<PAGE>   1


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-K

      FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                  FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES 
     EXCHANGE ACT OF 1934

          FOR THE TRANSITION PERIOD FROM ___________ TO ______________

                           COMMISSION FILE NO. 0-23678

                                  BIOSEPRA INC
--------------------------------------------------------------------------------
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

             DELAWARE                                    04-3216867
  -------------------------------              -------------------------------
  (STATE OR OTHER JURISDICTION OF                       (IRS EMPLOYER
  INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NO.)

                111 LOCKE DRIVE, MARLBOROUGH, MASSACHUSETTS 01752
--------------------------------------------------------------------------------
               (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (508) 357-7500

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                          COMMON STOCK, $.01 PAR VALUE
--------------------------------------------------------------------------------
                                 TITLE OF CLASS

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
                                    Yes _X_  No ___

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

     The aggregate market value of voting Common Stock held by non-affiliates of
the registrant was $2,388,271, based on the last reported sale price of the
Common Stock on the OTC: Bulletin Board on March 5, 1999.

     Number of shares outstanding of the registrant's class of Common Stock as
of March 5, 1999: 8,456,059.

                      DOCUMENTS INCORPORATED BY REFERENCE:
    Proxy Statement for the 1999 Annual Meeting of Stockholders - Part III.


<PAGE>   2


                                     PART I

ITEM 1.  BUSINESS

      BioSepra Inc. ("BioSepra" or the "Company") develops, manufactures and
sells chromatographic media for use by pharmaceutical companies in the
purification and production of biopharmaceuticals. BioSepra's products enable
pharmaceutical companies to reduce the time and cost required to develop and
manufacture biopharmaceuticals. The Company's media products are currently used
by pharmaceutical companies in the production of several commercial
biopharmaceuticals, including interferons, insulin, human growth hormone,
special enzymes and vaccines. On January 5, 1999, the Company announced the
acquisition of a 51% interest in Biosphere Medical, S.A. and completed the
acquisition on February 25, 1999.

      BioSepra was incorporated in December 1993 as a wholly-owned subsidiary of
Sepracor Inc., a Delaware corporation ("Sepracor"). Effective as of January 1,
1994, Sepracor transferred to BioSepra its chromatography business, including
all of the outstanding shares of BioSepra S.A., formerly called IBF S.A. In
March 1994, BioSepra completed an initial public offering of its common stock
resulting in net proceeds to BioSepra of approximately $17.9 million. Sepracor
owns approximately 64% of the outstanding common stock of BioSepra. The
Company's principal offices are located at 111 Locke Drive, Marlborough,
Massachusetts 01752 and its telephone number is (508) 357-7500. Unless the
context indicates otherwise, the "Company" and "BioSepra" include BioSepra Inc.
and its subsidiaries, including BioSepra S.A.

      On January 5, 1999, the Company announced the acquisition of a 51%
interest in Biosphere Medical, S.A. and completed the acquisition on February
25, 1999. The principle purpose for the acquisition is to gain access to product
know-how and CE (European equivalent to the FDA) approval of Biosphere's product
Embospheres(TM), a spherical bead used in three medical applications within the
European medical community. The Company believes that this technology has
applicability for the treatment of uterine fibroids without surgical
intervention, a procedure known as Uterine Fibroid Embolization.

INDUSTRY OVERVIEW

      Purification is a critical process in almost every stage in the
development and commercialization of a biopharmaceutical, from research through
production for clinical trials to commercial production. At both the laboratory
and commercial stages, a biopharmaceutical is typically produced by
genetically-engineered cells that are grown in a fermentation broth containing
cell culture media. The target biopharmaceutical molecules in the fermentation
broth must be purified from the host cells, contaminants and cell culture media.
This purification process is complex because the host cells produce extremely
small quantities of the target biomolecules relative to the volume of the
fermentation broth and because the contaminants produced in the broth are often
similar in size and structure to the target biomolecules. Several critical
purification steps are therefore required to extract and purify the final
product, which must be at least 99.9% pure. It is estimated that
biopharmaceutical purification accounts for approximately one-half of overall
commercial production costs.

      Chromatography is the principal method used for biopharmaceutical
purification. In chromatographic processes, the solution containing both the
desired product and unwanted contaminants and impurities is flowed through
columns that are packed with chromatographic particles ("media"). As the
solution flows through the columns, the target biomolecules are absorbed by the
media. The productivity of a chromatographic media depends on the protein
binding capacity of the media, the speed at which biomolecules are able to reach
the binding sites and the ability of the media to achieve the desired product
purity (resolution).

      In designing the purification process for any biopharmaceutical, a process
engineer or biochemist must typically evaluate a large number of different
chromatographic steps to determine the specific chemistries, column sizes, media
and process sequences that are able to yield the required process
characteristics and product purity on the most cost-effective basis. The design
process has historically involved a large number of time-consuming trial and
error experiments in which the engineer is required to set up, perform and
evaluate different process steps. Because a typical process purification step
can take hours to run, the trial and error method of process development can be
both inefficient and costly. Moreover, a process that operates effectively at
laboratory-scale may prove to be less than optimal when scaled-up for commercial
production.

      The Company believes that the market for improved chromatographic media
will continue to grow as biopharmaceutical and pharmaceutical companies develop
and commercialize biopharmaceuticals at an accelerating pace. As of December 31,
1998, over 80 recombinant biopharmaceuticals had been approved by the United
States Food and Drug Administration ("FDA") for commercial sale. United States
biotechnology companies currently have over 200 therapeutics in human clinical
development and it is estimated that over 1,500 biopharmaceuticals are in
various stages of development.


                                       2
 
<PAGE>   3

      In particular, BioSepra is targeting the purification of monoclonal
antibodies. The Company believes that there are more monoclonal antibody-based
drugs currently in Phase II and Phase III clinical trials than any other class
of biopharmaceuticals. A vast majority of these therapeutics are being developed
for patients with the most serious and poorly managed human diseases; e.g.,
cancer, AIDS, other immune-system disorders such as multiple sclerosis and
rheumatoid arthritis, and heart disease.

      Therapeutic monoclonal antibodies are used in very high doses as compared
with most other biopharmaceuticals. Hormones, vaccines, growth factors and
immune-system modulators, for example, all act as catalysts that stimulate a
biological response. Therefore, they need only be present in the body in
relatively small doses. Antibodies, on the other hand, act directly on
disease-causing agents, binding to them and removing them from circulation. They
are most effective when available in larger quantities and for extended periods
of time.

      Separation and purification can account for anywhere from 30 to 80 percent
of the cost of making monoclonal antibody-based drugs. Therefore, the Company
believes that purification of monoclonal antibodies may represent a large
opportunity for use of the Company's proprietary media, although there can be no
assurance that companies producing monoclonal antibody-based drugs will use the
Company's media in such production.

PRODUCTS

      BioSepra has developed chromatographic media products to enable
biopharmaceutical companies to increase the productivity of their purification
processes. The media products are based on established technologies, including
its Hyper D(R) media and new in-licensed technology.

   HYPERD(R) MEDia

      In March 1993, the Company introduced its advanced HyperDiffusion
Chromatography media, called HyperD media, which the Company believes can
increase the productivity of many purification applications.

      The productivity of chromatographic media depends on both the capacity of
the media to bind target biomolecules and the speed at which biomolecules can
reach the binding sites. Conventional chromatography media, such as soft gels,
have high binding capacity for target proteins, but are typically operated at
relatively slow flow rates because the high pressures resulting from the attempt
to increase flow rates would compress the soft media gels and impede or stop
flow. While more rigid porous materials have been developed to overcome the
compressibility of soft gels and thus facilitate higher flow rates, these rigid
porous materials have typically been unable to bind as much protein as
traditional gels.

      BioSepra's HyperD media combines the high protein binding capacity of soft
gels with the higher flow advantages of rigid porous materials. The soft gel
provides a high number of protein binding sites, while the rigid porous
materials (or shell) enable the media to resist compression even as solution is
flowing at high speeds. The media is therefore able to achieve rapid flow rates
while maintaining a high level of protein binding capacity.

      The Company believes that HyperD media can, in many applications,
significantly increase productivity. The Company believes that the unique
structure of BioSepra's HyperD chromatography media can enable companies to
produce monoclonal antibody-based drugs faster and at higher purity and yield
than they could using other products currently on the market. HyperD media is
currently being used by several major pharmaceutical companies in the production
and/or development of biopharmaceuticals.

      HyperD media is produced in various particle sizes and with various
hydrogel chemistries as required by specific applications. Chromatography
chemistries currently offered by the Company include Q, S, CM and DEAE Ion
Exchange, Protein A, Basilen Blue, Heparin, Lysine and certain customized
ligands. FDA Drug Master Files have been submitted on the Company's HyperD media
products to assist the Company's customers in obtaining regulatory approval of
production processes using HyperD media.

      BioSepra currently intends to reinforce its chromatography media product
line with the development of products specifically designed for the purification
of various classes of monoclonal antibodies. For example, in 1996, BioSepra
introduced CM HyperD, a high capacity ion-exchange media specifically designed
for the purification of IgGs -- the largest class of monoclonal antibodies. The
increased benefits of CM HyperD are due to targeted performance characteristics
which, the Company believes, will differentiate it from competitive protein
purification products. The Company has introduced in 1998 its protein-A ceramic
HyperD products with increased NaOH compatibility compared to existing
competitive products. 


                                       3
<PAGE>   4
      There can be no assurance that companies using HyperD media for the
production of monoclonal antibody based drugs will be successful in producing
such drugs or that additional companies will use HyperD media for such purpose
in the future.

      In 1997, the Company further developed its market position with respect to
antibody purification by gaining access to several families of ligands. The
Company entered into a long-term supply agreement for recombinant protein-A, a
key ligand for antibody purification. The Company also obtained a worldwide
exclusive license for chromatography to a family of peptide mimetics of
protein-A and licensed hydrophobic charge induction ("HCI") technology for the
purification of antibodies. HCI purification does not require large amounts of
salt, which is used in older hyrodphillic products and has been traditionally
associated with high cost, disposal issues and additional purification steps.

      In March 1995, the Company entered into a strategic marketing alliance
with Beckman appointing Beckman as its exclusive distributor worldwide (except
in Japan) of certain HyperD media in several sizes of prepacked columns for use
in the research and method development markets. In 1996, the Company extended
the agreement to include Japan and the non-exclusive distribution of additional
media for use in the research and method development market.

OTHER MEDIA PRODUCTS

      The Company offers a line of other chromatographic media products, most of
which were introduced in the 1980s. These products, which were developed for use
primarily in the blood fractionation industry still account for a significant
percentage of the Company's sales. The Company plans to continue to sell these
media products for use in existing commercial scale processes that use these
products, as well as new applications that do not require the high bioprocessing
performance of HyperD.

      The Company's established media products offer different capabilities for
purifying specific target molecules based on molecular charge, molecular size,
degree of hydrophobicity and binding affinity. The Company's products include
the following:

      Ultrogel(R) Gel Filtration Media. These products are used in the
separation of macromolecules such as immunoglobulins, interleukins and enzymes.

      Spherosil(R), Trisacryl(R) and Spherodex(R) Ion Exchange Media. These
products are used in the purification of albumin from blood plasma and the
fractionation of serum proteins; purification of growth factors, antibodies,
glycoproteins, enzymes, and other cell products from cell culture and
fermentations; separation of nucleotides and oligonucleotide mixtures including
sugars, polynucleotides, amino acids and peptides.

     HA Ultrogel Adsorption Media. These are used for separation of human serum
proteins, glycoproteins, nucleic acids and immunoglobulins.

      Protein A, Basilen Blue and Heparin Affinity Media. These products use
ligands such as those used for the purification of growth factors, coagulation
factors, fibronectin from fibroblasts or mammalian plasma, lipoproteins, and DNA
and RNA polymerases.

   OTHER PRODUCTS

      The Company sells several chemical products used in biopharmaceutical
research. The Company offers its proprietary UpScale(TM) Process columns
designed for larger scale applications with volume capacities ranging from one
to 130 liters of media.

      In addition, the Company is developing new purification devices for use by
genomics and proteomics companies. These products under development may also be
used by large pharmaceutical companies in their drug discovery programs.

      The Company expects that sales of its historical line of chromatography
bioprocessing products will not increase in 1999 and that the future success of
its business will depend on market acceptance of the Company's more recent
products, such as HyperD, in the faster growing markets of the biopharmaceutical
industry such as monoclonal antibodies. However, there can be no assurance that
the Company's more recent products - HCI, for example -- will be developed
successfully and/or achieve market acceptance.


                                       4
<PAGE>   5

COMPETITION

      The Company encounters intense competition in the sale of its current and
future products. The Company's principal competitors are
Amersham-Pharmacia-Biotech ("Pharmacia"), Bio-Rad, and PerSeptive Biosystems,
Inc. ("PerSeptive"), a subsidiary of Perkin-Elmer Corp. These competitors as
well as certain other companies selling or developing products for the
bioseparations market, have financial, marketing and other resources greater
than those of the Company. In addition, certain competitors have had long-term
relationships with many of the Company's existing and potential customers. The
Company competes primarily on the basis of product price and performance (speed
resolution and capacity) and production capability.

      Sales of chromatographic media products typically involve long lead times
and customers generally evaluate several different media products before
committing to a volume purchase. Also, customers typically are reluctant to
change the media used in a production process previously approved by the FDA
because such a change may require additional FDA approval. There can be no
assurance that the Company will be able to compete effectively against its
existing or future competitors or that developments by others will not render
BioSepra's product or technologies obsolete or noncompetitive.

MARKETING AND SALES

      In 1998, the Company marketed its products to the biopharmaceutical
industrial market through direct sales efforts in the United States and some
parts of Europe and through distributors in certain other countries. The Company
markets and sells its products through field sales representatives and
distributors, supported by application specialists, product managers, and
technical support/application development personnel in the Company's research
and development department. Pursuant to the Company's agreement with Beckman,
Beckman distributes worldwide certain HyperD media products.

      In 1996, 1997 and 1998, 47%, 43% and 75% respectively, of the Company's
sales were outside the United States. In 1996, 1997 and 1998, media and
biochemicals accounted for 69%, 61% and 92% respectively, of the Company's
revenues. The increase in 1998 for media and biochemicals, as a percentage of
total revenues, is due to the discontinuation of the instrument business at the
end of 1997.

      In 1998, sales to two major biopharmaceutical companies accounted for 22%
and 11% of the Company's revenues, respectfully. The loss of either or both of
these customers could have a material adverse effect on the results of
operations of the Company.

RESEARCH AND DEVELOPMENT

      BioSepra's research and development group consists of 13 persons. The
Company's research and development efforts are primarily dedicated to the
development of chromatographic products to speed up and optimize process design
and development and reduce production time and cost for biopharmaceutical drug
development and manufacture with a specific focus on monoclonal antibodies and
the genomics and gene therapy markets. During 1996, 1997 and 1998, the Company
spent $2,399,000, $1,859,000 and $1,299,000 respectively, on research and
development.

GOVERNMENT REGULATION

      FDA and comparable foreign regulations pertain not only to health care
products, but also to the processes and production facilities used to produce
such products. Among the conditions for FDA approval of a biopharmaceutical is
the requirement that the manufacturer's quality control and manufacturing
processes conform to current Good Manufacturing Practices ("GMP").

      BioSepra's customers are required to obtain the approval of the FDA and
similar health authorities in foreign countries to test clinically and sell
commercially pharmaceuticals for human use. Although the Company's products do
not require FDA approval for sale, the FDA and comparable foreign authorities
typically review the manufacturing procedures and inspect the facilities and
equipment of the Company's customers for compliance with applicable rules and
regulations. The Company's customers will often review and inspect the Company's
manufacturing facilities prior to ordering products for use in an FDA-approved
production process. The Company believes that its production and documentation
procedures are consistent with GMP. Also, the Company files with the FDA Drug
Master Files that facilitate the use by pharmaceutical companies of the
Company's media for both clinical trial production and commercial production.


                                       5
<PAGE>   6

      Historically, in the production of a biopharmaceutical, any material
change by a manufacturer of process or equipment traditionally has necessitated
additional FDA review and approval. Manufacturers were therefore typically
reluctant to change production methods for existing products. For this reason,
BioSepra has in the past encountered difficulties in selling its media products
to customers which had already applied for or obtained FDA licenses for
production processes that specified a different supplier's product.

      While this difficulty remains an issue for various categories of
biopharmaceuticals, new guidelines issued in 1996 by the FDA give
biopharmaceutical companies greater flexibility to make changes in the
production processes for certain classes of drugs, including monoclonal
antibody-based drugs, and to continue optimization of their production processes
subsequent to drug approval. In the past, a drug manufacturing process was
"locked in" during clinical trials, prior to product approval. Companies were
reluctant to make any process changes because the FDA would have required new
clinical studies. Now, companies affected by these new guidelines need only
demonstrate a product's biological equivalence to adopt process changes without
new clinical trials.

PATENTS AND PROPRIETARY RIGHTS

      BioSepra holds several patents and patent applications, including a United
States composition of matter patent (and comparable foreign patent applications)
on HyperD media. The Company's additional patents relate primarily to the
composition of its other media products and certain biopharmaceutical production
processes. There can be no assurance that any of the Company's issued patents
will afford the Company any significant protection, that any pending patent
applications will result in the issuance of patents or that competitors will not
successfully challenge the Company's patents or circumvent the Company's patent
position. The invalidation of key patents owned by BioSepra or the failure of
patents to issue on pending applications could result in increased competition.
The Company also relies on unpatented trade secrets and licensed technology.

      The patent positions of companies in the biopharmaceutical industry are
highly uncertain, involve complex legal and factual questions and recently have
been the subject of much litigation. A significant number of patents have been
applied for by and issued to other companies in BioSepra's industry, and other
companies may have filed applications for, may have been issued patents or may
obtain additional patents and proprietary rights relating to products
competitive with those of the Company.

      In addition, the Company's products may give rise to claims that they
infringe the proprietary rights of others. No assurance can be given that any
license required under any such patents or rights would be made available on
terms acceptable to the Company, if at all. If the Company does not obtain such
licenses, it could encounter delays in product introductions while it attempts
to design around such patents, or could find that the development, manufacture
or sale of products requiring such licenses could be precluded. Litigation may
be necessary to defend against or assert claims of infringement, to enforce
patents issued to the Company, to protect trade secrets or know-how owned by the
Company, or to determine the scope and validity of the proprietary rights of
others, and could result in substantial costs to and diversion of effort by, and
may have a material adverse impact on, the Company.

EMPLOYEES

     As of March 1, 1999, BioSepra, Inc. and its wholly owned subsidiary
BioSepra S.A. employed 50 persons, of whom 13 were primarily engaged in research
and development activities, 14 in manufacturing, and the remainder in marketing,
sales, administration and accounting. Of the 50 persons, 11 are located in the
United States and 39 in Europe.

     The Company's recently completed acquisition of a 51% interest in Biosphere
Medical, S.A (see "Recent Developments"). Biosphere Medical, S.A. has 27
employees, of which 11 are in engaged in manufacturing and 16 in sales, 
marketing and administration.

     The Company's employees in the United States are not covered by a
collective bargaining-agreement. In Europe, its employees are covered by the
provisions of two agreements setting forth national guidelines and standards for
labor relations in the chemical and metal industry. The Company considers its
relations with its employees to be good.


                                       6
<PAGE>   7
FACTORS THAT MAY AFFECT RESULTS

      This Annual Report on Form 10-K contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects,"
"intends," and similar expressions are intended to identify forward-looking
statements. There are a number of factors that could cause the Company's actual
results to differ materially from those indicated by such forward-looking
statements. These factors include, without limitation, those set forth in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Future Operating Results."

RELATIONSHIP WITH SEPRACOR

      Sepracor owns approximately 64% of the outstanding capital stock of the
Company. Sepracor is a leading specialty pharmaceutical company focused on the
cost-effective development of safer, purer and more effective drugs that are
improved versions of widely prescribed pharmaceutical compounds. Under
applicable provisions of the Delaware General Corporation Law, Sepracor will
have the ability, acting alone, to approve any action requiring approval of the
holders of a majority of the outstanding shares of Common Stock.

      Technology Transfer and License Agreement. In January 1994, The Company
and Sepracor entered into a Technology Transfer and License Agreement (the
"Technology Transfer Agreement") pursuant to which Sepracor transferred to the
Company all technology owned or controlled by Sepracor, including trade secrets,
patents and patent applications, that relates to and is used in researching,
developing or manufacturing products in the "Company Field." The Company Field
means generally the separation of biological molecules. The Technology Transfer
Agreement expired on January 1, 1998. Pursuant to the Technology Transfer
Agreement, the Company has granted to Sepracor a perpetual royalty-free,
exclusive license to the transferred technology for the development,
manufacture, use or sale of any products within the field of chiral synthesis,
chiral separations and the development, manufacture, use or sale of chiral drugs
and chiral drug intermediates (the "Sepracor Field"), as well as a non-exclusive
license to the transferred technology for the development, manufacture, use or
sale of any products outside the Company Field. In addition, Sepracor granted a
perpetual royalty-free, exclusive license to the Company for any improvements to
the transferred technology useful in the Company Field which are developed, or
otherwise acquired, by Sepracor during the term of the agreement
("Improvements"). Although the license granted by Sepracor to the Company
terminated when the Technology Transfer Agreement expired, it provided that any
licenses granted during the term survived to the extent they related to
Improvements existing on the date of termination. 

      Corporate Services Agreement. The Company and Sepracor entered into a
Corporate Services Agreement dated as of January 1, 1994, which provides for a
monthly fee to be paid by the Company for basic services, such as accounting,
human resources, data processing and other services provided by Sepracor. This
fee was determined by estimating Sepracor's cost of the Company's expected usage
of such basic services. The Company may purchase additional services from
Sepracor for a fixed rate based on the number of hours spent by each Sepracor
employee providing such services. For items with identifiable costs such as
insurance coverage, Sepracor charges the Company based upon costs directly
attributable to the Company. Management believes that the charges under the
Corporate Services Agreement are reasonable and that the terms of the Corporate
Services Agreement are at least as favorable to the Company as the terms that
could be obtained from an unaffiliated third party. This Agreement had an
initial term of one year and had been extended by the Company for three
additional one-year terms. The Company and Sepracor continue to operate under
the terms of the original agreement. Sepracor retains the right to decline to
provide any services that cause an unreasonable burden to Sepracor. The
Agreement permits the Company to terminate at any time following 60 days' notice
to Sepracor, and automatically terminates six months after Sepracor's ownership
percentage of the Company decreases to less than 50% of the Company's issued and
outstanding shares. The aggregate payments made by the Company to Sepracor for
basic services under this Agreement were approximately $208,000 in 1996,
$208,000 in 1997 and $155,000 in 1998.


                                       7
<PAGE>   8

      Sublease Agreements. Sepracor has entered into a Sublease Agreement with
the Company under which Sepracor subleases a portion of its facilities in
Marlborough, Massachusetts to the Company. The amount payable to Sepracor under
the Sublease Agreement is equal to Sepracor's rental costs under its lease
allocable to the portion of the premises subleased to the Company plus a pro
rata allocation of the estimated facility maintenance, utilities and other
operating costs. The rental payment made by the Company under this Agreement was
approximately $72,000 in 1996, $93,000 in 1997, and $81,000 in 1998. Operating
costs under this Agreement were approximately $233,000 in 1996, $227,000 in 1997
and $167,197 in 1998. The lease charges at the Massachusetts facility are equal
to a pro rata portion of Sepracor's costs, including maintenance, utilities and
other operating costs based upon square footage occupied.

      Registration Rights. Sepracor has certain registration rights with respect
to its shares in the Company as provided in the Technology Transfer Agreement.

      Promissory Note. In January 1996, the Company entered into a Promissory
Note for $350,000, or so much of such sum as shall have been advanced by
Sepracor. This amount is payable to Sepracor over sixty monthly installments and
does not bear interest. As of December 31, 1998, $163,600 was outstanding under
this Promissory Note.

      Guaranteed Indebtedness. The Company has indebtedness outstanding of
$402,000 as of December 31, 1999 under a French Franc loan that is guaranteed by
Sepracor. Additionally, the Company's $3,000,000 line of credit with a US Bank,
of which $2,000,000 is outstanding as of December 31, 1999, is guaranteed by
Sepracor.

      Any future arrangements and transactions between the Company and Sepracor
will continue to be on terms that the Company determines are fair and reasonable
to the Company.


ITEM 2.  PROPERTIES

      BioSepra's facilities are located in Marlborough, Massachusetts and
Villeneuve-la-Garenne, France. In Massachusetts, the Company subleases
approximately 15,000 square feet of office, laboratory and assembly space from
Sepracor. In Villeneuve-la-Garenne, France, the Company leases approximately
28,500 square feet of office, laboratory and manufacturing space. Of the total,
approximately 20,440 square feet are used for manufacturing operations, and the
balance is used for research and development and administration. The Company
believes that its space is adequate for the foreseeable future.

      At its facility in Villeneuve-la-Garenne, France, the Company produces its
chromatographic media. The Company has entered into a long-term lease
arrangement with Nationcredimurs Societe en nom Collectif, and expects to move
into its newly constructed facilities during the second quarter of 1999.

      At its facility in Louvres, France, the Company packages, assembles and
distributes its medical supplies and currently occupies 11,000 square feet of
space.

ITEM 3. LEGAL PROCEEDINGS

      The Company is not currently a party to any material legal proceedings.


                                       8
<PAGE>   9

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders of the Company,
through solicitation of proxies or otherwise, during the last quarter of the
year ended December 31, 1998.

EXECUTIVE OFFICERS OF THE COMPANY

      The following table sets forth the names, ages and positions of the
executive officers of the Company as of December 31, 1998.

<TABLE>
<CAPTION>
      NAME                     AGE                    POSITION
      ----                     ---                    --------
<S>                             <C>     <C>                     
Jean-Marie Vogel                48      President, Chief Executive Officer and Director
Egisto Boschetti, Ph.D.         53      Senior Vice President and Chief Scientific Officer
Therese Bourdy                  48      Vice President of Media Operations
Philip V. Holberton, CPA        56      Chief Financial Officer, Treasurer, Secretary
</TABLE>

      Mr. Vogel has served as President, Chief Executive Officer and a director
of the Company since September 1994. From January 1994 to August 1994, Mr. Vogel
served as Executive Vice President and Chief Operating Officer of the Company.
From 1992 to 1993, Mr. Vogel served as President of the European Operation of
Cuno, Inc., a supplier of filtration processes, equipment and devices used in
the production of biological drugs and food products. From 1977 to 1992, Mr.
Vogel served in various capacities with Millipore Corporation ("Millipore"), a
manufacturer of membrane filtration-based products, in its international
operations with experience in Asia, Latin America, the former Soviet Union, the
Middle East and Australia. Most recently, Mr. Vogel served as Vice President and
General Manager of Millipore's Asian Operations. Mr. Vogel is a French citizen.

     Dr. Boschetti has served as Senior Vice President and Chief Scientific
Officer of the Company since January 1997 and served as Vice President and Chief
Scientific Officer from January 1994 to January 1997. From June 1991 to January
1994, Dr. Boschetti served as Vice President of Research and Development and
Technical Operations -- Sepracor Europe. From 1986 until 1991, Dr. Boschetti was
Vice President of R&D and Technical Director of IBF. Dr. Boschetti has been
associated with IBF and its predecessor, Pointet-Girard S.A. for 20 years. Dr.
Boschetti has published over 130 articles in international scientific journals
and is a member of the editorial board of Preparative Chromatography. Dr.
Boschetti is Vice Chairman of the Biotechnology Commission of the French
Ministry of Research and is a French citizen.

      Ms. Bourdy has served as Vice President of Media Operations of the Company
since January 1997 and served as General Manager and Director of Operations,
BioSepra S.A. from August 1995 to January 1997. From 1992 to 1995, Ms. Bourdy
served as Quality Assurance, Operations and Marketing manager for Cuno, Inc., a
supplier of filtration processes, equipment and devices used in the production
of biological drugs and food products. From 1991 to 1992, Ms. Bourdy was an
independent consultant. From 1983 to 1991, Ms. Bourdy served in various
operational positions with National Fractionation Center France, a bioprocessing
company focusing on blood products. From 1974 to 1983, Ms. Bourdy served in
various capacities with Millipore, a manufacturer of membrane filtration-based
products, in its pharmaceutical, agrofood and water treatment divisions.

      Mr. Holberton has served as Chief Financial Officer, Treasurer and
Secretary of the Company since July 1, 1998 as a contract CFO. Concurrently and
prior thereto, he has served as contract CFO and consultant for other companies
since 1995. Prior thereto, he was Chief Financial Officer for Cambridge
NeuroScience, Inc., a publicly traded biotechnology company.


                                       9
<PAGE>   10

                                     PART II


ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

      The Common Stock of BioSepra Inc. traded on the Nasdaq National Market
under the symbol BSEP from March 25, 1994 through January 13, 1999, at which
time it moved to NASD's OTC: Bulletin Board. On January 14, 1999, the Common
Stock of BioSepra began trading on the OTC: Bulletin Board. On March 5, 1999,
the last reported sale price of the Company's Common Stock on the OTC: Bulletin
Board was $1.00. The following table sets forth for the periods indicated the
high and low sales prices per share of the Common Stock as reported by the
Nasdaq National Market for the last two fiscal years.


                                                       1998

                                              HIGH                  LOW
First Quarter                               $2 7/8                $1 1/4
Second Quarter                              $2 5/8                $1 1/2
Third Quarter                               $1 1/2                $  1/2
Fourth Quarter                              $1 1/16               $  1/4


                                                       1997

                                              HIGH                  LOW
First Quarter                               $4  7/8               $2 3/8
Second Quarter                              $3  7/8               $2 5/8
Third Quarter                               $2  9/16              $1 3/4
Fourth Quarter                              $3 23/32              $1 1/8

      On March 5, 1999, the Company had approximately 44 stockholders of record.
The Company believes that the number of record holders is not representative of
the number of beneficial holders because depositaries, brokers or other nominees
hold many shares.

     The Company has never paid dividends on its Common Stock. The Company
currently intends to reinvest its earnings, if any, for use in the business and
does not expect to pay cash dividends in the foreseeable future.


                                       10
<PAGE>   11

ITEM 6.  SELECTED FINANCIAL DATA

     The following table sets forth certain consolidated financial data with
respect to the Company. The selected consolidated financial data should be read
in conjunction with the consolidated financial statements and related notes
thereto.


<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
(In thousands, except per share amounts)                  1998         1997         1996         1995          1994
---------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>          <C>          <C>          <C>           <C>     
STATEMENT OF OPERATIONS DATA:
Revenue:
     Revenue from existing product sales                $ 6,996      $ 8,254      $10,345      $  7,380      $  8,490
     Revenue from discontinued product sales                 --        1,382        3,078         5,000         2,430
     License fees                                           120        3,600          900            --            --
     Research and development                               283           58           --           107           376
---------------------------------------------------------------------------------------------------------------------
     Total Revenue                                        7,399       13,294       14,323        12,487        11,296
---------------------------------------------------------------------------------------------------------------------
Cost and expenses:
     Cost of products sold                                4,124        5,523        6,338         8,344         5,933
     Research and development                             1,299        1,859        2,399         2,761         3,383
     Selling, general and administrative                  4,132        5,840        7,573         9,544         9,605
     Restructuring and impairment                          (351)       4,179           --         4,144            --
     Purchase of in-process research and                     --           --           --            --         3,500
     development
---------------------------------------------------------------------------------------------------------------------
     Total cost and expenses                              9,204       17,401       16,310        24,793        22,421
---------------------------------------------------------------------------------------------------------------------
Loss from operations                                     (1,805)      (4,107)      (1,987)      (12,306)      (11,125)
Other income (expense):
     Interest income                                        150          158          186           381           443
     Interest expense                                      (222)         (72)        (214)         (448)         (250)
     Other income (expense)                                  64          217         (105)         (302)         (191)
---------------------------------------------------------------------------------------------------------------------
Net loss                                                $(1,813)     $(3,804)     $(2,120)     $(12,675)     $(11,123)
---------------------------------------------------------------------------------------------------------------------

Basic and diluted net loss per common share             $ (0.21)     $  (.45)     $  (.27)     $  (1.81)     $  (1.76)(1)
Basic and diluted weighted average number of common
shares outstanding                                        8,437        8,423        7,832         7,004         6,326(1)

BALANCE SHEET DATA:
Cash and cash equivalents                               $ 2,235      $ 2,370      $ 4,142      $  3,693      $  7,983
Working capital                                           2,552        3,835        3,648        (1,269)        6,972
Total assets                                             14,717       14,906       23,169        23,824        35,605
Long-term debt and capital leases                           276          690        1,141         1,308           359
Shareholders' equity                                      9,097       10,380       14,442        10,914        23,010
</TABLE>

(1)  The basic net loss per share and the weighted average number of common
     shares outstanding for the year ended December 31, 1994 have been restated.
     These amounts have been restated to comply with the Securities and Exchange
     Commission's staff accounting bulletin No. 98 "Computation of Earnings Per
     Share," which eliminates the effects of 91,000 shares of "cheap stock" in
     the Company's original calculation of earnings per share.


                                       11
<PAGE>   12

     ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
     RESULTS OF OPERATIONS


RESULTS OF OPERATIONS

   Overview

     BioSepra Inc. and subsidiaries (the "Company") develop, manufacture and
sell chromatographic media for use by biopharmaceutical companies in the
purification and production of biopharmaceuticals. The Company offers a line of
chromatographic products that it believes enables biopharmaceutical companies to
reduce the time and cost required to develop and manufacture biopharmaceuticals.

     On March 26, 1998, the Company, Sepracor and Beckman entered into an
agreement pursuant to which the Company amended its Distribution Agreement with
Beckman and Sepracor amended its Stock Purchase Agreement with Beckman. Under
the amendment, the Company (i) granted to Beckman a non-exclusive right to
manufacture instruments, (ii) was relieved of its obligation to manufacture the
instruments for Beckman and (iii) sold the discontinued instrument product
inventory to Beckman for $250,000. Under the original Stock purchase Agreement,
Sepracor issued 312,500 shares of Sepracor's Series B Redeemable Exchangeable
Preferred Stock to Beckman in exchange for $5,000,000. Under the amendment,
Sepracor redeemed the Series B Preferred Shares for the original purchase price
plus accrued dividends totaling $6,850,000.

     In December 1997, the Company recorded restructuring and impairment charges
totaling $4,179,000. Of this amount, $3,328,000 relates to the write down of
intangible assets to their estimated net realizable value as required by SFAS
No. 121 and $851,000 relates to the cost reduction program implemented in
December 1997. The purpose of the program was to enable the Company to focus on
higher margin consumable products for the research and process segments of the
biopharmaceutical and genomics markets. The cost reduction program involved the
discontinuation of its instrument product line and a reduction in the number of
employees. Of the $851,000 related to the cost reduction program, $690,000
represents the write down of inventory and fixed assets associated with the
discontinued product lines and $161,000 represents severance and benefits
related to the reduction in workforce. The Company has completed its reduction
in workforce related to this cost reduction program, which has resulted in the
termination of 7 employees in the U.S. (consisting of marketing/sales, finance
and administrative personnel). The Company paid all of the severance and benefit
payments associated with this workforce reduction in the first half of 1998. In
1998, the Company recorded a $351,000 reduction in the restructuring charge for
excess amounts recorded in 1997. There can be no assurances that this program
will not result in loss of customers or temporary sales or production
disruptions that could have a material adverse effect on the Company's business,
financial condition or results of operations. See "Future Operating Results."

     In December 1997, the Company and Sepracor settled their long-standing
patent lawsuit with PerSeptive Biosystems, Inc ("PerSeptive"), a competitor of
the Company. Under the terms of the settlement, the Company obtained a limited,
non-exclusive license under PerSeptive's Perfusion Chromatography(R) patents to
make, use and sell its HyperD(R) product line free of claims of infringement by
PerSeptive and PerSeptive received an undisclosed payment.

     In December 1997, the Company amended its licensing agreement with Beckman
to eliminate the Company's obligation to repay part of the payments received
under the agreement if the Company terminates Beckman's right to use and sell
licensed products, including HyperD media, as a result of a court finding that
any such licensed products infringe any third party patents. As a result of the
amendment, the Company recognized $2,700,000 of license fee revenue in December
1997 rather than over the next three years.

     In January 1996, the Company entered into a promissory note for $350,000
with Sepracor. This amount is payable to Sepracor over sixty monthly
installments and does not bear interest. The Company used the funds for
leasehold improvements to the Company's facilities. As of December 31, 1998,
$163,600 was outstanding under the promissory note. In addition, the Company has
outstanding, under its revolving credit agreement, as of December 31, 1999,
$2,000,000 that is guaranteed by Sepracor.


                                       12
<PAGE>   13

     The Company's primary operations are located in facilities leased in France
and in facilities subleased from Sepracor in the United States for which the
Company is charged a portion of Sepracor's rent and operating costs based upon
the amount of space it occupies. In addition, Sepracor provides support services
to the Company, including laboratory support, data processing, accounting and
finance, legal and other administrative functions. Sepracor allocates a portion
of the costs of these activities to the Company based upon its pro rata usage of
such services.

   Years Ended December 31, 1998, 1997 and 1996

     The Company's revenue decreased to $7,399,000 for the year ended December
31, 1998 compared to $13,294,000 in 1997 and $14,323,000 in 1996. The decrease
from 1997 to 1998 is primarily attributed to decreased media sales and the
discontinuance of its instrument product line effective December 31, 1997,.
Additionally, during 1997, the Company recognized license fees of $2,700,000
upon the amendment of the Beckman agreement; also, included in 1997 revenue was
$1,382,000 of sales from its instrument product line discontinued in the fourth
quarter of 1997. The decrease in revenues from 1996 to 1997 is the result of (i)
decreased media sales, and (ii) decreased sales of the discontinued products
partially offset by $2,700,000 of licenses fees recognized upon the amendment of
the Beckman agreement.

     Costs of products sold decreased to $4,124,000 for the year ended December
31, 1998 compared to $5,523,000 in 1997 and $6,338,000 in 1996, representing
59%, 57% and 47% of product revenue, respectively. The decrease in profit margin
on product sales in 1998 compared to 1997 is due to an unfavorable product mix
of the Company's current media products and a decline in manufacturing
absorption due to lower sales, which is partially offset by the Company's
discontinued lower margin instrument business. The Company expects that its
profit margin will continue to fluctuate in future periods as a result of
changes in product mix and or manufacturing utilization. The decrease in gross
profit margins on product sales in 1997 compared to 1996 is attributable to
unfavorable product mix, and, to a lesser extent, the transition of resources
from the product development phase to production support associated with new
product introductions.

     Research and development expenses decreased to $1,299,000 in 1998 compared
to $1,859,000 in 1997 and $2,399,000 in 1996. The reduction in research and
development expenses from 1997 to 1998 is largely due to the discontinuation of
the instrument product line. The reduction in expenses from 1997 to 1996 is
primarily the result of transitioning resources from the product development
phase to production and commercialization support associated with new products.

     Selling, general and administrative expenses decreased to $4,132,000 in
1998 from $5,840,000 in 1997 and $7,573,000 in 1996. The reduction in selling,
general and administrative expenses from 1997 to 1998 was due primarily to the
discontinuation of the instrument product line, partially offset by an increase
in selling and marketing expenses of the Company's process media business. The
reduction in expenses from 1996 to 1997 was due primarily to a reduction in
overall personnel costs, the transition of resources to direct product support
of new products, and to a lesser extent, reduced legal fees.

     The Company recognized a gain of $351,000 related to the sale of its
instrument inventory to Beckman Instruments, Inc. which was previously written
off and included in the restructuring charge of 1997. The Company incurred
$4,179,000 in restructuring and impairment charges in 1997 as a result of a
write down of intangible assets to their estimated net realizable value and a
cost reduction program implemented in December 1997 as further detailed herein.

     Interest income decreased to $150,000 in 1998 from $158,000 in 1997 and
$186,000 in 1996. The decrease in 1998 and 1997 from 1996 was due primarily to
the decreased levels of cash investments and declines in the interest rates
earned on such investments. Interest expense increased to $222,000 in 1998 from
$72,000 in 1997 due primarily to the use of the Company's credit line for all of
1998. The decrease to $72,000 in 1997 from $214,000 in 1996 was primarily
attributed to decreased level of borrowings and changes in the interest rates
charged on such borrowings.

     Other income, net, decreased to $64,000 in 1998 from $217,000 in 1997 which
was an increase from other expense, net of $105,000 in 1996. The decrease in
1998 is primarily attributable to the reversal of a one-time accrual made in
prior years and the recording of non operating expenses related to the Company's
planned move to its new facility. The increase in other income in 1997 from 1996
is attributed to the net effect of foreign currency gains and losses due to
changes in the value of the U.S. dollar.


                                       13
<PAGE>   14
LIQUIDITY AND CAPITAL RESOURCES

     The Company has funded its operations to date primarily from revenues from
product sales and license fees, net proceeds provided from the Company's initial
public offering, funds provided by Sepracor, bank financing and equipment
financing leases. As of December 31, 1998, the Company had $2,235,000 of cash
and cash equivalents and $2,552,000 of working capital. Cash and cash
equivalents for the year ended December 31, 1998 decreased by $278,000 from
$1,466,000 for the year ended December 31, 1997. In 1998, the Company used cash
for operations of $1,466,000 primarily to fund the Company's net loss. The
Company used cash for investing activities of $278,000 primarily to purchase
property and equipment, increase in other assets, which were offset by proceeds
from the sale of equipment and decrease in restricted cash. In 1998, the Company
generated cash from borrowings of $2,000,000 under its line of credit offset by
repayments of $484,000 of long-term debt.

     The Company's French subsidiary has available three credit facilities
aggregating 4,000,000 French Francs, (approximately $715,000 at December 31,
1998), from three French commercial banks. At December 31, 1998, there was no
indebtedness outstanding under these credit facilities. At December 31, 1998,
$402,000 was outstanding under a French Franc loan which is guaranteed by
Sepracor. In addition, Sepracor guarantees certain capital lease obligations of
the Company. The outstanding balance of the capital lease obligation guaranteed
by Sepracor was $64,000 as of December 31, 1998. In addition, Sepracor
guarantees the Company's $3,000,000 line of credit.

     On December 31, 1996, the Company, in collaboration with Sepracor and
certain of its other subsidiaries, amended its revolving credit agreement with a
bank under which the Company may borrow up to $3,000,000, subject to limitations
defined in the agreement and on borrowings outstanding by other companies. There
is $2,000,000 outstanding under this agreement as of December 31, 1998. Interest
on outstanding borrowings is payable monthly in arrears at prime (7.75% at
December 31, 1998) or the LIBOR rate (5.07% at December 31, 1998) plus 1.75%.
The Company is required to pay a commitment fee equal to 1/4% per annum on the
average unused line. The agreement requires the Company to maintain certain
financial ratios and levels of cash and cash equivalents and tangible capital
bases. This facility is available until April 30, 1999 and is collateralized by
the personal property of the Company. Sepracor is guarantor of any amounts
outstanding under the agreement. The Company is currently in preliminary
discussions with the bank to extend this agreement, although there is no 
assurance that this will occur.

      Based upon the Company's current operating plan, the Company believes that
its current cash balance and available credit facilities are not sufficient to
fund the Company's operations through 1999. However, the Company's cash
requirements may be materially more or less than those now planned because of
numerous factors, including but not limited to, the timing of significant
product orders, commercial acceptance of new products, patent developments and
the introduction of competitive products. The Company is currently exploring
alternatives for generating additional cash including, but not limited to, a
financing, additional borrowings, and/or strengthening its process
chromatography media business by finding a strategic partner, which may include
licensing, merger or sale of the operating assets. In the event these efforts
are not successful, the Company may have to significantly reduce or curtail its
operations.

FUTURE OPERATING RESULTS

     Certain information contained in this Annual Report, including information
with respect to the ability of the Company to obtain additional financing, the
success of the Company's HyperD media and information with respect to the
Company's other plans and strategy for its business, including its plans to
introduce products for use in producing monoclonal antibody-based drugs, consist
of forward-looking statements. For this purpose, any statements contained herein
that are not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words "believes," "anticipates,"
"plans," "expects," "intends," and similar expressions are intended to identify
forward-looking statements. There are a number of factors that could cause the
Company's actual results to differ materially from those indicated by such
forward-looking statements. These factors include, without limitation, the
following:

     The future success of the Company will depend largely on the success of its
HyperD media product line, which was introduced in March 1993 and of the
successful development and market success of its HCI technology and fluidized
beds media. There can be no assurance that the Company's HyperD media product
line will achieve commercial success and any failure of such products to achieve
such success would have a materially adverse effect on the business and results
of operations of the Company.

     It is likely that the Company will require additional funds in 1999. There
can be no assurance that such financing will be available on favorable terms, if
at all. If the Company requires additional financing and such 


                                       14
<PAGE>   15

capital is not available on acceptable terms from third parties, Sepracor may,
but is not obligated to, guarantee or provide such financing. As of December 31,
1998, Sepracor had guaranteed $2,466,000 of outstanding bank borrowings and
lease financing obligations of the Company.

     Sales to process customers of chromatographic media products, such as
HyperD media, typically involve long lead times, and customers generally
evaluate several different media products before committing to a volume
purchase. Also, customers are typically reluctant to change media used in the
production process for a pharmaceutical previously approved by the FDA because
such a change may require additional FDA approval. There can be no assurance
that the Company will be able to compete effectively against its existing or
future competitors.

     In February 1999, the Company completed its acquisition of a 51% interest
in Biosphere Medical, S.A. The principle purpose for the acquisition is to gain
access to product know-how and CE (European equivalent to the FDA) approval of
Biosphere's product Embospheres(TM), a spherical bead used in three medical
applications within the European medical community. Biosphere Medical commenced
operations in May 1998 as a result of purchasing several product lines from
Guerbet, S.A. There are numerous risks associated with this acquisition
including, among other things, potential exposure to unknown liabilities of
BioSphere Medical prior to the acquisition, risks associated with assimilating
its operations and personnel, risks related to the acquired technologies and
with the further development and commercialization of the technology, potential
disruptions in the Company's business resulting from the acquisition, diversion
of management time and attention, and the potential failure to achieve
anticipated financial, operating and strategic benefits from the acquisition.

     Other factors that may adversely affect the Company's future operating
results include: intense competition from other companies selling or developing
bioseparation products, the loss of any significant customer, risks attendant to
the conduct of business in foreign countries, risks relating to the Company's
ability to maintain meaningful patent protection of its proprietary information
and the risk of product liability claims associated with the testing, marketing
and sale of the Company's media products.

     Because of the foregoing factors, the Company believes that
period-to-period comparisons of its financial results are not necessarily
meaningful and it expects that its results of operations may fluctuate from
period to period in the future.

YEAR 2000 COMPLIANCE

     The Company is currently working to negate any potential impact of the year
2000 on the processing of date-sensitive information by the Company's
computerized information systems. The year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculation or system failures. The Company has
completed the assessment of its requirements to become year 2000 compliant, the
readiness of its suppliers, and expects compliance to be completed by June 30,
1999. In this connection, the Company is upgrading certain of its computer
hardware and software, and does not believe it has any legacy systems that are
non-YK2 compliant. Total expenditures to achieve compliance will be less than
$100,000, substantially all of which already has been incurred. In the event
that it encounters year 2000 problems, the Company has a contingency plan in
place to minimize the disruption to its ongoing business operations. For the
remainder of 1999, it will focus upon the review and status of its suppliers'
readiness; the Company will also test its contingency plan. However, failure of
the Company, its customers or vendors to resolve any compliance issues in a
timely manner, could have an adverse effect on the Company's business, financial
condition and results of operations.


                                       15
<PAGE>   16

ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     The Company is subject to market risk in the form of interest rate risk and
foreign currency risk.

     The Company's investments in short-term cash equivalents are subject to
interest rate movements, but the time to maturity is very short and therefore
the Company does not believe these exposures are material. The Company purchases
product for resale from its French wholly owned subsidiary and resells that
product to U S customers. The payable is due in local French currency, and
therefore the company may experience gains and or losses upon the payment of
this account payable obligation.


                                       16
<PAGE>   17

ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                          INDEX TO FINANCIAL STATEMENTS


                                                                            PAGE
                                                                            ----


Report of Arthur Andersen LLP                                                18

Consolidated Balance Sheets at December 31, 1998 and 1997                    19

Consolidated Statements of Operations for the
         years ended December 31, 1998, 1997 and 1996                        20

Consolidated Statements of Shareholders' Equity
         for the years ended December 31, 1998, 1997 and 1996                21

Consolidated Statements of Cash Flows for the years ended
         December 31, 1998 and 1997 and 1996                                 22

Notes to Consolidated Financial Statements                                   23


                                       17
<PAGE>   18

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders of BioSepra Inc. and subsidiaries:

     We have audited the accompanying consolidated balance sheets of BioSepra
Inc. (a Delaware Corporation) and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, shareholders' equity and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of BioSepra Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.

     The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note A. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

                                           /s/ Arthur Andersen LLP



Boston, Massachusetts
February 2, 1999


                                       18
<PAGE>   19

<TABLE>
<CAPTION>
BIOSEPRA INC.
CONSOLIDATED BALANCE SHEETS
---------------------------

DECEMBER 31, (In thousands, except par value amounts)                             1998          1997
------------------------------------------------------------------------------------------------------
<S>                                                                             <C>           <C>     
ASSETS
Current assets:
   Cash and cash equivalents (Note B)                                           $  2,235      $  2,370
   Restricted cash                                                                    --           146
   Accounts receivable (less allowance for doubtful
   accounts of $106 in 1998 and $369 in 1997)                                      2,034         2,376
   Inventories                                                                     3,572         2,722
   Prepaid and other current assets
                                                                                      55            57
------------------------------------------------------------------------------------------------------
   Total current assets                                                            7,896         7,671
------------------------------------------------------------------------------------------------------

Property and equipment, net (Note E)                                               1,416         1,509
Goodwill, net                                                                      4,896         5,288
Other assets
                                                                                     509           438
------------------------------------------------------------------------------------------------------
Total assets                                                                    $ 14,717      $ 14,906
--------------------------------------------------------------------------------======================

LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
   Current portion of long-term debt and capital leases  (Note F)               $  2,458      $    488
   Accounts payable                                                                  984         1,307
   Accrued expenses                                                                1,432         1,277
   Related party payables (Note C)                                                   430           325
   Accrued expenses relating to acquisition                                           --           257
   Accrued restructuring (Note H)                                                     --           161
   Deferred contract revenue (Note I)                                                 40            21
------------------------------------------------------------------------------------------------------
   Total current liabilities                                                       5,344         3,836
------------------------------------------------------------------------------------------------------

Long-term debt and capital leases, net of current portion  (Note F )                 276           690
------------------------------------------------------------------------------------------------------
Total liabilities                                                                  5,620         4,526
------------------------------------------------------------------------------------------------------

Commitments and contingencies (Notes F and G)

Shareholders' equity
   Preferred stock, $0.01 par value, 1,000 shares authorized;
      none issued and outstanding                                                     --            --
   Common stock, $0.01 par value, 12,000 shares authorized;
      Issued and outstanding 8,456 shares in 1998
      and 8,431 shares in 1997                                                        84            84
   Additional paid-in capital                                                     40,587        40,515
   Unearned compensation, net                                                         --          (161)
   Accumulated deficit                                                           (31,535)      (29,722)
   Cumulative translation adjustment                                                 (39)         (336)
------------------------------------------------------------------------------------------------------
   Total shareholders' equity                                                      9,097        10,380
------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity                                      $ 14,717      $ 14,906
--------------------------------------------------------------------------------======================
</TABLE>


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


                                       19
<PAGE>   20

BIOSEPRA INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------

<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,(In thousands, except per share amounts)     1998         1997         1996
-------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>          <C>           <C>    
REVENUE (NOTE B):
   Product sales                                                           $ 6,996      $  9,636      $13,423
   License fees                                                                120         3,600          900
   Research and development                                                    283            58           --
-------------------------------------------------------------------------------------------------------------
   Total revenue                                                             7,399        13,294       14,323
-------------------------------------------------------------------------------------------------------------

COSTS AND EXPENSES:
   Cost of products sold                                                     4,124         5,523        6,338
   Research and development                                                  1,299         1,859        2,399
   Selling, general and administrative                                       4,132         5,840        7,573
   Restructuring and impairment costs (Note H)                                (351)        4,179           --
-------------------------------------------------------------------------------------------------------------
   Total costs and expenses                                                  9,204        17,401       16,310
-------------------------------------------------------------------------------------------------------------
Loss from operations                                                        (1,805)       (4,107)      (1,987)

OTHER INCOME (EXPENSE):
   Interest income                                                             150           158          186
   Interest expense                                                           (222)          (72)        (214)
   Other income (expense)                                                       64           217         (105)
-------------------------------------------------------------------------------------------------------------
Net loss                                                                   $(1,813)     $ (3,804)     $(2,120)
---------------------------------------------------------------------------==================================

Basic and diluted net loss per share (Note B)                              $  (.21)     $   (.45)     $  (.27)
Basic and diluted weighted average number of common shares outstanding       8,437         8,423        7,832
</TABLE>





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


                                       20
<PAGE>   21

     BIOSEPRA INC.
     CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
     -----------------------------------------------
<TABLE>
<CAPTION>

------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       
FOR THE YEARS ENDED DECEMBER 31                          Additional   Unearned   Accumu-   Cumulative       Total      
1998, 1997 and 1996                       Common Stock     Paid-in    Compen-     lated    Translation  Shareholders'  Comprehensive
(In thousands)                          Shares   Amount    Capital     sation    Deficit   Adjustment      Equity          Income
<S>                                      <C>       <C>     <C>         <C>      <C>           <C>          <C>            <C>
Balance at December 31, 1995             7,021     $70     $35,085     $(685)   $(23,798)     $ 242        $10,914     
Unearned compensation                                                                                                  
    amortization and termination            --      --        (202)      363          --         --            161     
Issuance of common stock under                                                                                         
     stock plans                            25      --          68        --          --         --             68     
Issuance of common stock upon                                                                                          
    conversion of subordinated                                                                                         
    convertible note                     1,370      14       5,534        --          --         --          5,548     
Change in translation adjustment            --      --          --        --          --       (129)          (129)          (129)
Net loss                                    --      --          --        --      (2,120)        --         (2,120)        (2,120)
                                                                                                                       ----------
Comprehensive loss for the year                                                                                           $(2,249)
                                        -------------------------------------------------------------------------------==========
Balance at December 31, 1996             8,416      84      40,485      (322)    (25,918)       113         14,442     
Unearned compensation amortization          --      --          --       161          --         --            161     
Issuance of common stock under                                                                                         
    stock plans                             15      --          30        --          --         --             30     
Change in translation adjustment            --      --          --        --          --       (449)          (449)          (449)
Net loss                                    --      --          --        --      (3,804)        --         (3,804)        (3,804)
                                                                                                                       ----------
Comprehensive loss for the year                                                                                           $(4,253)
                                        -------------------------------------------------------------------------------==========
Balance at December 31, 1997             8,431      84      40,515      (161)    (29,722)      (336)        10,380     
Unearned compensation amortization          --      --          --       161          --         --            161     
Issuance of common stock under                                                                                         
     stock plans                            25      --          41        --          --         --             41     
Compensation for common stock warrants                                                                                 
(Note M)                                    --      --          31        --          --         --             31     
Change in translation adjustment            --      --          --        --          --        297            297            297
Net loss                                    --      --          --        --      (1,813)        --         (1,813)        (1,813)
                                                                                                                       ----------
Comprehensive loss for the year                                                                                           $(1,516)
                                        -------------------------------------------------------------------------------==========
Balance at December 31, 1998             8,456     $84     $40,587        --    $(31,535)     $ (39)       $ 9,097       
                                        =============================================================================== 
</TABLE>
                                                               

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


                                       21
<PAGE>   22

BIOSEPRA INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------

<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, (In thousands)                    1998         1997         1996
---------------------------------------------------------------------------------------------------

<S>                                                              <C>          <C>          <C>     
Cash flows from operating activities:
     Net loss                                                    $(1,813)     $(3,804)     $(2,120)
     Adjustments to reconcile net loss to net cash (used in)
         provided by operating activities:
     Depreciation and amortization                                 1,045        1,566        2,400
     Provision for doubtful accounts                                (263)         150          142
     Loss on disposition of long-term assets                           7            3           10
     Restructuring and impairment costs                               --        4,018           --
     Compensation for common stock warrants                           31           --           --
     Changes in operating assets and liabilities,
         Accounts receivable                                         715          322          230
         Inventories                                                (625)         (46)        (364)
         Prepaid and other current assets                              2           (3)         (30)
         Accounts payable                                           (397)          88          443
         Related parties payable                                     120          168         (654)
         Accrued expenses                                            114         (178)         208
         Accrued expenses relating to acquisition                   (257)         (84)         (13)
         Accrued restructuring                                      (161)         148         (204)
         Deferred contract revenue                                    16       (3,620)         147
---------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities               (1,466)      (1,272)         195
---------------------------------------------------------------------------------------------------
Cash flows from investing activities:
     Purchase of property and equipment                             (367)        (405)      (1,018)
     Proceeds from sale of equipment                                  36            7          147
     Decrease (increase) in marketable securities                     --          360         (360)
     Decrease (increase) in restricted cash                          146           (1)        (170)
     (Increase) decrease in other assets                             (93)          (6)          75
     Cash purchase price of BioPass S.A. held in escrow               --           --        1,614
     Decrease in acquisition payable                                  --           --       (1,614)
---------------------------------------------------------------------------------------------------
Net cash used in investing activities                               (278)         (45)      (1,326)
---------------------------------------------------------------------------------------------------
Cash flows from financing activities:
     Proceeds from investment by parent company                       --           --        5,548
     Proceeds from issuance of common stock                           41           30           68
     Net repayments under line of credit agreements                   --          (11)      (2,299)
     Proceeds from long-term borrowings                            2,000          174          350
     Repayments on long-term borrowings                             (484)        (480)        (477)
---------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities                1,557         (287)       3,190
---------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents          52         (168)           4
---------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents                (135)      (1,772)       2,063
Cash and cash equivalents at beginning of year                     2,370        4,142        2,079
---------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                         $ 2,235      $ 2,370      $ 4,142
-----------------------------------------------------------------=================================
Supplemental schedule of cash flows information:
     Cash paid for interest                                      $   207      $    73      $   231
     Acquisition of equipment under capital lease                     --           --      $    61
</TABLE>


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


                                       22
<PAGE>   23
BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


A.   NATURE OF THE BUSINESS:
BioSepra Inc. and subsidiaries (the "Company") was incorporated in December 1993
as a wholly owned subsidiary of Sepracor Inc. ("Sepracor"). Sepracor transferred
its chromatography business, including all of the outstanding shares of Sepracor
S.A. (now BioSepra S.A., a wholly-owned subsidiary of the Company) to the
Company as of January 1, 1994. The Company develops, manufactures and sells
chromatographic media for use by biopharmaceutical companies in the purification
and production of biopharmaceuticals. The Company's products are designed to
enable pharmaceutical companies to reduce the time and cost required developing
and manufacturing biopharmaceuticals.

The Company is subject to risks common to companies in its industry including,
but not limited to, commercial market acceptance of the Company's products,
development by the Company or its competitors of new technological innovations,
dependence on key personnel, protection of proprietary technology and the need
to obtain adequate financing to fund future operations.

The Company has funded its operations through equity issuances and a revolving
line of credit. As discussed in Note F, the revolving line of credit expires in
April 1999 and there is no assurance that it will be extended. Based upon its
current operating plan, management believes its current cash balance and
available credit facilities are not sufficient to fund the Company's operations
through 1999, and, therefore, the Company is exploring financing alternatives.
There is no assurance the Company's efforts will be successful. If the Company
is unable to extend its revolving line of credit and obtain additional
financing, it may not be able to continue as a going concern. The accompanying
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.


B.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All material intercompany balances and
transactions have been eliminated in consolidation.

TRANSLATION OF FOREIGN CURRENCIES
The accounts of the Company's international subsidiaries are translated in
accordance with Statement of Financial Accounting Standards (SFAS) No. 52,
"Foreign Currency Translation". Accordingly, the assets and liabilities of the
Company's international subsidiaries are translated into U.S. dollars using the
exchange rate at each balance sheet date. Statements of operations amounts are
translated at average exchange rates prevailing during the period. The resulting
translation adjustment is recorded in the cumulative translation adjustment
account in shareholders' equity. Foreign exchange transaction gains and losses
are not material and are included in other expense in the accompanying statement
of operations.

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 following: (1) the reported amounts of assets and liabilities,
(2) the disclosure of contingent assets and liabilities at the date of the
financial statements and (3) the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company applies SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities". The Company considers all highly liquid investments with
an original maturity of three months or less to be cash equivalents. Cash
equivalents primarily consist of a repurchase agreement of $268,442 and $575,000
at December 31, 1998 and 1997, respectively and U S Treasury Notes of $1,526,184
and $1,448,000 at December 31, 1998 and 1997, respectively

RESTRICTED CASH
The Company had $146,000 of restricted cash at December 31, 1997, held in an
escrow account in a French commercial bank. The restricted cash represented the
portion of a contract advance for the purchase of materials to be used in the
manufacturing process for a customer's product. The amount due the Company was
held as a guarantee for 60 days after the product is shipped to the customer.
There were no such arrangements at December 31, 1998.


                                       23
<PAGE>   24

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


CONCENTRATION OF CREDIT RISK
SFAS No. 105, "Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk", requires disclosure of any significant off-balance-sheet or credit risk
concentrations. The Company has no significant off-balance-sheet concentration
of credit risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements. The Company maintains the majority of its cash
balances with financial institutions. Financial instruments that subject the
Company to credit risk consist primarily of trade accounts receivable. Customers
with amounts due to the Company that represent greater than 10% of the accounts
receivable balance are as follows:

     YEAR ENDED DECEMBER 31:                    1998         1997
     -----------------------                    ----         ----
     Customer A                                  --           24%
     Customer B                                  --           16%
     Customer C                                  11%          11%
     Customer D                                  10%          --

Revenue from significant customers are as follows:

     YEAR ENDED DECEMBER 31:                    1998         1997         1996
     -----------------------                    ----         ----         ----
     Customer B                                  --           38%          25%
     Customer C                                  22%          11%          --
     Customer D                                  11%          --           13%

For financial information by geographic area see Note K.

FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments," requires
disclosure about fair value of financial instruments. Financial instruments
consist of cash and cash equivalents, accounts receivable, accounts payable and
notes payable. The estimated fair value of these financial instruments
approximates carrying value.

PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Costs of major additions and
betterments are capitalized; maintenance and repairs that do not improve or
extend the life of the respective assets are charged to operations. On disposal,
the related cost and accumulated depreciation or amortization are removed from
the accounts and any resulting gain or loss is included in the results of
operations. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. All laboratory, manufacturing and office
equipment have estimated useful lives of three to ten years. Leasehold
improvements are amortized over the shorter of the estimated useful lives of the
improvements or the remaining term of the lease.

GOODWILL AND OTHER ASSETS
Goodwill is amortized using the straight-line method over 20 years. Accumulated
amortization was approximately $7,868,000 and $7,476,000 at December 31, 1998
and 1997, respectively. The Company capitalizes all significant costs associated
with the successful filing of a patent application as a component of other
assets in the accompanying consolidated balance sheet. Patent costs are being
amortized over their estimated useful lives, not to exceed 17 years. Accumulated
amortization for patent costs was approximately $453,000 and $441,000 at
December 31, 1998 and 1997, respectively.

The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" in 1995. SFAS No. 121
requires that long-lived assets be reviewed for impairment by comparing the fair
value of the assets with their carrying amount. Any write-downs are to be
treated as permanent reductions in the carrying amount of the assets.
Accordingly, the Company evaluates the possible impairment of goodwill and other
assets at each reporting period based on the undiscounted projected cash flows
of the related asset. In 1997, the Company recognized an impairment charge of
approximately $3,328,000 to reduce the carrying value of goodwill to its
estimated net realizable value based upon estimated future cash flows. In 1998,
the Company's analysis indicated that there was no impairment.

REVENUE RECOGNITION
Revenues from media and small-scale bioprocess instrument sales are recognized
when goods are shipped, and from production-scale systems when installation is
complete. Revenues for contracted services and research and development
contracts are recorded based on effort incurred or milestones achieved in
accordance with the terms of the contract. Deferred contract revenue represents
progress payments received from customers pursuant to contract revenues not yet
earned.


                                       24
<PAGE>   25
BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


RESEARCH AND DEVELOPMENT
Research and development costs are expensed in the period incurred.

NET LOSS PER SHARE
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share". SFAS No.
128 establishes standards for computing and presenting earnings per share and
requires presentation of both basic and dilutive earnings per share on the
consolidated statement of operations. Basic loss per common share was computed
by dividing net loss by the weighted average number of common shares outstanding
during the year. Diluted loss per share is the same as basic loss per share as
the effects of common stock equivalents are antidilutive. Options and warrants
to purchase a total of 1,627,000, 1,588,000 and 977,000 common shares have been
excluded from the computation of dilutive weighted average shares outstanding
for the years ended December 31, 1998, 1997 and 1996, respectively. This
accounting change had no effect on the Company's historical loss per common
share.

NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative instruments
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. SFAS No.
133 is effective for fiscal years beginning after June 15, 1999. The Company
does not expect the adoption of this statement to have a material impact on its
consolidated financial position or results of its operations.

C.   ALLOCATIONS FROM AND AGREEMENTS WITH SEPRACOR:
Since the Company's inception, all facilities and support services of U.S.
operations of the Company, including administrative support, have been provided
by Sepracor. For these facilities and services, the Company was charged
approximately $440,000, $528,000 and $513,000 for the years ended December 31,
1998, 1997 and 1996, respectively. These charges represent an allocation of the
Company's proportionate share of Sepracor's overhead costs using formulas which
management believes are reasonable based upon the Company's use of such
facilities and services. All other costs of United States operations, including
payroll costs, are directly attributable to the Company. Net amounts payable to
Sepracor at December 31, 1998 and 1997 were $430,000 and $325,000, respectively.

Under a Corporate Services Agreement, commencing January 1, 1994, the Company
receives certain basic support services from Sepracor in exchange for a variable
monthly payment, adjusted annually. These basic services include support for
shipping and warehousing and assistance with certain administrative services,
including recruiting and benefits administration, purchasing, data processing,
risk management, corporate communications, patents and legal, accounting,
finance and treasury activities. The Service Agreement is renewable for two
one-year increments by the Company and is cancelable by the Company with 60 days
notice. This agreement had an initial term of one year and has been extended by
the Company and Sepracor for three additional one-year terms. The Company
continues to operate under the terms of the initial agreement, as revised. The
monthly payments to Sepracor for basic administrative support services under the
Corporate Services Agreement in 1997 and 1996 were $17,315 for a total annual
allocated cost of approximately $208,000 in both 1997 and 1996. In 1998, the
monthly payments to Sepracor were $12,879 for a total allocated cost of
approximately $155,000. During 1997 and 1996, the Company provided warehouse,
shipping and receiving services to Sepracor. Total payments received from
Sepracor amounted to $91,000 in 1997 and $20,750 in 1997. Effective January 1,
1998, the Company returned that responsibility back to Sepracor and accordingly,
received those services in 1998 from Sepracor. Total payments made to Sepracor
in 1998 amounted to $36,000.

Under a Sublease Agreement, the Company leases certain laboratory, research and
office space from Sepracor through 2007 in exchange for monthly rent payments
which increase at various dates and which approximate the Company's
proportionate share of Sepracor's cost of providing the facilities, including
building maintenance, utilities and other operating costs (see Note G). The
rental payment made by the Company under this Agreement was approximately
$72,000 in 1996, $93,000 in 1997, and $81,000 in 1998.
Operating costs under this Agreement were approximately $233,000 in 1996,
$227,000 in 1997 and $167,197 in 1998.

Under a Technology Transfer and License Agreement ("Agreement"), Sepracor
transferred to the Company all technology owned or controlled by Sepracor,
including trade secrets, patents and patent applications, that relates to and is
used in researching, developing or manufacturing products in the Company Field.
The Company Field means generally the separation of biological molecules. The
Agreement expired on January 1, 1998. Pursuant to the Agreement, Sepracor
granted a perpetual royalty-free, exclusive license to the Company for any
improvements to the transferred technology useful in the Company Field which are
developed, or otherwise acquired, by Sepracor during the term of the agreement
("Improvements"). Although the license granted by Sepracor to the Company
terminated when the Agreement expired, it provided that any licenses granted
during the term survived to the extent they related to Improvements existing
on the date of termination. The Company has granted to Sepracor a perpetual,
royalty-free, exclusive license to the transferred technology for the
development, manufacture, use or sale of any products within the field of chiral


                                       25
<PAGE>   26

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


synthesis, chiral separations and the development, manufacture, use or sale of
chiral drugs and chiral drug intermediates, as well as a non-exclusive license
to the transferred technology for the development, manufacture, use or sale of
any products outside of the Company Field. 

In addition, beginning March 1998, Sepracor is entitled to certain rights with
respect to the registration under the Securities Act for a total of 4,000,000
shares of Common Stock. These rights provide that Sepracor may require the
Company, on two occasions, to register the shares having an aggregate offering
price of at least $5,000,000, subject to certain conditions and limitations. As
of December 31, 1998, Sepracor has not exercised such rights.


D.   INVENTORIES:
<TABLE>
<CAPTION>
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following at December 31,  (in thousands)                                  1998         1997
------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>          <C>    
Raw material                                                                            $   956      $   600
Work in progress                                                                            136          129
Finished goods                                                                            2,480        1,993
------------------------------------------------------------------------------------------------------------
    Total inventory                                                                     $ 3,572      $ 2,722
----------------------------------------------------------------------------------------====================

E    PROPERTY AND EQUIPMENT:
Property and equipment consists of the following at December 31,  (in thousands)           1998         1997
------------------------------------------------------------------------------------------------------------
Laboratory and manufacturing equipment                                                  $ 2,587      $ 1,944
Office equipment                                                                            564          924
Leasehold improvements                                                                    1,273        1,010
------------------------------------------------------------------------------------------------------------
                                                                                          4,423        3,878
Less:  accumulated depreciation and amortization                                         (3,008)      (2,405)
------------------------------------------------------------------------------------------------------------
                                                                                          1,416        1,473
Construction in progress                                                                     --           36
------------------------------------------------------------------------------------------------------------
    Total property and equipment                                                        $ 1,416      $ 1,509
----------------------------------------------------------------------------------------====================
</TABLE>
Depreciation and amortization expense was $639,000, $696,000 and $729,000 for
the years ended December 31, 1998, 1997 and 1996, respectively.


                                       26
<PAGE>   27

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


F.   LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS:
<TABLE>
<CAPTION>
Long-Term Debt and Capital Lease Obligations consist of the following                                        
      at December 31, (in thousands)                                                         1998         1997
---------------------------------------------------------------------------------------------------------------
<S>                                                                                        <C>          <C>
Note payable to a bank  under revolving credit agreement, guaranteed by Sepracor           $ 2,000           --
EURIBOR plus .80% French Franc Loan payable in quarterly installments through 2000,
Guaranteed by Sepracor                                                                         402      $   624
Non-interest bearing promissory note payable to Sepracor in monthly
      Installments through 2000                                                                164          245
EURIBOR plus 1.80% French Franc Loan Payable in quarterly installments through  2001           104          138
Obligations under capital leases (See Note  G)                                                  64          170
Variable rate, 7.5%, French Franc Line of Credit                                                --            1
---------------------------------------------------------------------------------------------------------------
                                                                                             2,734        1,178
Less current portion                                                                        (2,458)        (488)
---------------------------------------------------------------------------------------------------------------
Total long-term debt                                                                       $   276      $   690
-------------------------------------------------------------------------------------------====================
</TABLE>

On December 31, 1996, the Company, in collaboration with Sepracor and certain of
its other subsidiaries, amended its revolving credit agreement with a bank under
which the Company may borrow up to $3,000,000, subject to limitation defined in
the agreement and on borrowings outstanding by other companies. Borrowings
outstanding under this agreement as of December 31, 1998 amounted to $2,000,000.
Interest is payable monthly in arrears at prime (7.75% at December 31, 1998) or
the LIBOR rate (5.07% at December 31, 1998) plus 1.75%. The Company is required
to pay a commitment fee equal to 1/4% per annum on the average unused line. This
facility is available until April 30, 1999 and is collateralized by the personal
property of the Company. Sepracor is guarantor of any amounts outstanding under
the agreement.

The Company's French subsidiary has available three credit facilities
aggregating 4,000,000 French Francs (approximately $715,000 at December 31,
1998) from three French commercial banks. At December 31, 1998 and 1997 there
was $ 0 and $1,000 outstanding, respectively, under these credit facilities. At
December 31, 1998 and 1997, $402,000 and $624,000, respectively was outstanding
under the EURIBOR plus .80% French Franc loan which is guaranteed by Sepracor.
The interest rate on this loan at December 31, 1998 and 1997 was 4.366% and
4.495%, respectively.

Minimum annual principal repayments of long-term debt, excluding capital leases,
in each of the next three fiscal years are as follows: 1999 - $2,394,000; 2000 -
$263,000; 2001 - $13,000.

G.   COMMITMENTS:
Future minimum payments under all non-cancelable leases in effect at December
31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
                                                     Capital  Operating  Sub-Lease  
Year                                                  Leases    Leases   Sepracor   Total
------------------------------------------------------------------------------------------
<S>                                                     <C>      <C>         <C>     <C>
1999                                                    64       148         99      311
2000                                                    --        11         99      110
2001                                                    --         9         99      108
2002                                                    --         3        106      106
2003                                                    --        --        106      106
Thereafter                                              --        --        212      212
------------------------------------------------------------------------------------------
Total minimum lease payments                            64       171        721      956
------------------------------------------------------------------------------------------
</TABLE>
                                                                       
Future minimum lease payments under operating and non-cancelable capital leases
relate to the French subsidiary's office, laboratory and production facilities,
equipment and motor vehicles as well as office and computer equipment in the
U.S. Under certain circumstances, Sepracor is the guarantor of debt incurred to
acquire equipment under the leasing facilities. The facility lease requires the
Company to pay its allocated share of taxes and operating costs in addition to
the annual base rent payments. Rental expense under these and other leases
amounted to $589,000, $635,000 and $663,000 for the years ended December 31,
1998, 1997 and 1996, respectively.


                                       27
<PAGE>   28

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


H.   RESTRUCTURING AND IMPAIRMENT:
In December 1997, the Company recorded restructuring and impairment charges
totaling $4,179,000. Of this amount, $3,328,000 relates to the write down of
intangible assets to their estimated net realizable value as required by SFAS
No. 121 (see Note B) and $851,000 relates to the cost reduction program
implemented in December 1997. The purpose of the cost reduction program was to
enable the Company to focus on higher margin consumable products for the
research and process segments of the biopharmaceutical and genomics market. The
program involved the discontinuation of its instrument product line and a
reduction in the number of employees. As part of the cost reduction program,
$690,000 represents the write down of inventory and fixed assets associated with
the discontinued product lines and $161,000 represents severance and benefits
related to the reduction in workforce. The Company has completed its reduction
in workforce related to this cost-reduction program, which resulted in the
termination of 7 employees in the U.S. (consisting of marketing/sales, finance
and administrative personnel). There can be no assurances that this program will
not result in loss of customers or temporary sales or production disruptions
that could have a materially adverse effect on the Company's business, financial
condition or results of operations. In the first quarter of 1998, the Company
sold its discontinued inventory to Beckman Instruments, Inc. ("Beckman") for
$351,000 and recorded it as a reduction to the previously recorded restructuring
costs.

I.   DISTRIBUTION AGREEMENTS:
In March 1995, the Company and Beckman entered into a joint distribution and
development agreement. The agreement was extended in July 1996, allowing Beckman
to market on a worldwide exclusive basis for a Period of three years certain
HyperD(TM) chromatographic columns and provides for the development (in
accordance with certain milestones) and manufacture by the Company of
chromatographic systems for Beckman. The Company was required to repay part of
the payments received under the agreement if the Company terminated Beckman's
right to use and sell licensed products, including HyperD media, should a court
find that any such licensed products infringe any third party patents. In
December 1997, the agreement was amended, eliminating the Company's obligation
to repay part of the payments received under the agreement. As a result of the
amendment, the Company recognized $2,700,000 of license fee revenue in December
1997 rather than over the next three years.

The Company recognized revenue totaling $3,600,000 and $900,000 during 1997 and
1996, respectively. There were no deferred revenue amounts outstanding under
this agreement at December 31, 1998 or 1997.

On March 26, 1998, the Company, Sepracor and Beckman entered into an agreement
pursuant to which the Company amended its Distribution Agreement with Beckman
and Sepracor amended its Stock Purchase Agreement with Beckman. Under the
amendment, the Company granted to Beckman a non-exclusive right to manufacture
instruments, is relieved of its obligation to manufacture the instruments for
Beckman and sold the discontinued instrument product inventory to Beckman for
$250,000. Under the original Stock purchase Agreement, Sepracor issued 312,500
shares of Sepracor's Series B Redeemable Exchangeable Preferred Stock to Beckman
in exchange for $5,000,000. Under the amendment, Sepracor redeemed the Series B
Preferred Shares for the original purchase price plus accrued dividends totaling
$6,850,000.

J.   INCOME TAXES:
The Company accounts for income taxes in accordance with SFAS No.109,
"Accounting for Income Taxes" which requires the recognition of deferred tax
assets or deferred tax liabilities for the expected future tax consequences of
events that have been included in the Company's consolidated financial
statements. Deferred tax assets and liabilities are determined based on the
difference between the financial statement carrying amounts and tax basis of
existing assets and liabilities, using enacted tax rates in effect in the years
in which the differences are expected to reverse.

The Company's statutory and effective tax rates were 34% and 0%, respectively,
in each of 1998, 1997 and 1996 due to a net loss in each year and the
nonrecognition of any deferred tax asset for its net operating loss
carryforwards. At December 31, 1998, the Company had federal and state tax net
operating loss carryforwards of approximately $16,379,000 and $18,310,000, which
will expire through the year 2018 and the year 2013, respectively. The Company
also had a net operating loss carryforward from its operations in France of
approximately $10,514,000. Approximately $6,009,000 of this net operating loss
carryforward will expire in the year 2000, and the remainder may be used
indefinitely. At December 31, 1998, the Company had federal and state research
and experimentation credit carryforwards of approximately $177,000 and $169,000,
respectively, which will expire in the year 2013.

Net operating losses of the Company incurred while operating as a division of
Sepracor are not available for carryforward because the Company's results for
those periods were included in the consolidated tax return of Sepracor.


                                       28
<PAGE>   29

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
The components of the Company's net deferred tax asset are as
   follows at December 31, (in thousands):                   1998          1997
---------------------------------------------------------------------------------
<S>                                                        <C>           <C>     
Assets
        Domestic NOL carryforwards                         $  6,667      $  5,370
        Foreign NOL carryforwards                             3,504         4,431
        Inventory reserve                                       135           226
        Tax credit carryforwards                                347           300
        General accruals                                         66           340
        Other                                                   951         1,293
Liabilities
        Property and equipment                                               (104)
---------------------------------------------------------------------------------
Subtotal                                                     11,670        11,856
        Valuation allowance                                 (11,670)      (11,856)
---------------------------------------------------------------------------------
Net deferred tax asset                                     $     --      $     --
---------------------------------------------------------------------------------
</TABLE>

Due to uncertainty of the realization of these potential tax benefits, the
Company has recorded a valuation allowance against its entire deferred tax
asset.

K.   SEGMENT INFORMATION:
The Company has adopted SFAS 131, Disclosure About Segments of an Enterprise and
Related Information, for the year ended December 31, 1998. SFAS 131 requires
certain financial and supplementary information to be disclosed on an annual and
interim basis for each reporting segment. The Company develops, manufactures and
markets processes and products for the separation and purification of
biopharmaceutical compounds. The Company operates exclusively in the separations
business, which the Company considers as one business segment. Financial
information by geographic area is as follows for the years indicated:

For the years ended December 31,  (in thousands)
<TABLE>
<CAPTION>
                                                                1998          1997          1996
--------------------------------------------------------------------------------------------------
<S>                                                           <C>           <C>           <C>     
REVENUE
   United States
        Unaffiliated customers                                $  1,733      $  7,767      $  8,136
        Related parties                                              7            --            --
        Transfer to other geographic areas                          --           (16)          431
--------------------------------------------------------------------------------------------------
                                                                 1,740         7,751         8,567
--------------------------------------------------------------------------------------------------
   Europe
        Unaffiliated customers                                   5,666         5,527         6,187
        Related parties                                             --            --            --
        Transfer to other geographic areas                       1,278         1,571         2,999
--------------------------------------------------------------------------------------------------
                                                                 6,944         7,098         9,186
--------------------------------------------------------------------------------------------------
   Elimination and adjustments                                  (1,285)       (1,555)       (3,430)
--------------------------------------------------------------------------------------------------
   Total revenue                                              $  7,339      $ 13,294      $ 14,323
--------------------------------------------------------------------------------------------------
OPERATING (LOSS) INCOME
   United States                                              $ (2,557)     $ (5,050)     $ (3,743)
   Europe                                                          752           942         1,753
   Elimination and adjustments                                      --             1             3
--------------------------------------------------------------------------------------------------
   Total operating loss
                                                              $ (1,813)     $ (4,107)     $ (1,987)
--------------------------------------------------------------------------------------------------
TOTAL ASSETS
   United States                                              $ 12,608      $ 13,002      $ 19,917
   Europe                                                        6,597         5,802         6,343
   Elimination and adjustments                                  (4,455)       (3,898)       (3,091)
--------------------------------------------------------------------------------------------------
   Total assets                                               $ 14,717      $ 14,906      $ 23,169
--------------------------------------------------------------------------------------------------
</TABLE>


                                       29
<PAGE>   30

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


L.   SHAREHOLDERS' EQUITY:
Common Stock
The Company's authorized capital stock includes 12,000,000 shares of common
stock, par value $0.01 per share. At December 31, 1998 and 1997, 5,369,788
shares (64%) of the Company's common stock outstanding are held by Sepracor. The
common stock has no preemptive, subscription, redemption or conversion rights.
On January 29, 1999, the Board of Directors approved to amend and restate the
Company's Certificate of Incorporation to modify the number of authorized shares
of common stock, par value, $0.01 per share from 12,500,000 to 25,000,000.

Preferred Stock
The Company's authorized capital stock includes 1,000,000 shares of preferred
stock, par value $0.01 per share, with such rights, restrictions and
specifications as the Board of Directors may determine. As of December 31, 1998
and 1997, no shares of preferred stock have been issued.

M.   STOCK PLANS AND WARRANTS:
Stock Option Plans
The 1994 Stock Option Plan (the "1994 Plan") provides for the grant of both
incentive stock options ("ISOs") and nonstatutory stock options ("NSOs") to
officers, directors and key employees of the Company. The 1994 Plan also
provides for the grant of NSOs to consultants of the Company who are not also
employees of the Company. In March 1995, the Board of Directors approved an
amendment to the 1994 Plan increasing the number of shares of common stock that
may be granted to 1,000,000. The exercise price for ISOs must be at least equal
to the fair market value of the stock on the date of grant, and the exercise
price of NSOs must be at least equal to 50% of the fair market value of the
stock on the date of grant. Options generally become exercisable in five equal
annual installments beginning on the first anniversary of the date of grant.
ISOs have a maximum term of ten years from the date of grant.

In 1997, the shareholders approved the 1997 Stock Option Plan (the "1997 Plan").
The 1997 Plan provides for the grant of both incentive stock options ("ISOs")
and nonstatutory stock options ("NSOs") to officers, directors and key employees
of the Company. The 1997 Plan also provides for the grant of NSOs to consultants
of the Company who are not also employees of the Company. A total of 2,851,500
shares of common stock may be issued upon the exercise of options granted under
the 1997 Plan. The exercise price for ISOs must be at least equal to the fair
market value of the stock on the date of grant, and the exercise price of NSOs
must be at least equal to 50% of the fair market value of the stock on the date
of grant. Options generally become exercisable in five equal annual installments
beginning on the first anniversary of the date of grant. ISOs have a maximum
term of ten years from the date of grant. On January 29, 1999, the Company's
Board of Directors approved an amendment of the "1997 Plan" to allow for up to
5,000,000 shares of common stock to be issued upon the exercise of options
granted. On January 19, 1999, the Company granted options at $.8125 to key
executives to purchase up to 1,771,500 shares of common stock, of which the
option to purchase approximately 500,000 shares begins vesting after the price
of the Company's common stock reaches $5.00 per share and the option for another
500,000 shares begins vesting at $7.50 per share.

The Director Option Plan (the "Director Plan") provides for the granting of NSOs
to directors of the Company who are not officers or employees of the Company or
of any subsidiary of the Company. A total of 150,000 shares of common stock
options may be issued under the Director Plan subject to adjustments as provided
therein. Except as noted below, the exercise price per share will equal the fair
market value of a share of common stock on the date on which the option is
granted. Options granted under the Director Plan will vest in either two or five
equal installments beginning on the first anniversary of the date of the grant
depending on the nature of the grant.


                                       30
<PAGE>   31

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


The following table summarizes all stock option activity under the three stock
option plans for the three years ended December 31,1998:

<TABLE>
<CAPTION>
                                               1998                   1997                 1996
                                     ------------------------------------------------------------------
                                                   Weighted               Weighted             Weighted
                                         Number     Average     Number     Average    Number    Average
                                           Of      Exercise       Of      Exercise      of     Exercise
(In thousands, except option price)      Shares      Price      Shares      Price     Shares     Price
-------------------------------------------------------------------------------------------------------
<S>                                       <C>        <C>           <C>      <C>         <C>      <C>  
Outstanding at January 1,                 1,543      $2.63         977      $2.74       824      $2.66
     Granted                                294      $1.89         603      $2.46       223      $3.14
     Exercised                               --         --          (1)     $2.00       (11)     $2.00
     Canceled                              (255)     $2.76         (36)     $2.94       (59)     $3.21
                                                                                                    --
-------------------------------------------------------------------------------------------------------
Outstanding at December 31,               1,582      $2.51       1,543      $2.63       977      $2.74
-------------------------------------------------------------------------------------------------------
Options exercisable at year-end             719                    470                  227
Weighted average fair value of                                                       
     Options granted during the year     $ 1.28                 $ 2.10                $3.08    
</TABLE>
                                                                         
The range of exercise prices for options outstanding and options exercisable
under the three stock option plans at December 31, 1998 are as follows:


<TABLE>
<CAPTION>
                                Options Outstanding          Options Exercisable
                          --------------------------------- --------------------

      Range of                                    Weighted              Weighted
      Exercise                         Remaining   Average               Average
       Price                 Number   Contractual Exercise     Number   Exercise
     Per Share            Outstanding     Life      Price   Exercisable   Price
--------------------------------------------------------------------------------
<S> <C>                       <C>          <C>      <C>        <C>        <C>  
    $1.31 - $1.31             40,000       9.5      $1.31      10,000     $1.31
    $1.75 - $1.75             14,000       9.4      $1.75          -- 
    $1.88 - $1.88            350,000       8.8      $1.88      70,000     $1.88
    $2.00 - $2.00            546,836       6.5      $2.00     313,318     $2.00
    $2.50 - $2.50            175,500       5.7      $2.50     124,800     $2.50
    $2.63 - $2.63             10,000       8.3      $2.63       2,000     $2.63
    $2.75 - $2.75             95,000       8.4      $2.75      32,000     $2.75
    $2.88 - $3.88            185,000       7.1      $3.62      65,400     $3.62
    $4.00 - $4.63            143,600       6.7      $4.28      83,080     $4.26
    $5.38 - $5.38             12,000       7.4      $5.38      12,000     $5.38
    $6.13 - $6.13             10,000       6.8      $6.13       6,000     $6.13
--------------------------------------------------------------------------------
    $1.31 - $6.13          1,581,936       7.3      $2.51     718,598     $2.60
--------------------------------------------------------------------------------
</TABLE>

The weighted average remaining contractual life of outstanding options under
these plans is 7.27 years, 8.00 years and 8.05 years as of December 31, 1998,
1997 and 1996, respectively.

During 1994 and prior to the Company's initial public offering, options to
purchase 586,000 NSOs were granted to directors, officers, key employees and
consultants at an exercise price of $2.00 per share. The estimated fair market
value on the date of the grant was $4.00 per share. The Company recognized a
compensation charge of $161,000 in 1998, 1997 and 1996 related to the NSOs.

In connection with the initial public offering, the Company granted to the
Underwriter an option to purchase 300,000 shares of common stock at an excise
price equal to 150% of the initial public offering price per share or $10.50 and
subject to adjustment in certain circumstances. The option is exercisable at any
time or from time to time after March 24, 1995, and before March 24, 1999. The
option may be transferred in whole or part at any time under specific
conditions.


                                       31
<PAGE>   32

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 123 requires that companies either recognize
compensation expense for grants of stock, stock options, and other equity
instruments to employees based on fair value, or provide pro forma disclosure of
net income and earnings per share in the notes to the financial statements. The
Company adopted the disclosure provisions of SFAS No. 123 in 1996 and has
applied Accounting Principles Board Opinion No. 25 and related interpretations
in accounting for its plans.

The fair value of each stock option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions:

<TABLE>
<CAPTION>
                December 31,                            1998            1997           1996
                -------------------------------------------------------------------------------

                <S>                                  <C>            <C>             <C> 
                Risk-free interest rate              5.5% - 5.9%    6.0% - 6.9%     5.8% - 6.7%
                Expected dividend yield                  --             --              --
                Expected lives                         7 years        10 years       10 years
                Expected volatility                      65%            80%         134% - 152%
</TABLE>


Had compensation cost for the Company's stock based compensation plans and
employee stock purchase plan been determined consistent with SFAS No. 123, the
Company's net loss and net loss per share would have been increased to the
following pro forma amounts:

<TABLE>
<CAPTION>
             December 31, (in thousands
             except per share amounts)                  1998            1997           1996
             --------------------------------------------------------------------------------
<S>                                                   <C>             <C>            <C>     

             Net loss
                  As reported                         $(1,813)        $(3,804)       $(2,120)
                  Pro Forma                           $(2,321)        $(4,219)       $(2,276)

             Basic and Diluted net loss per share
                  As reported                         $  (.21)        $  (.45)       $  (.27)
                  Pro Forma                           $  (.27)        $  (.50)       $  (.29)
</TABLE>

Because the method prescribed by SFAS No. 123 has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.

The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions including expected stock price volatility. Because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

Employee Stock Purchase Plan
In 1997 the shareholders approved the 1997 Employee Stock Purchase Plan
("Purchase Plan"), which succeeds the 1995 Employee Stock Purchase Plan. Under
the Purchase Plan, an aggregate of 50,000 shares of common stock may be
purchased by employees at 85% of the fair market value on the first or last day
of each six month offering period, whichever is lower. An eligible employee may
elect to have up to a maximum of 10% deducted through payroll deductions from
his or her regular salary. During 1998, 1997 and 1996, there were 25,478, 13,085
and 14,494 shares, respectively, issued under the Purchase Plan. At December 31,
1998, 21,628 shares of authorized but unissued common stock were reserved for
future issuance under the Purchase Plan.

Stock Warrants
In 1997, the Company issued a warrant to purchase 45,000 shares of the Company's
common stock at $3.00 per share. The warrant expires on June 5, 2002. As of
December 31, 1998, the warrant to purchase 45,000 shares remains outstanding, of
which 35,000 shares are exercisable.


                                       32
<PAGE>   33

BIOSEPRA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


N.   EMPLOYEES SAVINGS PLAN:
The Company adopted a 401(k) savings plan for all domestic employees in 1994.
Under the provisions of the plan, employees may voluntarily contribute up to 15%
of their compensation subject to statutory limitations. In addition, the Company
can make matching contributions at its discretion. In 1997, the Company
increased its match to 50% of the first $3,000 contributed by employees up to
$1,500 maximum per employee from a match of 50% of the first $2,000 contributed
by employees up to $1,000 maximum per employee in 1996. Employer matching
contributions amounted to $20,406, $28,000 and $14,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.

O.   ACQUISITION OF BIOSPHERE MEDICAL, S.A.
On February 25, 1999, the Company acquired 51% of the outstanding common stock
of Biosphere Medical, S.A. ("Biosphere"), a French societe anonyme. The Company
acquired the 51% ownership by granting an exclusive license pertaining to
certain patents and technology and the transfer of certain other technology to
Biosphere. The Company has the option to acquire the remaining 49% of the
outstanding common stock of Biosphere through December 31, 2004, as defined.
Additionally, the holder of the remaining 49% of the outstanding common stock of
Biosphere has an option to require the Company to purchase its shares from
December 31, 2003 until December 31, 2004 at a price of not less than FF
6,000,000 ($1,072,000 December 31, 1998). The results of operations for
Biosphere will be included in the Company's operations from the date of
acquisition.  The historical results of operations of Biosphere are not material
to the Company's financial statements.


                                       33
<PAGE>   34

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
         FINANCIAL DISCLOSURE

         The Company had no disagreement with its independent auditor, Arthur
Andersen L.L.P., on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure in connection with the
audits of the Company's financial statements for the fiscal years ended December
31, 1998, 1997 and 1996.


PART III

ITEMS 10-13.

         The information required for Part III in this Annual Report on Form
10-K is incorporated by reference from the Company's definitive proxy statement
for the Company's 1998 Annual Meeting of Stockholders. Such information will be
contained in the sections of such proxy statement captioned "Stock Ownership of
Certain Beneficial Owners and Management", "Election of Directors", "Board and
Committee Meetings", "Compensation for Directors", "Compensation of Executive
Officers", "Compliance with Section 16 Reporting Requirements", and "Certain
Relationships and Related Transactions". Information regarding executive
officers of the Company is also furnished in Part I of this Annual Report on
Form 10-K under the heading "Executive Officers of the Company."


                                     PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  The following documents are included as part of this Annual Report on Form
     10-K.


1.   Reference is made to the Index to Financial Statements under Item 8 of this
     Annual Report on Form 10-K.
2.   The Schedule listed below and the Reports of Independent Accountants on
     financial statement schedules are filed as part of this Annual Report on
     Form 10-K.
3.   Report of Arthur Andersen LLP on Financial Statement Schedule
4.   Schedule II - Valuation and Qualifying Accounts All other schedules are
     omitted as the information required is inapplicable or the information is
     presented in the consolidated financial statements or the related notes.
5.   The Exhibits listed in the Exhibit Index immediately preceding the Exhibits
     are filed as a part of this Annual Report on Form 10-K.




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

     The following trademarks of the Company are mentioned in this Annual Report
on Form 10-K: HyperD, Trisacryl, Spherodex, Ultrogel and UpScale


                                       34
<PAGE>   35
              REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE



To the Board of Directors and Shareholders of BioSepra Inc. and subsidiaries:

We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of BioSepra Inc. and subsidiaries and have
issued our report thereon dated February 2, 1999. Our audit was made for the
purpose of forming an opinion on the basic financial statements taken as a
whole. The schedule listed in Item 14(a)2 herein is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states, in all material respects, the financial data required to
be set forth therein, in relation to the basic financial statements taken as a
whole.




                                           /s/ Arthur Andersen LLP


Boston, Massachusetts
February 2, 1999



                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS



<TABLE>
<CAPTION>
                              Balance at
                             Beginning of  Charged To    Charged to                  Balance at
                                Period      Expenses   Other Accounts  Deductions  End of Period
                             -------------------------------------------------------------------
<S>                          <C>             <C>                       <C>            <C>     
Year ended
12/31/98
Accounts Receivable Reserves $369,010        $1,388          --        $(264,438)     $105,960
                             -------------------------------------------------------------------
                             $369,010        $1,388          --        $(264,438)     $105,960
                             ===================================================================
</TABLE>





                                       35




<PAGE>   36

                                  Exhibit Index


EXHIBIT NO.       DESCRIPTION

      3.1*        Certificate of Incorporation, as amended, of the Company.

      3.2*        By-Laws of the Company.

      4*          Specimen Certificate for shares of Common Stock, $.01 par 
                  value, of the Company.

(1)  10.1*        1994 Director Option Plan.

     10.2*        Form of Technology Transfer and License Agreement dated as of 
                  January 1, 1994 between the Company and Sepracor Inc.

     10.3*        Form of Corporate Services Agreement dated as of January 1, 
                  1994 between the Company and Sepracor Inc.

     10.5*        Service Contract dated June 28, 1991 between IBF and 
                  Rhone-Poulenc Rorer Principes Actifs (translated from French).

     10.6*        Contract for Supply of Spherosil Media dated May 22,1991 
                  between IBF and Pasteur Merieux Serums et Vaccins (translated 
                  from French).

     10.9***+     Distribution Agreement dated March 14, 1995 between the 
                  Company and Beckman Instruments, Inc.

     10.10****    Amended and Restated Revolving Credit and Security Agreement
                  by and between Fleet National Bank and the Company dated as of
                  December 31, 1996.

     10.11***     Intellectual Property Security Agreement by and between Fleet 
                  Bank of Massachusetts, N.A. and the Company dated December 28,
                  1994.

     10.12***     Sub-Sublease dated December 12, 1995 by and between Sepracor 
                  Inc. and the Company.

     10.13***     Sublease dated January 1, 1996 by and between Sepracor Inc. 
                  and the Company.

     10.14***     Promissory Note dated January 1, 1996 made in favor of 
                  Sepracor Inc. by the Company.

     10.15****    Confirmation of and Amendment to Intellectual Property 
                  Security Agreement by and between Fleet National Bank and the 
                  Company dated as of December 31, 1996.

     10.16*****   Senior Management Retention Agreement dated October 3, 1997 by
                  and between the Company and Jean-Marie Vogel.

     10.17*****   Senior Management Retention Agreement dated October 1997 by 
                  and between the Company and Egisto Boschetti.

     10.18******  Lease for new facility of BioSepra, S.A. (translated from 
                  French to English)

     21           Subsidiaries of the Company.

     23.1         Consent of Arthur Andersen LLP


                                       36
<PAGE>   37

        27        Financial Data Schedule


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

(1)     Management contract or compensatory plan or arrangement filed as an
        exhibit to this Form 10-K pursuant to Items 14(a) and 14(c) of 
        Form 10-K.

*       Incorporated herein by reference to the Company's Registration Statement
        on Form S-1, as amended (File No. 33-75212).

**      Incorporated herein by reference to the Company's 8-K filed on September
        30, 1994.

***     Incorporated herein by reference to the Company's 10-K for the year
        ended December 31, 1994.

****    Incorporated herein by reference to the Company's Form 10-K for the year
        ended December 31, 1996.

*****   Incorporated herein by reference to the Company's Form 10-Q for the
        quarter ended September 30, 1997.

******  Incorporated herein by reference to the Company's Form 10-Q for the
        quarter ended September 30, 1998

+       Confidential treatment requested as to certain portions.


                                       37
<PAGE>   38

                                   SIGNATURES

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

                                 BIOSEPRA, INC.

                                 By: /s/ Jean-Marie Vogel      
                                     --------------------------------------
                                     Jean-Marie Vogel
                                     President and Chief Executive Officer

Date: March 18, 1999

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

<TABLE>
<CAPTION>
SIGNATURE                                             TITLE                                   DATE

<S>                                     <C>                                              <C> 
/s/ JEAN-MARIE VOGEL                    President, Chief Executive Officer,              MARCH 18, 1999
------------------------------------    and Director (Principal Executive Officer)       --------------
    Jean-Marie Vogel                 


/s/ Philip V Holberton                  Chief Financial Officer, Treasurer, and          MARCH 18, 1999
-------------------------------------   Secretary (Principal Financial and               --------------
    Philip V Holberton                  Accounting Officer)                 
                                        

/s/ Timothy J. Barberich                Director                                         MARCH 18, 1999
------------------------------------                                                     --------------
    Timothy J. Barberich

/s/ William M. Cousins, Jr.             Director                                         MARCH 18, 1999
------------------------------------                                                     --------------
    William M. Cousins, Jr.

/s/ Alexander M. Klibanov, Ph.D.        Director                                         MARCH 18, 1999
-------------------------------------                                                    --------------
    Alexander M. Klibanov, Ph.D.

/s/ Paul A. Looney                      Director                                         MARCH 18, 1999
------------------------------------                                                     --------------
    Paul A. Looney

/s/ Riccardo Pigliucci                  Director                                         MARCH 18, 1999
------------------------------------                                                     --------------
    Riccardo Pigliucci

/s/ William E. Rich                     Director                                         MARCH 18, 1999
------------------------------------                                                     --------------
    William E. Rich

/s/ David P. Southwell                  Director                                         MARCH 18, 1999
------------------------------------                                                     --------------
    David P. Southwell
</TABLE>


                                       38