 4.39
-----
-----
Weighted average fair value of
options granted................
</TABLE>

The options outstanding at December 31, 1997 have exercise prices ranging
between $2.50 and $5.00, with a weighted average exercise price of $4.61 and a
weighted average remaining contractual life of 2.98 years.

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 fiscal 1996, fiscal 1997 and for the first
quarter of fiscal 1998, respectively: risk-free interest rates of 6.43%, 6.24%
and 5.85%; expected lives of 5, 5.57 and 5 years; and expected volatility of 73%
for fiscal 1996 and fiscal 1997 and 63% for the first quarter of fiscal 1998.

The Company accounts for the options under APB Opinion No. 25, under which
no compensation cost has been recognized. Had compensation cost for the options
been determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net income (loss) would have been the following pro
forma amounts:

<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
SEPTEMBER 30, DECEMBER 31,
----------------------- ---------------------
1996 1997 1996 1997
----------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net income (loss):
As reported................................ $ (193,727) $ 235,673 $ 26,235 $ 151,024
Pro forma.................................. (194,890) 155,541 20,026 120,281
Net income (loss) per common share:
As reported diluted........................ $ (.04) $ .04 $ .00 $ .03
Pro forma diluted.......................... (.04) .03 .00 .02
</TABLE>

Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to October 1, 1995, the resulting pro forma information
may not be representative of that to be expected in future periods.

F-12
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

5. INCOME TAXES:

Deferred income taxes consisted of the following as of September 30:

<TABLE>
<CAPTION>
1996 1997
------------- -------------
<S> <C> <C>
Deferred tax assets............................................. $ 3,025,000 $ 2,850,000
Less--Valuation allowance....................................... (3,025,000) (2,850,000)
------------- -------------
Net deferred tax assets....................................... $ -- $ --
------------- -------------
------------- -------------
</TABLE>

These deferred tax assets result from differences in the recognition of
transactions for income tax and financial reporting purposes. The principal
temporary differences relate to certain financial reserves not deductible for
tax purposes until paid, a capital loss carryforward and net operating loss
carryforwards.

The Company's net operating loss carryforwards of approximately $6.4 million
at September 30, 1997 expire in varying amounts through 2011. Certain
restrictions under the Tax Reform Act of 1986, caused by the change in ownership
resulting from sales of common and convertible preferred stocks, may limit
annual utilization of the net operating loss carryforwards. The Company also has
$519,000 of capital loss carryforwards at September 30, 1997, which expire in
2001. A valuation allowance for the full amount of the deferred tax asset has
been established due to the uncertainty of realization.

During fiscal 1997, the Company utilized $64,000 of net operating loss
carryforwards to offset the 1997 income tax liability.

6. COMMITMENTS AND CONTINGENCIES:

OPERATING LEASES

The Company leases its office and laboratory space under an operating lease
that expires in fiscal 2000. The lease provides for base monthly payments, which
increase annually, and additional amounts to cover the Company's share of common
area expenses and property taxes. The Company is responsible for maintenance,
insurance and other normal operating costs. Rental expense for the base monthly
payments and additional costs was approximately $280,000, $290,000, $290,000,
$73,000 and $74,000 for the years ended September 30, 1995, 1996 and 1997, and
the three months ended December 31, 1996 and 1997, respectively.

As of December 31, 1997, future commitments under the operating lease are as
follows:

<TABLE>
<S> <C>
1998 (nine months ended September 30, 1998)....................... $ 158,000
1999.............................................................. 216,000
2000.............................................................. 54,000
---------
$ 428,000
---------
---------
</TABLE>

GOVERNMENT CONTRACTS

Under provisions contained in the government research contracts,
representatives of the government agencies have the right to access and review
the Company's underlying records of contract costs. The government retains the
right to reject expenses considered unallowable under the terms of the contract.

F-13
<PAGE>
SURMODICS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)

6. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
The Defense Contract Audit Agency has reviewed the contracts through 1989. In
the opinion of management, future amounts due, if any, with respect to open
contract years will not have a material impact on the financial position or
results of operations of the Company.

7. DEFINED CONTRIBUTION PLAN:

The Company has a profit-sharing/401(k) retirement and savings plan for the
benefit of qualified employees. Under the plan, qualified employees may elect to
defer up to 15% of their compensation, subject to a maximum limit determined by
the Internal Revenue Service. The Company, at the discretion of the board of
directors, may elect to make an additional contribution. Contributions of
approximately $67,000, $78,000, $86,000, $16,000 and $33,000 have been charged
to operations for the years ended September 30, 1995, 1996 and 1997, and the
three months ended December 31, 1996 and 1997, respectively.

8. EVENTS SUBSEQUENT TO DATE OF REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS:

INITIAL PUBLIC OFFERING

The Company has filed a Registration Statement with the Securities and
Exchange Commission for the sale of up to 2,000,000 shares (excluding the
Underwriters' over-allotment option to purchase an additional 300,000 shares) of
common stock (the Offering). The Company intends to use the net proceeds from
the Offering (estimated to be approximately $13.5 million) for research and
development, sales and marketing and upgrades to its manufacturing equipment, to
strengthen its patent protection and for working capital and general corporate
purposes.

PRO FORMA BALANCE SHEET AND STATEMENT OF STOCKHOLDERS' EQUITY AS OF DECEMBER
31, 1997

As discussed in Note 3, each share of the Series A Convertible Preferred
Stock will be automatically converted into four shares of voting common stock
upon the closing of the Offering and the authorized shares of Series A
Convertible Preferred Stock will be eliminated and this class of stock canceled.
The Company's pro forma balance sheet and pro forma statement of stockholders'
equity as of December 31, 1997 give effect to the conversion.

F-14
<PAGE>
[PHOTOGRAPH OF THE MIXING OF THE REAGENTS]

PhotoLink is a simple, light-activated coating technology. Reagent is dissolved
into solution, applied to the device, and the device is exposed to a light
source. The PhotoLink process is quick, uses cost-effective equipment, and is
easily incorporated into existing manufacturing operations.

[PHOTOGRAPH OF DIPPING THE
DEVICE INTO THE REAGENT]

[PHOTOGRAPH OF PREPARING THE COATED
DEVICE FOR EXPOSURE TO DIRECT LIGHT]

[PHOTOGRAPH OF A COATED
CATHETER]

[LOGO]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO
WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO
ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 2
Risk Factors................................... 5
Use of Proceeds................................ 12
Dividend Policy................................ 12
Capitalization................................. 13
Dilution....................................... 14
Selected Financial Data........................ 15
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 16
Business....................................... 20
Management..................................... 32
Principal Stockholders......................... 37
Description of Capital Stock................... 38
Shares Eligible for Future Sale................ 40
Underwriting................................... 42
Legal Matters.................................. 43
Experts........................................ 43
Available Information.......................... 43
Index to Financial Statements.................. F-1
</TABLE>

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

UNTIL MARCH 28, 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

2,000,000 SHARES

[LOGO]

COMMON STOCK

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

PROSPECTUS

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

JOHN G. KINNARD AND COMPANY,
INCORPORATED

MARCH 3, 1998

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