KENSEY NASH CORP - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

For the Fiscal Year Ended: June 30, 2002

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: 0-27120

KENSEY NASH CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 36-3316412
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)

MARSH CREEK CORPORATE CENTER, 55 EAST UWCHLAN AVENUE,
EXTON, PENNSYLVANIA 19341
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (610) 524-0188
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
(TITLE OF CLASS)

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

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

The aggregate market value of the voting stock held by non-affiliates of
the registrant as of September 20, 2002 was $165,032,532, based on the closing
price per share of common stock of $15.35 as of such date reported by the Nasdaq
National Market.

The number of shares outstanding of the registrant's Common Stock, par
value $.001 per share, as of September 20, 2002 was 10,751,305.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated by reference into this
report:
Definitive Proxy Statement in connection with the 2002 Annual Meeting of
Stockholders
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PART I

ITEM 1. BUSINESS

This discussion below contains forward-looking statements relating to future
events or our future financial performance. These statements are only
predictions and actual events or results may differ materially. In evaluating
such statements, you should carefully consider the various factors identified in
this report which could cause actual results to differ materially from those
indicated in any forward-looking statements, including those set forth in "Risk
Factors" in this Annual Report on Form 10-K. See "Forward-Looking Statements".

OVERVIEW

Kensey Nash is a leader in cardiovascular medical technology and has significant
experience and expertise in the design, development, manufacture and processing
of absorbable biomaterials for medical applications. The Angio-Seal(TM) Vascular
Closure Device (Angio-Seal), of which we were the original designer, developer
and manufacturer, is currently the leader in the arterial puncture closure
device market, a potential $600 million to $1 billion market. The Angio-Seal is
designed to seal and close femoral artery punctures made during diagnostic and
therapeutic cardiovascular catheterizations. We licensed the Angio-Seal to St.
Jude Medical, Inc. who manufactures, markets and distributes the product
worldwide. Additionally, we developed the TriActiv(TM) Balloon Protected Flush
Extraction System (the TriActiv), a device designed to provide distal protection
during saphenous vein graft treatment. This market opportunity is currently
estimated at $300 to $500 million. The TriActiv was commercially launched in
Europe in May 2002 and is in clinical trials in the United States. In addition,
we have significant experience in designing, developing, manufacturing and
processing proprietary biomaterials products for the orthopaedics, cardiology,
drug/biologics delivery, periodontal, general surgery and wound care markets. We
intend to continue to leverage our proprietary knowledge and expertise in all of
these markets to develop new products and technologies and to explore additional
applications for our existing products.

THE TRIACTIV(TM) BALLOON PROTECTED FLUSH EXTRACTION SYSTEM

DISTAL PROTECTION -- MARKET OVERVIEW

There are approximately 600,000 coronary bypass surgeries performed annually
worldwide and approximately half of all these bypass grafts become diseased or
occluded within ten years of surgery. The market for the treatment of these
occluded grafts is currently estimated at $300 to $500 million. During many
coronary bypass procedures, the saphenous vein is removed from the patient's leg
and is surgically implanted to bypass a diseased or occluded native coronary
artery. The saphenous vein graft (SVG) is used as a replacement for the diseased
or occluded native coronary artery to restore blood flow. Current treatment
options for diseased SVGs include drug therapy, device-based therapies
(including angioplasty and the placement of stents) or repeat bypass surgery.
There are significant risks involved with these treatments ranging from
continued progression of disease, heart attack and possible death. Specifically,
during the treatment of diseased SVGs via device-based therapy, the rate of
major complication (known as the MACE rate, or major adverse coronary event
rate) is approximately 15 to 20%. These complications occur primarily because
the material clogging the SVG is dislodged during the treatment and released
into the vasculature causing clots or heart attack. Distal protection is a
method of preventing this debris from going downstream during device based
therapy procedures. Current devices in the distal protection market include
filter and balloon based therapies. These protection devices have been
clinically proven to reduce the MACE rates associated with device based
therapies.

THE TRIACTIV

We have designed the TriActiv, a balloon based therapy, to provide distal
protection during SVG treatment procedures. In addition to the balloon
protection, the TriActiv utilizes active flushing and extraction to remove
debris from the vessel after a treatment procedure. Clinical data from our pilot
study demonstrated that the

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use of the TriActiv reduces the MACE rate to 6.9% for patients treated within
the clinical protocol. Documented studies have shown that MACE rates in
non-protected SVG procedures are approximately 15 to 20%.

We believe the TriActiv is currently the only device, in clinical trials or
commercially available, which offers all three of the following features:

- a distal protection balloon placed beyond the occlusion to prevent debris
from flowing downstream and potentially causing a heart attack;

- a flush catheter advanced over a guidewire that delivers fluid to the
vessel; and

- an active, controlled extraction system which removes the debris.

To operate the TriActiv, a guiding catheter is positioned at the entrance to the
graft. The guidewire, containing the distal protection balloon, is advanced
through the SVG beyond the occlusion. The distal protection balloon is inflated
and a stent is placed in the vessel at the occlusion. Following stent placement,
saline and contrast media are delivered into the graft from the flush catheter
to dislodge the occlusive material. The particles and debris that are dislodged
by the flush system are extracted through the lumen of the guiding catheter.

We received CE Mark approval for the TriActiv in January 2002. The CE Mark is an
international symbol of adherence to quality assurance standards established by
the European Union and compliance with applicable European medical device
directives. The commercial launch of the device occurred at the Paris Course on
Revascularization (PCR) in May 2002 and we shipped our first product in June
2002. We plan to sell the device through our direct sales force in Germany and
through a network of distributors throughout the European Union.

In December 2001, we initiated the PRotection during Saphenous Vein Graft
Intervention to Prevent Distal Embolization (PRIDE) Trial in the U.S. The PRIDE
Trial is a randomized, controlled study of up to 800 patients at 50
investigational sites in the U.S. and in Europe. We expect to complete
enrollment in the PRIDE Trial by mid 2003 and will then submit to the FDA for
510(k) approval of the device, the approval which allows the commercial sale of
the device in the U.S.

We are in the process of modifying the design of the TriActiv to address
additional applications where distal embolization is a concern. These
applications include the treatment of native coronary, carotid and peripheral
arteries. We intend to begin a pilot study in carotid arteries with a modified
version of the existing device during 2003.

THE ANGIO-SEAL(TM) DEVICE

ARTERIAL PUNCTURE CLOSURE -- MARKET OVERVIEW

Arterial puncture closure is the closing and sealing of femoral artery punctures
made during cardiovascular catheterizations. Current treatment options include
manual pressure, the current standard of care, and device based therapy. Device
based treatment options consist of either suture or biomaterial-based devices.
Leading cardiology industry journals currently estimate that there are
approximately 6.5 million cardiovascular catheterization procedures performed
annually, which translates to a potential worldwide arterial puncture closure
market of approximately $600 million to $1 billion. The U.S. market accounts for
approximately 75% of this total market. Industry estimates of current market
penetration for arterial puncture closure devices are approximately 25% and 27%,
for the U.S. and the international markets, respectively.

THE ANGIO-SEAL

With the launch of the latest generation of the Angio-Seal product line, the
Self Tightening Suture (STS) platform, in March 2002 the Angio-Seal has become
the leading product in the worldwide arterial puncture closure market. The
Angio-Seal has been sold in Europe since 1995 and in the U.S. since 1996. There
have been 2.1 million Angio-Seal devices sold as of June 30, 2002. Industry
estimates show the Angio-

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Seal worldwide market share at June 30, 2002 was approximately 48% compared to
approximately 35% at June 30, 2001.

The Angio-Seal puncture closure device is a biomaterial-based device which acts
to close and seal femoral artery punctures made during diagnostic and
therapeutic cardiovascular catheterizations. The device consists of four
components:

- an absorbable polymer anchor seated securely against the inside surface
of a patient's artery at the point of puncture;

- an absorbable collagen plug applied adjacent to the outside of the artery
wall;

- an absorbable suture; and

- a delivery system consisting of an insertion sheath, puncture locator,
guidewire and tamper tube.

The anchor and suture act as a pulley to position the collagen into the puncture
tract adjacent to the outside of the artery wall, to seal and close the
puncture. A tamper tube is used to further position and secure the closure
device. The anchor, collagen and suture are all designed to be absorbed into the
patient's body within 60 to 90 days after the procedure. We believe that this
mechanical (anchor and collagen) and biochemical (collagen) approach offers
physicians a method for sealing and closing punctures with significant
advantages over traditional manual or mechanical compression methods, as well as
over other competitive products. The Angio-Seal has been proven to have several
advantages over traditional manual or mechanical compression procedures,
including: reduced time to ambulation, reduced staffing and hospital time,
possible reduction in procedure costs, increased patient comfort, greater
flexibility in post-procedure blood thinning therapy and increased blood flow to
the leg.

The Angio-Seal is manufactured, marketed, sold and distributed by St. Jude
Medical, Inc. (St. Jude Medical). We receive a royalty on every unit sold. In
addition, we manufacture components for the Angio-Seal and have historically
augmented St. Jude Medical's manufacturing of completed devices. We believe the
impact of continued sales and marketing efforts by St. Jude Medical, along with
product enhancements planned by St. Jude Medical, will provide continued growth
opportunities for the Angio-Seal.

BIOMATERIALS

BIOMATERIALS -- MARKET OVERVIEW

Biomaterials, which are substances that treat, augment, or replace tissue,
organs or body functions, are used regularly as components and elements in a
wide variety of absorbable and permanent implants. Advances in materials
technology and a better understanding of the biological processes involved in
tissue formation and remodeling have led to the introduction of absorbable
biomaterials-based products to address long-standing deficiencies of traditional
products and therapies. This trend has been observed in many markets, including
orthopaedics, cardiology, drug/biologics delivery, wound care, surgery,
periodontics and urology. Generally, absorbable biomaterials-based products have
proven attractive solutions for a number of reasons. First, physicians generally
prefer to use an implant which will not require a second surgery to remove the
device. Also, the rate of absorption of products can be carefully engineered to
promote healing as the biomaterials-based products work with the body's natural
healing response. Finally, absorbable biomaterials offer tremendous potential
for drug delivery. The ability to provide staged and sustained release of drugs
and biologics offers significant potential for growth in the use of absorbable
biomaterials-based products.

OUR BIOMATERIALS TECHNOLOGY AND PRODUCTS

The technological challenges involved in developing biomaterials products are
substantial. Developing products made from absorbable biomaterials requires an
understanding of the mechanical integrity, biocompatibility, and absorption
rates, as well as the ability to sterilize these products without jeopardizing
their material properties. Our expertise in biomaterials enables us to design,
develop and manufacture proprietary biomaterials products. These products are
characterized by their ability to be absorbed or incorporated in the body's own
tissue. Our particular expertise is in the properties, usage and processing of
polymers, collagen,
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ceramics and other absorbable materials. We believe that our diverse platforms
in, and significant experience with, biomaterials technology give us a
competitive advantage because many participants in the market specialize in only
one biomaterial or have far less experience in biomaterials. Our extensive
background with multiple materials enables us to provide essential biomaterials
building blocks across multiple biomaterials platforms to address specific
product needs in a wide variety of markets.

- Polymers. We are a leader in the design, development and manufacture of
absorbable polymer products. We use many different types of polymers, in
combination or as single entities, to achieve the desired properties in a
particular product. We have developed several unique polymer-based
materials, products and processes, which have a variety of applications
in implantable absorbable medical devices. We offer our customers and
partners a complete solution, including product design and engineering,
tool design, process development, commercial manufacture and packaging
configuration.

Our polymer technology platform includes a porous tissue matrix (PTM)
technology which allows us to create porous implants which support cell
growth, tissue regeneration and the delivery of biologics, growth factors
and drugs. The implants are designed to facilitate wound healing in both
bone and soft tissue and are bioabsorbable at controlled rates for specific
functions and tissues. We have a series of products, development programs
and intellectual property related to porous biodegradable regeneration
matrices. Specifically, we are researching applications for articular
cartilage regeneration, vascular grafts and bone growth scaffolds for
spinal, trauma and for the delivery of drugs and growth factors.

- Collagen and Other Naturally-Occurring Materials. We design, develop and
manufacture products using naturally-occurring materials such as
collagen, elastin, hyaluronic acid and alginate, which have applications
in a wide variety of absorbable medical devices. We have significant
expertise in processing collagen into diverse product formulations,
including powders, gels, pastes, sponges and structural matrices. We
combine collagen and other naturally-occurring materials using our
proprietary processes, thereby creating new materials with unique
characteristics and diverse product applications.

We have completed extensive biocompatibility and viral inactivation studies
on our collagen products. We have established, and currently maintain,
device master files which contain the data from these studies. Unlike many
of our competitors, we allow customers who incorporate our collagen
products into their products to reference our device master files in their
regulatory submissions, thereby eliminating the extensive and time
consuming process of independently generating their own data. We believe
our policy of making our device master files available to our customers
provides us with a significant competitive advantage.

- Ceramics Products. We have experience using ceramic materials, primarily
with calcium phosphate salts such as hydroxyapatite. These materials can
be designed to replicate bone structure and support new bone growth or as
osteoconductive implants. Ceramics are also useful for enhancing the
material properties of products, such as strength, when used in
combination with other biomaterials. We have expertise in the compounding
of ceramic materials with various absorbable polymers to enhance strength
characteristics primarily for orthopaedic applications. We are currently
working with select orthopaedic customers to incorporate this enhanced
material into their existing products or to develop new products. In
addition, we are independently developing blended materials, using
ceramics in combination with other biomaterials, for applications in
filling of bone defects and fracture repair.

We either manufacture biomaterials products for our customers who incorporate
them into their products or manufacture a complete product incorporating our
biomaterials and provide the finished product to our customers for distribution.
We provide our customers with a variety of proprietary products ranging from
components to final packaged products which are then marketed and sold to end
users. We also independently design and develop biomaterials products that may
enhance the features and benefits of our customers' products. We continue to
independently develop new proprietary products and explore new commercial
relationships with customers to maximize our return on our increased investment
in these products. As we continue to increase our investment in the development
of new biomaterials and products, we believe we will be able to increase our
margins on commercialized products using our biomaterials technology. We sell
many of our biomaterials products to leading companies in each of the markets
listed below. The structure of our
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relationships with our customers varies and includes development partnerships
and manufacturing contracts. The following table describes our biomaterials
products, the markets they address and their current status.

BIOMATERIALS MARKETS BIOMATERIALS PRODUCTS PRODUCT STATUS

Orthopedics:
Sports Medicine Meniscal Repair Tacks Commercial
Anterior Cruciate Ligament Repair Screws Commercial; additional products in
development
Rotator Cuff Repair Screws Commercial
Rotator Cuff Repair Patch Commercial
Spinal Fixation Absorbable Growth Factor Delivery Commercial, international only; clinical
Matrices
Trauma Fixation Bone Void Filler Regulatory review, U.S. only
Joint Replacement ImproVise(TM) Cement Restrictor Commercial
Cartilage Repair Cartilage Regeneration Development
Cardiology:
Arterial Puncture Closure Absorbable Polymer Anchors and Collagen Commercial
Plugs for Angio-Seal(TM)
Vascular Grafts Vascular Graft Coatings Commercial, international only
Vascular Graft Development
Wound Care:
Burn Treatments and Skin Collagen Tissue Engineering Substrates Commercial; regulatory approval
Defects used for Culturing Skin Cells
Wound Dressings Collagen incorporated into Topical Wound Commercial
Dressings
Periodontal:
Periodontal Drilac Commercial
Periodontal Epi-Guide Commercial
General Surgery:
Cosmetic Surgery Cosmetic Surgery Repair Device Product in development and regulatory
review
General Surgery Collagen incorporated in Surgical Repair Commercial
Applications

Product status definitions:
Commercial -- Product approved by the appropriate regulatory agency and/or
available for sale or actively pursuing distribution channel.
Regulatory review -- Regulatory submissions have been made; awaiting response.
Clinical -- Product approved by the appropriate regulatory agency for human
clinical studies.
Development -- Product in-process which has demonstrated feasibility but has not
been approved for clinical trials or sale.

We have products that are commercially available for sale in the U.S. and
international markets, and products that are in various stages of development,
clinical trials or regulatory review. Additionally, we have biomaterials
research programs which we believe will provide us with opportunities to expand
our product offerings and strategic alliances. The following are descriptions of
the markets into which our biomaterials products are being placed, as well as
the applications for which our products and technology are currently being used
or have future potential use.

Orthopaedic Products. The orthopaedic portion of our biomaterials business
represented 47% of total biomaterials sales for fiscal 2002. Applications in the
orthopaedic market for our biomaterials products include sports medicine, as
well as spinal and trauma fixation. Orthopaedic applications of biomaterials
include repair, regeneration or augmentation of musculoskeletal tissues,
including bone, cartilage, ligaments, spinal discs and tendons. Companies in
this market often look to third parties to develop and manufacture their product
concepts into marketable products. Our capabilities and expertise have enabled
us to develop relationships with several major orthopaedic companies, to whom we
provide our biomaterials products or compounded materials.

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Many of our biomaterials products manufactured from absorbable materials are
designed to replace metallic devices used in the fixation and repair of
musculoskeletal tissues. Use of absorbable biomaterials eliminates the need for
a second surgery which is frequently necessary to remove non-absorbable metallic
implants like bone rods and pins. This benefit provides our customers with a
cost-effective alternative to traditional non-absorbable based products.

Sports Medicine. The primary application for our biomaterials in the sports
medicine segment is soft tissue fixation. Soft tissue fixation includes the
repair of tendons and ligaments in the knee, such as the anterior cruciate
ligament, and in the shoulder, such as the rotator cuff.

Trauma Fixation. Trauma fixation devices are used to repair broken bones
using nails, screws, plates, pins and bone growth stimulation techniques.

Cartilage Regeneration. The healing and growth properties of absorbable
biomaterials make them ideal for use as the foundation for cartilage
regeneration, as they are bioabsorbable at controlled rates for specific
tissues. We are researching the use of our PTM technology for articular
cartilage regeneration under a grant from the National Institute of
Standards and Technologies (NIST). We are now in the large animal study
phase of development, and results from initial small animal studies are
promising.

Cardiology Products. Our biomaterials are used in arterial puncture closure
products and coatings for synthetic vascular grafts. These cardiology products
represented 45% of total biomaterials sales in fiscal 2002. In addition, we are
developing an absorbable polymer matrix to deliver angiogenic growth factors to
promote the growth of new blood vessels for use in myocardial revascularization
procedures and are exploring the use of our biomaterials in an arterial stent.
Lastly, we are developing a vascular graft utilizing our PTM technology. This
research is being done under an NIST grant obtained in November 2001.

Drug/Biologics Delivery Products. Biomaterials are particularly useful for the
controlled release of drugs and other biologically active agents such as growth
factors. In these applications, the drug is deposited or incorporated into a
biomaterials delivery matrix. As the matrix dissolves or is degraded by the
body, the drug is gradually released. The use of a biomaterials matrix for drug
delivery permits a locally targeted, low-dose release profile, improving the
delivery of the drug. The PTM technology provides benefits that traditional
biomaterials do not offer, as the porosity of the material provides additional
release capabilities. Our biomaterials are used in several applications within
the drugs/biologics delivery field including the delivery of cancer treatment
drugs to targeted areas and as cell culturing matrices for artificial skin
growth for burn victims. These products accounted for 1% of our total
biomaterials sales in fiscal 2002.

Wound Care Products. While the wound care market is currently dominated by
conventional bandages and dressings and surgical staples or sutures, there is a
new generation of products resulting from recent advances in biomaterials,
tissue engineering and biotechnology. Our biomaterials are used in topical wound
dressing products, which accounted for less than 1% of our total biomaterials
sales for fiscal 2002.

Periodontal Products. Biomaterials are commonly used in the periodontal segment
of the dentistry market. We now have two commercialized products in the
periodontal field, Drilac(TM), a product which prevents dry socket following
tooth extraction, and Epi-Guide(TM), a barrier membrane used in periodontal
restorative procedures to prevent soft tissue cells from growing into space
reserved for bone. These two products accounted for 2% of our total biomaterials
sales in fiscal 2002.

General Surgery and Urology Products. Biomaterials are used in these market
segments in products ranging from cosmetic surgery devices to absorbable sutures
to tissue barriers and stents. The products we place through our customers are
in the surgical repair field and in cosmetic surgery and accounted for 2% of
total biomaterials sales in fiscal 2002.

We intend to utilize our experience and expertise in the design, development and
processing of the above materials to expand our market penetration in
biomaterials products and technology. Our strategy to accomplish this expansion
is as follows.

- Develop New Proprietary Biomaterials Products. We continue to leverage
our technology and expertise in polymers, collagen and other absorbable
materials to develop new proprietary biomaterials products.
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We are using this expertise to develop new biomaterials products, new
formulations and applications of existing materials and products. During
fiscal 2002 we received 510(k) approval from the FDA for our proprietary
product, ImproVise(TM), an absorbable cement flow restrictor for use in
certain orthopaedic surgical procedures. In addition, we are seeking
regulatory approval for another proprietary PTM technology-based product
with application in the orthopaedics market. We are in the final phases
of researching a cartilage regeneration product and have recently begun
researching a vascular graft application both of which utilize our PTM
technology.

- Expand Our Existing Biomaterials Business. We intend to aggressively
expand our existing biomaterials business by increasing sales to our
current customers and attracting new customers by providing proprietary,
technologically superior biomaterials products. We offer a complete range
of services including design, development, regulatory consulting,
manufacturing and package engineering. We intend to continue to invest in
new manufacturing technology and processes to meet our customers'
requirements, support product launches and increase the demand for our
biomaterials products. Additionally, we intend to expand our marketing
efforts to broaden our customer base in the orthopaedic, cardiology,
drug/biologics delivery, periodontal, general surgery and wound care
markets.

- Pursue Strategic Acquisitions and Alliances. We will continue to seek
strategic acquisitions and alliances which add complementary technologies
and expertise, broaden our intellectual property portfolio and strengthen
our competitive position in our biomaterials business. We believe that
our expertise in biomaterials allows us to identify and attract these
opportunities. In September 2001, we entered into an agreement with
Curasan AG for the European and Middle Eastern distribution of our
Epi-Guide(TM) periodontal barrier membrane product. In August 2002, we
entered into an agreement with OraPharma, Inc. for the distribution of
our Epi-Guide and Drilac(R) Surgical Dressing products in the United
States and Canada. We also entered into an agreement with Becton
Dickinson in February 2002 to market our three dimensional cell culture
scaffolds that enhance a researchers ability to study tissue engineering,
gene therapy and cell biology.

PATENTS AND PROPRIETARY RIGHTS

Our intellectual property covers technology in the fields of arterial puncture
closure, blood vessel location, arterial revascularization and distal protection
systems, drug/biologics delivery, wound care, periodontal, angiogenesis products
and surgical instruments. We protect our technology by, among other things,
filing patent applications for the patentable technologies that we consider
material to our business. Our first U.S. patent for arterial revascularization
was issued in 1986 and for the concept of sealing arterial punctures was issued
in 1988. As of September 20, 2002, we held 78 United States patents and 81
foreign national patents and had various United States patents and foreign
national patent applications pending.

We also rely heavily on trade secrets and unpatented proprietary know-how which
we seek to protect through non-disclosure agreements with corporations,
institutions and individuals exposed to our proprietary information. As a
condition of employment, we require that all full-time and part-time employees
enter into an invention assignment and non-disclosure agreement. Additionally,
non-compete agreements are being utilized for certain employees who are exposed
to our most sensitive trade secrets.

We have licensed our United States and foreign patents for the Angio-Seal to St.
Jude Medical and are required to license all improvements for the Angio-Seal to
St. Jude Medical. The license agreements with St. Jude Medical are exclusive and
worldwide, with rights to make, have made, use, sell, and have sold the
Angio-Seal, but are limited to the cardiovascular field of use only.

We intend to continue to aggressively protect new manufacturing processes,
biomaterials products and technologies and medical products and devices which we
have invented or developed. We intend to broaden the scope of our intellectual
property and consider our core technologies to be critical to our future product
development.

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MANUFACTURING

We have developed unique manufacturing and processing capabilities for
absorbable collagen and polymers. We manufacture numerous absorbable
biomaterials products for use in applications including orthopaedics,
cardiology, drug/biologics delivery, periodontal and wound care. We have also
established manufacturing processes and capabilities for the TriActiv, which we
currently manufacture for the European markets and for ongoing clinical trials.
We have our own capabilities in tool and die making, injection molding,
extrusion, compounding, machining, model making and laser welding, which allow
us to engineer and reengineer our products in development on site.

We currently manufacture two of the major absorbable components of the
Angio-Seal, the collagen plug and polymer anchor, for St. Jude Medical. Prior to
August 2000, we manufactured complete Angio-Seal devices for St. Jude Medical's
use worldwide in clinical trials and manufactured partially and fully completed
commercial devices for sale in the U.S. and Europe. For fiscal 2002, the plug
and the anchor represented a total of $7.2 million ($3.6 million for each
component), or 45% of our total sales revenue. St. Jude Medical has the right to
manufacture the absorbable polymer anchor and intends to manufacture that
component in the future. However, we anticipate we will continue to be a source
of anchor requirements during fiscal 2003. While we continue to supply St. Jude
Medical with the collagen requirements for the Angio-Seal, our formal collagen
supply agreement with St. Jude Medical expired in May 2000.

Our FDA-registered manufacturing facility in Exton, Pennsylvania contains
separate areas for the TriActiv and absorbable collagen and polymer
manufacturing. While our facility is currently adequate to handle ours as well
as our customers product volumes, significant expenditures would have to be made
in order to scale-up to mass manufacture the TriActiv device to supply the U.S.
market in addition to increased European demands. Our manufacturing facility is
equipped with multiple class 100,000 clean room facilities and is certified to
the two international quality standards, ISO 9001 and EN 46001. Certification is
based on adherence to established standards of quality assurance and
manufacturing process control. Our manufacturing facility is subject to
regulatory requirements and periodic inspection by regulatory authorities. We
have a separate in-house quality assurance department that sets standards,
monitors production, writes and reviews operating procedures and protocols and
performs final testing of sample devices and products manufactured by or for us.

We purchase most raw materials, parts and peripheral components used in our
products. Although many of these supplies are off-the-shelf items readily
available from several supply sources, others are custom-made to meet our
specifications. We maintain safety stock levels of these custom materials in
order to prevent any product downtime in the case of supply interruption. In
addition, we believe that, in most of these cases, alternative sources of supply
for custom-made materials are available or could be developed within a
reasonable period of time.

RESEARCH AND DEVELOPMENT

Our research and development and regulatory and clinical staff consisted of 72
individuals at September 20, 2002. Our research and development efforts are
focused on the continued development of the TriActiv and of our biomaterials
capabilities. We incurred total research and development expenses of $10.8, $7.3
and $5.3 million in fiscal 2002, 2001 and 2000, respectively. In December 2000,
we also had a $7.6 million in-process research and development (IPR&D) charge
related to our acquisition of THM in September 2000.

In addition to the resources dedicated to the product development process, we
have an internal regulatory affairs and clinical management staff responsible
for managing our clinical trials and obtaining regulatory approvals for the
TriActiv. Our staff also works closely with several of our customers to obtain
regulatory approvals for their products in the U.S., the European Union and
several other countries.

OUR RELATIONSHIP WITH ST. JUDE MEDICAL

The Angio-Seal is licensed to St. Jude Medical, which manufactures, markets and
sells the Angio-Seal worldwide. Under our license agreements, St. Jude Medical
has exclusive rights to manufacture, market and distribute all current and
future sizes of the patented Angio-Seal for hemostatic puncture closures for

9

cardiovascular use worldwide. We retain the rights to use this technology for
other applications. We earn a royalty on each Angio-Seal sold by St. Jude
Medical. The royalty rates are based on cumulative volume of Angio-Seal units
sold. Our royalty rate was 12% until October 2000, when it decreased to 9%,
based on Angio-Seal unit sales reaching a cumulative total of one million units
sold. The final decrease in royalty rate, to 6%, will occur when four million
cumulative units have been sold. We expect this decrease will occur sometime
during our fiscal 2005.

The term of the license agreements extends to the expiration date of the most
recently issued licensed patent, including all continuations or supplements. The
most recent patent for the Angio-Seal technology was issued in July 2000. St.
Jude Medical may terminate the license agreements at any time after the fifth
royalty year (ended September 30, 2001) for any reason upon twelve months
notice. At such time, we would receive all sales and marketing, manufacturing
and distribution rights to the Angio-Seal product line back. "Angio-Seal" is a
trademark of St. Jude Medical.

If a license under any third-party patent is necessary to make, use or sell the
Angio-Seal product licensed to St. Jude Medical, any payments and royalties for
such third-party license and any related attorney's fees, will be deducted from
payments due to us, on a territory-by-territory basis, in an amount not to
exceed in any one year one-half of any royalties in any such territory for that
year.

SALES AND MARKETING

In January 2002, we established Kensey Nash Europe GmbH in Eschborn, Germany for
the purpose of selling and marketing the TriActiv in Europe. The TriActiv was
commercially launched in Europe in the fourth quarter of fiscal 2002. We plan to
sell the system direct to the market in Germany and through distributors for the
rest of Europe. We have entered into distribution agreements for sales in the
United Kingdom, Ireland, Switzerland, and Austria as of June 30, 2002 and are in
the process of identifying distributors for the rest of Europe. We have also
begun to establish our international sales and clinical specialist team to
market and sell the TriActiv. At September 20, 2002 we had seven individuals on
the European sales and marketing team which includes sales people and clinical
specialists. In the U.S. we have developed a marketing and clinical specialist
team to increase market awareness, prepare for commercial launch and support the
PRIDE study for the TriActiv. At September 20, 2002, we had seven individuals on
the U.S. team including six clinical specialists.

As we develop and receive regulatory approval for new products, we will explore
a variety of means of commercializing these products. As a result, we may
contract with distributors, develop our own sales and marketing force and/or
license products to third parties. We have just begun the hiring and training
process for a sales and marketing force and we may not be able to maintain a
sales and marketing force with technical expertise and the necessary supporting
distribution capabilities.

We have entered into an agreement with OraPharma, Inc. for distribution of the
Drilac and Epi-Guide products in the U.S. and Canada. We have also entered into
an agreement with Curasan AG for European and middle eastern distribution of the
Epi-Guide.

COMPETITION

The markets for our current and proposed products are fragmented, intensely
competitive, subject to rapid change and sensitive to new product introductions
and enhancements. We expect that the competitive environment for our products
will become more intense as additional companies enter our markets and as new
techniques and technologies are adopted. Our biomaterials and medical devices
compete directly and indirectly for customers with a range of products and
technologies produced by a wide variety of companies, as well as other processes
and procedures which do not require the use of our products or those of our
competitors. Many of our existing competitors, as well as a number of potential
new competitors, have longer operating histories in these markets, greater name
recognition, larger customer bases and greater financial, technical and
marketing resources.

10

Generally, we believe that the principal competitive factors for our products
include:

- the ability to obtain regulatory approvals;

- safety and effectiveness;

- performance and quality;

- ease of use;

- marketing;

- distribution;

- pricing;

- cost effectiveness;

- customer service;

- the development or acquisition of proprietary products and processes;

- the ability to attract and retain skilled personnel;

- improvements to existing technologies;

- reimbursement; and

- compliance with regulations.

Our biomaterials products compete with the products of many of the larger
companies in the industry. In the vascular sealing device market, our products
compete with products sold by Datascope Corp., Perclose, Inc. (a subsidiary of
Abbott Laboratories) and Vascular Solutions, Inc. While we consider the
Angio-Seal and other sealing devices to be a superior method of vascular
sealing, the substantial majority of vascular sealing is still performed through
manual compression, which represents our primary competition. If we are
successful in commercializing the TriActiv, our competitors in that market will
include Boston Scientific Corporation, Johnson and Johnson, Inc., Medtronic,
Inc. (which owns Percu-Surge, Inc.) and Guidant Corporation, among others.

CUSTOMERS

In fiscal 2002, we had approximately 20 customers for our biomaterials products,
excluding our periodontal products which are sold directly to periodontists
around the country. However, two customers each accounted for more than 10% of
our total revenues for the fiscal year. Royalty income from, and sales of
biomaterials to, St. Jude Medical associated with the Angio-Seal represented
approximately 62% of total revenue while sales of biomaterials products to one
other customer, a distributor of orthopedic products, represented approximately
23% of total revenues. Our TriActiv device will be sold to hospitals throughout
Europe either through our direct sales force or through distributors.

GOVERNMENT REGULATION

Our medical devices are subject to extensive regulation by the U.S. Food and
Drug Administration, or FDA, and by foreign governments. The FDA regulates the
clinical testing, design, manufacture, labeling, distribution and promotion of
medical devices. Noncompliance with applicable requirements can result in, among
other things, fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production, failure of the government
to grant pre-market clearance or pre-market approval for devices, withdrawal of
marketing approvals and criminal prosecution. The FDA also has the authority to
recall or request repair, replacement or refund of the cost of any device we
manufacture or distribute.

International sales of medical devices are subject to the regulatory agency
product registration requirements of each country in which they are sold. The
regulatory review process varies from country to country. Many countries also
impose product standards, packaging requirements, labeling requirements, price
restraints and
11

import restrictions on devices. Delays in receipt of, or a failure to receive
approvals or clearances, or the loss of any previously received approvals or
clearances, could have a material adverse effect on our business, financial
condition and results of operations. In addition, reimbursement coverage must be
obtained in some countries.

Generally, our biomaterials products are incorporated by our customers into
another product which receives FDA and other government approvals. We maintain
device master files for some of our biomaterials products containing information
relating to the specifications, manufacturing, biochemical characterization,
biocompatibility and viral safety of our biomaterials products. These files, in
addition to our technical expertise, help our clients in their regulatory
approval process for products incorporating our biomaterials.

In January 2002, we received CE Mark approval from the European regulatory
authority for the TriActiv, which allows commercial sale of the product in the
European Union. Our TriActiv pilot study data was presented to the appointed
Data Safety Monitoring Board (DSMB) in November 2001. Approval from the DSMB
allowed us to begin our pivotal trial, the PRIDE study, which was initiated in
December 2001. We anticipate enrollment in the PRIDE study will be completed by
mid 2003 at which time we will submit to the FDA for 510(k) approval of the
device, the approval which allows the commercial sale of the device in the U.S.

The Angio-Seal product line has received both CE Mark and FDA approval. St. Jude
Medical is responsible for all future FDA premarket approval application
supplements for the Angio-Seal.

When human clinical trials of a device are required in connection with our new
proprietary products and the device presents a significant risk, we must file an
investigational device exemption (IDE) application with the FDA in order to
commence human clinical trials. The IDE application must be supported by data,
typically including the results of animal and laboratory testing. If the IDE
application is approved, human clinical trials may begin at a specific number of
investigational sites with a specific number of patients, as approved by the
FDA. The conduct of human clinical trials is also subject to regulation by the
FDA. Sponsors of clinical trials are permitted to sell those devices distributed
during the course of the trial provided such compensation does not exceed
recovery of the costs of manufacture, research, development and handling.
Similar approvals are required to conduct clinical trials in foreign countries.

Any products we manufacture or distribute pursuant to FDA clearance or approvals
are subject to pervasive and continuing regulation by the FDA, including record
keeping requirements and reporting of adverse experiences with the use of the
device. As a device manufacturer, we are required to register our manufacturing
facility with the FDA and list our devices with the FDA, and are subject to
periodic inspections by the FDA and certain state agencies. The Federal Food,
Drug, and Cosmetic Act requires devices to be manufactured in accordance with
Quality System regulations which impose certain procedural and documentation
requirements with respect to manufacturing and quality assurance activities.
Labeling and promotional activities are subject to scrutiny by the FDA and, in
certain instances, by the Federal Trade Commission. The FDA actively enforces
regulations prohibiting marketing of products for unapproved uses.

Manufacturers are also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, manufacturing practices,
environmental protection, fire hazard control and disposal of hazardous or
potentially hazardous substances. We may be required to incur significant costs
to comply with such laws and regulations in the future and any failure to comply
with such laws or regulations will have a material adverse effect upon our
ability to do business.

EMPLOYEES

As of September 20, 2002, we had 206 employees, including 97 employees in
operations, 72 employees in research and development and clinical and regulatory
affairs, 22 employees in finance and administration and 15 employees in sales
and marketing, including six in Europe. Two of our employees are currently
located in Duluth, Minnesota, five in Germany and one in the United Kingdom. All
of our remaining employees are located at our facility in Exton, Pennsylvania.
We believe that our success depends in large part on our ability to attract and
retain employees in all areas of our business.

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ITEM 2. PROPERTIES

We lease approximately 53,000 square feet of executive offices, manufacturing
and research and development facilities in Exton, Pennsylvania, a suburb of
Philadelphia. Our lease expires in fiscal 2006, subject to additional renewal
options. In addition, we currently lease approximately 1,400 square feet of
research and development facilities in Duluth, Minnesota on a monthly lease and
a 10,000 square foot warehouse in Exton, Pennsylvania for which our lease
expires in fiscal 2003. We also lease a small office space in Eschborn, Germany.

We do not believe our existing facility will support full-scale manufacturing of
the TriActiv device for both Europe and the U.S. We are investigating additional
space in our building in Exton, Pennsylvania in the event that we continue to be
the sole manufacturer of the device. We do not anticipate any significant
difficulty in leasing additional or alternate space or renewing our leases for
additional terms, at reasonable rates, in the event we need additional space or
upon the expiration, cancellation or termination of any of our existing leases.

ITEM 3. LEGAL PROCEEDINGS

We, along with St. Jude Medical, filed a patent infringement suit against
Perclose, Inc., a competitor in the puncture closure market. The original suit,
filed in 1998, along with a subsequent amendment filed in 1999, both filed in
Federal District Court for the Eastern District of Pennsylvania, claim that
Perclose infringes our U.S. patent numbers 5,676,689 and 5,861,004. These
patents cover systems and methods related to sealing percutaneous punctures. We
seek damages and an order to permanently enjoin Perclose from making, using or
selling products that infringe these patents. In November, 1999, Abbott
Laboratories acquired Perclose.

Perclose filed four counterclaims against our suit in answer to the complaint.
The first counterclaim seeks to declare our patents invalid and not infringed.
The additional counterclaims asserted by Perclose allege that our claims are
frivolous and assert various antitrust counter-claims, including price
discrimination, predatory pricing and attempted monopolization of the puncture
closure market.

The U.S. District Court, Eastern District of Pennsylvania, entered a Markman
hearing Order regarding claims interpretation, in favor of the defendant
Perclose. The judge denied our Motion for Reconsideration on August 21, 2001,
and the parties stipulated a Final Judgement, which was entered on October 19,
2001. On November 15, 2001, we filed a timely Notice of Appeal, thereby
initiating an appeal in the Court of Appeals for the Federal circuit. Briefs
have been filed by both sides and we now await oral argument which is
anticipated to take place in late 2002.

We are unable to predict the final outcome of this suit or whether the
resolution of this matter could materially affect our results of operations,
cash flows or financial position.

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

No matters were submitted to a vote of security holders in the fourth quarter of
fiscal 2002.

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PART II

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

Our common stock is listed on the Nasdaq National Market under the symbol "KNSY"
and has been traded publicly since our initial public offering in December 1995.
The following table sets forth the high and low closing sale prices per share of
our common stock as reported by the Nasdaq National Market for the periods
indicated.

On September 20, 2002, the last reported sale price of our common stock in the
Nasdaq National Market was $15.35 per share. As of September 20, 2002, there
were 61 record owners. Such record owners include several owners who are
nominees for an undetermined number of beneficial owners. There were also
approximately 3,289 beneficial owners of the shares of our common stock at that
date.

We have not declared or paid cash dividends and do not anticipate declaring or
paying any dividends on our common stock in the near future. Any future
determination as to the declaration and payment of dividends will be at the
discretion of our board of directors and will depend on the then existing
conditions, including our financial conditions, results of operations,
contractual restrictions, capital requirements, business prospects and other
relevant factors.

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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected consolidated statement of operations and
consolidated balance sheet data for the fiscal years ended June 30, 2002, 2001,
2000, 1999 and 1998. The selected financial data for each such fiscal year
listed below has been derived from the consolidated financial statements of the
Company for those years, which have been audited by Deloitte & Touche LLP,
independent certified public accountants, whose report for fiscal years 2002,
2001 and 2000 is included elsewhere herein. The following data for fiscal years
2002, 2001, and 2000 should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and with our
consolidated financial statements and the related notes and other financial
information included herein.

15

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

The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and our financial statements and the
related notes included in this report.

This discussion and analysis below contains forward-looking statements relating
to future events or our future financial performance. These statements are only
predictions and actual events or results may differ materially. In evaluating
such statements, you should carefully consider the various factors identified in
this report which could cause actual results to differ materially from those
expressed in, or implied by, any forward-looking statements, including those set
forth in "Risk Factors" in this Annual Report on Form 10-K. See "Forward-Looking
Statements."

OVERVIEW

REVENUES

Our revenues consist of three components: net sales, research and development
revenue and royalty income.

Net Sales. Net sales is comprised of sales of absorbable biomaterials products
and the TriActiv and has historically also included sales of Angio-Seal devices
manufactured by us.

Biomaterials. The biomaterials component of net sales represents the sale
of our biomaterials products to customers for use in the following markets:
orthopaedics, cardiology, drug/biologics delivery, periodontal, general
surgery and wound care. In 1997, our biomaterials sales were comprised
almost 100% of the absorbable collagen and polymer components of the
Angio-Seal supplied to our strategic alliance partner. Since that time, we
have experienced significant sales growth in our biomaterials products as
we have brought in new customers, increased sales to those customers over
the past five years, assisted in the development of new product offerings
and expanded our marketing activities. For fiscal 2002, the Angio-Seal
components represent only 42% of our total biomaterial sales. We believe
the growth in our overall biomaterials sales, which was 23% in fiscal 2002
over fiscal 2001, will continue because of greater acceptance by the
medical community of biomaterials and technological advances which have
expanded the applications for our biomaterials products.

TriActiv. The TriActiv was commercially launched in Europe in the fourth
quarter of fiscal 2002. While TriActiv sales were less than 1% of our total
sales for fiscal 2002, we anticipate the TriActiv will become a more
significant component of net sales in fiscal 2003 as the product will be on
the market in Europe for the entire fiscal year. We anticipate commercial
launch of TriActiv in the U.S. in the second half of fiscal 2004.

Angio-Seal. In fiscal 2001 and 2000, we manufactured and sold Angio-Seal
devices to St. Jude Medical to supplement their production requirements. In
August 2001, St. Jude Medical transitioned the manufacturing of these
devices to their facility. We do not expect any revenue from the
manufacture of completed Angio-Seals in the future. The manufacture of
Angio-Seal represented $5.5 million, or 42% of our total net sales for
fiscal 2000. While this was a significant portion of our total net sales
for fiscal 2000, because of the substantial growth of our biomaterials
business from fiscal 2000 to fiscal 2001, we were able to achieve an 11%
increase in net sales despite the loss of the Angio-Seal device
manufacturing business.

Research and Development Revenue. During fiscal 2000, research and development
revenue was derived solely from development work performed on the Angio-Seal. As
anticipated, these research and development activities fully transitioned to St.
Jude Medical during fiscal 2000. Angio-Seal research and development revenue is
not expected in the future. Fiscal 2001 research and development revenue was
derived entirely from a single National Institute of Standards & Technology
(NIST) grant, under which we are researching cartilage regeneration utilizing
our porous tissue matrix (PTM) technology. This project is expected to continue
through early fiscal 2003. In addition, in October 2001 we received a second
NIST grant, under

16

which we are researching a synthetic vascular graft also utilizing our PTM
technology. This project is expected to continue through early fiscal 2005.

Royalty Income. We receive a royalty on every Angio-Seal unit sold worldwide. We
anticipate sales of the Angio-Seal will continue to grow as St. Jude Medical
continues to expand its sales and marketing efforts and releases future
generations of the Angio-Seal. As a result, we expect that royalty income will
continue to be a significant source of revenue. During fiscal 2001 our royalty
rate decreased from 12% to 9%, in accordance with our licensing agreements. This
rate reduction occurred during the second quarter of fiscal 2001, when a
cumulative one million Angio-Seal units had been sold. There will be one further
decrease in the royalty rate, to 6%, upon reaching four million cumulative units
sold. We anticipate this next reduction will not occur until fiscal 2005.

Cost of Products Sold. We experienced an overall increase in gross margin during
fiscal 2002 reflecting the continued increase in volume of biomaterials product
sales. This increased volume from both our existing customers and new customers
has resulted in manufacturing efficiencies. The volume increase also results in
our fixed costs being spread over a greater number of units. We anticipate the
gross margin on our biomaterials products will continue to improve with
continued increased sales volume. This increase will be partially offset by
lower gross margin associated with initial sales of the TriActiv, as we expect
margins on the initial TriActiv sales to be minimal due to the start-up nature
of the manufacturing process. As a result of this product mix, for fiscal 2003,
we believe our total gross margin, across all product lines, will be only
slightly improved over fiscal 2002. As volumes increase and the manufacturing
process matures for the TriActiv, we expect the gross margin on TriActiv to
increase.

Research and Development Expense. Research and development expense consists of
expenses incurred for the development of absorbable biomaterials products and
technologies, our proprietary technologies such as the TriActiv and other
development programs including expenses under the NIST programs. While we no
longer perform research and development on the Angio-Seal, the clinical expenses
in pursuit of CE Mark and FDA approvals and continuing development costs of the
TriActiv as well as our continued development of proprietary biomaterials
products and technologies has more than offset the absence of Angio-Seal. We
anticipate research and development expense will continue to increase as we
pursue U.S. commercialization of the TriActiv as well as explore opportunities
for our other technologies.

Selling, General and Administrative. Selling, general and administrative
expenses include general and administrative costs as well as costs related to
the sales and marketing of our products. The costs of our patent litigation are
also included within selling, general and administrative expenses. The sales and
marketing component of selling, general and administrative expenses has
increased as we have commercialized the TriActiv in Europe and move toward
commercialization of the TriActiv in the U.S. In January 2002, we received CE
Mark approval from the European regulatory authority for the TriActiv, which
allows commercial sale of the product in the European Union. Effective January
2002, we established a subsidiary in Germany, Kensey Nash Europe GmbH, and hired
a Vice President of European sales. We have begun to establish a European sales
and marketing team and will continue to add personnel to this team as we will be
selling the TriActiv directly to the market in Germany. We will be using
distributors to market the product throughout the rest of Europe. We have
entered into distribution agreements for sales in the United Kingdom, Ireland,
Switzerland, and Austria as of June 30, 2002 and are in the process of
identifying distributors for the rest of Europe. We anticipate sales and
marketing expenses will continue to increase as we expand our European sales
team and prepare for U.S. commercial launch. We also continue to evaluate
opportunities for commercialization of the TriActiv in the United States and to
expand the marketing efforts for our biomaterials business.

CRITICAL ACCOUNTING POLICIES

Revenue Recognition. We recognize revenue under the provisions of Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements
(SAB 101). Accordingly, sales revenue is recognized when the related product is
shipped. Revenue under research and development contracts is recognized as the
related costs are incurred. Royalty revenue is recognized as the related product
is sold.

17

Advance payments received for products or services are recorded as deferred
revenue and are recognized when the product is shipped or services are
performed.

Stock-Based Compensation. We account for stock-based compensation costs under
SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), which permits
continued application of the intrinsic value method of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Under
the intrinsic value method, compensation cost represents the excess, if any, of
the quoted market price of the Company's common stock at the grant date over the
amount the grantee must pay for the stock. Our policy is to grant stock options
at the closing price of the stock on the date of grant. Therefore, we do not
have any compensation costs for options granted to employees. Options granted to
non-employees, as defined under SFAS 123, would be recorded as compensation
expense. The Company has not granted any options to non-employees during fiscal
2002.

Research and Development Expenses. Research and development charges, including
clinical trials expense, are expensed as incurred.

RESULTS OF OPERATIONS

COMPARISON OF FISCAL YEARS 2002 AND 2001

Total Revenue: Net Sales. Total revenues increased 25% to $29.0 million in the
year ended June 30, 2002 from $23.2 million in the year ended June 30, 2001. Net
sales of products increased 20% to $17.5 million for fiscal 2002 from $14.6
million for fiscal 2001. This increase was entirely attributable to increased
sales of biomaterials products.

Research and Development Revenue. Research and development revenues increased
132% to $765,000 for fiscal 2002 from $330,000 for fiscal 2001. Fiscal 2002
revenues were generated under the NIST articular cartilage and synthetic
vascular graft development grants. As the synthetic vascular graft grant was
received during fiscal 2002, research and development revenues for the same
period a year earlier were generated by work performed on the NIST articular
cartilage development grant only.

Royalty Income. Royalty income increased 31% to $10.8 million for fiscal 2002
from $8.2 million for fiscal 2001. This increase reflects a greater number of
units sold as well as an increase in average selling price for the Angio-Seal
offset by a decrease in the average royalty rate from approximately 9.8% in
fiscal 2001 to 9.0% in fiscal 2002. The decrease in the average rate came as a
result of a drop in the royalty rate from 12% to 9% in October 2000, as
discussed above. Royalty units increased 39% as approximately 670,000 Angio-Seal
units were sold to end-users during fiscal 2002 compared to approximately
483,000 units sold during fiscal 2001. We believe that this unit increase was
primarily due to St. Jude Medical's increased sales and marketing efforts, and
the launch of the new self-tightening suture (STS) version of the Angio-Seal,
which was introduced in the U.S. in March 2002.

Cost of Products Sold. Cost of products sold increased 11% to $8.2 million in
fiscal 2002 from $7.4 million in fiscal 2001 which gross margin increased to 53%
from 49%. The increase in gross margin reflected the higher margins on our
biomaterials products attributable in part to higher volumes which result in
manufacturing efficiencies, as well as continued allocation of overhead across
greater sales volumes, which results in a decrease in per unit costs. The cost
of the initial quantities of the TriActiv were an insignificant portion of cost
of products sold for fiscal 2002.

Research and Development Expense. Research and development expense increased 48%
to $10.8 million in fiscal 2002 compared to $7.3 million in fiscal 2001. This
increase was mainly attributable to our continued development efforts on the
TriActiv, including clinical trial expenses. Research and development expenses
related to the TriActiv increased $2.2 million, or 71%, to $5.3 million in
fiscal 2002 from $3.1 million in fiscal 2001. We also continued to expand our
development efforts on our biomaterials products including our work under the
NIST grants. Biomaterials and other proprietary technologies spending increased
$1.3 million, or 38% to $4.7 million in fiscal 2002 from $3.4 million in fiscal
2001.

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Selling, General and Administrative Expense. Selling, general and administrative
expense increased 56% to $4.7 million in fiscal 2002 from $3.0 million, in
fiscal 2001. This increase was primarily the result of increased sales and
marketing expenses which increased $1.1, million to $1.8 million in fiscal 2002
from $703,000 in fiscal 2001. This increase related primarily to European sales
and marketing efforts on the TriActiv. In addition, general and administrative
expenses increased $559,000, to $2.8 million in fiscal 2002 from $2.3 million in
fiscal 2001. This was attributable to $350,000 in increased personnel costs and
$209,000 in increased professional services and public company expenses,
including investor relations and filing fees. These increases were related to
our continued sales and research and development growth.

Net Interest Income. Interest expense decreased $16,000, or 7%, to $223,000 in
fiscal 2002 from $239,000 in fiscal 2001. This was due to a lower principal
balance on the THM acquisition obligation as a result of scheduled repayments.
Interest income was consistent at $1.9 million in fiscal 2002 and 2001. Although
our cash and investment balances increased, this was offset by lower interest
rates.

Other Non-Operating Income (Expense). Other non-operating expense was $15,000
for fiscal 2002 compared to other non-operating income of $24,000 for fiscal
2001. Other non-operating expense (income) for both periods represented
primarily the net gain or loss on the sale of fixed assets.

Net Income. Net income increased 27% to $4.6 million in fiscal 2002 from $3.6
million in fiscal 2001. This was primarily the result of increased sales and
royalty income as described above, offset in part by increased expenses
associated with research and development and sales and marketing efforts related
to the TriActiv, also described above. In addition, the Company recognized $2.4
million in income tax expense in fiscal 2002 compared to a $4.1 income tax
benefit in fiscal 2001. The prior year income tax benefit was recognized when
the valuation allowance related to certain deferred tax assets was reversed.
Based on our projections of taxable income, we believed it was likely we would
be able to utilize our federal net operating loss (NOL) carryforwards. As a
result, the valuation allowance related to these carryforwards was no longer
considered necessary. Lastly, in fiscal 2001 we recognized an IPR&D charge of
$7.6 million, described below.

COMPARISON OF FISCAL YEARS 2001 AND 2000

Revenues. Revenues increased 17% to $23.2 million in the year ended June 30,
2001, or fiscal 2001, from $19.8 million in the year ended June 30, 2000, or
fiscal 2000. Net sales of products increased 11% to $14.6 million from $13.1
million for fiscal 2001 and 2000, respectively. Of this increase, $6.6 million
was attributable to increased sales of biomaterials products. This increase was
offset by a $5.1 million decrease in 6F Angio-Seal device sales to St. Jude
Medical. We had been providing St. Jude Medical with Angio-Seal devices for the
international and U.S. markets, however, St. Jude Medical transitioned the
manufacturing of these devices to their facility in August 2000.

Research and Development Revenue. Research and development revenues increased
451% to $330,000 from $60,000 for fiscal 2001 and 2000, respectively. Current
year revenues were generated under the NIST articular cartilage development
grant acquired in conjunction with the THM acquisition. Research and development
revenues for the same period a year earlier were generated by work performed on
the Angio-Seal product for St. Jude Medical. As St. Jude Medical has
transitioned the Angio-Seal product research and development to their
facilities, we do not expect Angio-Seal product research and development
revenues in the future.

Royalty Income. Royalty income increased 25%, to $8.2 million from $6.6 million
in fiscal 2001 and 2000, respectively. This increase was achieved despite the
anticipated 25% reduction in the Angio-Seal royalty rate from 12% to 9% during
the second fiscal quarter of fiscal 2001 and reflects a greater number of units
sold as well as an increase in average selling price for the Angio-Seal. Royalty
units increased 36% as approximately 483,000 Angio-Seal units were sold to
end-users during fiscal 2001 compared to approximately 354,000 units sold during
fiscal 2000. This unit increase was due to St. Jude Medical's increased sales
and marketing efforts, continued strong sales of the 6F Angio-Seal and sales of
the new 8F Angio-Seal in the U.S. market. The new version of the 8F Angio-Seal
was introduced in the U.S. in September 2000.

Cost of Products Sold. Cost of products sold decreased 2% to $7.4 million in
fiscal 2001 from $7.6 million in fiscal 2000.In addition, gross margin increased
to 49% from 42%. This increase reflects the higher margins on

19

our biomaterials products as well as continued allocation of overhead across
greater sales volumes, which results in a decrease in per unit costs.

Research and Development Expense. Research and development expense increased 37%
to $7.3 million in fiscal 2001 compared to $5.3 million in fiscal 2000. This
increase was mainly attributable to our continued development efforts on the
TriActiv, including clinical trial expenses. We also continued to expand our
development efforts on our biomaterials products including our work under the
NIST articular cartilage development grant.

Selling, General and Administrative Expense. Selling, general and administrative
expense increased 13% to $3.0 million from $2.6 million, in fiscal 2001 and
fiscal 2000, respectively. This increase was primarily the result of increased
sales and marketing expenses which increased to $703,000 in fiscal 2001 from
$398,000 in fiscal 2000 related to marketing efforts on the TriActiv and our
biomaterials products. In addition, general and administrative expenses
increased $362,000, to $2.1 million in fiscal 2001 from $1.8 million in fiscal
2000. This was attributable to $100,000 of goodwill amortization expense related
to the THM acquisition as well as increased personnel costs to support our
current sales research and development growth. This was partially offset by a
$315,000 decrease in litigation expenses.

Net Interest Income. Interest expense decreased 44% to $239,000 in fiscal 2001
from $430,000 in fiscal 2000. This was due to the repayment of the financing
agreement in May 2000 with the proceeds of our secondary offering offset by the
addition of an obligation incurred in September 2000 in conjunction with the THM
acquisition. Interest income increased 100% to $1.9 million in fiscal 2001 from
$953,000 in fiscal 2000 as a result of an increase in average total cash and
investment balances primarily related to the investment of our secondary
offering proceeds.

Other Non-Operating Income (Expense). Other non-operating income was $24,000 for
fiscal 2001 compared to other non-operating expense of $1,000 for fiscal 2000.
Other non-operating income (expense) for both periods represented primarily the
net gain or loss on the sale of fixed assets.

Net Income. Net income decreased 24% to $3.6 million in fiscal 2001 from $4.7
million in fiscal 2000 as a result of the changes noted above, an IPR&D charge
of $7.6 million (described below) and a $4.1 million income tax benefit. The
income tax benefit was recognized when the valuation allowance related to
certain deferred tax assets was reversed. Based on our current projections of
taxable income, we believe it is likely we will be able to utilize our federal
net operating loss (NOL) carry forwards. As a result, the valuation allowance
related to these carry forwards was no longer considered necessary.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by our operating activities was $6.4 million and $5.4 million
during fiscal 2002 and 2001, respectively. In fiscal 2002, changes in asset and
liability balances resulted in a net $300,000 use of cash, offset by net income
of $4.6 million and non-cash depreciation and amortization of $2.1 million. In
fiscal 2001, changes in asset and liability balances resulted in a net $7.6
million use of cash, offset by net income of $3.6 million, non-cash depreciation
and amortization of $1.8 million and a non-cash write-off of in-process research
and development of $7.6 million.

In conjunction with our acquisition of THM in September of 2000, we incurred a
note payable to the shareholders of THM in the amount of $4.5 million (the
Acquisition Obligation). The Acquisition Obligation is due in equal quarterly
installments of $281,250 which began on December 31, 2000 and end on September
30, 2004. The cash outflow related to the Acquisition Obligation over the next
five years will be $1,125,000 in fiscal years 2003 and 2004 and $281,250 in
fiscal 2005, when the obligation will be fully repaid.

Our operating leases also represent a significant cash outflow. Lease expense
under non-cancelable operating leases over the next five years will be as
follows: $512,000 in fiscal 2002; $578,000 in fiscal 2003; $574,000 in fiscal
2004; $543,000 in fiscal 2005; and $231,000 in fiscal 2006.

Our cash, cash equivalents and short-term investments were $31.9 million at June
30, 2002. In addition, we had $2.1 million in restricted investment accounts. We
have pledged $2.1 million in investments as collateral

20

to secure bank loans made to employees to pay taxes incurred by these employees
when they received common stock at the time of our initial public offering. In
exchange for our pledging this collateral, the employees have pledged their
common stock to us as collateral.

We had a $4.2 million capital spending plan for fiscal 2002, which was expended
primarily on machinery, equipment and leasehold improvements. These expenditures
were related to the continued expansion of our manufacturing capabilities for
our biomaterials and new TriActiv product lines. We have a $5.1 million capital
spending plan for fiscal 2003 which will continue to be expended primarily on
the expansion of our manufacturing capabilities and space for all product lines.

We plan to continue to spend substantial amounts to fund clinical trials, to
gain regulatory approvals and to continue to expand research and development
activities, particularly for the TriActiv and our biomaterials products. We
believe our current cash and investment balances in addition to cash generated
from operations will be sufficient to meet our operating and capital
requirements through at least fiscal 2003. Our future capital requirements and
the adequacy of available funds will depend, however, on numerous factors,
including market acceptance of our existing and future products; the successful
commercialization of products in development; progress in our product
development efforts; the magnitude and scope of such efforts; progress with
pre-clinical studies, clinical trials and product clearance by the FDA and other
agencies; the cost and timing of our efforts to expand our manufacturing
capabilities; the cost of filing, prosecuting, defending and enforcing patent
claims and other intellectual property rights; competing technological and
market developments; and the development of strategic alliances for the
marketing of certain of our products. There can be no assurance that we will
record profits in future periods. See "Risk Factors."

The terms of any future equity financing may be dilutive to our stockholders and
the terms of any debt financing may contain restrictive covenants which limit
our ability to pursue certain courses of action. Our ability to obtain financing
is dependent on the status of our future business prospects as well as
conditions prevailing in the relevant capital markets. No assurance can be given
that any additional financing will be made available to us or will be available
on acceptable terms should such a need arise. Our estimate of the time periods
for which our cash and cash equivalents will be adequate to fund operations is a
forward looking statement within the meaning of Private Securities Litigation
Reform Act of 1995 and is subject to risks and uncertainties. Actual results may
differ materially from those contemplated in such forward-looking statements. In
addition to those described above, factors which may cause such a difference are
set forth under the caption "Risk Factors" in this annual report on Form 10-K.

ACQUISITION OF THM BIOMEDICAL, INC. AND IN-PROCESS RESEARCH AND DEVELOPMENT
CHARGE

On September 1, 2000, we acquired THM Biomedical, Inc. (THM), a developer of
porous, biodegradable, tissue-engineering devices for the repair and replacement
of musculoskeletal tissues, for approximately $10.5 million plus acquisition
costs of approximately $228,000. The transaction was financed with $6.6 million
in cash and a note payable to the shareholders of THM in the amount of $4.5
million (the Acquisition Obligation). The Acquisition Obligation is due in equal
quarterly installments of $281,250 which began on December 31, 2000 and end on
September 30, 2004. Accordingly, the present value of the cash payments
(discounted based upon our available borrowing rate of 7.5%) of $3.9 million was
recorded as a liability on the Company's financial statements, with a remaining
balance of $2.3 million at June 30, 2002.

In fiscal 2001, the $7.6 million IPR&D charge represented the estimated fair
value of purchased in-process technology which has not yet reached technological
feasibility and has no alternative future use and was comprised of the following
projects: Articular Cartilage ($5.4 million), Bone Fusion ($389,000), Other Bone
Applications ($261,000), and Drug Delivery ($1.5 million). Each of the four
projects utilizes the core open-cell poly lactic acid (OPLA) technology, a
porous tissue matrix (PTM) technology developed by THM. PTM technology
facilitates wound healing in both bone and soft tissue and is bioabsorbable at
controlled rates for specific functions and tissues. Each of the IPR&D projects
utilizes these properties of the PTM technology to address its respective
market. For example, the articular cartilage project uses the PTM technology as
the foundation for an articular cartilage repair and regrowth product. The total
IPR&D value was determined by estimating the stage of completion of each IPR&D
project at the date of the acquisition, estimating the costs

21

to develop each IPR&D project into commercially viable products, estimating the
resulting net cash flows from such projects, and discounting the net cash flows
back to their present values. The discount rate in each project takes into
account the uncertainty surrounding the successful development and
commercialization of the purchased in-process technology.

The stage of completion for all projects ranged from 48% to 72% as of the
acquisition date with the weighted average completion rate of approximately 56%.
As of that date, the estimated costs to bring the projects under development to
technological feasibility and through clinical trials were approximately $7.3
million.

Since the date of the acquisition, as planned, we have primarily devoted our
development efforts of PTM technology to the articular cartilage and other bone
applications and have expended approximately $880,000 on such efforts through
June 30, 2002. In addition, we received 510(k) approval for a proprietary PTM
based product, ImproVise(TM), an absorbable cement flow restrictor for use in
certain orthopaedic surgical procedures. In addition, we are seeking regulatory
approval for a second proprietary PTM based product with application in the
orthopaedics market.

The net cash flows from IPR&D projects were based on management's best estimates
of revenue, cost of sales, research and development costs, general and
administrative costs, and income taxes from such projects. These estimates were
determined considering our historical experience and industry trends and
averages. Sales of products incorporating these technologies are expected to
commence between fiscal 2003 and fiscal 2005, depending on the project, with
projected revenue growth rates in the 50% range in the immediate years following
worldwide market launch, declining to the 5% range as each market nears
maturity. These projections were based on our best estimates of market size and
growth, expected trends in technology and the nature and expected timing of new
product introductions by us and our competitors. The cash flows from revenues in
each period are reduced by related expenses, capital expenditures, the cost of
working capital and an assigned contribution to the core technology serving as a
foundation for the research and development.

The discount rates used in discounting the net cash flows from purchased
in-process technology were 80% for articular cartilage, 85% for bone fusion, 78%
for other bone applications and 83% for drug delivery. These discount rates for
each project were determined upon consideration of the stage of completion of
the project, the assumptions, nature and timing of the remaining efforts for
completion and risks and uncertainties of the project.

Substantial further research and development, pre-clinical testing and clinical
trials will be required to determine the technical feasibility and commercial
viability of the products under development. There can be no assurance such
efforts will be successful. If these projects are not successfully developed,
our revenue and profitability may be adversely affected in future periods. We
are continuously monitoring our development projects and believe that the
assumptions used in the valuation of purchased in-process technology reasonably
estimate the future benefits attributable to such purchased in-process
technology. No assurance can be given that actual results will not deviate from
those assumptions in future periods.

22

RISK FACTORS

You should carefully consider the risks and uncertainties described below, in
addition to the other information set forth in this report, because they could
materially and adversely affect our business, operating results, financial
condition, cash flows and prospects as well as adversely affect the value of an
investment in our common stock.

RISKS RELATED TO OUR BUSINESS

WE CANNOT ASSURE YOU THAT THE CLINICAL TRIALS FOR THE TRIACTIV WILL BE
SUCCESSFUL OR THAT WE WILL BE ABLE TO OBTAIN THE NECESSARY REGULATORY APPROVALS
FOR THE TRIACTIV IN THE UNITED STATES.

We need to conduct additional human clinical trials for the TriActiv. It is
possible that, during these trials, the TriActiv may be found to be ineffective
or unsafe or we encounter other problems that cause us to delay or suspend
development of the product. The TriActiv has not been approved for marketing by
the FDA. We will require substantial additional expenditures to develop the
product, conduct clinical trials and gain the necessary regulatory approval for
the TriActiv in the U.S. prior to granting approval, the FDA may require
clarification of information provided in our regulatory submissions, more
information or more clinical studies. If granted, FDA approval may impose
limitations on the uses for which our product may be marketed or how our product
may be marketed. Should we experience delays or be unable to receive approval
from the FDA, our operating results and business may be substantially impaired.

ALTHOUGH WE HAVE RECEIVED CE MARK APPROVAL AND EVEN IF WE RECEIVE FDA APPROVAL,
WE MAY NOT BE SUCCESSFUL COMMERCIALIZING THE TRIACTIV.

If the TriActiv clinical trials are completed successfully and we obtain the
necessary governmental approvals, we will need to commercialize the product. We
cannot assure you that we will be able to find a suitable partner and/or develop
and train our own sales force to sell and market the TriActiv. We recently began
to build a sales and marketing force, but had no prior experience hiring or
training a sales and marketing force. We may not be able to expand and maintain
an internal sales and marketing force with technical expertise and supporting
distribution capabilities. If we are unable to successfully commercialize the
TriActiv, our growth prospects will be diminished.

WE DERIVE A SUBSTANTIAL MAJORITY OF OUR REVENUES FROM ONLY TWO CUSTOMERS.

A substantial majority of our total revenues are derived from only two
customers. Royalty income from, and sales of biomaterials to, St. Jude Medical
associated with the Angio-Seal represented approximately 62% of total revenue
while sales of biomaterials products to one other customer, a distributor of
orthopedic products, represented approximately 23% of total revenues. It is not
possible for us to predict the future level of demand for our products that will
be generated by these customers or the future demand for the Angio-Seal from
customers of St. Jude Medical. Our customer concentration exposes us to the risk
of changes in the business condition of our major customers and to the risk that
the loss of a major customer would adversely affect our results of operations.
Our relationship with these customers is subject to change at any time.

WE ANTICIPATE THAT A SUBSTANTIAL PORTION OF OUR REVENUES WILL CONTINUE TO COME
FROM THE ANGIO-SEAL, WHICH IS MANUFACTURED, MARKETED AND DISTRIBUTED BY ST. JUDE
MEDICAL.

Under our license agreements with St. Jude Medical, the Angio-Seal is
manufactured, marketed and sold on a worldwide basis by St. Jude Medical. Two of
our significant sources of revenue for the future are expected to be sales of
collagen to St. Jude Medical for use in the Angio-Seal and royalty income from
the sale of the Angio-Seal product line. As of June 1, 2000, St. Jude Medical is
no longer obligated to buy collagen from us. Our success with the Angio-Seal
depends in part on the time, effort and attention that St. Jude Medical devotes
to the Angio-Seal product line and on their success in manufacturing, marketing
and selling the Angio-Seal product line. Under the terms of our agreements with
St. Jude Medical, we have no control over the pricing and marketing strategy for
the Angio-Seal product line. In addition, we depend on St. Jude Medical to
successfully maintain levels of manufacturing sufficient to meet anticipated
demand, abide by

23

applicable manufacturing regulations and seek reimbursement approvals. St. Jude
Medical can terminate our arrangement at any time for any reason upon 12 months
notice. At such time, we would receive all sales and marketing, manufacturing
and distribution rights to the Angio-Seal product line back. There can be no
assurance that St. Jude Medical will successfully pass future inspections of its
manufacturing facility or adequately perform its manufacturing, marketing and
selling duties. Any such failure by St. Jude Medical may negatively impact
Angio-Seal unit sales and therefore reduce our royalties and impair our
operating results and business.

IF OUR BIOMATERIALS PRODUCTS ARE NOT SUCCESSFUL, OUR OPERATING RESULTS AND
BUSINESS MAY BE SUBSTANTIALLY IMPAIRED.

The success of our existing biomaterials products, as well as any we develop in
the future, depends on a variety of factors, including our ability to continue
to manufacture, sell and competitively price these products and the acceptance
of these products by the medical profession. In addition, we may be required to
obtain regulatory approval for any future biomaterials products. We will require
substantial additional funds to develop and market our biomaterials products. We
expect to fund the growth of our biomaterials business out of our operating
income and cannot guarantee that this operating income will be sufficient to
develop new biomaterials products. To date, we have relied on strategic partners
or customers to market and sell our biomaterials products. We cannot assure you
that we will commercialize our products successfully either indirectly through
strategic partners or directly through the development of a sales force.

WE DEPEND ON OUR CUSTOMERS TO MARKET AND OBTAIN REGULATORY APPROVALS FOR THEIR
BIOMATERIALS PRODUCTS.

We depend on the efforts of our biomaterials customers in marketing their
products which include our biomaterials components. There can be no assurance
that our customers' end use products which include our biomaterials components
will be commercialized successfully by our customers or that our customers will
otherwise be able to compete effectively in their markets. If our customers fail
to commercialize their products, our operating results and business may be
substantially impaired.

WE MAY BE REQUIRED TO DELAY, REDUCE OR ELIMINATE SOME OR ALL OF OUR EFFORTS TO
DEVELOP AND MARKET THE TRIACTIV IF WE FAIL TO OBTAIN ADDITIONAL FUNDING THAT MAY
BE REQUIRED TO SATISFY OUR FUTURE CAPITAL NEEDS.

We plan to continue to spend substantial funds to develop and market the
TriActiv. Our future liquidity and capital requirements will depend upon
numerous factors, including the progress and success of our clinical trials, the
timing and cost involved in obtaining regulatory approvals, the timing and cost
of developing sales and marketing strategies, our ability to enter into
strategic alliances, manufacturing and research and development activities, the
extent to which the TriActiv gains market acceptance and competitive
developments. Any additional required financing may not be available on
satisfactory terms, if at all. If we are unable to obtain financing, we may be
required to delay, reduce or eliminate some or all of our research and
development activities or sales and marketing efforts, in which case our
operating results and business may be substantially impaired.

THE MARKETS FOR OUR PRODUCTS ARE HIGHLY COMPETITIVE AND ARE LIKELY TO BECOME
MORE COMPETITIVE, AND OUR COMPETITORS MAY BE ABLE TO RESPOND MORE QUICKLY TO NEW
OR EMERGING TECHNOLOGIES AND CHANGES IN CUSTOMER REQUIREMENTS.

The markets for our current and proposed products are fragmented, intensely
competitive, subject to rapid change and sensitive to new product introductions
and enhancements. We expect that the competitive environment for our products
will become more intense as additional companies enter our markets and as new
techniques and technologies are adopted. Our biomaterials and medical devices
compete directly and indirectly for customers with a range of products and
technologies produced by a wide variety of companies, as well as other processes
and procedures which do not require the use of our products or those of our
competitors. Many of our existing competitors, as well as a number of potential
new competitors, have longer operating histories in these markets, greater name
recognition, larger customer bases and greater financial, technical and
marketing resources.
24

Our biomaterials products compete with the products of many of the larger
companies in the industry. In the vascular sealing device market, our products
compete with products sold by Datascope Corp., Perclose, Inc. (a subsidiary of
Abbott Laboratories) and Vascular Solutions, Inc. The substantial majority of
vascular sealing is performed through manual compression, which represents our
primary competition. If we are successful in commercializing the TriActiv, our
competitors in that market will include Boston Scientific Corporation, Johnson
and Johnson, Inc., Medtronic, Inc. (which owns Percu-Surge, Inc.) and Guidant
Corporation, among others.

Our competitors may have broad product lines which allow them to negotiate
exclusive, long-term supply contracts and offer comprehensive pricing for their
products. Broader product lines may also provide our competitors with a
significant advantage in marketing competing products to group purchasing
organizations and other managed care organizations that are increasingly seeking
to reduce costs through centralized purchasing. Greater financial resources and
product development capabilities may allow our competitors to respond more
quickly to new or emerging technologies and changes in customer requirements
that may render our products obsolete.

Because a significant portion of our revenue depends on sales of medical devices
by our customers to the end user market, we are also affected by competition
within the markets for these devices. Competition within the medical device
market could also have an adverse effect on our business for a variety of
reasons, including that our customers may compete directly with larger, dominant
manufacturers with extensive product lines and greater sales, marketing and
distribution capabilities. We are also unable to control other factors that may
impact the commercialization of our components for end use products, such as
marketing and sales efforts and competitive pricing pressures within particular
markets.

IF OUR PRODUCTS ARE NOT ACCEPTED BY THE MEDICAL COMMUNITY OR IF OUR PRODUCTS ARE
REPLACED BY NEW TECHNOLOGIES, OUR BUSINESS MAY SUFFER.

The success of our existing products depends on continued acceptance of these
products by the medical community. We cannot predict whether or not our products
will continue to be accepted and if that acceptance will be sustained to over
the long term. The success of any products we develop in the future will depend
on the adoption of these products by our targeted markets. We can not predict
how quickly, if at all, the medical community will accept our future products or
the extent to which our future products will be used. If we encounter
difficulties introducing future products into our targeted markets, our
operating results and business may be substantially impaired. In addition, new
technologies and techniques may be developed which may render our current
products, along with those under development, obsolete.

THE LOSS OF, OR INTERRUPTION OF SUPPLY FROM, KEY VENDORS COULD LIMIT OUR ABILITY
TO MANUFACTURE OUR PRODUCTS.

We purchase certain materials and components for our products from various
suppliers. Some of these components are custom made for us, including many of
our absorbable polymer and suture raw materials which are used in our custom
polymer products across all markets. Any loss of, or interruption of supply
from, key vendors may require us to find new vendors. We could experience
production or development delays while we seek new vendors which could
substantially impair our operating results and business.

WE MAY HAVE PROBLEMS MANUFACTURING AND DELIVERING OUR BIOMATERIALS PRODUCTS IN
THE FUTURE.

The biomaterials industry is an emerging area, using many materials which are
untested or whose properties are still not known. Consequently, from time to
time we may experience unanticipated difficulties in manufacturing and
delivering our biomaterials products to our customers. These difficulties may
include an inability to meet customer demand, delays in delivering products or
quality control problems with certain biomaterials products. Any such difficulty
to fulfill orders on a timely basis could materially and adversely affect our
operating results and business.

25

OUR USE OF HAZARDOUS MATERIALS EXPOSES US TO THE RISK OF MATERIAL ENVIRONMENTAL
LIABILITIES.

Because we use hazardous substances in our research and development and
manufacturing operations, we are potentially subject to material liabilities
related to personal injuries or property damages that may be caused by hazardous
substance releases or exposures at or from our facility. Decontamination costs,
other clean-up costs and related damages or liabilities could substantially
impair our business and operating results. We are required to comply with
increasingly stringent laws and regulations governing environmental protection
and workplace safety, including requirements governing the handling, storage and
disposal of hazardous substances.

ST. JUDE MEDICAL'S INTERNATIONAL SALES ARE SUBJECT TO A NUMBER OF RISKS THAT
COULD HARM FUTURE INTERNATIONAL SALES OF ANGIO-SEAL AND THEIR ABILITY TO
SUCCESSFULLY COMMERCIALIZE NEW PRODUCTS IN INTERNATIONAL MARKETS.

St. Jude Medical sells the Angio-Seal product line internationally and pays us a
royalty on each unit sold. Our royalties from those international sales are
subject to several risks, including:

- the impact of recessions in economies both within and outside the United
States;

- unexpected changes in regulatory requirements, tariffs or other trade
barriers;

- weaker intellectual property rights protection in some countries;

- fluctuations in exchange rates;

- potentially adverse tax consequences; and

- political and economic instability.

The occurrence of any of these events could seriously harm St. Jude Medical's
future international sales and our ability to receive royalties from sales of
the Angio-Seal in international markets.

OUR SUCCESS DEPENDS ON KEY PERSONNEL, THE LOSS OF WHOM COULD IMPAIR OUR
OPERATING RESULTS AND BUSINESS.

Our success depends, to a significant extent, upon the efforts and abilities of
Joseph W. Kaufmann, Douglas G. Evans and other members of senior management. The
loss of the services of one or more of these key employees could harm our
operating results and business. In addition, we will not be successful unless we
can attract and retain skilled personnel, particularly in the areas of research
and product development.

OUR FAILURE TO EXPAND OUR MANAGEMENT SYSTEMS AND CONTROLS TO SUPPORT ANTICIPATED
GROWTH OR INTEGRATE FUTURE ACQUISITIONS COULD SERIOUSLY HARM OUR OPERATING
RESULTS AND BUSINESS.

Our operations continue to grow and we expect this expansion to continue as we
execute our business strategy. Sustaining our growth has placed significant
demands on management and our administrative, operational, information
technology, manufacturing, financial and personnel resources. Accordingly, our
future operating results will depend on the ability of our officers and other
key employees to continue to implement and improve our operational, client
support and financial control systems, and effectively expand, train and manage
our employee base. We may not be able to manage our growth successfully. This
inability to sustain or manage our growth could seriously harm our operating
results and business.

ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS, DILUTE STOCKHOLDER VALUE AND HARM OUR OPERATING RESULTS.

We may acquire or make investments in complementary businesses, technologies,
services or products if appropriate opportunities arise. The process of
integrating any acquired business, technology, service or product into our
business and operations may result in unforeseen operating difficulties and
expenditures. Integration of any acquired company also may consume much of our
management's time and attention that could otherwise be available for ongoing
development of our business. Moreover, the anticipated benefits of any
acquisition may not be realized. Furthermore, we may be unable to identify,
negotiate or finance future
26

acquisitions successfully. Future acquisitions could result in potentially
dilutive issuances of equity securities or the incurrence of debt, contingent
liabilities or amortization expenses related to goodwill and other intangible
assets.

OUR FUTURE OPERATING RESULTS ARE DIFFICULT TO PREDICT AND MAY VARY SIGNIFICANTLY
FROM QUARTER TO QUARTER.

Our operating results have varied significantly from quarter to quarter in the
past and are likely to vary substantially in the future as a result of a number
of factors, some of which are not in our control, including:

- market perception and customer acceptance of our products;

- market perception and acceptance of our customer's products;

- our efforts to increase sales of our biomaterials products;

- our efforts to gain FDA approval and commercialize the TriActiv;

- the loss of significant orders;

- changes in our relationship with St. Jude Medical;

- our establishment of strategic alliances or acquisitions;

- timely implementation of new and improved products;

- delays in obtaining regulatory approvals;

- increased competition; and

- litigation concerning intellectual property rights in the medical device
industry.

You should not rely upon our results of operations for any particular quarter as
an indication of our results for a full year or any other quarter.

RISKS RELATED TO OUR INTELLECTUAL PROPERTY

IF WE ARE UNABLE TO PROTECT OUR PATENTS AND PROPRIETARY RIGHTS, OUR REPUTATION
AND COMPETITIVENESS IN THE MARKETPLACE MAY BE MATERIALLY DAMAGED.

We regard our patents, biomaterials trade secrets and other intellectual
property as important to our success. We rely upon patent law, trade secret
protection, confidentiality agreements and license agreements with St. Jude
Medical to protect our proprietary rights. Although we have registered certain
of our patents with applicable governmental authorities, effective patent
protection may not be available in every country in which our products are made
available, and we have not sought protection for our intellectual property in
every country where our products may be sold. The steps we take to protect our
proprietary rights may not be adequate to ensure that third parties will not
infringe or otherwise violate our patents or similar proprietary rights.

We and St. Jude Medical are plaintiffs in a patent infringement lawsuit against
Perclose, which was acquired by Abbott Laboratories, and we are co-defendants
against counterclaims filed by Perclose in response to our complaint. We have
spent substantial resources on this litigation and a Markman hearing order was
entered against us which, if upheld on appeal, would mean that our claims
against Perclose are denied. See "Item 3. Legal Proceedings." Intellectual
property litigation in recent years has proven to be very costly and complex,
and the outcome of such litigation is difficult to predict.

WE MAY BE ACCUSED OF INFRINGING UPON THE PROPRIETARY RIGHTS OF OTHERS AND ANY
RELATED LITIGATION COULD MATERIALLY DAMAGE OUR OPERATING RESULTS AND BUSINESS.

Third parties may claim that we have violated their intellectual property
rights. An adverse determination in any intellectual property litigation or
interference proceedings brought against us could prohibit us from selling our
products, subject us to significant liabilities to third parties or require us
to seek licenses from third parties.

27

The costs associated with these license arrangements may be substantial and
could include ongoing royalties. Furthermore, the necessary licenses may not be
available to us on satisfactory terms, if at all. Adverse determinations in a
judicial or administrative proceeding or failure to obtain necessary licenses
could prevent us from manufacturing and selling our products. Any of these
claims, with or without merit, could subject us to costly litigation and divert
the attention of key personnel.

WE DO NOT OWN OR CONTROL THE USE OF THE ANGIO-SEAL DEVICE TRADEMARK.

The term Angio-Seal is a trademark of St. Jude Medical. All goodwill generated
by the marketing and sales of devices bearing the Angio-Seal trademark belongs
to St. Jude Medical and not to us. Should the St. Jude Medical license
agreements terminate, we would not have the right to call any of our products
"Angio-Seal" unless we purchase or license the trademark from St. Jude Medical.
Without rights to the Angio-Seal trademark, we would have to market our products
under a different trademark. Moreover, upon the termination of the St. Jude
Medical license agreements, St. Jude Medical would have the right to compete
against us by selling collagen and puncture closure devices under the Angio-Seal
trademark. Thus, purchasers of puncture closure devices may be more likely to
recognize and purchase products labeled Angio-Seal regardless of whether those
devices originate from us.

RISKS RELATED TO OUR INDUSTRY

WE MAY FACE PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN COSTLY LITIGATION AND
SIGNIFICANT LIABILITIES.

The clinical testing, manufacture and sale of medical products involve an
inherent risk that human subjects in clinical testing or consumers of the
products may suffer serious bodily injury or death due to side effects or other
unintended negative reactions to our products. Accordingly, the clinical
testing, manufacture and sale of our products entail significant risk of product
liability claims. The medical device industry in general has been subject to
significant product liability litigation. Any product liability claims, with or
without merit, could result in costly litigation, reduced sales, significant
liabilities and diversion of our management's time, attention and resources. We
cannot be sure that our product liability insurance coverage is adequate or that
it will continue to be available to us on acceptable terms, if at all.

WE FACE UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT FOR OUR PRODUCTS.

We could be seriously harmed by changes in reimbursement policies of
governmental or private healthcare payers, particularly to the extent any
changes affect reimbursement for catheterization procedures in which our
Angio-Seal products are used. If physicians, hospitals and other users of our
products fail to obtain sufficient reimbursement from healthcare payers for
procedures in which our products are used or adverse changes occur in
governmental and private third-party payers' policies toward reimbursement for
these procedures, our operating results and business may be substantially
impaired.

OUR PRODUCTS AND MANUFACTURING ACTIVITIES ARE SUBJECT TO EXTENSIVE GOVERNMENTAL
REGULATION THAT COULD MAKE IT MORE EXPENSIVE AND TIME CONSUMING FOR US TO
INTRODUCE NEW AND IMPROVED PRODUCTS.

Our products and manufacturing activities are subject to extensive regulation by
a number of governmental agencies, including the FDA and comparable
international agencies. We are required to:

- obtain the approval of the FDA and international agencies before we can
market and sell new products;

- satisfy these agencies' requirements for all of our labeling, sales and
promotional materials in connection with our existing products;

- comply with all applicable manufacturing regulations; and

- undergo rigorous inspections by these agencies.

Compliance wi