SYNOVIS LIFE TECHNOLOGIES INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1933

FOR THE FISCAL YEAR ENDED OCTOBER 31, 2004

OR

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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 0-13907

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SYNOVIS LIFE TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)

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MINNESOTA 41-1526554
(State of Incorporation) (I.R.S. Employer Identification No.)

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

TELEPHONE NUMBER:
(651) 796-7300

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
COMMON STOCK PURCHASE RIGHTS

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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. [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]

As of April 30, 2004, 11,518,861 shares of Common Stock of the Registrant
were outstanding, and the aggregate market value of the Registrant's outstanding
Common Stock (based upon the last reported sale price of the Common Stock on
that date by the Nasdaq National Market), excluding shares owned beneficially by
executive officers and directors, was approximately $172,951,936.

Part III of this Annual Report on Form 10-K incorporates by reference (to
the extent specific sections are referred to herein) information from the
Registrant's Proxy Statement for its Annual Meeting of Shareholders to be held
February 22, 2005 (the "2005 Proxy Statement").

REGISTERED TRADEMARKS:

APEX Processing(TM), Peri-Strips(R), Peri-Strips Dry(R), PSD Gel(TM),
Dura-Guard(R), Vascu-Guard(R), Supple Peri-Guard(R), Peri-Guard(R), CV
Peri-Guard(R), Biograft(R), Flo-Rester(R), Vascular Probe(TM), Flo-Thru
Intraluminal Shunt(TM), Veritas(R), Navi-Glide(TM), Neurotube(R) and Synovis(TM)
are trademarks of the Company.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this Annual Report on Form 10-K are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. For this purpose, any statements contained in
this Form 10-K that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, words such as "may",
"should", "will", "expect", "believe", "anticipate", "estimate" or "continue" or
the negative or other variations thereof or comparable terminology are intended
to identify forward-looking statements. All forward-looking statements in this
document are based on information available to the Company as of the date
hereof, and the Company assumes no obligation to update any forward-looking
statements. You are advised, however, to consult any future disclosures we make
on related subjects in future filings with the SEC. Forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results to differ materially from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such
factors may include, among others, those factors set forth under the heading
"Important Factors" beginning in Part I, Item 1A.

1

PART I

ITEM 1 -- BUSINESS

(a) GENERAL DEVELOPMENT OF BUSINESS

INTRODUCTION

Synovis Life Technologies, Inc. ("Synovis" or the "Company"), a diversified
medical device company, develops, manufactures and markets products for the
surgical and interventional treatment of disease. Our business is conducted in
two reportable segments, the surgical business and the interventional business,
with segmentation based upon the similarities of the underlying business
operations, products and markets of each.

Our surgical business develops, manufactures and markets implantable
biomaterial products, devices for microsurgery and surgical tools, all designed
to reduce risk and/or facilitate critical surgeries, leading to better patient
outcomes and/or lower costs.

Our interventional business develops, engineers, prototypes and
manufactures coils, helices, stylets, guidewires and other complex micro-wire,
polymer and micro-machined metal components used in interventional devices for
cardiac rhythm management, neurostimulation, vascular and other procedures.

HISTORY

Synovis Life Technologies, Inc., formerly named Bio-Vascular, Inc., was
incorporated in July of 1985. In 1985, the Company was spun-off to the
shareholders of its then parent company, thereafter operating as a separate
public company. In the spin-off, the Company acquired the rights to certain
cardiovascular products. Only two of these products, Peri-Guard and Flo-Rester,
remain today.

In July 1998, we acquired Jer-Neen Manufacturing Co., Inc., as the
foundation of our present interventional business and subsequently changed
Jer-Neen's name to Synovis Interventional Solutions, Inc. in 2001.

In July 2001, we acquired Micro Companies Alliance, Inc. ("MCA"), a
Birmingham, Alabama company which provides products to the niche microsurgery
market. MCA's surgical products include the Microvascular Anastomotic Coupler, a
patented technology for connecting small arteries and/or veins faster, easier
and as effectively as conventional suturing. MCA's name was subsequently changed
to Synovis Micro Companies Alliance, Inc.

In March 2002, our wholly-owned subsidiary Synovis Interventional
Solutions, Inc. acquired Emtech, Inc., a privately held company with
manufacturing capabilities in injection molding, computer numerical control
machining and tool building. Subsequently, we expanded the capabilities of this
business to include micro machining, which serves the medical device,
pharmaceutical, biotechnology, and precision OEM markets. Emtech, Inc.'s name
was subsequently changed to Synovis Precision Engineering, a division of Synovis
Interventional Solutions, Inc.

In April 2003, Synovis Caribe, Inc., a wholly owned subsidiary of Synovis
Interventional Solutions, Inc., commenced operations in Dorado, Puerto Rico at a
leased 22,700 square foot manufacturing facility. We believe this facility
provides us a strategic and tactical advantage, including increasing the
manufacturing capacity of our interventional business.

In September 2003, we completed a $39,000,000 private placement of
1,500,000 shares of our common stock to institutional and other accredited
investors. Net proceeds were approximately

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$36,500,000 after deducting closing costs and related placement fees. A
registration statement covering resale of the shares sold in the placement was
declared effective by the Securities and Exchange Commission on October 9, 2003.

In December 2004, our wholly owned subsidiary Synovis Micro Companies
Alliance, Inc. purchased the rights to the Neurotube(R), a bioabsorbable nerve
conduit, which is designed to help reconstruct nerves severed as a result of
injury or disease.

Synovis Life Technologies' principal executive offices are located at 2575
University Avenue W., St. Paul, Minnesota 55114-1024. We can be contacted by
telephone at (651) 796-7300, by facsimile at (651) 642-9018, or by electronic
mail at info@synovislife.com. Our website is www.synovislife.com. We make
available free of charge on our website our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after filing
such material with, or furnishing it to, the Securities and Exchange Commission.

(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

For financial information regarding our industry segments, please refer to
Note 3 to our consolidated financial statements under Item 8 of this report.

(c) NARRATIVE DESCRIPTION OF BUSINESS

The table below summarizes the revenue contributed by our significant
products or product lines for the periods indicated.

3

PRODUCTS, MARKETS AND COMPETITION

Description of the Surgical Business

Our surgical business develops, manufactures and markets implantable
biomaterial products, devices for microsurgery and surgical tools, all designed
to reduce risk and/or facilitate critical surgeries, leading to better patient
outcomes and/or lower costs. Our products are sold by third party distributors
and independent sales representatives to surgeons and hospitals under the
Synovis brand name.

Biomaterial Products

A core competency of our surgical business is the development and
manufacture of implantable biomaterial products for use by surgeons in various
procedures where reinforcing, reconstructing and repairing tissue and preventing
leaks of air, blood or other body fluids is desirable to achieve a favorable
outcome. The historical choice when tissue repair is necessary has been to use
autologous tissues, requiring the surgeon to excise tissue from another part of
the patient's body. Harvesting tissue from the second surgical site may increase
the procedural cost and time and increase the risk of complications, leading to
additional pain and recovery time for the patient. Use of an available,
off-the-shelf implantable medical product, whether tissue-based or synthetic, is
an alternative to harvesting autologous tissue from the patient and is a means
to reduce surgical costs and improve patient outcomes.

Our biomaterial products are produced from bovine pericardium. Many of the
product characteristics and competitive advantages are derived from the
pericardium's collagen composition. Collagen, a fibrous protein found in
animals, makes the pericardium durable and provides superior handling
characteristics similar to autologous tissue. Host cells deposit a collagen
matrix on the surface of the pericardial product allowing the biomaterial
product to integrate into the host tissue. The bovine pericardium is processed
using proprietary and patented technologies.

Peri-Strips. More than half of our biomaterial sales are derived from
Peri-Strips -- soft tissue stapling buttresses which are used as reinforcement
at the surgical staple line to reduce the risk of potentially fatal fluid leaks,
most significantly in gastric bypass surgery, a treatment for morbid obesity,
and in lung volume reduction surgery ("LVRS"), a treatment for a segment of the
late stage emphysema patient population. Peri-Strips accounted for 44% of our
surgical business' revenue in fiscal 2004, compared to 46% in fiscal 2003.

There are presently several factors affecting the gastric bypass market and
the market for Peri-Strips: capacity constraints of many surgical practices that
perform gastric bypass, the American Society of Bariatric Surgeons driving the
development of centers of excellence which specialize in gastric bypass surgery
and have an expected lower rate of complications, insurance providers
aggravating capacity constraints by encouraging patients towards such centers of
excellence, certain hospitals electing not to support gastric bypass programs,
concerns of some insurers that offer either health care or liability coverage,
and competing products and technologies.

In August of 2003, the Centers of Medicare and Medicaid Services ("CMS")
announced its intent to cover lung volume reduction surgery ("LVRS") following
the outcome of a study that spanned seven years. Peri-Strips have been used in
this procedure since 1994, but revenue from Peri-Strips usage in LVRS declined
substantially after Medicare made a national non-coverage decision related to
the surgery in January 1996. In fiscal 1995, the only full year of reimbursement
for the surgery, Peri-Strips revenue from this procedure reached $5,550,000. We
continued to derive Peri-Strips revenue from LVRS following the CMS national
non-coverage decision from non-CMS reimbursed procedures, but product revenue
declined each year until surgeons began using the product in gastric bypass in
fiscal 2001. We expect

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increased revenue from Peri-Strips as a result of the CMS LVRS coverage
decision, although the amount and timing of such revenue will be impacted by the
frequency with which the procedure is performed and the extent to which
Peri-Strips are utilized in such procedures.

Other Biomaterial Products. Our other biomaterials product group includes
Tissue-Guard and Veritas. Our Tissue-Guard product line is composed of
biomaterial products used to repair and replace damaged tissue in cardiac,
vascular, thoracic and abdominal surgeries and to repair the membrane covering
the brain following neurosurgery. Our Veritas product line has market clearance
for use in pelvic floor reconstruction, stress urinary incontinence treatment,
vaginal and rectal prolapse repair as well as soft tissue repair. Veritas is
remodelable, as demonstrated in animal studies with the formation of new blood
vessels and host cell in-growth occurring into the Veritas patch in as early as
28 days. Other Biomaterial products accounted for 33% of our surgical business'
revenue for fiscal 2004, compared to 32% during fiscal 2003.

Devices for Microsurgery and Surgical Tools

In addition to our biomaterial products, our surgical business offers
devices for microsurgery and surgical tools designed to enhance productivity in
a variety of cardiovascular, microsurgical and other surgical procedures. The
device we believe to have the greatest potential is the Microvascular
Anastomotic Coupler (the "Coupler"), a patented mechanical anastomotic product
comprised of a pair of implantable, single-use rings. The Coupler is available
in five sizes, ranging from 1.0mm to 3.0mm in diameter, to fit varying vessel
diameters. We are working to expand the offerings of the Coupler to include
3.5mm and 4.0mm sizes, and expect to launch these additional sizes during fiscal
2005. The Coupler enables microsurgeons in numerous surgical specialties,
including plastic and reconstructive, head and neck, orthopedic and hand, to
perform highly effective anastomotic microsurgical procedures (the connecting of
miniscule veins and arteries) faster, more easily and as or more dependably than
traditional suture or sleeve anastomosis. The current device is used primarily
with veins.

Competition

Our surgical products compete primarily on the basis of product performance
and service. The surgical markets in which we compete are characterized by
intense competition. These markets are dominated by very large, established
manufacturers that have broader product lines, greater distribution
capabilities, substantially greater capital resources and larger marketing,
research and development staffs and facilities than we have. Many of these
competitors offer broader product lines within our specific product market,
particularly in our surgical tool markets and/or in the general field of medical
devices and supplies. Broad product lines give many of our competitors the
ability to negotiate exclusive, long-term medical device supply contracts and,
consequently, the ability to offer comprehensive pricing for their products,
including those that compete with our products. By offering a broader product
line in the general field of medical devices and supplies, competitors may also
have an advantage in marketing competing products to group purchasing
organizations, health maintenance organizations and other managed care
organizations that increasingly seek to reduce costs by centralizing and
consolidating their purchasing functions.

Competition with our biomaterial products is primarily from synthetic
materials, other biological tissues and cadaveric tissue. The ability of these
alternative products to compete with our biomaterial products vary based on each
such product's indications for use, relative features and benefits and surgeon
preference.

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There are presently two large private companies (W.L. Gore and Cook Group
Inc.) with buttress products competing with Peri-Strips in the gastric bypass
market. In addition, we also face indirect forms of competition, which include
alternate surgical techniques such as oversewing the staple line and alternative
procedures such as gastric banding. There can be no assurance that competing
products or indirect forms of competition will not achieve greater acceptance or
that future products or alternative treatments for morbid obesity will not offer
similar or enhanced performance advantages.

Synthetic materials are generally cheaper to produce and to the extent that
comparable synthetic materials are available and effective in surgical
procedures, we face significant price competition for our biomaterial products.
There are other multi-purpose patches made from bovine and other types of animal
tissue that compete with our products. We do not believe that these alternative
bovine pericardium products have specific Food and Drug Administration ("FDA")
marketing clearance for all surgical specialty markets in which we compete.

Cadaveric tissue from tissue banks or from commercial distributors is
sometimes utilized in neurological surgery and is often the choice for urologic
procedures. We believe that the collagen characteristics exclusive to our
biologic tissue, the strength of the multi-directional fibers of the pericardial
substrate, the special configuration of our biomaterial products, and the
proprietary tissue-fixation and purification processes we employ, offer
significant benefits in product performance over cadaveric tissue and synthetic
materials.

Patent protection of our key products and manufacturing processes is an
important component of our competitive position. The method by which Peri-Strips
are attached to surgical staplers offers an ease of use advantage and is patent
protected with regard to any and all materials. In addition, the manufacturing
process of our remodelable Veritas product is patented.

Description of the Interventional Business

Our interventional business develops, engineers, prototypes and
manufactures coils, helices, stylets, guidewires and other complex micro-wire,
polymer and micro-machined metal components used in interventional devices for
cardiac rhythm management, neurostimulation, vascular and other procedures.
These products are sold primarily to other medical device manufacturing
companies who incorporate them into their own products. In addition, our
interventional business is designing and developing proprietary technology
platforms which can be adapted for our customers.

During the second quarter of fiscal 2003, our interventional business
opened Synovis Caribe, Inc., a manufacturing facility in Puerto Rico. We believe
this facility provides us a strategic and tactical advantage, including
increasing the manufacturing capacity of our interventional business.

Coils and Helices. Micro precision coils are intricately complex precision
wire components, comprised normally of several strands of specialty wire
materials wound into specific configurations. These coils are manufactured
utilizing proprietary processes and typically involve the use of specialty
metals such as medical grade stainless steel, silver, platinum, and various
other metal alloys. These micro coils are used to carry the electrical signal
required for operation of a medical device that is implanted within the
patient's body. A subcategory of coils is called helices, which compose the
distal portion of many pacing and defibrillation leads that are used to actively
fix the lead tip to the endocardium.

Stylets and Other Wireforms. Stylets and other critically defined delivery
devices are produced through the application of proprietary processes using
medical grade stainless steel and plastic cap and body components. Stylets are
typically used in the placement of cardiovascular and neurostimulation leads.

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Machining, Molding and Tool Making. Machining, molding and tool making
provides micro-machining, polymer injection molding, micro-molding and CNC
machining for customers in the medical device, pharmaceutical, biotechnology,
instrumentation and electronics industries.

Competition

Our interventional business competes on the basis of superior quality of
processes and production, rapid and flexible customer response, early
development partnering and a fair price. Because the component parts provided by
our interventional business usually comprise a minor portion of the total
device-level price, we believe vendor performance and responsiveness are
generally more critical competitive factors. There are several competitors to
our core interventional business, most of which are substantially larger. Given
the concentration of the wire component product industry, we believe that
medical device customers are generally motivated to promote healthy competition
among their various suppliers in order to ensure multiple supply sources for
their critical device components.

The primary medical device companies involved in the interventional cardiac
and neurological markets include Medtronic, Guidant Corporation, St. Jude
Medical, Boston Scientific and Johnson and Johnson Cordis. In addition, numerous
early stage companies are pursuing new technologies in cardiovascular and
interventional medicine. We anticipate that the cardiovascular and
interventional medicine industry will continue to experience significant
consolidation with the acquisition of earlier stage companies by the major
industry participants. Although there can be no assurance, we believe that this
consolidation will not hinder our interventional segment's growth opportunity as
the major participants are expected to continue to seek multiple supply sources
for critical device components such as those we offer.

INTELLECTUAL PROPERTY

Surgical Business

In our surgical business, we protect our technology through patents, trade
secrets, and proprietary know-how. We also seek to protect our technology
through confidentiality agreements with employees, consultants and other
parties. Supple Peri-Guard, which is used in the manufacture of the majority of
our Tissue-Guard products, is protected exclusively by trade secrets. We hold
United States patents related to Peri-Strips and Veritas Collagen Matrix. One of
our patents on Peri-Strips includes provisions for the method of application of
any material -- biological or synthetic -- to the surgical stapler. We also have
the exclusive, worldwide, perpetual license to make, use and sell our Coupler
products, which are patent protected.

Interventional Business

In our interventional business, we rely primarily on trade secret
protection for our processes. We seek to practice a strict trade secret
discipline with all employees, consultants, customers and other parties. We also
maintain a confidentiality protocol on behalf of each of our customers,
consistent with the business sensitivity to customer expectations and needs. The
technology and equipment used in the interventional product manufacturing
process is a combination of proprietary know-how and adaptation and development
utilizing readily available components and equipment. Additionally, our
interventional business is moving towards patent protection of proprietary
technology platforms. During fiscal 2004, our interventional business was issued
two patents from the U.S. Patent and Trademark Office -- one for a steerable
stylet delivery system and another for an adjustable stiffness stylet delivery
system.

7

MARKETING AND CUSTOMERS

Surgical Business

Our surgical business' marketing and sales strategies include supporting
our superior quality products with innovative and effective sales and marketing
programs. These programs include advertising and direct mail campaigns,
participation in surgical trade shows, support of the gathering, publication and
presentation of clinical data and new product information by key surgeons, and
collaboration with key surgeons on educational activities. An important strategy
is to identify and assess customer needs. This is accomplished by developing and
maintaining a close working relationship with the hospitals and surgeons who
purchase and use our products and through observations and interactions with our
customers.

Our surgical business sells almost all of its products through a
combination of third-party distributors and independent sales representatives.
Our marketing and sales group works closely with these distributors and
representatives to implement marketing strategies and to provide product
training and support. Written agreements with distribution partners generally
impose limited geographic exclusivity and minimum purchase requirements which
approximate the distributor's estimates of growth that can be accomplished.
These agreements may be terminated upon breach of the agreement by the
distributor, including breach of the minimum sales obligations imposed by the
agreement.

In November 2004, we announced that our surgical business will transition
to new distributors for our surgical products in a large distribution territory
during fiscal 2005. Our current distributor, whose territory covers
approximately 22% of the United States population and approximately 200
hospitals, will continue selling through our second fiscal quarter. New
distributors will begin field activities with us in our second fiscal quarter,
and will be fully responsible for sales initiatives beginning in our third
fiscal quarter.

Interventional Business

Our interventional business strategy is to proactively seek significant
business relationships with both our large participants and early development
firms in major markets including cardiac rhythm management ("CRM"),
neurostimilation and vascular intervention. The primary marketing strategy is to
provide a rapid, flexible and creative response to customer needs, coupled with
state of the art, high quality production. Additionally, our marketing strategy
seeks to differentiate ourselves from competitors by promoting our custom
development and engineering capabilities, supported by a relatively large
engineering and technical staff, and extensive medical device experience amongst
its professional employees. The utilization of these highly technical solutions
and timely, effective delivery of development prototypes is believed to provide
a key competitive advantage to both the customer and our interventional
business. Our interventional facilities in Lino Lakes are ISO 9001-2000
certified and expect to pursue ISO 13485:2003 compliance in fiscal 2005, a
demonstration to our customers of our quality commitment. Our facility in
Dorado, Puerto Rico achieved ISO 13485:2003 compliance in August 2004.

Information regarding our significant customers is included in Note 10 to
our consolidated financial statements under Item 8 of this report.

ADDITIONAL INFORMATION REGARDING THE SURGICAL AND INTERVENTIONAL BUSINESSES

Backlog

Based on experience, we believe that backlog is not a meaningful predictor
of future revenue levels in either of our businesses.

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Raw Materials

We acquire bovine pericardium for use in the biomaterial product line from
United States Department of Agriculture ("USDA") inspected meat-packing
facilities. The supply of raw materials, including wire, precious metals and
plastics required for our products and in our manufacturing activities, is
currently adequate. We have not experienced any product shortages arising from
interruptions in the supply of any raw materials or components, and have
identified alternative sources of supply for significant raw materials and
components.

Research and Development

As a component of our business growth strategy, we continue to make a
significant investment in research and development ("R&D") as well as new
product design and engineering in both our surgical and interventional
businesses. Our consolidated R&D expense for fiscal 2004, 2003 and 2002 was
$4,072,000, $3,806,000 and $2,272,000, respectively.

The R&D activities our surgical business is expecting to advance in fiscal
2005 include new applications for Veritas, additional products for colon and
colorectal opportunities, product enhancements related to Peri-Strips and
advancing the technology of the Coupler. Our surgical business' longer-term
initiatives, among others, include expansion of the Coupler into the coronary
and/or other markets. We cannot estimate the probability of success, timing of
completion or project costs related to this project due to growing FDA scrutiny
with regards to such a device.

In fiscal 2005, our interventional business' R&D initiatives will continue
to focus on designing and developing proprietary technology platforms which can
be adapted for our customers. Recent R&D efforts included technology platforms
for a steerable stylet and an adjustable stiffness stylet. The steerable stylet
technology will initially be used for placement of CRM and neurostimulation
leads. We expect to advance these and other technologies to indications where
they could be adapted to deliver devices and therapy.

GOVERNMENTAL REGULATION

General

The medical device industry in which our businesses operate is subject to
extensive and rigorous regulation by the FDA and by comparable agencies in
foreign countries. In the United States, the FDA regulates the design control,
development, manufacturing, labeling, record keeping and surveillance procedures
for medical devices.

Food and Drug Administration

FDA regulations classify medical devices based on perceived risk to public
health as either Class I, II or III devices, which are subject to general
controls, special controls or pre-market approval ("PMA") requirements,
respectively. While most Class I devices are exempt from pre-market submission,
it is necessary for most Class II devices to be cleared by a 510(k) pre-market
notification prior to marketing. This establishes that the device is
"substantially equivalent" to a device that was legally marketed prior to May
28, 1976, the date on which the Medical Device Amendments of 1976 became
effective. The 510(k) pre-market notification must be supported by data
establishing the claim of substantial equivalence to the satisfaction of the
FDA. The process of obtaining a 510(k) clearance typically can take several
months to a year or longer. If the product is notably new or different and
substantial equivalence cannot be established, the FDA will require the
manufacturer to submit a PMA application for a Class III device that must be
reviewed and approved by the FDA prior to sale and marketing of the device in
the United

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States. The process of obtaining PMA approval can be expensive, uncertain,
lengthy and frequently requires anywhere from one to several years from the date
of FDA submission, if approval is obtained at all. FDA controls the indicated
uses for which a product may be marketed and strictly prohibits the marketing of
medical devices for unapproved uses. FDA can withdraw products from the market
for failure to comply with laws or the occurrence of safety risks.

Of our current medical device products, Biograft is a Class III device. All
other surgical products and the Navi-Glide steerable stylet have been classified
as Class II medical devices and have received 510(k) marketing clearance from
the FDA. For our interventional components, our customers are responsible for
obtaining FDA market clearance for their end devices, of which our products are
components of. Devices incorporating our interventional components are also
subject to FDA marketing clearance, which is the responsibility of our
customers.

Our surgical and interventional business' manufacturing operation is
subject to periodic inspections by the FDA, whose primary purpose is to audit
the Company's compliance with the Quality System Regulations published by the
FDA and other applicable government standards. Strict regulatory action may be
initiated in response to audit deficiencies or to product performance problems.
We believe that our manufacturing and quality control procedures are in
compliance with the requirements of the FDA regulations.

International Regulation

International regulatory bodies have established varying regulations
governing product standards, packaging and labeling requirements, import
restrictions, tariff regulations and duties and tax. Many of these regulations
are similar to those of the FDA. With the exception of the European Union
("EU"), Canada and Australia, we typically rely on our surgical independent
distributors covering a given country to comply with the majority of the foreign
regulatory requirements, including registration of our devices with the
appropriate governmental authorities. To date, and to the best of our knowledge,
we have complied with the regulatory requirements in the foreign countries in
which our surgical devices are marketed. We do, however, face certain regulatory
risks in international markets related to our bovine tissue products, which are
discussed in Part I, Item 1A of this Report.

The registration system in the EU for our surgical devices requires that
our quality system conform with international quality standards and that our
surgical devices conform with "essential requirements" set forth by the Medical
Device Directive ("MDD"). Manufacturing facilities and processes under which our
surgical devices are produced are inspected and audited by the British Standards
Institute ("BSI") to verify our compliance with the essential requirements of
the MDD, as well as supplementary requirements for "Medical Devices
Incorporating Animal Tissue." BSI verifies that our quality system conforms with
the international quality standard and that our products conform with the
"essential requirements" and "supplementary requirements" set forth by the MDD
for the class of surgical devices we produce. BSI certifies our conformity with
both the quality standards and the MDD requirements, entitling us to place the
"CE" mark on all our current surgical devices, except Biograft, which is exempt.
See the discussion on the risk factors of Biograft in Item 1, Part 1A of this
Report.

THIRD PARTY REIMBURSEMENT

Our surgical devices are purchased primarily by hospitals and other users,
while the interventional business' component products are sold directly to
medical device manufacturers which, in turn, sell finished medical devices to
hospitals and other end-users. Hospitals and end-users of such products bill
various third party payers for the services provided to the patients. These
payers, which include Medicare,

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Medicaid, private health insurance plans and managed care organizations,
reimburse all or part of the costs and fees associated with the procedures
utilizing our products and/or components.

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

In response to the focus of national attention on rising health care costs,
a number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be, proposals by legislators and regulators
and third party payers to curb these costs. The development or increased use of
more cost effective treatments for diseases could cause such payers to decrease
or deny reimbursement for surgeries or to favor non-surgical alternatives to
those surgical procedures currently utilizing our surgical products. A
significant number of Americans enroll in some form of managed care plan. Higher
managed care utilization typically drives down the payments for health care
procedures, which in turn places pressure on medical supply prices. This causes
hospitals to implement tighter vendor selection and certification processes, by
reducing the number of vendors used, purchasing more products from fewer vendors
and trading discounts on price for guaranteed higher volumes to vendors.
Hospitals have also sought to control and reduce costs over the last decade by
joining group purchasing organizations or purchasing alliances. We cannot
predict what continuing or future impact these practices, the existing or
proposed legislation, or such third-party payer measures within a constantly
changing healthcare landscape may have on our future business, financial
condition or results of operations.

EMPLOYEES

At October 31, 2004, we employed approximately 420 full-time and part-time
individuals, with approximately 185 employees in our surgical business and 235
in our interventional business. Our employees are not represented by a union,
and we consider our relationship with our employees to be good.

(d) FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

For information regarding our major customers and net revenue by geographic
area, please refer to Note 10 to our consolidated financial statements under
Item 8 of this report.

ITEM 1A -- IMPORTANT FACTORS

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

WE MAY NOT BE ABLE TO MANAGE FLUCTUATIONS IN REVENUES.

Our revenues have fluctuated significantly over the past several years. In
fiscal 2004, our revenues decreased five percent from the prior year. In fiscal
2003 and 2002 we achieved growth of 45% and 40%, respectively, primarily through
successful acquisitions, internal product and technology development, and
increased market acceptance of our products. There can be no assurance that we
can manage the significant challenges that accompany such fluctuations in
revenue, including alignment of infrastructure to match revenue levels,
appropriate staffing levels, and manufacturing flexibility. In addition, there
can be no

11

assurance that we will be able to identify and successfully consummate
acquisitions, develop new products and applications, and increase market
acceptance of our products to the degree necessary to achieve rates of revenue
growth and profitability in future periods comparable to those experienced in
fiscal 2003 and 2002. Additionally, our interventional business has customarily
experienced variations in revenue from period to period primarily due to
inherent variability in the timing of customer demand. Such variations are
difficult to precisely predict and are expected to continue in the future.

WE ARE PRESENTLY INVOLVED IN CLASS ACTION LITIGATION.

Between June and August 2004, five lawsuits were filed against the Company
and certain of its executive officers in the United States District Court for
the District of Minnesota by individual shareholders who seek to represent a
class of purchasers of the Company's common stock during the period from October
16, 2003 to May 18, 2004. The complaints generally allege that the defendants
violated the Securities Exchange Act of 1934 by issuing false or misleading
statements about our business and prospects, which artificially inflated the
price of the Company's securities. No damages have been specified. We believe
that the lawsuits have no factual basis and intend to vigorously defend the
actions. Two related actions brought by individual shareholders who seek to
represent the Company derivatively have also been filed in United States
District Court for the District of Minnesota. Those lawsuits allege that certain
officers and the Company's directors violated their fiduciary duties to the
Company. The Company's Board of Directors has also received a demand to commence
a claim against certain directors and officers and has created a special
litigation committee to address that demand. We are unable to evaluate the
likelihood of prevailing in these cases at this early stage of the proceedings
and have not recorded a liability in our consolidated balance sheet. We have
incurred legal expenses and expect to incur additional legal expenses related to
these suits in the future, potentially up to $500,000 in aggregate, the
deductible under the insurance policy we believe provides coverage for such
lawsuits.

WE FACE SIGNIFICANT COMPETITION FROM ESTABLISHED COMPETITORS IN THE MEDICAL
DEVICE INDUSTRY.

We face intense competition. The medical device industry is highly
competitive and characterized by rapid innovation and technological change. We
expect technology to continue to develop rapidly, and our success will depend to
a large extent on our ability to maintain a competitive position with our
technology. There can be no assurance that we will be able to compete
effectively in the marketplace or that products developed by our competitors
will not render our products obsolete or non-competitive. Similarly, there can
be no assurance that our competitors will not succeed in developing or marketing
products that are viewed by surgeons as providing superior clinical performance
or are less expensive relative to the products we currently market or may
develop.

Established companies manufacture and sell products that compete with each
of our products. Some of the companies with whom we compete have greater sales
and/or distribution capabilities, substantially greater capital resources and
larger marketing, research and development staffs and facilities than we have.
In addition, many of our competitors offer broader product lines within our
specific product markets. Broad product lines may give our competitors the
ability to negotiate exclusive, long-term medical product or interventional
supply contracts and the ability to offer comprehensive pricing for their
products, including those that compete with our products. There can be no
assurance that we will be able to compete effectively with such manufacturers.

WE ARE DEPENDENT ON A SINGLE CUSTOMER FOR A LARGE PERCENTAGE OF THE SALES IN OUR
INTERVENTIONAL BUSINESS.

One customer accounts for a large percentage of the sales of our
interventional business. This customer represented 46% and 56% of this business
segment's revenue for the years ended October 31,

12

2004 and 2003, respectively. We provide multiple products to this customer,
which are ultimately incorporated into a variety of medical devices. There can
be no assurance that we will be able to maintain our relationship with this
significant customer, or, in the event of a deterioration or termination of the
relationship, that we will be able to achieve the same production levels with
new or existing customers. The significant deterioration or loss of this
customer could materially adversely affect our business, financial condition and
results of operations.

WE MAY NOT BE ABLE TO ADEQUATELY ENFORCE OR PROTECT OUR INTELLECTUAL PROPERTY
RIGHTS OR TO PROTECT OURSELVES AGAINST THE INFRINGEMENT CLAIMS OF OTHERS.

In our surgical business, we protect our technology through patents, trade
secrets, and proprietary know-how. We also seek to protect our technology
through confidentiality agreements with employees, consultants and other
parties. In our interventional business, we rely largely on trade secret
protection for our processes, although we are seeking patent protection of
proprietary technology platforms, and in fiscal 2004 have been issued two
patents from the U.S. Patent and Trademark Office.

There can be no assurance that our trade secrets or confidentiality
agreements will adequately protect our proprietary information or, in the event
of a breach of any confidentiality agreement, that we will have adequate
remedies. Additionally, there can be no assurance that any pending or future
patent applications will result in issued patents, or that any current or future
patent, regardless of whether we are an owner or licensee of such patent, will
not be challenged, invalidated or circumvented or that the rights granted
thereunder or under our licensing agreements will provide a competitive
advantage to us. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate any technology developed
by us, or that our technology does not or will not infringe patents or other
rights owned by others.

The medical device industry is characterized by frequent and substantial
intellectual property litigation, and competitors may resort to intellectual
property litigation as a means of competition. Intellectual property litigation
is complex and expensive, and the outcome of such litigation is difficult to
predict. Any future litigation, regardless of the outcome, could result in
substantial expense to us and significant diversion of the efforts of our
technical and management personnel. Litigation may also be necessary to enforce
patents issued to us and license agreements entered into by us, to protect our
trade secrets or know-how or to determine the enforcement, scope and validity of
the proprietary rights of others. An adverse determination in any such
proceeding could subject us to significant liabilities to third parties or
require us to seek licenses from third parties or pay royalties that may be
substantial. Furthermore, there can be no assurance that the necessary licenses
would be available to us on satisfactory terms, if at all. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent us from manufacturing or selling certain
of our products, which, in turn, would have a material adverse effect on our
business, financial condition and results of operations.

OUR FAILURE TO OBTAIN REGULATORY CLEARANCE/APPROVAL AND MAINTAIN REGULATORY
COMPLIANCE FOR ANY OF OUR PRODUCTS WOULD IMPACT OUR ABILITY TO GENERATE REVENUE
FROM THOSE PRODUCTS.

We must comply with FDA regulations to market our products in the United
States. The medical device industry in which our business operates is subject
to extensive and rigorous regulation by the FDA and by comparable agencies in
foreign countries. In the United States, the FDA regulates the design control,
development, manufacturing, labeling, record keeping and surveillance procedures
for medical devices including our surgical devices, any interventional devices
and those medical devices which incorporate our interventional business
component products.

13

The process of obtaining marketing clearance or approvals from the FDA for
new products and new applications for existing products can be time-consuming
and expensive, and there is no assurance that such clearance/approvals will be
granted, or that the FDA review will not involve delays that would adversely
affect our ability to commercialize additional products or additional
applications for existing products. Some of our surgical products and those
devices incorporating interventional components that are in the research and
development stage may be subject to a lengthy and expensive pre-market approval
process with the FDA. FDA has the authority to control the indicated uses of a
medical device. Products can also be withdrawn from the market due to failure to
comply with regulatory standards or the occurrence of unforeseen problems. FDA
regulations depend heavily on administrative interpretation, and there can be no
assurance that future interpretations made by the FDA or other regulatory
bodies, with possible retroactive effect, will not adversely affect us.

Our manufacturing facilities and processes are subject to regulation. The
FDA, various state agencies and foreign regulatory agencies inspect our
manufacturing facilities to determine whether we are in compliance with various
regulations relating to quality systems, such as manufacturing practices,
validation, testing, quality control, product labeling and product surveillance.
A determination that we are in violation of such regulations could lead to
imposition of civil penalties, including fines, product recalls or product
seizures and, in extreme cases, criminal sanctions, depending on the nature of
the violation.

We must obtain regulatory approvals to market our products
internationally. The registration scheme in the majority of international
markets (e.g. Europe, Canada) for our surgical business' products requires that
our quality system conforms to international quality standards. Compliance with
these requirements as well as product standards allows their sale in these
countries. There can be no assurance that we will be able to maintain compliance
with these regulations. In addition, there can be no assurance that we will be
successful in obtaining registration for new product introductions. Devices
incorporating our interventional products are also subject to these
requirements, and there can be no assurance that we or our interventional
business customers will be successful in obtaining or maintaining compliance
with the international regulatory scheme for current or future products.

Further, international regulatory bodies have established varying
additional regulations governing product standards, packaging requirements,
labeling requirements, import restrictions, tariff regulations, duties and tax
requirements. We rely, in part, on our surgical independent distributors to
comply with such foreign regulatory requirements. As a result, our communication
with foreign regulatory agencies may be indirect as it occurs through the
foreign distributor. The inability or failure of independent distributors to
comply with the varying regulations or the imposition of new regulations could
restrict such distributors' ability to sell our surgical products
internationally and thereby adversely affect our business, financial condition
and results of operations.

BECAUSE OUR BIOMATERIAL PRODUCTS ARE MANUFACTURED FROM BOVINE PERICARDIUM,
PERCEPTIONS ABOUT BOVINE SPONGIFORM ENCEPHALOPATHY MAY IMPACT OUR SALES.

Under the direction of the USDA, the U.S. government has had an active
program of surveillance and import controls since the late 1980s designed to
prevent the introduction of Bovine Spongiform Encephalopathy ("BSE") into U.S.
cattle. The USDA program includes certain feed restrictions beginning in 1997.
While BSE had previously been endemic to certain European Union markets, the
first and only known case involving cattle in the U.S. was reported in December
2003. The World Health Organization has categorized the levels of BSE
infectivity of tissue. Using this scheme, pericardium (which primarily consists
of collagen) is categorized as no detectable infectivity. The European
authorities have specifically reviewed our biomaterial sourcing and
manufacturing processes and have also certified our bovine pericardium products.

14

We obtain all of the raw pericardium for our biomaterial products from
USDA-inspected slaughterhouses. The pericardium is collected under strict
conditions; a USDA inspector examines each heart for disease and anomalies prior
to harvesting the pericardium. Additional measures are also taken to ensure
brain and spinal cord matter does not come into contact with the pericardium.
Our tissue products are manufactured with sodium hydroxide, a processing
technique recommended by international experts to remove or inactivate the
prion, the agent believed to cause BSE, should it exist in the tissue.
Pericardium is sourced from animals who are 30 months or younger. BSE clinical
detectability is found in older animals. Sourcing from younger animals markedly
decreases the likelihood of BSE transmission. Notwithstanding these safeguards,
if BSE is found in cattle in the U.S. and/or the perception of risk associated
with BSE increases, it could have a material adverse effect on our business,
financial condition and results of operations.

Our Dura-Guard product has not been approved for sale in France, nor are
any of our bovine-based products currently approved for sale in Japan. We
understand that regulatory approvals will not be granted in the present
environment within those countries for use of animal derived products, including
bovine pericardium, unless traceability to the specific source can be
established. Total international sales of our bovine-based products accounted
for 5.6% and 4.7% of our consolidated net sales for the year ended October 31,
2004 and 2003, respectively, and increased 14% over the previous year. Any
prohibition by certain other countries of bovine pericardium products as a
result of concerns related to BSE could have an adverse effect on our ability to
maintain or grow international sales of these products.

In 2004, the EU enacted medical device regulations that require product
specific evaluation of bovine-based products for potential BSE patient health
risks. All bovine-based surgical products currently sold in the EU are subject
to this evaluation. Our bovine based products have been evaluated and have
obtained approval.

ONE OF OUR PRODUCTS, THE BIOGRAFT, CONTAINS HUMAN TISSUE PRODUCTS THAT WILL
BECOME SUBJECT TO MORE STRICT REGULATION IN THE UNITED STATES AND EUROPE.

Spurred by incidents of the transmission of human disease during tissue
transplantation, both the United States and Europe have recently focused
attention on the safety of donor tissue and tissue processing establishments. In
the United States, medical devices containing human tissue will be subject to
additional controls, including umbilical cord vein grafts such as our Biograft
product. As a result, Biograft will be subject to regulations that include
screening and donor testing procedures effective May 2005.

The medical device directive issued by the EU explicitly excludes medical
devices from human tissue; however, there is an effort to include such devices
under a comprehensive regulatory program. In Europe, Biograft will be subject to
additional regulations that parallel U.S. regulations. These additional
regulations are expected to be finalized in 2006.

As a result, these additional regulatory requirements could make it
uneconomical to sell Biograft. Revenue from Biograft was $907,000 and $977,000
in fiscal 2004 and 2003, respectively.

WE MAY FACE THE RISK OF PRODUCT LIABILITY CLAIMS AND PRODUCT RECALLS THAT COULD
RESULT IN COSTLY AND TIME CONSUMING LITIGATION AND SIGNIFICANT LIABILITY.

The medical device industry historically has been litigious, and the
manufacture and sale of our products inherently entail a risk of product
liability claims. In particular, our principal surgical devices and a
significant portion of our interventional component products are designed to be
permanently placed in the human body, and production or other errors could
result in an unsafe product and injury to the patient. Although we maintain
product liability insurance in amounts believed to be adequate based upon the

15

nature and risks of our business in general and our actual experience to date,
there can be no assurance that one or more liability claims will not exceed the
coverage limits of such policies or that such insurance will continue to be
available on commercially reasonable terms, if at all. Furthermore, we do not
expect to be able to obtain insurance covering our costs and losses as the
result of any recall of our products due to alleged defects, whether such a
recall is instituted by us or required by a regulatory agency. A product
liability claim, recall or other claim with respect to uninsured liabilities or
in excess of insured liabilities could have a material adverse effect on our
business, financial condition and results of operations.

WE SELL MOST OF OUR SURGICAL PRODUCTS THROUGH INDEPENDENT DISTRIBUTORS AND SALES
REPRESENTATIVES.

We utilize independent distributors and sales representatives to transact
essentially all of our current surgical business. The loss of a significant
distributor or sales representative, or a significant number of other
distributors or sales representatives, could materially adversely affect our
business, financial condition and results of operations if a new distributor or
other suitable sales organization could not be found on a timely basis in the
relevant geographic market.

In November 2004, we announced that our surgical business will transition
to new distributors for our surgical products in a large distribution territory
during fiscal 2005. Our current distributor, whose territory covers
approximately 22% of the United States population and approximately 200
hospitals, will continue selling through our second fiscal quarter ending April
30, 2005. New distributors will begin field activities with us in our second
fiscal quarter, and will be fully responsible for sales initiatives beginning in
our third fiscal quarter. Factors that could impact sales in the region during
and after the change in distribution include, but are not limited to, the
effectiveness of training of new sales reps on our products, our ability to
successfully convert hospital purchasing from previous distribution to new
distribution and the ever-present potential of increased competition.

DUE TO THE UNPREDICTABILITY OF THE HEALTH CARE INDUSTRY, OUR CUSTOMERS MAY NOT
BE ABLE TO RECEIVE THIRD PARTY REIMBURSEMENT FOR THE SURGICAL PROCEDURES
UTILIZING OUR PRODUCTS.

Our surgical products are purchased primarily by hospitals and other users,
and we sell our interventional component products directly to medical device
manufacturers who, in turn, sell finished medical products to hospitals and
other end-users. Hospitals and end-users of our products bill various
third-party payers, including government health programs, private health
insurance plans, managed care organizations and other similar programs, for the
health care goods and services provided to their patients. Third-party payers
may deny reimbursement if they determine that a procedure was not in accordance
with established third-party payer protocol regarding treatment methods. Our
surgical products are reimbursed as a component of the overall surgical
procedure reimbursement obtained from the third-party payer.

Third-party payers are also increasingly challenging the prices charged for
medical products and services and, in some instances, have put pressure on
medical device suppliers to lower their prices. While we believe our pricing is
appropriate for the niche markets and technology of our products, we are unable
to predict what changes will occur made in the reimbursement methods used by
third-party payers. There can be no assurance that surgical procedures in which
our products are directly or indirectly used will continue to be considered
cost-effective by third-party payers, that reimbursement for such procedures
will be available or, if available, will continue, or that third-party payers'
reimbursement levels will not adversely affect our ability to sell our products
on a profitable basis. The cost of health care has risen significantly over the
past decade, and there have been and may continue to be proposals by
legislators, regulators and third-party payers to curb these costs.

16

Failure by hospitals and other users of our products to obtain
reimbursement from third-party payers for procedures in which our products are
used, changes in third-party payers' policies towards reimbursement for
procedures directly or indirectly using our products or legislative action could
have a material adverse effect on our business, financial condition and results
of operations.

WE DEPEND ON HIGHLY SPECIALIZED EQUIPMENT TO MANUFACTURE OUR PRODUCTS AND LOSS
OF OR DAMAGE TO OUR MANUFACTURING FACILITIES COULD RESULT IN SIGNIFICANT LOSSES.

We operate a single manufacturing facility for our surgical business and
three manufacturing facilities for our interventional business, with certain
overlapping capabilities for manufacturing stylets, coils and helices. The loss
of or damage to any manufacturing facility due to natural disaster, equipment
failure or other difficulty could result in significant delays in production.
Locating third party manufacturers to manufacture our products in such event
would likely be difficult given the specialized equipment and processes
necessary to produce those products. Although we maintain business interruption
insurance to address the financial impact on our business, any sustained period
of suspended production would likely have a material adverse effect on our
business, financial condition and results of operations.

OUR STRATEGY TO ACQUIRE COMPLEMENTARY BUSINESSES AND TECHNOLOGIES INVOLVES RISK
AND MAY RESULT IN DISRUPTIONS TO OUR BUSINESS BY, AMONG OTHER THINGS,
DISTRACTING MANAGEMENT TIME AND DIVERTING FINANCIAL RESOURCES.

One of our growth strategies is the acquisition of complementary businesses
and technologies. We may not be able to identify suitable acquisition
candidates, or if we do, we may not be able to make such acquisitions on
commercially acceptable terms or at all. If we make acquisitions, a significant
amount of management time and financial resources may be required to complete
the acquisition and integrate the acquired business into our existing
operations. Even with this investment of management time and financial
resources, an acquisition may not produce the revenue, earnings or business
synergies that we anticipated. Acquisitions involve numerous other risks
including: assumption of unanticipated operating problems or legal liabilities,
problems integrating the purchased operations, technologies or products,
diversion of management's attention from our core businesses, adverse effects on
existing business relationships with suppliers and customers, incorrect
estimates made in the accounting for acquisitions and amortization of acquired
intangible assets which would reduce future reported earnings, and potential
loss of customers or key employees of acquired businesses.

ITEM 2 -- PROPERTIES

The Company has a lease for the corporate headquarters and surgical
business, totaling 65,000 square feet, located at 2575 University Ave. W., St.
Paul, Minnesota.

- The base rent of the first lease for 36,000 square feet, which commenced
August 1, 1995 and was due to expire July 31, 2005, is approximately
$255,000 annually. An extension of the first lease was completed,
extending the term to December 31, 2008, at a base rent to be determined
based on market price on August 1, 2005.

- In fiscal 2003, the Company signed an addendum lease to expand the office
and manufacturing space at 2575 University Ave. W. by 29,000 square feet,
which commenced on January 1, 2004 and runs through December 31, 2008.
Annual base rent for the additional 29,000 square feet from January 2004
through December 2006 is approximately $316,000, and from January 2007
through December 2008 is approximately $330,000.

17

The Company also has leases on three facilities for its interventional
business totaling 33,000 square feet at 471 and 475 Apollo Drive, Lino Lakes,
Minnesota.

- The first lease for 25,000 square feet, commenced December 1, 1997 and is
scheduled to expire on December 31, 2007. The base rent is approximately
$113,000 annually.

- The base rent of the second lease for 4,000 square feet, which commenced
April 1, 1999 and expires on March 31, 2009 is approximately $19,000
annually.

- The base rent of the third lease for 4,000 square feet, which commenced
on December 1, 2003 and expires on March 31, 2009, is approximately
$27,000.

The Company leases approximately 22,700 square feet for its Caribe facility
at Road 693, Km. 7.3, Dorado, Puerto Rico. The base rent of this lease, which
commenced January 1, 2003 and expires February 28, 2008, is approximately
$93,000 annually.

The Company leases approximately 3,750 square feet for its MCA facility at
439 Industrial Lane, Birmingham, Alabama. The base rent of this lease, which
commenced July 1, 2002 and expires June 30, 2005, is $33,600 annually.

The Company pays apportioned real estate taxes and common costs on its St.
Paul and Lino Lakes leased facilities. The Company also owns a 20,000 square
foot manufacturing facility at 400 Apollo Drive, Lino Lakes, Minnesota, which
was acquired in conjunction with an acquisition of a business in March 2002.

ITEM 3 -- LEGAL PROCEEDINGS

Between June and August 2004, five lawsuits were filed against the Company
and certain of its executive officers in the United States District Court for
the District of Minnesota by individual shareholders who seek to represent a
class of purchasers of the Company's common stock during the period from October
16, 2003 to May 18, 2004. The complaints generally allege that the defendants
violated the Securities Exchange Act of 1934 by issuing false of misleading
statements about our business and prospects, which artificially inflated the
price of the Company's securities. No damages have been specified. We believe
that the lawsuits have no factual basis and intend to vigorously defend the
actions. Two related actions brought by individual shareholders who seek to
represent the Company derivatively have also been filed in United States
District Court for the District of Minnesota. Those lawsuits allege that certain
officers and the Company's directors violated their fiduciary duties to the
Company. The Company's Board of Directors has also received a demand to commence
a claim against certain directors and officers and has created a special
litigation committee to address that demand. We are unable to evaluate the
likelihood of prevailing in these cases at this early stage of the proceedings
and have not recorded a liability in our consolidated balance sheet. We have
incurred legal expenses and expect to incur additional legal expenses related to
these suits in the future, potentially up to $500,000 in aggregate, the
deductible under the insurance policy we believe provides coverage for such
lawsuits.

From time to time, the Company may become involved in litigation which is
ordinary, routine litigation incidental to its business. Further, product
liability claims may be asserted in the future relative to events not known to
management at the present time. Management believes that the Company's risk
management practices, including its insurance coverage, are reasonably adequate
to protect against potential material product liability losses.

18

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

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

ITEM 4A -- EXECUTIVE OFFICERS OF THE REGISTRANT

The Company's executive officers, their ages, and their offices held as of
October 31, 2004 are as follows:

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

David A. Buche. Mr. Buche has served as a Vice President and Chief
Operating Officer of Synovis Surgical Innovations since May 2004. From January
1998 to May 2004, he served as Vice President of Marketing and Sales of Synovis
Surgical Innovations. Prior to January 1998, Mr. Buche held the positions of
Director of Marketing from November 1997 and Director of International Marketing
and Sales from March 1995. From 1988 to February 1995, Mr. Buche held various
product and sales management positions at Spectranetics Corporation, a company
that develops and markets technology for interventional cardiovascular therapy.

Michael K. Campbell. Mr. Campbell has served as President of Synovis Micro
Companies Alliance since July 6, 2001, the acquisition date of MCA by the
Company. Prior to the acquisition he was President and CEO of MCA from July 2000
through July 2001. From June 1999 to May 2000, Mr. Campbell served as Executive
Vice President of PrimeSource Surgical, a specialty operating room distributor.
From 1979 to June 1999, he was with Futuretech, Inc., a specialty medical
distribution company serving the southeastern United States, and served as
principal board member and Vice President.

19

Mary L. Frick, M.S.C. Ms. Frick has served as Vice President of
Regulatory/Clinical/Quality Affairs of the Company since November 2003. She has
previously served in several positions within the surgical business, including
Vice President of Regulatory/Clinical/Quality Affairs since November 2000,
Director of Regulatory/Clinical/Quality Affairs since November 1998 and as Group
Manager of Regulatory/Clinical/Quality Affairs from June to November of 1998.
From 1984 to June 1998, Ms. Frick held a series of management positions in
Research, Operations and Regulatory/Clinical Affairs at INCSTAR Corporation, a
diagnostic medical device manufacturer. From 1979 to 1984, Ms. Frick worked in
research at the University of Minnesota-Medical School.

Evan S. Johnston. Mr. Johnston has served as Vice President of Operations
of Synovis Surgical Innovations since November 2000. Joining the Company in
September 1998, Mr. Johnston served as Director of Operations from November
1999. From 1996 to 1998, Mr. Johnston held the position of Director of
Manufacturing and Operations at LecTec Corp., a manufacturer of skin interface
medical devices. From 1995 to 1996, he served as Director of Manufacturing of
Lakeside Nameplate Co., a custom manufacturer of electronic membrane switches.
Mr. Johnston served as Manager of Industrial Engineering from 1990 to 1995 at
Orthomet Inc., a manufacturer of orthopedic implants and related surgical
instruments. From 1986 to 1990, Mr. Johnston held various project management
positions for Honeywell, Control Systems Division, a developer of automation
solutions for government and commercial industries.

Richard W. Kramp. Mr. Kramp has served as President and Chief Operating
Officer of the Company's interventional business since August 2004. Prior to
joining the Company, Mr. Kramp most recently served as the president and chief
operating officer of Medical CV, Inc. From 1988 to 2003, Mr. Kramp served as
President and Chief Operating Officer, and then President and Chief Executive
Officer, as well as a Board Member at ATS Medical. From 1978 to 1988, Mr. Kramp
held sales and marketing positions at St. Jude Medical, serving as Vice
President of Sales and Marketing from 1981. Earlier, Mr. Kramp held sales
management positions with Life Instruments, Inc., engineering positions with
Cardiac Pacemakers, Inc., now part of Guidant Inc. Mr. Kramp has also served on
the boards of C.A.B.G., Inc., Enpath Medical, Inc., Optical Sensors and the
Lillehei Surgical Society.

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

B. Nicholas Oray, Ph.D. Dr. Oray has served as Vice President of Research
and Development since November 2003. Prior to that, Dr. Oray served as Vice
President of Research and Development of Synovis Surgical Innovations since
April 1998. From 1997 to April 1998, he served as Director of Research and
Development at Seatrace Pharmaceuticals Inc. From 1993 to 1996, Dr. Oray held a
series of positions with CryoLife Inc., including Director of Bioadhesive
Manufacturing and Associate Director of Biomedical Products Laboratory. From
1991 to 1993, he held several positions with F.A.C.T., a clinical research
organization, including Director of Regulatory Affairs and Associate Director of
Clinical Trials Operations. From 1988 to 1990, Dr. Oray served as Director of
Manufacturing, Director of Sterile Manufacturing and Director of Purification
and Production Group at Carrington Laboratories, Inc.

20

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

COMMON STOCK INFORMATION

PRICE RANGE

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

DIVIDENDS

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

SHAREHOLDERS

As of November 30, 2004, there were approximately 5,500 beneficial owners
and 1,000 registered shareholders of the Company's common stock.

ITEM 6 -- SELECTED FINANCIAL DATA

SUMMARY STATEMENTS OF INCOME DATA

21

SUMMARY BALANCE SHEET DATA

22

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

OVERVIEW

Synovis Life Technologies, Inc. ("Synovis" or the "Company") is a
diversified medical device company engaged in developing, manufacturing and
marketing products for the surgical and interventional treatment of disease. Our
business is conducted in two reportable segments, the surgical business and
interventional business, with segmentation based upon the similarities of the
underlying business operations, products and markets of each.

Our surgical business develops, manufactures and markets implantable
biomaterial products, devices for microsurgery and surgical tools, all designed
to reduce risk and/or facilitate critical surgeries, leading to better patient
outcomes and/or lower costs.

Our interventional business develops, engineers, prototypes and
manufactures coils, helices, stylets, guidewires and other complex micro-wire,
polymer and micro-machined metal components used in interventional devices for
cardiac rhythm management, neurostimulation, vascular and other procedures.

After several years of significant business growth, both businesses
confronted changes to their markets, which resulted in decreases in consolidated
revenue and operating income in fiscal 2004. Key drivers of our fiscal 2004
results are factors causing the gastric bypass market to be in a state of flux
and a significant decline in demand from our CRM customers as they adjusted
their purchases. The following highlight our fiscal 2004 results:

- Net revenue decreased 5% to $55.0 million.

- Surgical business revenue increased 5% to $26.8 million.

- Interventional business revenue decreased 13% to $28.2 million.

- Operating income decreased 79% to $1.6 million; operating margin of 2.8%.

- Surgical business operating income decreased 37% to $3.0 million.

- Interventional business operating loss was $1.4 million, a decrease of
$4.1 million from income of $2.7 million in fiscal 2003.

- Net income of $1.3 million or 11 cents per diluted share; down from 47
cents and 31 cents per diluted share in fiscal 2003 and 2002,
respectively.

23

The following tables summarize the Company's condensed consolidated
operating results for the years ended October 31, 2004, 2003 and 2002.

OPERATING RESULTS -- 2004 (IN THOUSANDS EXCEPT PER SHARE DATA)

Net revenue decreased 5% during fiscal 2004 to $55,044 from $57,989 in
fiscal 2003. Operating income decreased $5,791, or 79%, to $1,557 in fiscal 2004
from $7,348 in the prior year. Net income for fiscal 2004 decreased to $1,278,
or 11 cents per diluted share, from $4,973, or 47 cents per diluted share,
during fiscal 2003.

Surgical business net revenue increased 5% to $26,787 in fiscal 2004 from
$25,623 in fiscal 2003. The following table summarizes our surgical business net
revenue by product for the years ended October 31:

Driving the growth in fiscal 2004 was our Other Biomaterial product line.
This line, which includes Tissue-Guard and Veritas(R), accounted for 69% of this
segments' growth. Veritas and Tissue-Guard patches

24

used in vascular procedures were responsible for most of this growth. Our
Devices for Microsurgery and Surgical Tools product line increased $285 or 6% to
$4,812, driven by a 31% increase in sales of the Coupler to $1,748. The Coupler
is a device used to connect extremely small arteries or veins, without sutures,
quickly, easily and with consistently excellent results. We consider our
surgical tools product line to be mature.

Peri-Strips(R) revenue increased $138 or 1% to $11,860 in fiscal 2004.
Peri-Strips are used to reduce risks and improve patient outcomes in surgical
procedures, notably gastric bypass surgery and lung volume reduction surgery
("LVRS"). Gastric bypass surgery is a treatment for morbid obesity which is
believed to afflict between 15 and 23 million Americans. The slowdown in
Peri-Strips revenue growth during fiscal 2004 is attributable to several factors
within the gastric bypass market which are in flux. These factors include:
capacity constraints of many surgical practices that perform gastric bypass, the
American Society of Bariatric Surgeons driving the development of centers of
excellence which specialize in gastric bypass surgery and have an expected lower
rate of complications, insurance providers aggravating capacity constraints by
encouraging patients towards such centers of excellence, certain hospitals
electing not to support gastric bypass programs, concerns of some insurers that
offer either health care or liability coverage, and competing products and
technologies.

During the third quarter, the Centers for Medicare and Medicaid Services
("CMS") announced that they now consider obesity to be an illness, meaning they
will evaluate obesity treatments to reach conclusions about their effectiveness
and potential coverage. Additionally, two studies published in fiscal 2004 in
the journal Obesity Surgery cite the advantages of using Peri-Strips in gastric
bypass surgery. First, a study at Baylor University Medical Center, Dallas,
associated the use of Peri-Strips with preventing leaks and decreasing bleeding
at the gastric staple line, and furthermore, facilitating the transition of this
operation to an outpatient procedure at Baylor. The second study, commissioned
by Synovis, was conducted in Italy and demonstrated that using Peri-Strips to
reinforce the gastric staple line during laparoscopic gastric bypass surgery
reduced both the number of titanium clips used to prevent bleeding and
concurrently reduced operating time.

While the CMS consideration and study results are positive, the multitude
of factors affecting the gastric bypass market are still in flux, and need to
stabilize before we can reasonably assess our potential growth opportunities.

Peri-Strips revenue from LVRS has been slow to materialize in fiscal 2004,
following the decision by CMS to cover the procedure. Going forward, the amount
and timing of such revenue will be impacted by the frequency with which the
procedure is performed and the extent to which Peri-Strips are utilized in such
procedures.

Interventional business net revenue decreased 13% to $28,257 in fiscal 2004
from $32,366 in fiscal 2003. Our interventional business customers predominantly
operate in the cardiac rhythm management ("CRM") market and we address three
segments of this market: pacing, implantable cardioverter defibrillation and
congestive heart failure. Within the CRM market, we produce conductor and
shocking coils for pacing and defibrillator leads, helices for active fixation
leads, and stylets used to implant all types of leads. Our interventional
business has customarily experienced variations in revenue from period to period
primarily due to inherent variability in the timing of customer demand. Such
variations may continue in the future.

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The following table summarizes our interventional business net revenue by
market for the years ended October 31:

The following table summarizes our interventional business net revenue by
product for the years ended October 31:

Revenue from the three largest customers of the interventional business was
a combined $22,640 in fiscal 2004, a decrease of $5,429 or 19% from $28,069 in
fiscal 2003. Our interventional business is affected by the general dynamics of
the CRM market, and we are most affected by the actions of our customers in
response to this market. We, like other companies serving the CRM device
industry, were severely impacted in fiscal 2004 as customers reduced purchases.
Recently, the market opportunities in CRM seem more promising due to expansion
of indications for some of these devices, although there can be no assurance
that this will positively impact future revenue.

Our interventional business was issued two patents in fiscal 2004 from the
U.S. Patent and Trademark Office -- one for a steerable stylet delivery system
and another for an adjustable stiffness stylet delivery system. We expect these
technologies to have applications in site-specific and minimally invasive
therapies. In March 2004, our interventional business received clearance from
the FDA regarding 510(k) approval for its Navi-Glide(TM) Steerable Stylet
("Navi-Glide"), a proprietary single-use device intended to enable the physician
to define and vary the curvature of the stylet during implantation of the
cardiac lead, thereby avoiding the need to remove and recurve the stylet during
introduction of the lead. Our interventional business is moving the Navi-Glide
and its patented steerable technology towards commercialization through our
customers, with any related revenue dependant upon the time required to develop
the technology to our customers' specifications, acceptance by our customers of
the developed technology and market acceptance of the products using this
technology, as well as timing of customer orders.

Our consolidated gross margin decreased three percentage points to 41% in
fiscal 2004 from 44% during fiscal 2003. Gross margins in our interventional
business decreased eight percentage points to 20% in fiscal 2004 from 28% in
fiscal 2003. This decrease is primarily the result of significantly higher
overhead rates attributable to lower production volumes and reduced labor hours,
directly related to lower than planned revenue. In our surgical business, the
gross margin for fiscal 2004 decreased two percentage points to 63%, primarily
due to lower utilization of manufacturing resources and higher fixed production
costs, which thereby resulted in higher overhead rates associated with fiscal
2004 manufacturing activities. Factors which affect the consolidated gross
margin include the relative revenue of each business segment, product mix within
each business segment, volume and other production activities. Accordingly, our
consolidated gross margins may fluctuate from period to period based on
variations in these factors.

26

Selling, general and administrative ("SG&A") expense during fiscal 2004
increased 17% to $16,687 from $14,276 in fiscal 2003. As a percentage of net
revenue, SG&A expense increased five percentage points, from 25% in fiscal 2003
to 30% in fiscal 2004. Planned increases in regulatory and clinical expenses,
facility expansion costs and marketing efforts, combined with lower revenue
levels, are the primary reasons for this percentage increase.

Research and development ("R&D") expense during fiscal 2004 was $4,072, an
increase of 7%, from $3,806 in 2003. As a percentage of net revenue, R&D expense
increased from 6.6% in fiscal 2003 to 7.4% in fiscal 2004. This increase is
partially due to the increased number, timing and nature of various surgical R&D
projects, as well as development expenses of various interventional projects
including proprietary technology platforms which can be adapted for our
customers. In both business units, R&D expense can fluctuate from year to year
based on the timing and progress through external parties of the projects, and
the timing of such expense will continue to be influenced primarily by the
number of projects and the related R&D personnel requirements, development and
regulatory approval path, expected costs, timing and nature of those costs for
each project.

During the second half of fiscal 2004 we incurred $179 of other operating
expenses, which were recorded within our surgical business. We incurred $133 of
expenses related to our consideration of a significant acquisition, which was
terminated for a variety of reasons. The remaining $46 was for legal fees
incurred through October 31, 2004 pertaining to lawsuits filed against the
Company in fiscal 2004 which allege that the Company and certain of its
executive officers violated the Securities Exchange Act of 1934 by issuing false
or misleading statements about the Company's business and prospects, which
artificially inflated the price of the Company's securities. We believe that the
lawsuits have no factual basis and intend to vigorously defend the actions.
However, we expect to incur additional legal expenses related to these suits in
the future, potentially up to $500,000 in aggregate, the deductible under the
insurance policy the Company believes provides coverage for such lawsuits.

Operating income for fiscal 2004 was $1,557, a 79% decrease from $7,348
during fiscal 2003. Surgical business operating income decreased 37% to $2,972
in fiscal 2004 from $4,681 in fiscal 2003. Our interventional business recorded
an operating loss of $1,415 in fiscal 2004, compared with operating income of
$2,667 in fiscal 2003. Other income, primarily interest, increased to $336 in
fiscal 2004 compared with $41 in fiscal 2003, as a result of increased cash,
cash equivalents and short-term investments due to $36,486 in net proceeds from
our September 2003 private placement.

The provision for income taxes was $615 in fiscal 2004, at an effective tax
rate of 33%, as compared to $2,416, at an effective tax rate of 33% in fiscal
2003. As of October 31, 2004, we have recorded $1,088 in net current deferred
income tax assets and $1,227 in net long-term deferred income tax liabilities.

OPERATING RESULTS -- 2003 (IN THOUSANDS EXCEPT PER SHARE DATA)

Net revenue increased 45% during fiscal 2003 to $57,989 from $39,962 in
fiscal 2002. Operating income increased $2,798, or 61%, to $7,348 in fiscal 2003
from $4,550 in the prior year. Net income for fiscal 2003 increased to $4,973,
or 47 cents per diluted share, from $3,041, or 31 cents per share, during fiscal
2002.

Interventional business net revenue increased 59% to $32,366 in fiscal 2003
from $20,416 in fiscal 2002, following its fiscal 2002 growth rate of 60%. Our
interventional business generated revenue growth in every product category over
the same period of fiscal 2002. Product line revenue from coil and helices
increased $7,234 or 66%, to $18,122 in fiscal 2003 from $10,888 in fiscal 2002.
Product line revenue from stylets and other wireforms was $10,204 in fiscal
2003, an increase of $3,587 or 54% from $6,617 in fiscal 2002. The revenue
increases noted in each of these product groups was primarily due to the high
demand

27

for interventional customers' end products during the year. Our interventional
business manufactures products for customers providing medical devices in the
large, high-growth markets of cardiac rhythm management, neurostimulation and
vascular intervention. Growth drivers in these markets during fiscal 2003
included new medical device features and applications, a growing senior
population and new clinical studies which support the use of device technologies
as an alternative to traditional drug therapies. All of these factors
contributed to increased demand for the devices our interventional customers
provide to these markets, and accordingly increased demand for products
manufactured by the interventional business.

Our interventional business added machining, molding and tool making
capabilities through an acquisition in March 2002 and subsequently added micro
machining capabilities through continued investments made in fiscal 2003. These
capabilities expanded the scope of offerings to interventional customers,
resulting in net revenue of $2,252 in fiscal 2003 and $1,123 from March to
October of fiscal 2002, in all cases excluding product manufactured for internal
use. In March 2003, operations commenced at Synovis Caribe, Inc., a leased
22,700 square foot manufacturing facility in Dorado, Puerto Rico. The new
facility is designed to increase the manufacturing capacity of our
interventional business and strategically position us to capture new business.

Net revenue for our surgical business increased 31% to $25,623 in fiscal
2003 from $19,546 in fiscal 2002. Revenue increases occurred across all
significant surgical product groups during fiscal 2003. Peri-Strips(R) revenue
increased $4,485 or 62% to $11,722 in fiscal 2003, and accounted for 74% of the
segment's revenue growth.

Revenue from our other surgical business product lines was $13,901 in
fiscal 2003, an increase of 13% from $12,309 in fiscal 2002. Our microsurgery
product line increased 26%, with net revenue of $1,335 in fiscal 2003 compared
to $1,062 in fiscal 2002.

Our consolidated gross margin decreased four percentage points from 48% in
fiscal 2002 to 44% during fiscal 2003. Gross margins in our interventional
business decreased five percentage points to 28% in fiscal 2003 from 33% in
fiscal 2002. In fiscal 2002, our interventional business received milestone
payments of $415, with no associated cost, for work performed under a
development agreement. This revenue contributed two margin percentage points in
fiscal 2002. There was no revenue from such contractual milestone payments in
fiscal 2003. Product mix and the costs of a growing workforce also contributed
to the decrease in the interventional business gross margin in fiscal 2003. In
our surgical business, the gross margin for fiscal 2003 increased two percentage
points to 65%, primarily due to sales mix, production volume and related
manufacturing efficiencies.

SG&A expense during fiscal 2003 increased 17% to $14,276 from $12,182 in
fiscal 2002. As a percentage of net revenue, however, SG&A expense decreased by
five percentage points, from 30% in fiscal 2002 to 25% in fiscal 2003. The
percentage decrease is the result of controlled SG&A spending increases in a
period of incrementally higher levels of revenue.

R&D expense during fiscal 2003 was $3,806, an increase of 68%, from $2,272
in 2002. As a percentage of net revenue, R&D expense increased from 5.7% in
fiscal 2002 to 6.6% in fiscal 2003. This planned increase was partially due to
the development expenses of various interventional projects including
proprietary devices for sale to interventional customers, along with the
increased number, timing and nature of various surgical R&D projects.

Operating income for fiscal 2003 was $7,348, a 61% increase, from $4,550
during fiscal 2002. Surgical business operating income increased 96% to $4,681
in fiscal 2003 from $2,387 in fiscal 2002. The increase in our surgical business
was primarily due to relatively greater increases in volume of products sold,
gross

28

margin gains, and reduction in organizational operating expense as a percentage
of revenue. Interventional business operating income increased 23% to $2,667 in
fiscal 2003 from $2,163 in fiscal 2002.

The provision for income taxes was $2,416 in fiscal 2003, at an effective
tax rate of 33%, as compared to $1,544, at an effective tax rate of 34% in
fiscal 2002. The decrease in the effective tax rate in fiscal 2003 is primarily
due to higher R&D credits reflecting greater levels of R&D expenditures.

LIQUIDITY AND CAPITAL RESOURCES (IN THOUSANDS)

The following table summarizes our contractual obligations, capital leases
and operating leases. For more information, see Note 6 to our consolidated
financial statements. Our commitments under these obligations are as follows for
the year ended October 31:

Cash and cash equivalents were $15,369 at October 31, 2004 as compared to
$44,102 at October 31, 2003, a decrease of $28,733. The decrease in cash is
primarily related to our net purchases of $26,931 of short-term investments
during fiscal 2004. These investments represent highly liquid, low-risk
commercial paper with maturities greater than three months. Additional cash was
used primarily for investments in capital equipment and facilities necessary to
support our expected future growth.

Operating activities provided cash of $2,740 in fiscal 2004, as compared to
$2,777 in fiscal 2003. Cash was provided by operations during fiscal 2004
through the combination of net income of $1,278 and non-cash expenses of $4,165,
partially offset by a net increase in working capital. Working capital was used
primarily for accounts receivable ($1,212) and inventories ($742), partially
offset by cash provided by accounts payable ($1,500). Depreciation increased
$497 in fiscal 2004 due mainly to the facility expansion at our St. Paul
location. Inventory increased $742 due primarily to increased production and
overhead rates within our surgical business. Our consolidated days sales
outstanding in accounts receivable at October 31, 2004 was at 52 days, up from
42 days the previous year, and is largely attributable to one customer within
our interventional business, who subsequently brought their account current in
the first quarter of fiscal 2005.

Investing activities used $32,890 of cash during fiscal 2004 compared to
$4,411 in fiscal 2003, an increase of $28,479. The increase is primarily due to
the net purchases of $26,931 in short-term investments. Capital expenditures
were $5,712 in fiscal 2004, an increase of $1,373 from fiscal 2003, and largely
reflect expenditures for building improvements and expansion, new enterprise
resource planning software systems within certain businesses, as well as
equipment acquisitions tied to expanding the capacity and capabilities of the
interventional business. During fiscal 2005, we currently expect to invest up to
$5,000 in capital assets for various manufacturing and other projects.

Financing activities provided $1,417 of cash during fiscal 2004, compared
to $37,870 in 2003. In fiscal 2003, we completed a private placement, which
provided net proceeds of $36,486. Proceeds from our stock based compensation
plans totaled $1,703 in fiscal 2004, a slight decrease of $39 from fiscal 2003,
while payments of capital lease and other long-term obligations decreased $72 to
$286 in fiscal 2004.

We have historically funded the operations and investments in our
businesses utilizing internally generated cash flow and existing cash balances.
We believe existing cash, cash equivalents and short-term

29

investments, coupled with anticipated cash flow from operations will be
sufficient to satisfy our operating cash requirements for the next 12 months.
These forward-looking statements, as well as our long-term cash requirements,
will be a function of a number of variables, including research and development
priorities, acquisition opportunities and the growth and profitability of the
business.

We may enter into derivative instruments or perform hedging activities.
However, our policy is to only enter into contracts that can be designated as
normal purchases or sales.

INFLATION

We believe inflation has not had a material effect on our operations or
financial condition.

FOREIGN CURRENCY TRANSACTIONS

Substantially all of our foreign transactions are negotiated, invoiced and
paid in U.S. dollars. Fluctuations in currency exchange rates in other countries
may therefore influence the demand for our products by changing the price of our
products as denominated in the currency of the countries in which the products
are sold.

NEW ACCOUNTING STANDARDS

In November 2004, the FASB issued SFAS No. 151, Inventory Costs. This
statement amends Chapter 4 of ARB No. 43 to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs and wasted material
(spoilage), as well as requiring that allocation of fixed production overheads
to the costs of conversion be based on the normal capacity of the production
facilities. The provisions of this statement are effective for inventory costs
incurred during fiscal years beginning after June 15, 2005 and the Company is
currently assessing the impact of SFAS No. 151 on its operating results and
financial condition.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The principal financial instruments we maintain are in cash and cash
equivalents, short-term investments and accounts receivable. We believe that the
interest rate, credit and market risk related to these accounts is not
significant. We manage the risk associated with these accounts through periodic
reviews of the carrying value for non-collectibility of assets and establishment
of appropriate allowances in connection with our internal controls and policies.
We do not utilize any derivative financial instruments, derivative commodity
instruments, or other financial instruments or engage in any other hedging
activities, except where such instruments can be designated as a normal purchase
or sale.

CRITICAL ACCOUNTING POLICES

Goodwill: We account for goodwill under SFAS No. 142, Goodwill and Other
Intangible Assets. Accordingly, goodwill is not amortized, but is reviewed
annually as of October 31 for impairment. See Note 2 to the consolidated
financial statements included in this report on Form 10-K for additional
goodwill information.

Other Intangible Assets: Our other intangible assets, primarily developed
technology, patents, trademarks, and non-compete agreements pertaining to
business acquisitions, are recorded at cost and are amortized using the
straight-line method over their estimated useful lives, generally seven to 17
years. These assets are reviewed for impairment whenever events or changes in
circumstances indicate that the

30

carrying amount of the asset in question may not be recoverable. See Note 2 to
the consolidated financial statements included in this report on Form 10-K for
additional intangible asset information.

Revenue Recognition: Our policy is to ship products to customers on FOB
shipping point terms. We recognize revenue when the product has been shipped to
the customer if there is evidence that the customer has agreed to purchase the
products, delivery and performance have occurred, the price and terms of sale
are fixed and collection of the receivable is expected. All amounts billed to
customers in a sales transaction related to shipping and handling are classified
as net revenue. Our sales policy does not allow sales returns.

Inventories: Inventories, which are comprised of component parts,
subassemblies and finished goods, are valued at the lower of first-in, first-out
("FIFO") cost or market. Overhead costs are applied to sub-assemblies and
finished goods based on annual estimates of production volumes and such costs.
These estimates are reviewed and assessed for reasonableness on a quarterly
basis and adjusted if so needed. The estimated value of excess, slow-moving and
obsolete inventory as well as inventory with a carrying value in excess of its
net realizable value is established by us on a quarterly basis through review of
inventory on hand and assessment of future product demand, anticipated release
of new products into the market, historical experience and product expiration.

Derivative Instruments and Hedging Activities: We may enter into
derivative instruments or perform hedging activities. However, our policy is to
only enter into contracts that can be designated as normal purchases or sales.

31

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Synovis Life Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Synovis
Life Technologies, Inc. and Subsidiaries (the "Company") as of October 31, 2004
and 2003, and the related consolidated statements of income, changes in
shareholders' equity, and cash flows for each of the three years in the period
ended October 31, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 consolidated 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, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of October 31,
2004 and 2003, and the results of its operations and cash flows for each of the
three years in the period ended October 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
December 20, 2004

32

ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

SYNOVIS LIFE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF INCOME