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, 2003

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]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in the Exchange Act Rule 12b-2). Yes X No __

The aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant as of December 31, 2002 (the last business day
of the registrant's most recently completed second fiscal quarter) was
$196,791,614, based on the closing price per share of Common Stock of $18.27 as
of such date reported by the NASDAQ National Market. Shares of the registrant's
Common Stock held by each executive officer and director and by each person who
owns 10% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the registrant's Common Stock, par
value $.001 per share, as of September 19, 2003 was 11,448,325.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrant's definitive Proxy Statement, to be filed pursuant to
Regulation 14A
under the Securities Exchange Act of 1934, in connection with the registrant's
2003 Annual
Meeting of Stockholders scheduled to be held on December 3, 2003.

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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 "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors" in this Annual Report on Form 10-K. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Forward-Looking Statements".

OVERVIEW

We are a leader in cardiovascular medical technology and have 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, estimated to be a potential $1 billion annual market. The
Angio-Seal device is designed to seal and close femoral artery punctures made
during diagnostic and therapeutic cardiovascular catheterizations. St. Jude
Medical, Inc. (St. Jude Medical) acquired the worldwide license to the
Angio-Seal device in March of 1999. St. Jude Medical develops, manufactures,
markets and distributes the product worldwide.

Additionally, we have developed the TriActiv(R) Balloon Protected Flush
Extraction System (the TriActiv), a device designed to provide embolic
protection during diseased saphenous vein graft treatment. This market
opportunity is currently estimated at $300 million annually. The TriActiv was
commercially launched in Europe in May 2002 and is in clinical trials in the
United States. Future generations of the TriActiv currently in development and
in clinical trials, will address additional markets. These future applications
will include the treatment of diseased carotid and native coronary arteries and
acute myocardial infarction (AMI) or a heart attack. Industry estimates indicate
that the addition of these applications broadens the potential market for the
TriActiv platform to over $1 billion.

We also 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(R) BALLOON PROTECTED FLUSH EXTRACTION SYSTEM -- EMBOLIC PROTECTION
MARKET OVERVIEW

SAPHENOUS VEIN GRAFT APPLICATION

There are approximately 550,000 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 million annually. 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 (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. Embolic protection is a method of
preventing this debris from going downstream during device based therapy

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procedures. Current devices in the embolic 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.

ADDITIONAL APPLICATIONS

In addition to its application for the treatment of SVG disease, embolic
protection is being tested for effectiveness in reducing complication rates
during the treatment of diseased carotid arteries and diseased native coronary
arteries and AMI.

CAROTID ARTERIES

Each year, there are over 200,000 surgical endarterectomies performed
worldwide to treat carotid artery disease. An endarterectomy is an open
invasive surgical procedure performed to remove debris from the carotid
artery. It is also known that a significantly larger number of patients are
affected by carotid artery disease, with many going untreated due to the
invasiveness of the surgical procedure. With the advent of carotid stenting
in combination with embolic protection devices continuing to show promising
results, it is believed that carotid stenting with embolic protection could
become the standard of care for the treatment of carotid artery disease.

NATIVE CORONARY ARTERIES AND AMI

Distal embolization of plaque is increasingly recognized as a contributor
to complication rates in common percutaneous transluminal coronary
angioplasty (PTCA) and stent placement procedures. This seems to be
particularly apparent in AMI or heart attack patients where a significant
amount of blood clot (thrombus) is often present. If the thrombus is
dislodged and collects downstream, it generally leads to adverse short-term
and/or long-term outcomes for the patients. Embolic protection devices are
being studied as tools for lowering complication rates in these patients.

THE TRIACTIV

We have designed the TriActiv, a balloon based embolic protection 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 use of the TriActiv reduced the MACE rate
to 6.9% for patients treated within our 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:

- an embolic 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 device, a guiding catheter is positioned at the entrance to the
graft. The guidewire, containing the embolic protection balloon, is advanced
through the SVG beyond the occlusion. The embolic 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
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Revascularization (PCR) in May 2002 and we shipped our first product in June
2002. Effective January 2002, we established a subsidiary in Germany, Kensey
Nash Europe GmbH, and hired a Vice President of European sales. We have
established a European sales and marketing team and will continue to add
personnel to this team as required to meet our clinical and sales goals. This
team sells the product direct in the German market and supports our distributor
relationships in the rest of Europe.

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 up to 80
investigational sites in the U.S. and in Europe. We anticipate enrollment
completion and submission to the FDA for 510(k) approval of the device (the
approval, which allows the commercial sale of the device in the U.S.) between
December 2003 and February 2004. If the submission meets the requirements of the
FDA, we would anticipate receiving approval for commercial sale of the device by
June 2004.

FUTURE GENERATIONS OF THE TRIACTIV

We have modified the design of the TriActiv to improve the ease-of-use for SVG
applications as well as to address additional applications where distal
embolization is a concern. These additional applications include the treatment
of native coronary and carotid arteries as well as AMI. Testing of these
additional designs will occur during our years ended June 30, 2004 and 2005
(fiscal 2004 and 2005).

The second generation SVG application device has been designed to improve the
ease-of-use of the original device. We have submitted for CE Mark approval for
the 2nd generation TriActiv and will commence sales in Europe upon receipt of
approval. We expect to receive approval in the second quarter of fiscal 2004.

We completed a six patient pilot study, the TRACER study, on the carotid artery
application in September 2003. This study was completed at one clinical site in
Costa Rica. The TriActiv carotid application device was successfully used to
provide protection from potential stroke-causing emboli by actively removing
debris during carotid stenting procedures. We plan to begin enrollment in a CE
Mark study for the TriActiv carotid application in our third fiscal quarter of
fiscal 2004.

We also plan to initiate a CE Mark study for the native coronary/AMI application
by the end of fiscal 2004.

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.
Existing device based treatment options consist of either suture or
biomaterial-based devices. Leading cardiology industry journals currently
estimate that there are approximately 7.0 million cardiovascular catheterization
procedures performed annually, which translates to a potential worldwide
arterial puncture closure market of approximately $1 billion annually. The U.S.
market represents approximately 70-75% of this total market opportunity.
Industry estimates of current market penetration for arterial puncture closure
devices are approximately 41% and 27%, for the U.S. and the international
markets, respectively.

THE ANGIO-SEAL SYSTEM

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.
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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 offer 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 product has been proven to have several
advantages over traditional manual or mechanical compression procedures,
including: reduced time to ambulation and hemostasis, 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 device is manufactured, marketed, sold and distributed by St.
Jude Medical. We receive a royalty on every unit sold. In addition, we
manufacture components for the Angio-Seal device and have augmented St. Jude
Medical's manufacturing of completed devices in the past. 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. These efforts and enhancements include the launch of the product
in the Japanese market and the launch of the STS Plus platform in the U.S. in
the first quarter of fiscal 2004.

With the launch of the latest generations of the Angio-Seal product line, the
Self Tightening Suture (STS) and STS Plus platforms in March 2002 and September
2003, respectively, the Angio-Seal device 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 approximately
three million Angio-Seal devices sold as of June 30, 2003. Industry estimates
show the Angio-Seal worldwide market share at June 30, 2003 was approximately
55%, compared to approximately 48% at June 30, 2002.

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. In addition, 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
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

Biomaterials continue to be a source of new emerging technologies for our
company. Alongside our Angio-Seal and TriActiv platforms, we have built a solid
reputation and significant market presence in the development of biomaterials
for use in medical implants. The technological challenges involved in developing
biomaterials products are substantial. Developing products made from absorbable
and nonabsorbable biomaterials, such as polymers, collagen, polysacharides and
ceramics, 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, ceramics and
other absorbable and nonabsorbable materials. We believe that

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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 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 and nonabsorbable 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 and permanent 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 and
development programs utilizing intellectual property related to our porous
biodegradable regeneration matrices. Specifically, we are researching
applications for articular cartilage regeneration, vascular grafts, bone
growth scaffolds for spinal and trauma indications 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 participate in this biomaterials market in several ways:

- We manufacture biomaterials products for our customers who incorporate
them into their products;

- We manufacture a complete product incorporating our biomaterials and
provide the finished product to our customers for distribution;

- These products are provided in a variety of forms ranging from components
to final packaged products which are then marketed and sold to end users;

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- We independently design and develop biomaterials products that may
enhance the features and benefits of our customers' products;

- We design and develop potential enhancements to our customers' products.

A majority of our biomaterials sales are concentrated among a few strategic
customers and partners. The relationship with these customers and partners is
generally long-term and contractual in nature, with contracts specifying the
characteristics of the product to be supplied and pricing. Our products often
represent a key strategic source for these customers and partners. In many
cases, the technology incorporated in the product is our proprietary technology
and, therefore, the "switching costs" for customers are thought to be high.
These would include identification and testing of alternative technology, time
to develop specifications with new suppliers, and, in many cases, regulatory
modifications. As a result, we view the nature of our customer relationships as
a long-term sustainable competitive advantage.

We have established several strategic partnerships with companies selling
biomaterials based products. We act as a strategic partner and are often the
exclusive supplier of certain biomaterials technology to our customers. Our
biomaterials customers include St. Jude Medical, to whom we supply the
Angio-Seal components, in addition to a leading manufacturer of sports medicine
products and multiple other leading orthopaedic companies, among others. In the
case of our proprietary periodontal or dental products, it has entered into
multi-year distribution agreements with OraPharma, Inc. (now a subsidiary of
Johnson & Johnson) in the U.S. and CurasanAG for certain markets outside the
United States (OUS). In March 2003, we also entered into a joint development
agreement with Orthovita, Inc. to create new biomaterials-based spine products,
based on Orthovita's VITOSS bone void filling product. Orthovita will sell the
products through its established distribution network.

We continue to independently develop new proprietary products, to pursue other
strategic partnerships in multiple fields of use (orthopaedics, cardiology,
wound repair, aesthetics, general surgery and drug delivery, among others) and
to work with both leading and emerging companies to commercialize
biomaterials-based technology to maximize our return on our increased investment
in these products. As we continue to increase

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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.

BIOMATERIALS MARKETS BIOMATERIALS PRODUCTS PRODUCT STATUS

Orthopaedics:
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 based Wound Dressings Commercial
Periodontal:
Periodontal Drilac(R) Commercial
Periodontal Epi-Guide(R) Commercial
General Surgery:
Cosmetic Surgery Cosmetic Surgery Repair Device Commercial
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. Nowhere is the transition to biomaterials based products
more evident than in the orthopaedics market where absorbable biomaterials have
reduced healing times, improved patient outcomes and lessened or eliminated
morbidity issues related to the use of autologous tissue as graft material.
While traditional surgical methodologies continue to be utilized, the trend
toward new biomaterial-based products is driving innovation and growth in the
orthopaedic industry.

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

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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. The orthopaedic portion of our
biomaterials business represented 42% of our total biomaterials sales for our
year ended June 30, 2003 (fiscal 2003). Applications in the orthopaedic market
for our biomaterials products include sports medicine, as well as spinal and
trauma fixation. 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. Sports medicine is a broad area of healthcare that
includes medical management and treatment of injury in persons engaged in
sports and exercise. Sports injuries, once most commonly associated with
professional athletes, are becoming commonplace in our increasingly active
population. This trend is driving the discovery of new products and
technologies to address this fast growing market.

Soft Tissue Fixation. 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, both markets to which we manufacture products.

Trauma Fixation. Trauma fixation devices are used to repair broken bones
using nails, screws, plates, pins and bone growth stimulation
techniques. We currently manufacture trauma screws for orthopeadic
repair.

Cartilage Regeneration. Articular cartilage covers the opposing surfaces
of all moving joints in the body. Significant debilitation can result
from even minor injury to articular cartilage. U.S. physicians perform
over 500,000 procedures each year to repair damaged cartilage in the
knee and a majority of these are repeat procedures illustrating the
ineffectiveness of current therapeutic approaches. Over time,
debilitating osteoarthritis may develop in the afflicted joint,
ultimately requiring knee replacement or other invasive treatment.

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. This research started under a grant from the National
Institute of Standards and Technologies (NIST) under which we performed
two large animal studies. Initial results from both of these studies
were very promising. Based on these results, we have sponsored a third
animal study, which began in June 2003 with expected results by June
2004.

Spine. The application of biomaterials is an increasingly important
aspect of the spinal surgery market. Major companies have introduced
growth factors delivered via biomaterials matrices into the market, a
trend that is garnering significant attention. In addition, bone void
fillers and alternatives to autografts (bone harvested from the human
body) are increasingly being used in conjunction with metal cages in
spinal fusion procedures as well as to fill the voids left by bone
harvest procedures.

In March 2003, We entered an agreement with Orthovita, Inc. to
commercialize new products based on Orthovita's proprietary VITOSS bone
graft substitute material in combination with our proprietary
biomaterials.

The new products will build upon the VITOSS technology, a resorbable
porous calcium phosphate scaffold that allows for resorption, cell
seeding and rapid in-growth of host bone. The products will be directed
toward the spinal surgery market, the fastest growing market in
orthopaedics, estimated at $1.2 billion on a world-wide basis. Under the
agreement, we will manufacture the products and Orthovita will market
and sell the products worldwide. Orthovita expects to launch the initial
products for spine applications in 2004.
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Bone. Next to blood, bone is the most commonly transplanted tissue in
humans. It is estimated that more than 500,000 bone-grafting procedures
are performed annually in the U.S. Surgeons today have few choices for
materials used in bone grafting. Therefore, the need for an improved
alternative to currently available materials remains an important issue
in orthopaedic and maxillofacial surgery.

We are developing several different bone graft substitutes fabricated
from collagen, synthetic polymers or composite biomaterials. We also
manufacturer for a strategic partner a resorbable growth factor delivery
matrix that is commercially available outside the U.S. Extensive
pre-clinical study of our synthetic polymer bone graft substitute has
shown it to be an excellent carrier of biologically active agents as
well as suitable substrate for bone formation and healing.

Cardiology Products. Our biomaterials are used in arterial puncture closure
products and coatings for synthetic vascular grafts. These cardiology products
represented 54% of total biomaterials sales in fiscal 2003. 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.

Vascular. Medical options for resolving arterial blockage include vessel
replacement or bypass surgery to divert blood flow around an obstruction.
Over 1.7 million surgical procedures are performed annually worldwide that
employ some type of arterial graft; nearly 900,000 of them require grafts
of a very small diameter. Vein grafts taken from the patient's leg are the
only reliable choice available for those small diameter-grafting
procedures. Although the standard of care today, these grafts have
significant issues related to availability, performance, trauma and
expense.

Recognizing this significant medical need, we are developing a synthetic
technology that incorporates multiple biomaterials into an "off-the-shelf"
implantable graft. In fiscal 2002, we received a three-year, $1.9 million
award from the Advanced Technology Program (ATP) of NIST to support
development of this technology. Pre-clinical studies are currently being
conducted to assess the capabilities of the graft in a surgical setting.

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. Utilizing our PTM technology, we are researching sustained
or controlled release of chemotherapeutic drugs for the treatment of breast
cancer under a National Institute of Health (NIH) grant received in fiscal 2003.

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 2003.

Periodontal Products. Biomaterials are commonly used in the periodontal segment
of the dentistry market. We now have two commercialized products in the
periodontal field, the Drilac(R) product, which prevents dry socket following
tooth extraction, and the Epi-Guide(R) 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 2003.

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 accounted for less than 1% of total
biomaterials sales in fiscal 2003.

10

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
and nonabsorbable materials to develop new proprietary biomaterials
products. We are using this expertise to develop new biomaterials
products, new formulations and applications of existing materials and
products. We have 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 are 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.

We have an agreement with Becton Dickinson under which they market our
three dimensional cell culture scaffolds. These scaffolds enhance a
researcher's ability to study tissue engineering, gene therapy and cell
biology.

In August 2002, we entered into an agreement with OraPharma, Inc. for the
distribution of our proprietary Epi-Guide and Drilac(R) Surgical Dressing
products in the United States and Canada. We also have an agreement with
Curasan AG for European and Middle Eastern distribution of our Epi-Guide
product.

In March 2003, we entered into an agreement with Orthovita to
commercialize new products using Orthovita's proprietary ultra porous
VITOSS bone void filler material in combination with our proprietary
biomaterials in spine applications. Under the agreement, we will be
responsible for manufacturing these products and Orthovita will be
responsible for worldwide sales and marketing.

PATENTS AND PROPRIETARY RIGHTS

Our intellectual property covers technology in the fields of arterial puncture
closure, blood vessel location, arterial revascularization and embolic
protection systems, drug/biologics delivery, wound care, periodontics,
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 19, 2003, we held 83 United States
patents and 83 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.
11

We have licensed our United States and foreign patents for the Angio-Seal device
to St. Jude Medical and are required to license all improvements for the device
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 device, 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.

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, general surgery and urology,
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 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 2003, the plug
and the anchor represented a total of $14.5 million, or 53% of our net 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 secondary source of anchor requirements
during fiscal 2004. We continue to supply St. Jude Medical with the collagen
requirements for the Angio-Seal under a formal collagen supply agreement with
St. Jude Medical which expires in November 2005.

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 to supply the U.S. market
in addition to increased European demands. Our manufacturing facility is
equipped with multiple ISO class 8 clean room facilities and is certified to
three international quality standards, ISO 13485, ISO 9001 and EN 46001.
Certification is based on adherence to established standards of design, service,
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, creates 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 19, 2003. 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 $14.5
million, $10.8 million, and $7.3 million in fiscal 2003, 2002 and 2001,
respectively.

12

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 versions of the
patented Angio-Seal for hemostatic puncture closure for 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 rate
is 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 fourth quarter of
fiscal 2004.

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 end of
the fifth royalty year, which 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

THE TRIACTIV

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 the fiscal year ended
June 30, 2002 (fiscal 2002). We are selling 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,
Austria, and Italy and are in the process of identifying distributors for the
rest of Europe. We have also established our international sales and clinical
specialist team to market and sell the TriActiv. At September 19, 2003 we had
nine 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 19, 2003, we had 12 individuals on the U.S.
team including 10 clinical specialists. As we near U.S. regulatory approval of
the device, we will be evaluating various options for the commercial marketing,
sale and distribution of the device. These options include, but are not limited
to, creating a direct sales force, establishing distributor relationships or
entering into a licensing arrangement.

BIOMATERIALS

Sales and marketing efforts for our biomaterials products are primarily
conducted by our senior management team. Sales are concentrated among a few
customers and partners and our marketing efforts are focused more on the sale of
our technology and expertise than on specific products. When appropriate, we
seek to partner

13

with a sales and marketing organization to commercialize or advance our
proprietary products and technologies.

We have an agreement with Becton Dickinson under which they market our three
dimensional cell culture scaffolds. These scaffolds enhance a researcher's
ability to study tissue engineering, gene therapy and cell biology.

We have an agreement with Curasan AG for European and Middle Eastern
distribution of our proprietary Epi-Guide product. During fiscal 2003, we
entered into an agreement with OraPharma, Inc. for distribution of the Epi-Guide
and Drilac products in the U.S. and Canada.

Also during fiscal 2003, we entered into an agreement with Orthovita to
commercialize new products using Orthovita's proprietary ultra porous VITOSS
bone void filler material in combination with our proprietary biomaterials in
spine applications. Under the agreement, we will be responsible for
manufacturing these products and Orthovita will be responsible for worldwide
sales and marketing.

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.

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 Corporation, 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 majority of vascular sealing is still performed through
manual compression, which represents our primary competition. The TriActiv is
currently

14

only commercially available in Europe, where our competitors include Boston
Scientific Corporation, Johnson and Johnson, Inc., Medtronic, Inc. (which owns
Percu-Surge, Inc.) and Guidant Corporation, among others. If we are successful
in commercializing the TriActiv in the U.S., we anticipate the competitors will
be the same companies against which we are competing in Europe, as well as
others.

CUSTOMERS

In fiscal 2003, we had approximately 23 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 69% of total revenues. Sales of biomaterials products to one other
customer, a distributor of orthopaedic products, represented approximately 22%
of total revenues. Our TriActiv device is being 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 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. In the U.S. 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 and
submission to the FDA for 510(k) approval of the device, the approval which
allows the commercial sale of the device in the U.S., will be completed between
December 2003 and March 2004. We have submitted for CE Mark approval of the next
generation TriActiv, an improved SVG device, and anticipate approval by the end
of our second fiscal quarter of 2004. In addition, we anticipate initiating CE
Mark studies on both the carotid and native coronary/AMI applications of the
TriActiv by the end of fiscal 2004.

The Angio-Seal product line has received both CE Mark and FDA approval. St. Jude
Medical is responsible for all future FDA pre-market 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

15

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 19, 2003, we had 256 employees, including 138 employees in
operations, 72 employees in research and development and clinical and regulatory
affairs, 26 employees in finance and administration and 20 employees in sales
and marketing, including nine employees in Europe. During fiscal 2003, we had
two employees in Duluth, Minnesota who were part of our research and development
team. Effective August 15, 2003, we closed the Duluth, Minnesota facility. All
of our remaining U.S. 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.

ITEM 2. PROPERTIES

We lease approximately 68,000 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 a 10,000 square foot warehouse in
Exton, Pennsylvania for which our lease expires in fiscal 2004. 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. There may be a need to obtain
more space to support increased sales of both TriActiv and biomaterials. We do
not anticipate any significant difficulty in obtaining 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

From time to time, in the normal course of business, we are a party to various
legal proceedings. We do not expect that any currently pending proceedings will
have a material adverse effect on our business, results of operations or
financial condition.

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, claimed that
Perclose infringed our U.S. patent numbers 5,676,689 and 5,861,004. These
patents cover systems and methods related to sealing

16

percutaneous punctures. We sought 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 sought to declare our patents invalid and not infringed.
The additional counterclaims asserted by Perclose alleged that our claims were
frivolous and asserted 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 (CAFC).
Oral arguments were heard on December 3, 2002. On February 5, 2003, the CAFC
issued its opinion in which it affirmed the District Court's decision. We
decided not to appeal the decision and, therefore, the case is concluded. We
have expensed legal costs, as a component of selling, general and administrative
expenses, as services have been incurred. No further expenses are anticipated in
connection with this lawsuit.

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 2003.

17

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 19, 2003, the last reported sale price of our common stock in the
Nasdaq National Market was $27.99 per share. As of September 19, 2003, there
were 53 record owners. Such record owners include several owners who are
nominees for an undetermined number of beneficial owners. There were also
approximately 6,000 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.

18

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, 2003, 2002,
2001, 2000 and 1999. 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 2003,
2002 and 2001 is included elsewhere herein. The following data for fiscal years
2003, 2002, and 2001 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.

19

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 biomaterials products and the
TriActiv device.

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 and nonabsorbable 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 expanded our customer base and marketing
activities, increased sales to existing customers and assisted in the
development of new product offerings. For fiscal 2003, the Angio-Seal
components represented 54% of our total biomaterial sales. We believe the
growth in our overall biomaterials sales, which was 54% in fiscal 2003 over
fiscal 2002, 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. We are selling direct to the market in Germany and
through distributors throughout the rest of Europe. We have entered into
distribution agreements for sales in the United Kingdom, Ireland,
Switzerland, Austria, and Italy as of June 30, 2003 and are in the process
of identifying distributors for the rest of Europe. While TriActiv sales
were less than 1% of our total sales for fiscal 2003, we anticipate the
TriActiv will become a more significant component of net sales in fiscal
2004 and beyond as we gain new customers in the European markets, launch
new versions and applications of the product and launch the product in the
U.S. market. We anticipate commercial launch of TriActiv in the U.S. in the
second half of fiscal 2004.

Research and Development Revenue. Fiscal 2001 research and development revenue
was derived entirely from a single NIST grant, under which we are researching
cartilage regeneration utilizing our PTM technology. This grant continued
through fiscal 2002 and we received all remaining funds under this grant in our
second quarter of fiscal 2003. In addition, in October 2001 we received a second
NIST grant, under which we are researching a synthetic vascular graft also
utilizing our PTM technology. This project is expected to continue through early
fiscal 2005. In January 2003, we received a NIH grant, under which we are
researching sustained or controlled release of chemotherapeutic drugs for the
treatment of breast cancer utilizing our PTM technology. This grant will
continue through early fiscal year 2004.

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, including its launch of the
Angio-Seal product line in the Japanese market, and releases future generations
of the Angio-Seal system, including its recent launch of the STS Plus version of
the device in the U.S. As a result, we expect that royalty income will continue
to be a significant source of revenue. Our current royalty

20

rate is 9%. The original rate of 12% was contractually reduced from 12% to 9%,
in accordance with our licensing agreements during the fiscal quarter ended
December 31, 2000, 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 that this final rate reduction
will occur in the fourth quarter of our fiscal 2004. As of June 30, 2003
approximately three million Angio-Seal units have been sold.

Cost of Products Sold. We have experienced an overall increase in gross margin
during fiscal 2003 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 in gross margin
will be partially offset by lower gross margins associated with the TriActiv, as
we expect margins on early sales to be lower than the biomaterials margins due
to the start-up nature of the manufacturing process and low volume. As a result
of this product mix, for fiscal 2004, we believe our total gross margin, across
all product lines, will be only slightly improved over fiscal 2003. As volumes
increase and the manufacturing process matures for the TriActiv, we expect the
gross margin on the product to increase.

Research and Development Expense. Research and development expense consists of
expenses incurred for the development of our proprietary technologies, such as
the TriActiv, absorbable and nonabsorbable biomaterials products and
technologies and other development programs, including expenses under the NIST
and NIH programs. In December 2001, we began our TriActiv U.S. pivotal clinical
study, a planned 500 to 800 patient randomized trial at up to 80 sites around
the U.S. and in Europe. We anticipate completion of trial enrollment and
submission to the Food and Drug Administration (FDA) for 510(k) approval by the
end of the second quarter or early third quarter of fiscal 2004. Clinical
efforts in pursuit of FDA approval and continuing development of the TriActiv,
as well as our continued development of proprietary biomaterials products and
technologies, requires significant research and development spending. We
anticipate research and development expense will continue to increase as we
pursue commercialization of the TriActiv device in the U.S., and explore
opportunities for other indications related to TriActiv as well as our other
technologies, including the continued development of proprietary biomaterials
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 commercialized the TriActiv in Europe in May 2002 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 established a
European sales and marketing team and will continue to add personnel to this
team as required to meet our clinical and sales goals. This team is selling the
product direct in the German market and supports our distributor relationships
in the rest of Europe. We have entered into distribution agreements for sales in
the United Kingdom, Ireland, Switzerland, Austria and Italy as of June 30, 2003
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 prepare
for U.S. commercial launch. We also continue to evaluate opportunities for
commercialization of the TriActiv in the U.S. and to expand the marketing
efforts for our biomaterials business.

CRITICAL ACCOUNTING POLICIES

Our "critical accounting policies" are those that require application of
management's most difficult, subjective, or complex judgments, often as a result
of the need to make estimates about matters that are inherently uncertain and
may change in future periods. It is not intended to be a comprehensive list of
all of our significant accounting policies. In many cases, the accounting
treatment of a particular transaction is specifically dictated by generally
accepted accounting principles, with no need for management's judgment in their
application. There are also areas in which the selection of an available
alternative policy would not
21

produce a materially different result. We have identified the following as our
critical accounting policies: revenue recognition and accounting for stock-based
compensation.

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. All of our shipments are Free on Board (F.O.B.) shipping point. Revenue
under research and development contracts is recognized as the related costs are
incurred. Royalty revenue is recognized as the related product is sold. 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 No. 123), as amended
by SFAS No. 148 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 fair market value at the date
of grant. Therefore, we have not recognized any compensation expense for options
granted to employees. We account for stock-based awards to non-employees using
the fair value method in accordance with SFAS No. 123, which requires using
Black-Scholes option-pricing model to determine the fair value of the option at
the original grant date. Options granted to non-employees, as defined under SFAS
123, (as amended by SFAS No. 148) and Emerging Issues Task Force (EITF) 96-18
"Accounting for Equity Instruments that are Other Than Employees for Acquiring
or in Conjunction with Selling, Goods or Services", are recorded as expense over
the service period. The Company did not grant any options to non-employees
during fiscal 2002. See Note 12 to our financial statements for information
regarding options granted to a non-employee, an outside consultant, in October
2002.

RESULTS OF OPERATIONS

COMPARISON OF FISCAL YEARS 2003 AND 2002

Total Revenue and Net Sales. Total revenues increased 53% to $44.4 million in
the year ended June 30, 2003 from $29.0 million in the year ended June 30, 2002.
Net sales of products increased 55% to $27.1 million for fiscal 2003 from $17.5
million for fiscal 2002. While TriActiv sales increased 388% in fiscal 2003 over
fiscal 2002, they represented less than 1% of total sales for fiscal 2003. As
such, the increase in total sales was primarily attributable to increased sales
of the Angio-Seal components and our orthopaedic products.

Research and Development Revenue. Research and development revenues increased
26% to $963,000 for fiscal 2003 from $765,000 for fiscal 2002. Fiscal 2003
revenues were generated under the NIST articular cartilage and synthetic
vascular graft development grants and the NIH breast cancer drug delivery grant.
In the prior fiscal year, revenues were generated under the NIST articular
cartilage and synthetic vascular graft development grants. The NIST articular
cartilage grant provided revenue for four of the twelve months of fiscal 2003,
as the project concluded in October 2002. The NIST vascular graft grant provided
revenue for the entire year. The NIH breast cancer drug delivery grant was
initiated in September 2002. The increase over the prior fiscal year reflects
the addition of the NIH breast cancer grant which provided $46,000 of revenue in
fiscal 2003 and an increase in the activities and expenses related to the NIST
synthetic vascular graft grant. The vascular graft grant revenue increased
$454,000 in fiscal 2003, from fiscal 2002. These increases were offset by a
decrease of $302,000 in the NIST articular cartilage grant due to the conclusion
of the grant in early fiscal 2003.

Royalty Income. Royalty income increased 52% to $16.3 million for fiscal 2003
from $10.8 million for fiscal 2002. This increase reflects a greater number of
units sold as well as an increase in average selling price for the Angio-Seal.
Royalty units increased 44% as approximately 967,000 Angio-Seal units were sold
to end-users during fiscal 2003 compared to approximately 670,000 units sold
during fiscal 2002. We believe that this unit increase was primarily due to St.
Jude Medical's increased sales and marketing efforts, resulting in market

22

share gains for the Angio-Seal product line in both the U.S. and European
markets and the full year impact of the 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 48% to $12.2 million in
fiscal 2003 from $8.2 million in fiscal 2002 while gross margin increased to 55%
from 53%. 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 higher
margins on our biomaterials products were slightly offset by lower margins on
the TriActiv. The TriActiv margins will continue to be lower than our
biomaterials product margins until our manufacturing process matures and volumes
increase.

Research and Development Expense. Research and development expense increased 34%
to $14.5 million in fiscal 2003 compared to $10.8 million in fiscal 2002. 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 $1.9 million, or 31%, to $8.1 million in
fiscal 2003 from $6.2 million in fiscal 2002. 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
$1.8 million, or 39%, to $6.4 million in fiscal 2003 from $4.6 million in fiscal
2002.

Selling, General and Administrative Expense. Selling, general and administrative
expense increased 59% to $7.4 million in fiscal 2003 from $4.7 million, in
fiscal 2002. This increase was partially the result of increased sales and
marketing expenses which increased $1.5 million to $3.3 million in fiscal 2003
from $1.8 million in fiscal 2002. This increase related primarily to European
sales and marketing efforts on the TriActiv. In addition, general and
administrative expenses increased $1.3 million to $4.1 million in fiscal 2003
from $2.8 million in fiscal 2002. This was attributable to $696,000 in increased
personnel costs and $261,000 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, but
primarily to increased costs related to complying with the Sarbanes-Oxley Act of
2002 (SOA). In addition, selling, general and administrative include a $325,000
professional service fee, which relates directly to a research and development
tax credit project performed in our fiscal fourth quarter (see below).

Net Interest Income. Interest expense decreased $78,000, or 35%, to $145,000 in
fiscal 2003 from $223,000 in fiscal 2002. This was due to a lower principal
balance on the THM Acquisition Obligation as we continue to make the required
quarterly payments and as a result of early repayment to certain debt holders.
Interest income decreased by 37% to $1.2 million in fiscal 2003 from $1.9
million in fiscal 2002. Although our cash and investment balances increased,
this was more than offset by lower interest rates.

Other Non-Operating Income (Expense). Other non-operating income was $700 for
fiscal 2003 compared to other non-operating expense of $15,000 for fiscal 2002.
Other non-operating expense (income) for both periods represented primarily the
net loss or gain on the sale of fixed assets.

Net Income. Net income increased 91% to $8.8 million in fiscal 2003 from $4.6
million in fiscal 2002. 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 $2.5
million in income tax expense in fiscal 2003 compared to $2.4 million of income
tax expense in fiscal 2002. The tax expense in fiscal 2003 was net of a $1.5
million research and development tax credit described below.

COMPARISON OF FISCAL YEARS 2002 AND 2001

Total Revenue and 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 the Angio-Seal components and our orthopaedic 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
23

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 $3.1 million, or 100%, to $6.2 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
$1.2 million, or 35% to $4.6 million in fiscal 2002 from $3.4 million in fiscal
2001.

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

24

necessary. Lastly, in fiscal 2001 we recognized an in-process research and
development charge (IPR&D) of $7.6 million.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by our operating activities was $14.4 million and $7.3 million
during fiscal 2003 and 2002, respectively. In fiscal 2003, changes in asset and
liability balances resulted in a net $160,000 use of cash, offset by net income
of $8.8 million and non-cash depreciation and amortization of $3.2 million. In
fiscal 2002, changes in asset and liability balances resulted in a net $330,000
use of cash, net income of $4.6 million, and non-cash depreciation and
amortization of $2.1 million.

Our cash, cash equivalents and investments were $48.4 million at June 30, 2003.
As of June 30, 2002, we had $2.1 million in restricted investment accounts. We
had pledged this $2.1 million in investments as collateral to secure a bank loan
to an officer, which was used by the officer for the payment of taxes incurred
as the result of the receipt of Common Stock at the time of our initial public
offering in December 1995. The Company's security pledge related to these loans
was released by the bank in February 2003 when the officer's loans from the bank
were repaid in full. As such, the restriction on the Company's investments was
removed.

We spent approximately $4.9 million, 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 an $8.0 million capital spending plan for fiscal
2004 which will continue to be expended primarily on the expansion of our
manufacturing capabilities and space for all product lines.

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). Of that amount, $1.1 million had not been paid as of
June 30, 2003. The obligation was due in equal quarterly installments of
$281,250, which began on December 31, 2000 and was scheduled to end on September
30, 2004. As of February 28, 2003, due to repayments to certain former
shareholders of THM, we reduced our remaining quarterly installments to $223,256
through September 30, 2004. The cash outflow related to the Acquisition
Obligation will be $893,023 in fiscal year 2004 and $223,256 in fiscal 2005,
when the obligation will be fully repaid.

We received $6.1 million of proceeds and a tax benefit of $2.6 million from
employee stock option exercises during fiscal 2003.

Our operating leases, primarily on our facility in Exton, Pennsylvania, also
represent a significant cash outflow. Lease expense under non-cancelable
operating leases over the next three years will be as follows: $742,212 in
fiscal 2004; $711,696 in fiscal 2005; and $302,157 in fiscal 2006.

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 2004. 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."

We may need or otherwise decide to seek additional capital in the private and/or
public equity or debt markets to support a higher level of growth, to respond to
competition, to develop more products or for other reasons. 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
25

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

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 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 of THM, as planned, we have primarily devoted
our development efforts of the acquired PTM technology to an articular cartilage
application, a synthetic vascular graft, and a sustained release
chemotherapeutic drug treatment, and have expended approximately $1,073,000,
$1,110,000, and $49,000, on such efforts during fiscal 2003, 2002 and 2001,
respectively. 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.

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 were forecasted 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.

26

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.

RESEARCH AND DEVELOPMENT TAX CREDIT

During the fourth quarter of fiscal 2003, the Company recorded a research and
development tax credit of $1.5 million. The tax credit relates to qualified
research and development activities of the Company.

27

RISK FACTORS

You should carefully consider the risks, uncertainties and other factors
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 may 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 growth prospects will be diminished.

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 69% of our total
revenue for fiscal 2003 while sales of biomaterials products to one other
customer, a distributor of orthopaedic products, represented approximately 22%
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
either 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. 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
28

demand, abide by 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. St. Jude Medical may not 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.

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, but this operating income may not 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 that include our biomaterials components. There can be no assurance
that our customers' end-use products that 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.

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 enhan