COHESION TECHNOLOGIES INC, 10-K405, 1998-09-28

COHESION TECHNOLOGIES INC
10-K405, 1998-09-28
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS

Previous: OFFICE CENTRE CORP, RW, 1998-09-28

Next: CASTLE CREEK PARTNERS L P, 10-K, 1998-09-28

<PAGE> 1

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended JUNE 30, 1998,

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_____________ to _______________

Commission file number: 000-24103

COHESION TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 94-3274368
(State or Other (I.R.S. Employer
Jurisdiction of Identification No.)
Incorporation or
Organization)

2500 FABER PLACE, PALO ALTO, CA 94303
(Address of Principal Executive Offices, including Zip Code)

Registrant's telephone number, including area code: (650) 354-4300

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
PREFERRED SHARE PURCHASE RIGHTS

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 month (or 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 [ ] NO [X]

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

The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing price of the Common Stock on September 21,
1998 on the Nasdaq Stock Market, was approximately $16,035,555. Shares of Common
Stock held by each officer and director and by each person who owns 5% 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.

As of September 21, 1998, Registrant had 8,797,588 shares of Common Stock
outstanding.

<PAGE> 2

The following information should be read in conjunction with the
Consolidated Financial Statements and the notes thereto. This annual report on
Form 10-K, and in particular the Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements regarding future events or the future performance of the Company that
involve certain risks and uncertainties including those discussed in "Risk
Factors" below. In this report, the words "anticipates", "believes", "expects",
"future" and similar expressions identify forward-looking statements. Actual
events or the actual future results of the Company may differ materially from
any forward-looking statements due to such risks and uncertainties. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Company undertakes no obligation to publicly release the
results of any revision to these forward-looking statements, which may be made
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

The financial information of the Company set forth in this Form 10-K is
theoretical in nature and not necessarily indicative of the future results of
operations or financial position of the Company or the results of operations and
financial position which would have resulted had the Company been a stand-alone
company during the periods presented.

PART I

ITEM 1. BUSINESS

GENERAL

Cohesion Technologies, Inc. ("Cohesion" or the "Company") was organized as a
Delaware corporation and wholly owned subsidiary of Collagen Aesthetics, Inc.,
formerly known as Collagen Corporation ("Collagen"), in June 1997. In October
1997, Collagen announced that it would proceed to separate its Aesthetic
Technologies Group and its Collagen Technologies Group ("CTG") into two
independent, publicly-traded companies. Effective January 1, 1998, Collagen
contributed its research and development programs for hemostatic devices,
biosealants, orthopedics products and programs, adhesion barriers and
recombinant human collagen and thrombin and other related businesses of CTG (the
"Transferred Businesses") to the Company. Collagen also contributed various
equity investments to the Company, including all of its holdings in Boston
Scientific Corporation and Innovasive Devices, Inc., which had an aggregate
market value of $81.9 million at June 30, 1998. In connection with the
separation, Collagen distributed as a dividend to its stockholders on August 18,
1998, one share of the Company's Common Stock for each share of Collagen common
stock outstanding (the "Distribution"). The Company and Collagen have entered
into various agreements (the "Intercompany Agreements") to provide for an
orderly transition of matters and to govern certain ongoing matters between the
two entities and provide a mechanism for transitioning license, supply,
distribution, research and development, tax, service and other agreements in
connection with the Distribution.

The Company is focused on developing and commercializing proprietary surgical
products, including bioresorbable hemostatic devices and biosealants for tissue
repair and regeneration, which increase the effectiveness of, and minimize
complications following, open and minimally invasive surgeries. CoStasis(TM)
Surgical Hemostat ("CoStasis"), the Company's lead hemostatic product candidate,
is designed for use initially in cardiothoracic indications. The Company
completed a multi-site, randomized, pivotal clinical trial in Europe and
received European Community certification ("CE Mark") for CoStasis in September
1998. The Company has received an Investigational Device Exemption (an "IDE")
from the United States Food and Drug Administration (the "FDA") and has
commenced U.S. pivotal trials of CoStasis, targeting cardiac, hepatic,
orthopedic and general surgery indications. CoSeal(TM) surgical sealant
("CoSeal"), the Company's lead biosealant product candidate designed for sealing
organs and other tissues resulting from surgical wounds and incisions, is
expected to commence feasibility clinical trials during fiscal 1999. The Company
also sells its Collagraft(R) implant ("Collagraft"), an orthopedic product, and
has research and development programs in other orthopedic

<PAGE> 3

areas and in recombinant human collagen and thrombin. The Company's products and
programs are based on a platform of proprietary technologies centered around
collagen and hydrophilic polymers that quickly polymerize in vivo and bind to
tissue.

PRODUCTS AND DEVELOPMENT PROGRAMS

Although the Company is currently marketing a line of collagen-based
materials for research applications, which include Vitrogen, Cell Prime, Zygen,
Angiostat and other bulk collagen products (the "Intermediate Products"), most
of the Company's products are still under development. Most of these products
under development are being designed to target the market for wound treatment,
which includes two significant segments: hemostatic products, used to control
bleeding, and surgical sealants, used to seal organs and tissues compromised by
surgery or other trauma. During most surgical procedures, which entail damage to
the vasculature and the compromise of normal tissue barriers, bleeding is
inevitable, but the degree to which bleeding constitutes a threat to the
well-being of the patient depends on the degree of intervention and the tissues
involved. The ability to control bleeding and the subsequent repair of tissues
and systems containing fluids, such as the vasculature, heart, bladder and
bowel, however, are essential, as the consequences of uncontrolled bleeding and
fluid leakage can be catastrophic. In a typical cardiovascular surgical
procedure, for example, the surgeon first attempts to control bleeding from
major blood vessels, and the attendant pulsating blood loss, by tying off or
cauterizing the vessels. However, it is typically more difficult to control
diffuse bleeding from multiple veins and capillaries, which are too numerous to
close individually. This diffuse bleeding is time-consuming to control with
currently available products and limits the surgeon's ability to close the
patient at the end of a procedure. Surgeons must also close wounds created by
the trauma of surgery and seal the surgical site to prevent the leakage of
fluids, air or waste. Effective sealing of organs and tissues during surgery is
a critical factor in the ultimate success of a surgical procedure. Ineffective
sealing can result in life-threatening complications such as blood loss and
leakage of air or waste, higher levels of pain, prolonged hospitalization and a
higher mortality rate. As a result of these considerations, surgeons have
increasingly sought improved technologies for both bleeding control and wound
closure.

The Company's product offerings also includes a line of collagen-based
materials for research applications: Sales of intermediates were not material in
fiscal years 1998, 1997 and 1996.

COSTASIS HEMOSTATIC AGENT

The Company's first surgical product under development is the CoStasis
Surgical Hemostat. CoStasis is an atraumatic liquid hemostat designed for use in
surgical procedures to control bleeding from capillaries and small veins.
Composed of a sterile suspension of bovine fibrillar collagen and bovine
thrombin in calcium chloride, CoStasis is applied to the bleeding site with the
patient's plasma, incorporating the surgical advantages of collagen, fibrinogen
and thrombin. The pre-mixed, ready-to-use collagen/thrombin suspension is
supplied in one syringe and is mixed with the patient's own plasma from a second
syringe at the time of administration to the bleeding site. The patient's plasma
provides the source of fibrinogen that is cleaved by the thrombin to form a
collagen-reinforced fibrin clot, which is hemostatic and adherent to the
bleeding tissue.

The collagen component of CoStasis is derived from closed-herd cows, whose
maintenance is overseen by Collagen and which constitute a source available to
none of the Company's competitors. The thrombin component is obtained from
commercial sources, and is processed to a high level of purity. The use of these
components minimizes the possibility of allergic reactions associated with
lower-purity bovine collagen or thrombin used in other products. In addition,
both components come from manufacturing processes which eliminate viruses,
providing a further margin of safety. The pre-mixed nature of the
collagen/thrombin components reduces preparation time compared to lyophilized
commercial fibrin sealants, which must be reconstituted before use, and when
compared to other agents, which have complex preparation requirements.

In addition, the Company has developed a patented system, called the
CellPaker, which is designed to quickly and sterilely separate the patient's
blood into plasma in the operating room for use in conjunction with

<PAGE> 4

CoStasis. The CellPaker is a single-use device, which the Company plans to
package separately from CoStasis, and which the Company believes will make it
easy to obtain the patient's plasma upon entry into surgery. Unlike competitive
products, which generally require a large amount of a patient's blood (or plasma
from a pooled blood source) and have lengthy preparation times, CoStasis is
designed to require a small amount of a patient's blood and have a relatively
short preparation time (less than 10 minutes).

When applied to a bleeding surface, the CoStasis/plasma composite is designed
to rapidly form a collagen/fibrin matrix which conforms to the tissue surface
and is able to enter surface cracks and crevices. The hemostatic capacity of the
collagen/fibrin gel is a combination of the effects of collagen, fibrin and
thrombin in activation of the coagulation cascades and in presenting a physical
barrier which exerts pressure on the site to stem blood flow. Preclinical
studies have demonstrated that CoStasis acts significantly faster than
traditional hemostatic sponges and commercial fibrin sealants in the control of
bleeding from a variety of bleeding tissue sites. CoStasis also proved effective
in controlling bleeding in animal models in which coagulation was compromised
using heparin or aspirin. The Company believes that these preclinical data
indicate that CoStasis has the potential to be highly effective in the rapid
control of diffuse bleeding from capillaries, venules, and arterioles under
diverse conditions modeling clinical use and tissue conditions.

CoStasis has been used to control bleeding in several surgical indications in
clinical trials in the United States and Europe. In March 1997, the Company
received an IDE from the FDA to test CoStasis in feasibility studies in the
control of bleeding at split thickness skin graft donor sites in nine patients
who were undergoing skin grafting due to burns or tissue reconstruction
procedures. CoStasis was effective in the control of bleeding and no adverse
sequelae were reported with its use. Subsequently, in the latter half of 1997,
CoStasis was used in a European feasibility study in 13 subjects undergoing
coronary artery bypass surgery ("CABG"). In this study, CoStasis controlled
bleeding at the sites of grafted vessels joining vessels of the heart
(anastomoses) and the bleeding surface of the heart and chest wall. In January
1998, the Company began a multi-center, randomized, controlled, pivotal clinical
trial of CoStasis in Europe for the control of bleeding in approximately 100
CABG patients. The Company completed this study and received a CE Mark in
September 1998. The Company has received an IDE from the FDA to expand clinical
trials in the United States in the fields of cardiothoracic, orthopedic, general
and hepatic surgery. These trials were initiated in April 1998 and are expected
to be completed in early calendar 1999. The Company expects to use the data
available from these studies in Europe and the United States to support
worldwide submissions for approval to market CoStasis.

CoStasis contains thrombin, which is a FDA-licensed biological drug.
Consequently, the FDA considers CoStasis to be a combination product subject to
jurisdiction by the Center for Biologics Evaluation and Research ("CBER") and
the Center for Devices and Radiological Health ("CDRH"). The FDA has assigned
lead review responsibility to CDRH following a "Request for Designation"
determination by the FDA in September 1996. The Company believes that this
decision was significant because the regulatory approval processes for devices
conducted by CDRH are typically of a shorter duration and less complex than the
review process conducted by CBER for biological drugs; provided, however, there
can be no assurance of the duration or complexity of the regulatory review of
CoStasis.

COSEAL BIOSEALANT

The Company's second surgical product under development is the CoSeal
surgical sealant. Surgical repair necessitates the opening or puncturing of body
cavities and the compromise of barriers that normally prevent fluid, solids and
gas leakage in the body. This leakage ranges from a minor inconvenience to a
life-threatening event and is especially burdensome in cardiothoracic,
cardiovascular and abdominal surgery procedures. Currently, the surgeon is
dependent on meticulous use of surgical staples and sutures to create a fluid-
or gas-tight seal when repairing these tissues. In some cases, "home-brew" or
commercial fibrin sealants are used to assist in achieving a dependable seal.
While polymer-based hydrogels are an alternative to fibrin sealants, they are
unable to covalently cross-link directly to the tissue surface at the surgical
site and often require cumbersome processes, including light or energy
activation, in order to seal the surgical site of application.

The Company's CoSeal biosealant uses two biocompatible liquids which
polymerize in seconds at the site of application without the need for activating
equipment and are absorbed by the body within weeks after the tissue

<PAGE> 5

has repaired. CoSeal is based on reactive derivatives of polyethylene glycol
("PEG"), which has a history of safe use in other medical applications. These
PEG-polymers are liquids of low viscosity and flow readily across the surfaces
to be sealed. In seconds, they covalently cross-link with the patient's tissue
over the treated surgical site to form a tightly bound matrix with excellent
elasticity and strength. CoSeal is based on a completely synthetic, PEG-polymer
platform technology, which avoids the need for any blood products or animal
proteins, addressing concerns about transmission of infectious agents.

Some existing products and products in development use light- or
energy-activated polymers that require significant additional equipment in the
surgical field and are difficult to use in minimally invasive surgery. CoSeal is
a self-polymerizing device which does not require activating equipment. In
consultation with its clinical advisers, the Company is also developing a
variety of special delivery devices. These delivery devices complement the
designed flexibility in CoSeal, giving surgeons a variety of tools for diverse
applications.

CoSeal has demonstrated ease of use and clinical effectiveness in sealing
surgical sites in cardiovascular grafting procedures in animal models. Once
CoSeal was applied, vascular grafts did not leak at anastomoses or puncture
sites when treated. The Company expects to begin feasibility clinical trials of
CoSeal in cardiovascular and vascular surgery procedures during fiscal 1999.

ORTHOPEDICS

In addition to the market for wound treatment, the Company is focusing on the
market for bone graft substitutes. The Company has already developed and is
currently marketing Collagraft, a proprietary bone graft substitute product,
through its partner Zimmer, Inc. ("Zimmer"), a subsidiary of Bristol-Myers
Squibb Company. The Company is also developing a number of additional
collagen-based products for use in a variety of orthopedic indications.

Collagraft. The Company's Collagraft implant is a proprietary bone graft
substitute which provides a scaffolding around which new bone can grow. A bone
graft substitute eliminates the need for a patient to undergo a painful
autograft bone grafting procedure, which involves harvesting the patient's own
bone from another site, and prevents the transmission of human infectious agents
and inconsistent results from allograft procedures where bone graft supplied
through a bone bank is used. The Company's Collagraft paste and Collagraft strip
products are indicated for use in acute long bone fractures and traumatic bone
defects to provide a matrix for the repair process of bone. The Collagraft
products are a mixture of purified fibrillar collagen and
hydroxyapatite/tricalcium phosphate ceramic ("HA/TCP") and are supplied sterile
in both strip (premixed) and ready-to-mix form. When used with the patients's
own bone marrow, Collagraft takes on osteoinductive and osteogenic properties.
Hydroxyapatite is a biocompatible substance that is minimally reabsorbed.
Tricalcium phosphate is radiopaque, biocompatible and biodegradable. Its
degradation products can be reconstituted by the body to form new bone mineral,
allowing for bone deposition.

The Company is currently marketing its Collagraft products through its
partner, Zimmer, in the U.S. and Asia, pursuant to a product development and
distribution agreement between Collagen and Zimmer, which was assigned to the
Company pursuant to the Intercompany Agreements. Under the terms of such
agreement, Zimmer has exclusive and perpetual distribution rights for Collagraft
in certain specified countries and territories (the "Zimmer Territory") and the
Company is required to pay Zimmer a royalty for Collagraft products sold by the
Company over a specified period. The Company has sole discretion as to whether
and how to market Collagraft outside of the Zimmer Territory and holds a license
to use, with the right to sublicense, Zimmer's Collagraft trademark to market
Collagraft outside of the Zimmer Territory and to seek trademark protection of
Collagraft in its own name. The Company expects to sell Collagraft in Europe,
Canada, and Australia in calendar 1999 through a network of independent
distributors. The Company and Zimmer have also agreed under the same agreement
to jointly perform research, development and clinical studies and to obtain
regulatory approvals for Collagraft and other products composed solely of a
bovine collagen component and a HA/TCP component. The Company is the sole owner
of all inventions, improvements, trade secrets and other proprietary rights and
know-how with respect to any collagen-based or biologically based materials or
biologically active factors used or incorporated in Collagraft and developed
pursuant to the agreement.

<PAGE> 6

Osteoarthritis. Osteoarthritis, also known as degenerative joint disease, is
the most prevalent form of arthritis in the United States. The Centers for
Disease Control and Prevention estimated in 1990 that seven million people in
the United States suffered significant limitations in their daily activities due
to the effects of osteoarthritis. A European feasibility study involving 30
patients was conducted by the Company in 1997. Significant pain reduction was
obtained with a single injection of NeuColl(TM), the Company's injectable
collagen intra-articular implant. The Company expects to conduct additional
clinical trials in Europe during fiscal 1999.

Bone Anchors. Bone anchors are used to anchor soft tissue to bone. The
Company is in the process of developing a bone anchor product with Innovasive
Devices, Inc. ("Innovasive Devices") pursuant to a research and development
agreement. Under the terms of such agreement, the parties have agreed to jointly
develop fully or partially resorbable mechanical meniscal repair devices and
mechanical tissue-to-bone fixation devices and the rights, title and interest in
any technology jointly developed are jointly owned. The parties have agreed that
until October 2000, neither party will develop or commence the development of
any such products independently, or in collaboration with, or purchase any such
products from, any third party. Under a related distribution agreement,
Innovasive Devices holds exclusive marketing rights to such product.

OTHER PRODUCT DEVELOPMENT PROGRAMS

Resorbable Sealant for Percutaneous Access Sites. The Company is researching
the use of its hemostatic and biosealant technology for sealing sites for
percutaneous catheter-based femoral artery cardiovascular procedures. It is
estimated that approximately 2.1 million diagnostic and therapeutic
catheter-based procedures are performed worldwide each year, in applications
including coronary angiography and percutaneous transluminal coronary
angioplasty. Research studies in canine models have indicated that both the
CoStasis and CoSeal technologies can achieve effective, rapid hemostasis in the
sealing of these access sites.

Recombinant Human Collagen and Thrombin. The Company's recombinant program is
focused on the development of recombinant human collagen and thrombin through
transgenic animals and yeast. The Company's objective is to obtain commercially
significant quantities of recombinant human type I collagen and thrombin to
serve as an alternative to bovine collagen and thrombin in its products. The
Company believes that by achieving this objective, it will be able to develop a
wider range of innovative surgical products for tissue repair and regeneration.
The Company has made an equity investment in and is actively collaborating with
Pharming, B.V. of The Netherlands for the purpose of developing recombinant
human collagen through transgenic animals. In addition, the Company has a
collaborative agreement with Genotypes, Inc. of South San Francisco, California,
to develop recombinant human collagen through yeast. The Company is working with
Genzyme Transgenics, Inc. to produce human thrombin through transgenic animals.

Adhesion Prevention Barriers. The Company is also developing CoStop, an
adhesion-prevention barrier, based on the Company's proprietary PEG-polymer
technology. Adhesion-prevention barriers are used to prevent the formation of
debilitating or painful internal tissue adhesions (or scars) after surgery. The
few products currently on the market suffer serious shortcomings, including low
efficacy, high cost, difficult handling, and ineffectiveness in the presence of
blood. The Company believes CoStop, with its PEG-polymer technology, will offer
superior efficacy, greater ease-of-use and lower cost, relative to products on
the market or known to be under development.

<PAGE> 7

The following table summarizes the status of the Company's products and
development programs:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
PRIMARY
PROGRAM/PRODUCT STATUS(1) PRIMARY EXPECTED APPLICATION
--------------------------------------------------------------------------------------
<S> <C> <C>
COSTASIS HEMOSTAT Europe: Pivotal clinical trial Cardiothoracic procedures
completed; CE Mark received in
September 1998

United States: Pivotal clinical General, hepatic, orthopedic
trial started in April 1998 and cardiothoracic procedures

--------------------------------------------------------------------------------------
COSEAL BIOSEALANT Feasibility clinical trials Cardiovascular and vascular
planned during fiscal 1999 procedures

--------------------------------------------------------------------------------------
ORTHOPEDICS
Collagraft Currently marketed; U.S. and Bone grafting applications
Implant Asian distribution through
Zimmer, Inc.

Distribution planned in Europe,
Canada, and Australia by the
Company expected in calendar
1999

NeuColl(TM) Clinical feasibility study Pain relief from
completed in Europe in 1997; osteoarthritis (degenerative
European clinical trials joint disease in bones)
planned through 1999

Bone Anchor Development Soft tissue fixation to bone

--------------------------------------------------------------------------------------
OTHER DEVELOPMENT
PROGRAMS

Resorbable Sealant Preclinical studies Percutaneous catheterization
for Percutaneous procedures
Catheter Access
Sites

Adhesion Preclinical studies General, gynecological,
Prevention orthopedic and cardiovascular
Barriers procedures

Recombinant Research Replacement for bovine
Human Collagen collagen and thrombin
and Thrombin
--------------------------------------------------------------------------------------
</TABLE>

(1) Indicates product development status. "Preclinical" denotes formulation and
efficacy studies in animal models necessary to support an application to
commence human clinical testing. "Research" includes discovery, research,
development of and subsequent identification of a candidate for preclinical
studies. The regulatory approval process requires successful completion of
many steps before a product is approved for commercialization. See "Risk
Factors -- Government Regulation" and "-- Government Regulation."

<PAGE> 8

RESEARCH AND DEVELOPMENT

The Company's research and development efforts are directed at achieving
continuing improvements in surgical products to achieve hemostasis, tissue
sealing and adhesion prevention. It has identified opportunities in using only
synthetic agents and recombinant proteins in product configurations and in
achieving superior sealant properties with advanced hemostatic potential at the
surgical site. In addition, future product development will utilize the
Company's proprietary technology platforms in the generation of tissue
engineering products for tissue repair, regeneration and replacement. Research
and development expenses for the years ended June 30, 1998, 1997, and 1996 were
$16.3 million, $9.6 million and $4.3 million, respectively.

MANUFACTURING

Pursuant to the Intercompany Agreements, Collagen supplies the Company's
requirements for Collagraft and Intermediate Products. The Company anticipates
that it will manufacture and package the final products for CoStasis and CoSeal
and that it will use outside contractors for other functions such as
non-proprietary, high-volume processes. The Company has approximately 12,000
square feet of manufacturing space in Palo Alto, California. There can be no
assurance that the Company will be able to attract, train and retain the
required personnel or will be able to increase its manufacturing capability to
manufacture commercial quantities of its planned products in a timely manner, or
at all. Manufacturers often encounter difficulties in scaling up production of
their products, including problems involving production yields, quality control
and assurance, component supply and shortages of qualified personnel, and the
Company may encounter similar problems. The Company can make no assurance that
its manufacturing scale-up efforts will be successful or that high-volume
manufacturing, if needed, can be established or maintained at commercially
reasonable costs on a timely basis, if at all. Any of these factors could have
an material adverse effect on the Company's ability to develop and commercialize
its products, which in turn would have a material adverse effect on the
Company's business, financial condition and results of operations. See "Risk
Factors -- Intense Competition" and "Limited Manufacturing Capacity."

The Company purchases raw materials used in its products from various
suppliers. For example, the Company purchases all of its requirements for
collagen materials from Collagen pursuant to the terms of the Intercompany
Agreements. These materials have generally been readily available in the
marketplace and have not been the subject of shortages. There can, however, be
no assurance that the Company or its suppliers or contract manufacturers will
not experience materials shortages in the future. The source of the collagen
supplied by Collagen is bovine dermis. Collagen uses a patented viral
inactivation process for its collagen-based products to promote both safety and
quality. Since 1987, Collagen has sourced the bovine dermis from a "closed herd"
of cattle in an effort to prevent diseases, such as Bovine Spongiform
Encephalopathy ("BSE"), a disease commonly known as mad cow disease, from
contaminating its collagen-based products. Maintaining a closed herd requires
the physical separation of the herd from other herds, the tracking of the
lineage of each animal and the maintenance of each animal under a veterinary
program. In the event of any material diminution in the size of the herd for any
reason, including accident or disease, Collagen would have a limited ability to
quickly increase supply of acceptable cattle. Any such diminution would have a
material adverse effect on the Company's ability to sell bovine collagen-based
products and, as a result, the Company's business, financial condition and
results of operations would be materially and adversely affected. Under the
Company's product development and distribution agreement with Zimmer, the
Company is required to purchase HA/TCP (hydroxyapatite/tricalcium phosphate)
solely from Zimmer for the manufacture of the Collagraft implant; provided,
however, the Company is released from such obligation if Zimmer is unable to
meet certain product specifications, Zimmer fails to supply the Company with a
certain percentage of its requirements for three consecutive months or an
alternative supplier becomes available at competitive prices which Zimmer is
unwilling to match. Any future shortages of materials or components could have a
material adverse effect on the Company's business, financial condition and
results of operations.

The Company, as well as any third-party manufacturers of its products, will
be subject to inspections by the FDA for compliance with applicable good
manufacturing practices ("GMPs"), recently codified in the quality system
regulation ("QSR") requirements, which include requirements relating to
manufacturing conditions,

<PAGE> 9

extensive testing, control documentation and other quality assurance procedures.
The Company's facilities have undergone an ISO inspection in preparation for
obtaining a CE Mark on its products. Despite these efforts, the Company can make
no assurance as to its ability to obtain all necessary FDA inspections of its
facility in a timely fashion, if at all. See " -- Government Regulation."

SALES, MARKETING AND DISTRIBUTION

The Company's planned core marketing, sales and distribution strategy
includes using a combination of a direct sales force and distributors. Initial
distribution in Europe is planned through geographically-focused, specialty
cardiovascular distributors with existing customer relationships and established
sales infrastructures. In the United States, the Company plans to target the
concentrated cardiovascular surgery segment with a direct sales force in an
effort to maximize operating margins and to consider additional distribution
arrangements for other surgical specialties, such as general surgery,
neurosurgery and orthopedics; however it can make no assurance as to the
effectiveness of such strategy. The Company's sales, marketing and distribution
plans will be dependent in part on the Company's ability to enter into
successful strategic relationships and hire, train and retain specialized
personnel. There can be no assurance that the Company will be able to secure
such strategic relationships or hire, train or retain specialized personnel on
terms that are attractive and acceptable to the Company, if at all.

While sales of Collagraft bone graft products to Zimmer in fiscal years 1998,
1997, and 1996 totaled $1.5 million, $1.9 million, and $3.1 million,
respectively, the Company can make no assurance regarding future sales levels.
Collagraft bone graft products are marketed in the United States and Asia by
Zimmer. The Company holds marketing rights for Collagraft bone graft products in
Europe, Canada, Australia, Africa and the Middle East and expects to begin
selling Collagraft in these markets during fiscal 1999 through a network of
independent distributors. Sales of Intermediate Products were not material in
fiscal 1998, 1997, and 1996. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and " -- Government Regulation."

COMPETITION

The Company competes with many domestic and foreign medical device,
pharmaceutical and biopharmaceutical companies and organizations across each of
its product categories and areas in which it is conducting research and
development activities. Many of these companies and organizations have or will
have substantially greater financial, technological, research and development,
regulatory and clinical, marketing, sales and personnel resources than the
Company. They may also have greater experience in developing products,
conducting clinical trials, obtaining regulatory approvals, and manufacturing
and marketing such products. They may also develop alternative technologies and
products that are more effective, easier to use or more economical than those
which have been or are being developed by the Company or that render the
Company's technology and products obsolete and non-competitive. Recently
developed technologies or procedures are, or may in the future be, the basis of
competitive products. There can be no assurance that the Company's current
competitors or other parties will not succeed in developing alternative
technologies and products that are more effective, easier to use or more
economical than those which have been or are being developed by the Company or
that would render the Company's technology and products obsolete or
uncompetitive. In such an event, the Company's business, financial condition and
results of operations would be materially and adversely affected. Competitors
may also obtain approval or clearance by the FDA or foreign regulatory approval
organizations, achieve product commercialization or obtain patent protection
earlier than the Company. Additionally, there can be no assurance that any
marketing or other strategic partners that the Company may engage will not
pursue parallel development of technologies or products relating to or
competitive with the Company's planned product portfolio. Also, to the extent
the Company commences manufacturing activities, it will also face competition
with respect to manufacturing efficiency and marketing capabilities, areas in
which it currently has limited experience. Failure of the Company to address the
foregoing factors and circumstances could have a material adverse impact on the
Company, its financial condition and results of operations.

<PAGE> 10

Hemostatic and Biosealant Devices. In the hemostatic and biosealant areas,
the Company believes in the United States it faces strong competition from
existing methodologies for controlling bleeding and sealing wounds resulting
from surgery, such as hemostatic powders and sponges, as well as from
collagen-based hemostats and traditional sutures and staples marketed by
companies such as Johnson & Johnson, United States Surgical Corporation and
American Home Products Corporation. In addition, the Company faces competition
from more recent products and technologies, such as those developed by Fusion
Medical Technologies, Inc. ("Fusion") and Focal, Inc. ("Focal"). Outside of the
United States, other competitive products currently being marketed include
fibrin sealants, sold in Europe and the Pacific Rim countries by Immuno AG and
Centeon L.L.C. In the United States, there are several fibrin sealants under
development, including those by the American Red Cross, Convatec, a subsidiary
of Bristol-Myers Squibb Company, Haemacure Corporation and V.I. Technologies,
Inc. (Vitex). Baxter Healthcare Corporation recently received FDA approval for a
fibrin sealant product. In addition to conventional fibrin sealants, there are a
number of other products in late-stage development using either collagen or
polymer technologies, made by Fusion and Focal, as well as another class of
sealants, cyanoacrylates.

The Company plans to develop a second-generation, non-fibrinogen dependent
biosealant which eliminates the need to collect and process plasma at the time
of surgery due to the Company's PEG polymer technology and which will offer
surgeons strong, easy-to-apply sealing in sensitive open and endoscopic surgery
situations. The Company plans to ultimately seek additional indications in
general surgery, urology and neurology. The Company believes that the
second-generation biosealants it currently has under development will largely
supersede fibrin sealants in adhesive applications and that patch or membrane
products will likely remain niche products compared to liquid and gel
formulations, because patch products are generally more difficult to handle and
apply than a liquid or gel, especially in minimally invasive surgery. Most
second-generation products under development are still in the preclinical stage
in the United States and overseas, with the exception of those being developed
by Focal, which is marketing its FocalSeal photoactivated polymer hydrogel
outside of the United States with Ethicon, Inc., a Johnson & Johnson subsidiary.

Orthopedics. Bone graft substitutes currently are used in a small fraction of
bone grafting procedures. The majority of bone grafting procedures currently use
autograft (autologous bone) taken from the patient's own body and allograft
(bone from bone banks taken from deceased donors). Collagraft bone graft
products belong to a new family of products called bone graft substitutes. The
most direct competitor to Collagraft bone graft products is ProOsteon, a
synthetic bone graft substitute made from coral, which is marketed by Osteotech,
Inc. A less direct competitor to Collagraft bone graft products is an allograft
bone product called Grafton, which is marketed by Interpore International, Inc.
Several companies and institutions are engaged in the development of
collagen-based and other materials, techniques, procedures and products for use
in medical applications anticipated to be addressed by Collagraft bone graft
products.

INTELLECTUAL PROPERTY

Collagen and the Company have entered into an Assignment and License
Agreement, effective January 1, 1998 (the "Assignment and License Agreement"),
which, among other things, allocates Collagen's technology and intellectual
property between the Company and Collagen. Pursuant to the Assignment and
License Agreement, substantially all of Collagen's technology and intellectual
property (including patents, copyrights, trademarks, and trade secrets), other
than technology relating to the breast implant technology, has been assigned to
the Company, and the Company has granted back to Collagen an exclusive,
worldwide, perpetual, fully-paid license to such assigned technology and
intellectual property that is used solely in the field of Collagen's business,
which consists of the development, manufacture, use, sale and other
commercialization of human aesthetics products, technologies and treatments,
breast implant products and processes, urinary incontinence products and
treatments and ostomy products. The Assignment and License Agreement provides
that each of the Company and Collagen may obtain certain rights to improvements
made by the other company prior to March 15, 2004, inasmuch as such
improvements, if any, are in the applicable party's field of business. In
addition, under the Assignment and License Agreement, each of the Company and
Collagen have covenanted to not compete with each other's business until March
15, 2004.

As of September 1998, the Company's patent portfolio includes approximately
280 U.S. and foreign issued

<PAGE> 11

patents and approximately 100 U.S. and non-U.S. patents pending. These patents
cover novel compositions of a variety of biomaterials and uses in various fields
of medicine. The patent portfolio has a strong focus on proprietary technology
in the fields of collagen compositions and hydrophilic polymers used for in situ
polymerization. The Company also holds several registered trademarks in the
United States and a number of foreign countries and pursues the protection of
its trademarks and service marks, whether or not such marks are registered.
Notwithstanding these measures, the Company can make no assurance as to the
effectiveness of its efforts and many of the Company's older patents covering
collagen-containing compositions have already begun to expire. However, the
majority of the Company's patent portfolio covers biomaterials that are tailored
for use in a particular manner, and these patents will not expire until well
into the next decade. In addition, the Company has a number of more recently
issued patents covering various methods of treatment using specific formulations
of biomaterials that will not expire for 15 or more years.

The Company has filed patent applications covering tissue adhesives,
biosealants, and adhesion prevention agents; however, it can make no assurance
that any such patents will issue, will provide the Company any competitive
advantages or will not be challenged by third parties.

The Company also relies upon trade secret protection for certain unpatented
aspects of its proprietary technology. There can be no assurance that others
will not independently develop or otherwise acquire substantially equivalent
proprietary information or techniques, that others will not otherwise gain
access to the Company's proprietary technology or disclose such technology, or
that the Company can meaningfully protect its trade secrets. The Company
requires its employees and consultants to execute appropriate confidentiality
and proprietary information agreements upon the commencement of an employment or
consulting relationship with it. These agreements generally provide that all
confidential information developed or made known to the individual by the
Company during the course of the individual's relationship with the Company is
to be kept confidential and not disclosed to third parties, except in specific
circumstances. The agreements also generally provide that all inventions
conceived by the individual in the course of rendering services to the Company
shall be the exclusive property of the Company; however, certain of the
Company's agreements with consultants, who typically are employed on a full-time
basis by academic institutions or hospitals, do not contain assignment of
invention provisions. There can be no assurance that these agreements will
provide meaningful protection or adequate remedies for the Company in the event
of unauthorized use, transfer or disclosure of such information or inventions.

The Company's success will depend on its ability to obtain patent protection
for its products, preserve its trade secrets, prevent third parties from
infringing upon its proprietary rights, and operate without infringing upon the
proprietary rights of others, both in the United States and internationally.
There can be no assurance that the Company's pending or future patent
applications will issue, or that the claims of the Company's issued patents, or
any patents that may issue in the future, will provide any competitive
advantages for the Company's products or that they will not be successfully
challenged, narrowed, invalidated or circumvented in the future. Moreover,
litigation and interference or opposition proceedings associated with obtaining,
enforcing or defending patents or trade secrets is expensive and can divert the
efforts of technical and management personnel. The Company has filed patent
applications in certain foreign countries corresponding to certain patent
applications that it has filed in the United States and may file additional
patent applications inside and outside the United States. The Company believes
that obtaining foreign patents may be more difficult than obtaining domestic
patents because of differences in patent laws and believes the protection
afforded by foreign patents or any other foreign intellectual property
protection, if obtained, may be more limited than that provided domestically. In
addition, there can be no assurance that competitors will not seek to apply for
and obtain patents that will prevent, limit or interfere with the Company's
ability to make, use, offer for sale, sell and import its products. The Company
is aware that certain medical device, pharmaceutical and other companies,
universities and research institutions have filed patent applications or have
issued patents relating to compositions and methods for wound closure and
adhesion prevention. In addition, the medical device and pharmaceutical
industries have been characterized by litigation regarding patents and other
intellectual property rights, and many companies in the medical device industry
have employed intellectual property litigation to gain a competitive advantage.
There can be no assurance that litigation will not be brought against the
Company by third parties in the future challenging the Company's patent rights
or claiming infringement by the Company of patents held by these or other third
parties.

<PAGE> 12

Because of the substantial length of time and expense associated with
bringing new products through the development and regulatory approval processes
in order to reach the marketplace, the medical products industry places
considerable importance on obtaining patent and trade secret protection for new
technologies, products and processes. While the Company intends to seek patent
protection for its proprietary technology, products and processes, there can be
no assurance as to the success or timeliness in obtaining any such patents, that
the breadth of claims obtained, if any, will provide adequate protection of the
Company's proprietary technologies, products and processes, or that the Company
will be able to adequately enforce any such claims to protect its proprietary
technology, products and processes. Because patent applications in the United
States are confidential until the patents issue, and publication of discoveries
in the scientific and patent literature tends to lag behind actual discoveries
by several months, the Company cannot be certain that Company inventors or
licensors were the first to conceive of inventions covered by pending patent
applications or that the Company was the first to file patent applications for
such inventions. The Company may desire or may be required to obtain licenses to
patents or proprietary rights of others. No assurance can be given that any
licenses required under any patents or proprietary rights of third parties would
be made available on terms acceptable to the Company, or at all. If the Company
does not obtain such licenses, it could encounter delays in product
introductions while it attempts to design around or otherwise avoid such
patents, or it could find that the development, manufacture or sale of products
requiring such licenses is foreclosed.

Litigation may be necessary to defend against or assert claims of patent
infringement or invalidity, to enforce or defend patents issued to the Company,
to protect trade secrets or know-how owned by the Company, or to determine the
scope and validity of the proprietary rights of others. In addition,
interference proceedings in the U.S. Patent and Trademark Office, or opposition
proceedings in a foreign patent office, may be necessary to determine the
priority of inventions with respect to patent applications of the Company or its
licensors. Litigation, interference or opposition proceedings could result in
substantial costs to and diversion of effort by the Company, and adverse
determinations in any such proceedings could prevent the Company from
manufacturing, marketing or selling its products and could have a material
adverse effect on the Company's business, financial condition and results of
operations.

The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with collaborative partners, vendors, suppliers,
employees and consultants. The Company also has invention or patent assignment
agreements with its employees and certain, but not all, commercial partners and
consultants. There can be no assurance that relevant inventions will not be
developed by a person not bound by an invention assignment agreement. There can
be no assurance that binding agreements will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known or be independently discovered by competitors.
See "Risk Factors -- Uncertainties Relating to Intellectual Property."

GOVERNMENT REGULATION

The Company's existing and proposed products, research and development and
planned commercialization activities are subject to regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. The Federal Food, Drug and Cosmetic Act, as amended
(the "FDC Act"), the regulations promulgated thereunder, and other federal and
state statutes and regulations, govern, among other things, the preclinical and
clinical testing, manufacturing conditions, device safety, efficacy, labeling
and storage, record keeping, advertising and the promotion of medical devices
and drugs. Product development and approval within this regulatory framework
take a number of years and involve the expenditure of substantial resources.

<PAGE> 13

obtain CE Mark certification. CE Mark certification is an international symbol
of adherence to quality assurance standards and compliance with applicable
European medical device directives. In the first half of 1998, the Company
completed a successful quality systems audit to the ISO 9001/EN46001 and Medical
Devices Directive requirements, which is one of the principal steps in the CE
Mark process. The remainder of the CE Mark process consists primarily of review
by the approving body of additional documentation submitted by the Company to
document each product's clinical safety and performance. Although a quality
system audit has been completed, there can be no assurance that the Company will
be successful in completing the remainder of the CE Mark certification process
or obtaining CE Mark certification in a timely manner, if at all.

In the United States, medical devices are classified into three different
classes (Class I, Class II and Class III) on the basis of controls deemed
necessary to reasonably ensure the safety and effectiveness of the device. Class
I devices are subject to general controls (relating to labeling, premarket
notification and adherence to the FDA's GMPs, as recently codified in the QSR
requirements. Class II devices are subject to general and special controls
(relating to performance standards, postmarket surveillance, patient registries,
and FDA guidelines). Class III devices are those which must receive premarket
approval by the FDA to ensure their safety and effectiveness. Class III devices
are generally life-sustaining, life-supporting and implantable devices, or new
devices which have been found not to be substantially equivalent to legally
marketed devices. Before a new medical device can be marketed, marketing
clearance must be obtained through a premarket notification under Section 510(k)
of the FDC Act or a premarket approval ("PMA") application under Section 515 of
the FDC Act. A 510(k) clearance will typically be granted by the FDA if it can
be established that the device is substantially equivalent to a "predicate
device," which is a legally marketed Class I or Class II device or a
preamendment Class III device (i.e., one that has been marketed since a date
prior to May 28, 1976) for which the FDA has not called for PMAs. The FDA has
been requiring an increasingly rigorous demonstration of substantial equivalence
and this demonstration may include a requirement to submit human clinical trial
data. It generally takes four to 12 months from the date of a 510(k) submission
to obtain clearance, but it may take longer. The FDA may determine that a
medical device is not substantially equivalent to a predicate device, or that
additional information is needed before a substantial equivalence determination
can be made. A "not substantially equivalent" determination, or a request for
additional information, could prevent or delay the market introduction of new
products that fall into this category. For any devices that are cleared through
the 510(k) process, modifications or enhancements that could significantly
affect the safety or effectiveness, or that constitute a major change in the
intended use of the device, will require new 510(k) submissions.

A PMA application must be filed if a proposed device is not substantially
equivalent to a legally marketed Class I or Class II device, or if it is a
preamendment Class III device for which the FDA has called for PMAs. A PMA
application must be supported by valid scientific evidence to demonstrate the
safety and effectiveness of the device, typically including the results of
clinical trials, bench tests, and laboratory and animal studies. The PMA must
also contain a complete description of the device and its components, and a
detailed description of the methods, facilities and controls used to manufacture
the device. In addition, the submission includes the proposed labeling,
advertising literature, and any training materials. The PMA can be expensive,
uncertain and lengthy, and a number of devices for which FDA approval has been
sought by other companies have never been approved for marketing. Upon receipt
of a PMA application, the FDA makes a threshold determination as to whether the
application is sufficiently complete to permit a substantive review. If the FDA
determines that the PMA application is sufficiently complete to permit a
substantive review, the FDA will accept the application for filing. Once the
submission is accepted for filing, the FDA begins an in-depth review of the PMA
application. The FDA review of a PMA application generally takes one to three
years from the date the PMA application is accepted for filing, but may take
significantly longer. The review time is often significantly extended by the FDA
asking for more information or clarification of information already provided in
the submission. During the review period, an advisory committee, typically a
panel of clinicians and others knowledgeable in the applicable field, may be
convened to review and evaluate the application and provide a recommendation to
the FDA as to whether the device should be approved. The FDA accords substantial
weight to the recommendation but is not bound by it. Toward the end of the PMA
application review process, the FDA generally will conduct an inspection of the
manufacturer's facilities to ensure compliance with applicable QSR requirements,
which include extensive requirements relating to product design, manufacturing
processes, testing, control documentation and other quality assurance
procedures.

<PAGE> 14

If the FDA evaluations of both the PMA application and the manufacturing
facilities are favorable, the FDA may issue either an approval letter or an
approvable letter, which usually contains a number of conditions that must be
met in order to secure final approval of the PMA application. When, and if,
those conditions have been fulfilled to the satisfaction of the FDA, the FDA
will issue a PMA letter, authorizing marketing of the device for certain
indications. If the FDA's evaluation of the PMA application or manufacturing
facilities is not favorable, the FDA will deny approval of the PMA application
or issue a "non-approvable" letter. The FDA may determine that additional
clinical trials are necessary, in which case the PMA application may be delayed
for one or more years while additional clinical trials are conducted and
submitted in an amendment to the PMA application. Modifications to a device that
is the subject of an approved PMA application, its labeling or manufacturing
process may require approval by the FDA of PMA supplements or new PMA
applications. Supplements to a PMA application often require the submission of
the same type of information required for an initial PMA application, except
that the supplement is generally limited to that information needed to support
the proposed change from the product covered by the original PMA application.

If human clinical trials of a device are required, either for a 510(k)
premarket notification or a PMA application, and the device presents a
"significant risk," the sponsor of the trial must file an investigational device
exemption ("IDE") application prior to commencing 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 by the FDA and one or
more appropriate Institutional Review Boards ("IRBs"), human clinical trials may
begin at a specific number of investigational sites with a specific number of
patients, as approved by the FDA. If the device presents a "nonsignificant risk"
to the patient, a sponsor may begin the clinical trial after obtaining approval
for the study by one or more appropriate IRBs, without the need for FDA review.
Submission of an IDE provides no assurance that the FDA will approve the IDE.
Even if the IDE is approved, there can be no assurance that the FDA will
determine that the data derived from the studies support the safety and efficacy
of the device or warrant the continuation of clinical studies. Sponsors of
clinical trials are permitted to sell investigational devices distributed in the
course of the study, provided such compensation does not exceed recovery of the
costs of manufacture, research, development and handling. An IDE supplement must
be submitted to and approved by the FDA before a sponsor or investigator may
make a change to the investigational plan that may affect its scientific
soundness or the rights, safety or welfare of human subjects.

The Company anticipates that its products currently in development will be
regulated as Class III medical devices and will require PMA prior to being
marketed in the United States. If this belief is true, the Company will need to
obtain for each of its products an IDE in order to conduct clinical trials in
the United States. There can be no assurance that the Company will receive Class
III medical device designation for its products or that it will be able to
obtain IDEs for each of its planned products or that data from such clinical
studies if and when commenced will demonstrate the safety and effectiveness of
the Company's product or will adequately support a PMA application.

If clearance or approval for a given product of the Company is obtained, such
product will be subject to pervasive and continuing regulation by the FDA. For
example, the Company will be subject to routine inspection by the FDA and will
have to comply with the host of regulatory requirements that usually apply to
medical devices marketed in the United States, such as labeling regulations,
applicable QSR requirements, the Medical Device Reporting ("MDR") regulations
(which require a manufacturer to report to the FDA certain types of adverse
events involving its products), and the FDA prohibitions against promoting
products for unapproved or "off-label" uses. Any failure by the Company to
comply with applicable regulatory requirements could result in the detention or
seizure of products, issuance of an enjoinment of future product activities and
the assessment of civil and criminal penalties against the Company, its officers
and its employees. Failure to comply with the regulatory requirements could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, regulations regarding the manufacture and
sale of the Company's products are subject to change. The Company cannot predict
the effect, if any, that such changes might have on its prospects, business,
financial condition or results of operations.

<PAGE> 15

breakthrough devices, tracking and postmarket surveillance, accredited third
party review, and the dissemination of off-label information. The Company cannot
predict how or when these changes will be implemented or what effect the changes
will have on the regulation of the Company's products.

Although the Company anticipates that its products in development will be
classified by the FDA as medical devices, in the event that a given product is
classified by the FDA as a drug, it will require FDA approval of a new drug
application ("NDA") prior to commercialization in the United States. The NDA
process is generally more onerous, costly and lengthy than the PMA process,
often requiring more extensive preclinical and clinical testing. Many products
for which NDAs have been submitted by other companies have never been approved
for marketing. Before clinical studies of a new drug can begin, an
investigational new drug ("IND") application must be submitted to the FDA. FDA
regulations provide that human clinical trials may begin 30 days following
submission of an IND application, unless the FDA advises otherwise or requests
additional information, clarification or additional time to review the
application. An IND application contains extensive preclinical data and
information about the drug. There can be no assurance that the Company will
develop sufficient data and information to submit an IND for its products or
that such data and information if submitted, would be sufficient for the
purposes of commencing clinical studies of the products. Delays in the receipt
of or failure to obtain FDA authorization to begin or continue clinical trials
could have a material adverse effect on the Company's business, financial
condition or results of operations.

The FDA regulates the manufacturing, product testing, and marketing of both
medical devices and drugs. Manufacturers of drugs are required to comply with
applicable GMP and, in the case of medical devices, QSR requirements, which
include requirements relating to product design, manufacturing processes,
product testing, and quality assurance, as well as the corresponding maintenance
of records and documentation. There is no assurance that the Company will be
able to comply with the applicable QSR requirements. In addition, the Company is
required to provide information to the FDA on death or serious injuries alleged
to have been associated with the use of its medical devices, as well as product
malfunctions that would likely cause or contribute to death or serious injury if
the malfunction were to recur. Failure of the Company to comply with QSR
regulations, or other FDA regulatory requirements, could have a material adverse
effect on the Company's business, financial condition, or results of operations.

CoStasis contains thrombin, which is a FDA-licensed biological drug.
Consequently, the FDA considers CoStasis to be a combination product subject to
jurisdiction by CBER and CDRH. The FDA has assigned lead review responsibility
to CDRH following a "Request for Designation" determination by the FDA in
September 1996. The Company believes that this decision was significant, as
fibrin sealants containing human plasma are regulated as biological drugs, which
may substantially increase the duration and complexity of their regulatory
approval processes compared to that of CoStasis. Although CoStasis is considered
to be a combination product, consistent with lead review responsibility being
assigned to CDRH, the product will be regulated primarily as a device.
Consequently, the Company has filed an IDE application for CoStasis, and it is
currently conducting clinical studies pursuant to the IDE. If the clinical data
collected from these studies is satisfactory, the Company will file a PMA
application with the FDA seeking marketing approval for CoStasis. There can be
no assurance that the data from these studies will demonstrate the safety and
effectiveness of CoStasis to the satisfaction of the FDA, and consequently there
can be no assurance that CoStasis will be approved for commercial marketing by
the FDA.

With respect to CoSeal, the Company believes that the product will be
regulated by the FDA as a medical device because similar biosealant products of
other manufacturers have been classified and regulated as medical devices by the
FDA. The Company expects to begin feasibility clinical studies of CoSeal during
fiscal 1999, after filing an IDE application with the FDA, and would expect to
seek marketing clearance from the FDA at the conclusion of those studies. The
Company expects that the pathway towards marketing clearance will require the
filing of a PMA application with the FDA, although there is a possibility based
on prior administrative precedents that the FDA will agree to review CoSeal as a
510(k) premarket notification. In any event, there can be no assurance that the
FDA will agree that the clinical study results, once submitted, will have
adequately demonstrated the safety and effectiveness of CoSeal.

The collagen used in the Company's products is derived from the cow hides of
U.S. cattle. Bovine Spongiform Encephalopathy or BSE was initially reported in
cattle in the United Kingdom, characterized by

<PAGE> 16

degenerative lesions of the central nervous system. The source of infections in
animals derives from eating infected sheep-derived feed. While the disease has
been reported in European countries, the Company is not aware of any reports of
BSE in U.S. cattle to date, and, currently the Company relies on a "closed herd"
of U.S. cattle for its bovine collagen-based products. There can be no assurance
that the various foreign or domestic regulatory authorities will not raise
issues regarding BSE or other matters which may adversely affect the Company's
ability to manufacture, market or sell its bovine collagen-based products, which
could have a material and adverse effect on the Company's business, financial
condition and results of operations.

THIRD PARTY REIMBURSEMENT

Reimbursement and health care payment systems in international markets vary
significantly by country. In connection with international product
introductions, the Company and any future strategic marketing partners may be
required to seek international reimbursement approvals. If required, there can
be no assurance that any such approvals will be obtained in a timely manner, or
at all, and failure to receive such international reimbursement approvals could
have an adverse effect on market acceptance of the Company's products in the
international markets in which such approvals are sought.

In the United States, health care providers, such as hospitals and
physicians, which purchase medical devices such as the Company's products,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or part of the
cost of surgical procedures. The Company anticipates that in a prospective
payment system, such as the diagnostic-related group ("DRG") system utilized by
Medicare, and in many managed care systems used by private health care payors,
there will be no separate, additional reimbursement for the Company's products
and therefore no assurance that reimbursement for the Company's products will be
available. Accordingly, the Company believes that there will be no
procedure-specific reimbursement codes for the Company's products and therefore
no assurance that reimbursement for the Company's products will be available in
the United States or in international markets under either governmental or
private reimbursement systems. Furthermore, the Company could be adversely
affected by changes in reimbursement policies of governmental or private health
care payors. Failure by physicians, hospitals and other users of the Company's
products to obtain sufficient reimbursement from health care payors for
procedures in which the Company's products are used or adverse changes in
governmental and private third party payors' policies toward reimbursement for
such procedures would have a material adverse effect on the Company's business,
financial condition and results of operations. The Company's business may also
be materially and adversely affected by the continuing efforts of government and
third-party payors to contain or reduce the costs of health care through various
means. See "Risk Factors -- Third Party Reimbursement."

PRODUCT LIABILITY AND INSURANCE

The development, manufacture and sale of the Company's products may expose
the Company to product liability claims. Although to date no claim has been
asserted against the Company, there can be no assurance that the Company will
not experience losses due to product liability claims in the future. Although
the Company currently has general liability insurance with coverage in the
amount of $1 million per occurrence, subject to a $2 million annual limitation,
and product liability insurance with coverage in the amount of $5 million per
occurrence, subject to a $5 million annual limitation, there can be no assurance
that such coverage will be available to the Company in the future on reasonable
terms, if at all. In addition, there can be no assurance that all of the
activities encompassed within the Company's business are or will be covered
under the Company's policies. The Company may require additional product
liability coverage if the Company significantly expands commercialization of its
products. Such additional coverage is expensive, difficult to obtain and may not
be available in the future on acceptable terms, if at all. Any claims or series
of claims against the Company, regardless of their merit or eventual outcome,
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Risk Factors -- Potential Product
Liability Exposure; Limited Insurance Coverage."

<PAGE> 17

EMPLOYEES

As of September 15, 1998, the Company had 73 employees, 32 of whom were
engaged directly in research and new product development, ten in regulatory
affairs, quality assurance and clinical activities, 14 in manufacturing, three
in sales and marketing and 14 in finance and administration. The Company
maintains compensation, benefits, equity participation, and work environment
policies intended to assist in attracting and retaining qualified personnel. The
Company believes the success of its business will depend, in significant part,
on its ability to attract and retain such personnel. No employee of the Company
is represented by a collective bargaining agreement, nor has the Company
experienced any work stoppage. The Company considers its relations with its
employees to be good. See "Risk Factors -- Uncertainty of Ability to Attract and
Retain Key Management, Employees and Consultants."

ITEM 2. PROPERTIES

The Company's principal executive, research and development, marketing, and
manufacturing activities presently are located in two buildings in Palo Alto,
California. The Company leases approximately 55,000 square feet of facilities
under agreements that expire between 1999 and 2004 and contain renewal options.
The Company believes that its facilities are adequate to meet its requirements
through the end of fiscal year 2000.

ITEM 3. LEGAL PROCEEDINGS

The Company is currently involved in legal actions arising in the ordinary
course of business. While the outcome of such matters is currently not
determinable, it is management's opinion that these matters will not have a
material adverse effect on the Company's consolidated financial position or
results of its operations.

ITEM 4. RESULTS OF VOTES BY SECURITY HOLDERS

During the Company's fourth quarter ended June 30, 1998, its sole
stockholder Collagen Corporation approved by unanimous written consent (i) on
April 30, 1998 the adoption of the Company's 1998 Stock Option Plan, the 1998
Employee Stock Purchase Plan and the 1998 Directors' Stock Option Plan and (ii)
on June 25, 1998 the amendment and restatement of the Company's Certificate of
Incorporation.

<PAGE> 18

PART II

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

MARKET FOR COMMON STOCK

The Company's Common Stock began trading on The Nasdaq Stock Market under
the symbol CSON as of August 19, 1998. There was no public market for the Common
Stock prior to that date. As of September 18, 1998, the high and low stock price
since the initial trading date has been $5.625 and $3.00 per share,
respectively.

SALES OF UNREGISTERED SECURITIES

The Company has not engaged in any sale of unregistered securities.

HOLDERS OF RECORD

At September 15, 1998 there were approximately 845 holders of record of the
Company's Common Stock.

DIVIDENDS

The Company as a stand-alone company has never paid any cash dividends and
does not anticipate paying cash dividends in the foreseeable future. However,
the financial information set forth in this Form 10-K is theoretical in nature,
as if the Company had been a stand-alone company during the periods for which
financial information is presented, rather than a wholly owned subsidiary of
Collagen.

<PAGE> 19

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

COHESION TECHNOLOGIES, INC.

The tables below set forth selected historical financial data of the
Company. This information has been prepared from the audited consolidated
financial statements of the Company as of June 30, 1998 and 1997 and for each of
the three years in the period ended June 30, 1998 included herein. Financial
information as of June 30, 1996 and for the year ended June 30, 1995, has been
prepared from audited consolidated financial statements not included herein.
Financial information as of June 30, 1995 and 1994 and for the year ended June
30, 1994, has been prepared from unaudited consolidated financial statements not
included herein. During these periods, the Company was wholly owned by Collagen.
The historical financial information may not reflect the Company's future
performance or the future financial position or results of operations of the
Company, nor does it provide or reflect data as if the Company had actually
operated as a separate, stand-alone entity during the periods covered.

Historical share and per share data for each of the five years in the
period ended June 30, 1998 has not been presented as no common shares were
outstanding until June 25, 1998. Pro forma share and per share data has been
presented for each of the two years in the period ended June 30, 1998 assuming
the distribution of shares of the Company's Common Stock to Collagen's
stockholders had already occurred based on the number of Collagen common shares
and common equivalent shares outstanding for those periods, assuming a
one-for-one exchange ratio in the distribution.

The selected historical financial data should be read in conjunction with
the consolidated financial statements and related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
included elsewhere in this Annual Report. In the opinion of the Company's and
Collagen's management, the unaudited consolidated financial statements as of
June 30, 1995 and 1994 and for the year ended June 30, 1994 contain all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the financial position and results of operations for these
periods.

<PAGE> 20

COHESION TECHNOLOGIES, INC.

SELECTED CONSOLIDATED
FINANCIAL DATA (CONTINUED)

(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue -- product sales................ $ 2,043 $ 2,527 $ 3,612 $ 3,546 $ 4,302
Costs and expenses:
Cost of sales......................... 1,162 2,105 2,404 1,961 1,991
Research and development.............. 16,251 9,627 4,268 3,416 3,284
General and administrative............ 5,526 7,153 3,120 2,726 2,815
Purchased in-process research and
development.......................... 10,587 -- 3,000 -- --
-------- -------- ------- ------- -------
Total costs and expenses....... 33,526 18,885 12,792 8,103 8,090
-------- -------- ------- ------- -------
Loss from operations.................... (31,483) (16,358) (9,180) (4,557) (3,788)
Other income (expense):
Net gain on investments, principally
Boston Scientific Corporation
(Target Therapeutics, Inc.
("Target") prior to April 1997)... 19,096 9,063 82,093 5,110 --
Net gain on sale of investment in
Prograft Medical, Inc............... -- 15,395 -- -- --
Equity in earnings of Target(1)....... -- -- 1,430 2,417 1,675
Equity in losses of other affiliates.. (9) (813) (1,824) (1,230) (762)
Interest income....................... 332 566 378 25 25
Interest expense...................... -- (377) (2,532) (2,113) (1,530)
-------- -------- ------- ------- -------
Income (loss) before provision for
income taxes and minority interest.... (12,064) 7,476 70,365 (348) (4,380)
Provision (benefit) for income taxes.... (2,497) 3,162 31,718 553 (475)
Minority interest....................... -- (667) (27) -- --
-------- -------- ------- ------- -------
Net income (loss)....................... $ (9,567) $ 4,981 $38,674 $ (901) $(3,905)
======== ======== ======= ======= =======

Pro forma net income (loss)
per share - Basic(2).................. $ (1.07) $ .57

Pro forma net income (loss)
per share - Diluted(2)................ $ (1.07) $ .56

Shares used in calculating per share
information - Basic(2)................ 8,913 8,804
Shares used in calculating per share
information - Diluted(2).............. 8,913 8,930
</TABLE>

<TABLE>
<CAPTION>
JUNE 30,
---------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments $ 1,607 $ 13,798 $11,074 $ 491 $ 497
Working capital (deficiency) (1,900) 12,033 8,463 (30,530) (25,802)
Investment in Boston Scientific
Corporation (Target prior to 1997)(1) . 73,979 83,874 65,841 17,570 17,499
Total assets 95,653 114,604 97,916 32,915 30,328
Long-term liabilities 31,923 35,131 27,260 8,206 7,413
Total stockholder's and parent company
equity (net capital deficiency) 58,415 74,005 59,545 (8,560) (5,732)
</TABLE>

- ---------

(1) The first five months in fiscal 1996 and the 1994 and 1995 financial
information is presented with Target accounted for under the equity method.

(2) Historical per share data has not been presented as no Cohesion common
shares were outstanding until June 25, 1998. Pro forma share and per
share data has been presented assuming the distribution of shares of the
Company's Common Stock to Collagen's stockholders had already occurred based
on the number of Collagen common shares and common equivalent shares
outstanding for those periods, assuming a one-for-one exchange ratio in the
distribution.

<PAGE> 21

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

OVERVIEW

The following discussion should be read in conjunction with the Consolidated
Financial Statements and the related notes and the other information included
elsewhere in this Annual Report. Certain statements in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations" are
forward-looking. The forward-looking statements contained herein are based on
current expectations and entail various risks and uncertainties that could cause
actual results to differ materially from those expressed in such forward-looking
statements. For a more detailed discussion of these and other business risks,
see "-- Risk Factors."

Cohesion Technologies, Inc. ("Cohesion" or the "Company") was organized as a
Delaware corporation and wholly owned subsidiary of Collagen Aesthetics, Inc.
formerly known as Collagen Corporation ("Collagen") in June 1997. In October
1997, Collagen announced that it would proceed to separate its Aesthetic
Technologies Group and its Collagen Technologies Group ("CTG") into two
independent, publicly-traded companies. Effective January 1, 1998, Collagen
contributed its research and development programs for hemostatic devices,
biosealants, orthopedics products and programs, adhesion barriers and
recombinant human collagen and thrombin and other related businesses of CTG (the
"Transferred Businesses") to the Company. Collagen also contributed various
equity investments to the Company, including all of its holdings in Boston
Scientific and Innovasive, which had an aggregate market value of $81.9 million
at June 30, 1998. In connection with the separation of the two groups, Collagen
distributed as a dividend to its stockholders on August 18, 1998, one share of
the Company's Common Stock for each share of Collagen common stock outstanding,
(the "Distribution"). The Company and Collagen have entered into various
agreements (the "Intercompany Agreements") to provide for an orderly transition
of matters and to govern certain ongoing matters between the two entities and
provide a mechanism for transitioning license, supply, distribution, research
and development, tax, service and other agreements in connection with the
Distribution. A description of the assets and liabilities contributed by
Collagen to the Company is contained in Note 1 of Notes to Consolidated
Financial Statements.

The Company's historical financial position and results of operations reflect
the historical operations of the Transferred Businesses contributed by Collagen
to the Company. Prior to being contributed to the Company by Collagen, the
Transferred Businesses were part of the Collagen Technologies Group. In
particular, this Management's Discussion and Analysis of Financial Condition and
Results of Operations reflects the historical results of that operating group
for all years presented as if the contribution of the Transferred Businesses by
Collagen to the Company had occurred on July 1, 1992. (See Note 1 of Notes to
Consolidated Financial Statements.)

The Company is focused on developing and commercializing proprietary surgical
products, including bioresorbable hemostatic devices and biosealants for tissue
repair and regeneration, to increase the effectiveness of and minimize
complications following open and minimally invasive surgeries. CoStasis surgical
hemostat, the Company's lead hemostatic product, is designed for use initially
in cardiothoracic indications. The Company completed a multi-site, randomized,
pivotal clinical trial in Europe and has filed for a CE Mark. The Company has
received an IDE from the FDA and has commenced U.S. pivotal trials targeting
cardiac, hepatic, orthopedic and general surgery indications. CoSeal(TM)
surgical sealant, the Company's lead biosealant product designed for sealing
organs and other tissues resulting from surgical wounds and incisions, is
expected to commence feasibility clinical trials during fiscal 1999. The Company
believes its surgical products will provide several distinct advantages over
currently available technologies, including ease of preparation and use, novel
delivery systems, improved safety profiles and clinical effectiveness. The
Company also sells Collagraft implant, an orthopedic product, and has research
and development programs in other orthopedic areas and in recombinant human
collagen and thrombin. The Company's products and programs are based on a
platform of proprietary technologies centered around collagen and hydrophilic
polymers that quickly polymerize in-vivo and bind to tissue.

<PAGE> 22

RESULTS OF OPERATIONS

Fiscal Years Ended June 30, 1998, 1997 and 1996

Revenues were $2.0 million, $2.5 million and $3.6 million for fiscal years
1998, 1997 and 1996, respectively. Sales of Collagraft in fiscal 1998 were $1.5
million, a decrease of $400,000 from fiscal 1997 sales of $1.9 million. Fiscal
1997 sales of Collagraft were $1.9 million, a decrease of $1.2 million or 39%
from fiscal 1996 sales of $3.1 million. The decreases in sales were due to lower
sales of Collagraft by Zimmer and the consequent decrease in sales from the
Company to Zimmer. The Company expects sales of Collagraft in fiscal 1999 to be
at levels slightly higher than those of fiscal 1998 due to anticipated product
launches by Zimmer in Japan and by the Company in certain European countries.

A number of uncertainties exist surrounding the marketing and distribution of
Collagraft bone graft products. The Company's primary means of distribution for
the products is through Zimmer, a third party firm. The Company's business and
financial results could be adversely affected in the event that Zimmer is unable
to market the product effectively, anticipate customer demand accurately, or
effectively manage industry-wide pricing and cost containment pressures in
health care.

Cost of sales as a percentage of sales was 57%, 83%, and 67% for fiscal years
1998, 1997 and 1996, respectively. The decrease in cost of sales as a percentage
of sales in fiscal 1998 from 1997 was primarily due to a lower allocation of
fixed overhead in relation to the total cost of production at Collagen's
manufacturing facility. The smaller volume of Collagraft products relative to
the quantities of other collagen-based products is the reason for the change in
the allocation of fixed overhead. The increase in cost of sales as a percentage
of sales in fiscal 1997 over 1996 was due primarily to higher unit costs. Cost
of sales as a percentage of sales for fiscal 1999 is expected to be lower as
cost of sales will reflect a full year's impact of the supply agreement with
Collagen, which provides for cost to be determined on a defined formula.

Research and development ("R&D") expenses were $16.3 million, $9.6 million,
and $4.3 million for fiscal 1998, 1997 and 1996, respectively. R&D spending
represents program-specific costs and other indirect R&D costs related to the
Transferred Businesses and allocated to the Company. The allocation of indirect
costs is based on headcount associated with specific R&D programs and specific
identifiable costs. The increase in R&D spending in fiscal 1998 from 1997
primarily was due to clinical trial costs for the tissue adhesive program and
increased activity in the biosealant and recombinant human collagen programs,
including contractual payments owed to Pharming when program milestones were
met. The increase in fiscal 1997 from 1996 was primarily attributable to the
inclusion of a full year of R&D expenses for the tissue adhesive and biosealant
programs as a result of Collagen increasing its ownership percentage in Cohesion
Corporation to 81% in May 1996, and, to a lesser extent, to efforts in the
recombinant human collagen and orthopedic programs in fiscal 1997. The Company
expects R&D spending in fiscal 1999 to be at levels higher than fiscal 1998 as a
result of increased activities in these programs.

General and administrative ("G&A") expenses were $5.5 million, $7.2 million
and $3.1 million in fiscal 1998, 1997, and 1996, respectively. G&A costs
represent an allocation of Collagen's expenses to the Company derived primarily
as a function of headcount and specific identifiable costs. The decrease in
spending in fiscal 1998 was due to lower officer separation costs and legal fees
as a result of the settlement of a lawsuit with Matrix Pharmaceuticals, Inc.
("Matrix"). G&A expenses increased $4.1 million or 129%, from fiscal 1996 to
fiscal 1997, due primarily to payments made to Collagen's former Chief Executive
Officer, Howard Palefsky, in accordance with Mr. Palefsky's separation agreement
and costs associated with existing loans to Mr. Palefsky, which payments and
costs were allocated to the Company pursuant to the Intercompany Agreements. By
agreement, Mr. Palefsky will continue to serve as a consultant during the next
two years and provide general strategic advice, especially with respect to
stockholder value, as well as operational advice. The Company made cash payments
of $575,000 and $752,000 to Mr. Palefsky in fiscal 1998 and 1997, respectively,
and will make cash payments to Mr. Palefsky during fiscal 1999 totaling
$233,000. The Company also agreed to forgive all indebtedness, aggregating $1.6
million, owed by Mr. Palefsky to Collagen (and assumed by the Company effective
January 1, 1998) subject to certain conditions. (See Note 1 of Notes to
Consolidated Financial Statements.) Such indebtedness was fully reserved during
fiscal 1997. The increase in fiscal 1997 spending was also attributed to legal
expenses incurred in connection with a lawsuit with Matrix. In May 1997,
Collagen

<PAGE> 23

settled its lawsuit with Matrix, which had been pending since December 1994. The
lawsuit involved Collagen's claims of trade secret misappropriation against
Matrix and two former Collagen employees hired by Matrix in 1992, as well as
cross-complaints against Collagen by Matrix and the two employees for defamation
and violation of state unfair competition law. Collagen granted Matrix a
nonexclusive license to certain intellectual property (which was transferred to
the Company effective January 1, 1998) for certain nonmonetary consideration.
The lawsuit was settled and dismissed with prejudice. All claims by and against
all parties have been released. G&A expenses are expected to remain relatively
constant in fiscal 1999 due to reductions in costs associated with the
Distribution, and expenses associated with Mr. Palefsky, offset by anticipated
increased expenses associated with operating as a public company. Future levels
of G&A spending will depend on various factors, including the level of product
sales.

The charge for purchased in-process research and development ("in-process
R&D") of $10.6 million in fiscal 1998 was a non-recurring charge related to the
purchase of substantially all of the remaining shares in Cohesion Corporation,
including cash compensation expense of approximately $3.8 million associated
with the purchase of certain vested employee stock options. The charge for
purchased in-process R&D of $3.0 million in fiscal 1996 related to the increase
in ownership in Cohesion Corporation by Collagen from approximately 40% to 81%.
The Company expects to incur additional compensation expense in connection with
the cancellation of the remaining stock options of Cohesion Corporation. In
September 1998, the Company's Board of Directors approved a program to cancel
options to purchase shares of the common stock of Cohesion Corporation (the
"Canceled Options"). In connection with such program, the Company will offer to
pay each holder of Canceled Options a per share amount equal to the excess of
$16.70 over the exercise price of the Canceled Option (the "Option Payment").
The Company will make this Option Payment ratably over the original vesting
period of the Canceled Option so long as the holder thereof remains an employee
or consultant of the Company or Cohesion Corporation. Assuming the option
holders agree to the option cancellation plan, the Company expects to record
compensation expense of approximately $1.7 million in the quarter ended
September 30, 1998, in connection with vested options and an additional $3.9
million of compensation expense to be recognized during the next three fiscal
years.

Gains on sales of investments were $19.1 million, $24.4 million and $82.1
million in fiscal 1998, 1997 and 1996, respectively. In fiscal 1998, the Company
sold 332,340 shares of common stock of Boston Scientific Corporation ("Boston
Scientific") stock resulting in a gain of $19.0 million and cash proceeds of
$20.4 million. Subsequent to June 30, 1998, the Company sold 125,000 shares of
Boston Scientific common stock which provided cash proceeds of $9.6 million. In
April 1997, Target Therapeutics, Inc. ("Target") was acquired by Boston
Scientific and, as a result, Collagen received approximately 1,365,200 shares of
Boston Scientific common stock. In fiscal 1996, the Company recorded a net
pre-tax gain on investments of $82.1 million (after the recording of a $4.0
million reduction in the carrying value of certain equity investments due to a
decline in value determined to be other than temporary), resulting primarily
from the sale of 1,792,000 shares of Target common stock. In fiscal 1997, the
Company's net pre-tax gain on investments of $24.4 million, primarily resulted
from the sale of 330,000 shares of Target common stock and the sale of the
Company's holdings in Prograft Medical, Inc. ("Prograft") to W.L. Gore and
Associates, Inc. The timing and number of additional shares of Boston Scientific
common stock sold will depend on market conditions and the anticipated cash
needs of the Company.

Equity in earnings of Target were $1.4 million in fiscal 1996. In December
1995, when Collagen's ownership interest fell below 20%, Collagen changed from
the equity to the cost method of accounting for its investment in Target.

Equity in losses of other affiliate companies were $9,000, $813,000 and $1.8
million for fiscal 1998, 1997 and 1996, respectively. The decreases in equity
losses in fiscal 1998 and 1997 were due to the elimination of equity losses from
Cohesion Corporation as a result of Collagen increasing its ownership percentage
to 81% in May 1996 and such losses being consolidated thereafter.

Interest income was $332,000, $566,000 and $378,000 in fiscal 1998, 1997 and
1996, respectively. The decrease in 1998 was due to lower average cash, cash
equivalent, and short-term investment balances in fiscal 1998. The increase in
fiscal 1997 was due primarily to higher average cash, cash equivalent, and
short-term investment balances and higher interest rates.

<PAGE> 24

Interest expense was $0, $377,000 and $2.5 million in fiscal 1998, 1997 and
1996, respectively. Interest expense in fiscal 1997 related only to borrowings
under Collagen's $15.0 million revolving credit facility. The revolving line of
credit was allocated to the Company because the credit facility was secured by
shares of Target common stock, which were also allocated to the Company.
Interest expense in fiscal 1996 related primarily to borrowings under the $15.0
million revolving credit facility, which was paid in full and canceled in June
1997, and interest on parent company borrowings.

The Company recorded a benefit for income taxes of 21% for fiscal 1998. The
tax benefit is primarily due to the in-process research and development charges
related to the increase in ownership of Cohesion Corporation which is not
deductible for tax purposes. The Company's effective income tax rate was
approximately 42% for fiscal 1997 compared to 45% for fiscal 1996. The higher
effective tax rate in fiscal 1996 primarily was due to the impact of
non-deductible items such as equity losses in affiliates and in-process research
and development charges related to the increase in ownership of Cohesion
Corporation.

LIQUIDITY AND CAPITAL RESOURCES

On January 1, 1998, Collagen contributed to the Company, cash, cash
equivalents and short-term investments of $1.8 million, certain equity
investments, including Boston Scientific common stock and common stock of
Innovasive Devices, Inc. as well as the agreement with Zimmer regarding the
distribution of Collagraft products. The Company expects to rely upon proceeds
from the sale of these investments, as well as revenues from the sale of
Collagraft, for future working capital, capital expenditures and other corporate
purposes. The Company had a $5.0 million loan outstanding on a $15.0 million
revolving credit facility during fiscal 1996 and 1997; however, the balance was
paid in full and canceled in June 1997.

At June 30, 1998, cash, cash equivalents and short-term investments were $1.6
million compared to $13.8 million at June 30, 1997. Net cash used in operating
activities was $19.0 million, $6.1 million and $6.5 million for fiscal 1998,
1997 and 1996, respectively.

For the year ended June 30, 1998, cash provided by investing activities of
$5.9 million primarily related to proceeds of $20.4 million (net of taxes paid)
from the sale of 332,340 shares of Boston Scientific common stock and proceeds
of approximately $704,000 from the sale of shares in affiliates, partially
offset by the acquisition of substantially all of the remaining outstanding
shares of Cohesion Corporation totaling $10.6 million and capital expenditures
and investments in and loans to affiliates of $3.8 million. Subsequent to June
30, 1998, the Company sold 125,000 shares of Boston Scientific common stock
which provided cash proceeds of $9.6 million. The Company anticipates capital
expenditures, equity investments in, and loans to affiliate companies to be
approximately $6.0 million in fiscal 1999.

The Company's principal sources of liquidity include sales of Boston
Scientific common stock and its cash, cash equivalents and short-term
investments. During fiscal 1998, 1997 and 1996, the Company sold an aggregate of
3,312,500 shares of Target common stock (adjusted for a two-for-one stock split)
for an aggregate pre-tax gain of approximately $101.1 million ($116.6 million
proceeds less cost basis of $15.5 million). As a result of the acquisition of
Target by Boston Scientific in April 1997, Collagen received approximately
1,365,200 shares of Boston Scientific common stock in exchange for Collagen's
1,275,888 shares of Target common stock. The Company anticipates that stock
sales will be made from time to time, with the objective of generating cash for,
among other things, further investments in both current and new affiliate
companies. The Company may defer sales of Boston Scientific common stock for tax
planning purposes, although decisions concerning prospective Boston Scientific
common stock sales will also be affected by the then-current market price of
Boston Scientific common stock. As another source of financing, the Company may
in the near term establish a credit facility, although there can be no assurance
that a line of credit will be available to the Company on acceptable terms, if
at all.

In September 1998, the Company's Board of Directors approved a stock
repurchase program to buyback up to 1.0 million shares of the Company's Common
Stock at a price of up to $4.25 per share. As of September 21,

<PAGE> 25

1998, the Company had repurchased 50,000 shares of Common Stock under this
program.

The Company's capital requirements will depend on numerous factors, including
the progress of the Company's clinical research and product development
programs, the extent to which the Company enters into collaborative
relationships with third parties and the scope of the Company's obligations in
such relationships, the receipt of, and the time required to obtain, regulatory
clearances and approvals, the resources required to protect the Company's
intellectual property and other factors. The timing and amount of such capital
requirements cannot be accurately predicted.

The Company believes that its current sources of liquidity should be adequate
to fund its anticipated capital requirements through at least the next two
years. However, during this period and thereafter, the Company may require
additional financing. The Company does not anticipate significant capital
expenditures in the near term; however, it may make investments in businesses
and technologies that are necessary to support its objectives. There can be no
assurance that additional financing will be available to the Company on
acceptable terms, if at all.

INVESTMENTS, ACQUISITIONS AND LICENSING AGREEMENTS

Collagen increased its ownership position in Cohesion Corporation from
approximately 40% to 81% in May 1996 and from 81% to approximately 99% in
December 1997. In connection with Collagen's May 1996 and December 1997
investments and purchases of Cohesion Corporation shares, substantially all of
the $3.0 million and $10.6 million purchase prices, respectively, were allocated
to in-process research and development, which was expensed at the time of the
purchases. The $10.6 million purchase price includes cash compensation amounts
of approximately $3.8 million associated with the purchase of certain vested
employee stock options. Pursuant to the Intercompany Agreements, Collagen
tranferred its interest in Cohesion Corporation to the Company effective January
1, 1998.

The Company determined the amounts to be allocated to in-process technology
for Cohesion Corporation based on whether technological feasibility had been
achieved and whether there was any alternative future use for the technology.
The Company concluded that the in-process technology had no alternative future
use after taking into consideration the potential for both usage of the
technology in different products and for resale of the technology. The products
and programs related to the in-process technology acquired are currently in the
clinical trial and preclinical trial stages, respectively. This technology,
which relates to surgical hemostasis and sealing products the Company is
developing, utilizes liquid-based biomaterials and related delivery systems. The
Company expects to benefit from the in-process technology within the next three
years, provided that sufficient preclinical and clinical data has been
generated, submitted to regulatory authorities, and cleared for commercial sale
by those regulatory authorities; however the Company can make no assurance in
this regard. The Company expects to spend approximately $5 to 6 million per year
for the next three years on its in-process technology in an effort to develop
commercially viable products. If this technology is not successfully developed
and commercialized, the Company's ability to generate product revenue and its
business, financial condition and results of operations will be materially and
adversely effected.

Seeking to capitalize on technical success in expressing recombinant collagen
in mouse milk, in February 1996, Collagen made an additional equity investment
of approximately $4.5 million in Pharming B.V. of The Netherlands ("Pharming"),
which brought Collagen's ownership percentage in Pharming to approximately 12%.
In connection with the Distribution and pursuant to the Intercompany Agreements,
the Pharming ownership position was transferred to the Company, effective
January 1, 1998. In fiscal 1998, the Company invested an

<PAGE> 26

additional $2.5 million in Pharming when program milestones were met. At June
30, 1998, the Company's ownership position in Pharming was approximately 6%.
Pharming is dedicated to the development and worldwide commercialization of
human health care products produced in transgenic animals. The Company and
Pharming will attempt to produce collagen in the milk of transgenic cattle.

In October 1995, Collagen purchased approximately 844,000 shares of common
stock, representing approximately 9% of the outstanding capital stock of
Innovasive Devices, Inc. ("Innovasive") for $4.1 million and entered into a
collaborative product development agreement. Innovasive develops, manufactures
and markets tissue and bone reattachment systems that are particularly relevant
to the sports medicine and arthroscopy segments of the orthopedic surgery
market. The Company, pursuant to the Intercompany Agreements, assumed Collagen's
relationship and obligations with Innovasive. The Company and Innovasive are
collaborating to develop certain resorbable mechanical tissue-fixation devices
utilizing collagen-based biomaterials for applications in orthopedic tissue
repairs. The Company is performing development activities in accordance with a
project plan and Innovasive is reimbursing the Company for such activities in
accordance with the project budget. Accordingly, over the next several years,
the collaboration will require the Company's expertise with collagen-based
biomaterials and a small percentage of the Company's R&D expenditures. In the
event that marketable products are developed as a result of this collaboration,
the Company will have the right but not the obligation to manufacture such
products.

In June 1997, the Company sold its 21% investment in Prograft, a privately
held affiliate, to W.L. Gore and Associates, Inc. and recorded a pre-tax gain of
$15.4 million. Prograft was formed in July 1993 by Collagen, Target and Celtrix
Pharmaceuticals, Inc. to develop vascular prostheses, including stents, grafts,
and stent-grafts for the treatment of diseased and damaged blood vessels.

YEAR 2000

Under one of the Intercompany Agreements, the Company plans to use
Collagen's computer systems until June 30, 1999. Subsequent to June 30, 1999,
the Company may extend the terms of such agreement or elect to purchase its own
computer systems. Some of Collagen's older computer programs were written using
two digits rather than four to define the applicable year. As a result, those
computer programs have time-sensitive software that recognize a date using "00"
as the year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar business activity. Collagen has completed an assessment and has
notified the Company that it will modify or replace portions of its software so
that its computer systems will function properly with respect to dates in the
year 2000 and thereafter. The Company will incur no costs related to ensuring
that Collagen's computer systems are year 2000 compliant. If the Company elects
to purchase its own computer systems, the Company will ensure that these are
fully functional in the year 2000 as part of the system selection process.
Accordingly, the Company estimates that its costs associated with the year 2000
issue will be immaterial.

<PAGE> 27

RISK FACTORS

ABSENCE OF HISTORY AS AN INDEPENDENT COMPANY

Prior to being contributed to the Company by Collagen, the Transferred
Businesses were part of an operating group at Collagen, the Collagen
Technologies Group. The Company does not have an operating history as an
independent company. As is the case with many distributions, the Distribution
may result in some temporary dislocation of, and inefficiencies in the business,
operations, organization and personnel structure of the Company. Collagen is not
required to provide assistance or services to the Company, except as described
in the Intercompany Agreements, and, it is incumbent upon the Company to
establish an identity separate from Collagen. Although the Company intends to
invest substantial resources in the future to increase capital market and
industry awareness of its activities, there can be no assurance that such
investment will actually increase such awareness, and failure to achieve such
awareness could have a material adverse effect on the Company. The Company has
operated as a public company only since August 18, 1998, and it will continue to
incur increasing costs and expenses associated with being a public company. See
"-- No Prior Public Market; Volatility of Common Stock Price;" "-- History of
Operating Losses; Uncertainty of Future Profitability;" "-- Intense
Competition;" "Business;" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY

The Company's historical results of operations discussed in this Annual
Report, and contained in the financial statements and related notes included in
this Annual Report, reflect the historical operations of the Transferred
Businesses contributed by Collagen to the Company. The financial statements of
the Company included herein may not necessarily reflect the results of
operations, financial position and cash flows of the Transferred Businesses had
the Company been operated as an independent entity during the periods presented.
The Transferred Businesses incurred operating losses in each of the past five
years, including operating losses of $31.5 million, $16.4 million, and $9.2
million in fiscal 1998, 1997, and 1996, respectively. The Company's operating
losses have resulted primarily from expenses incurred in connection with the
Company's research and development activities, including preclinical and
clinical trials, development of manufacturing processes and general and
administrative expenses and the Company expects that such expenses will continue
to increase for the foreseeable future. While the Company had sales of
Collagraft bone products of $1.5 million and $1.9 million for the years ended
June 30, 1998 and 1997, respectively, the Company does not expect such sales to
increase substantially in the future. Such sales at their present levels do not
contribute, in a material way, to the Company's operating profitability. The
Company's ability to achieve and sustain operating profitability is highly
dependent upon obtaining in a timely and efficient fashion, regulatory approval
for and successfully commercializing its products in development, particularly
the CoStasis atraumatic hemostatic device and the CoSeal surgical sealant and
developing sales and marketing capabilities for its products, both in Europe,
the United States and other markets. There can be no assurance that the Company
will obtain required regulatory approvals in a timely fashion, if at all, or
successfully develop, manufacture, commercialize and market products or that the
Company will ever record significant product revenues or achieve operating
profitability. Operating profitability, if achieved, may not be sustained. See
"-- Absence of History as an Independent Company;" "-- Dependence on Boston
Scientific Stock;" "-- No Prior Public Market; Volatility of Common Stock
Price;" "-- Uncertainties Related to Early Stage of Commercialization and
Development;" "-- Government Regulation;" "-- Intense Competition;"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations;" and "Business."

UNCERTAINTIES RELATED TO COMMERCIALIZATION AND DEVELOPMENT

Except for Collagraft, the Company's orthopedic implant product, which is
currently marketed by Zimmer in the U.S. and Asia, and the Company's
Intermediate Products, all of the Company's products are in research or
preclinical or clinical development. The Company has not received marketing
approval for any of its products from the FDA or any other international
regulatory body. The development and commercialization of new

<PAGE> 28

products are highly uncertain, as is the timing associated with these
activities. Among other things, potential products that may appear to the
Company to be promising may not reach the market for a number of reasons,
including the possibilities that the potential products will be found to be
ineffective or to cause harmful side effects during preclinical testing or
clinical trials, will fail to receive necessary regulatory approvals, will be
difficult to manufacture on a commercial scale, will be uneconomical, will fail
to achieve market acceptance or will be precluded from commercialization by the
proprietary rights of third parties. No assurance can be made that any of the
Company's development programs will be successfully completed, that clinical
trials will generate anticipated results or will commence or be completed as
planned. Additionally, there can be no assurance that the Company will be able
to obtain CE Mark in Europe, on a timely basis, if at all, or that any PMA
application will be accepted or ultimately approved by the FDA on a timely
basis, if at all, or that any products for which approval is obtained will be
commercially successful. If any of the Company's development programs are not
successfully completed in a timely fashion, required regulatory approvals are
not obtained in a timely fashion, or products for which approvals are obtained
are not commercially successful, the Company's business, financial condition and
results of operations will be materially and adversely affected. See "-- Early
Stage of Clinical Trials and Lack of Extensive Clinical Data;" "-- Uncertainty
of Market Acceptance;" "-- Government Regulation; No Assurance of Regulatory
Approvals;" and "Business."

UNCERTAINTIES RELATED TO CLINICAL TRIALS AND LACK OF EXTENSIVE CLINICAL DATA

Although the Company's lead product candidate, CoStasis, completed clinical
trials in Europe and is currently in clinical trials in the United States,
clinical data obtained to date has been insufficient to demonstrate its safety
and efficacy under applicable FDA regulatory guidelines. Although the Company
completed a 100-patient, multi-site, randomized, pivotal human clinical trial in
Europe using CoStasis in cardiothoracic surgery indications and filed for CE
Mark in Europe, significant additional clinical data will be required prior to
submission of a PMA application in the United States. There can be no assurance
that any of the Company's product candidates will receive CE Mark in Europe or
marketing approval from the FDA in a timely fashion, if at all. Additionally,
clinical trials may identify significant technical or other obstacles that must
be overcome prior to obtaining necessary regulatory or international approvals.
Such obstacles could delay progress in the development and commercialization of
the Company's current product candidates. Adverse events related to the use of
the Company's product candidates may occur during clinical trials, and any such
events may require suspension or termination of clinical trials, and the filing
of reports with the FDA and other applicable U.S. and international regulatory
authorities. Such events could negatively impact the Company's ability to
achieve successful development and commercialization of its products. If the
Company's products under development do not prove to be safe and effective in
clinical trials, or if the Company is otherwise unable to commercialize these
products successfully, the Company's business, financial condition and results
of operations will be materially and adversely affected. See "Business;" and "--
Government Regulation; No Assurance of Regulatory Approvals."

UNCERTAINTY OF MARKET ACCEPTANCE

The Company's CoStasis atraumatic hemostat is a device designed to control
diffuse capillary and small vein bleeding, and the Company's CoSeal biosealant
is a device designed to seal anastomoses and sites of incision, in connection
with surgery. There can be no assurance that either of these products will gain
commercial acceptance among physicians, patients and health care payors, even if
necessary international and U.S. marketing approvals are obtained. The Company
believes that recommendations and endorsements by physicians will be essential
for market acceptance of its surgical products, and there can be no assurance
that any such recommendations or endorsements will be obtained. The Company
believes that surgeons will not use the Company's products unless they
determine, based on clinical data and other factors, that the products are an
effective means of controlling bleeding and sealing anastomoses and sites of
incision, and that the clinical benefits to the patient and cost savings
achieved through use of these systems outweigh their cost. Acceptance among
physicians may also depend upon the Company's ability to train surgeons and
other potential users of the Company's products in the application of sprayable
surgical products, which they typically have not used, and the willingness of
such users to learn these new techniques. Additional factors in achieving market
acceptance may include the Company's ability to address competition from U.S.
and international medical device,

<PAGE> 29

pharmaceutical and biopharmaceutical companies, to develop a marketing and sales
force, to form strategic partnerships and to manufacture price- and
cost-effective products. Failure of the Company's products to achieve
significant market acceptance will have a material adverse effect on the
Company's business, financial condition and results of operations. See "--
Intense Competition;" "-- Lack of Marketing and Sales Capabilities;" and
"Business -- Products."

DEPENDENCE ON BOSTON SCIENTIFIC STOCK TO FUND OPERATIONS

In connection with the activities surrounding the Distribution, Collagen
transferred to the Company, effective January 1, 1998, all of its equity
interest in Boston Scientific. Sales of Boston Scientific common stock
contributed pre-tax gains of approximately $20.4 million, $9.1 million and $85.8
million in fiscal years 1998, 1997 and 1996, respectively. As of June 30, 1998,
the Company owned approximately 1.0 million shares of Boston Scientific common
stock, valued at $74.0 million, based on a market price of $71.63 per share on
such date as reported on the New York Stock Exchange. The Company has
implemented a "protect" strategy based on purchases of put options and sales of
call options in combination, commonly known as an "equity collar," covering
725,000 shares of its Boston Scientific holdings. While the strategy is designed
to minimize downside risk of loss should the stock price decline below
approximately $63.00 and allow for limited upside participation should the stock
price rise above approximately $98.00, there can be no assurance that the
Company will be able to sell the remaining unhedged shares of Boston Scientific
common stock at attractive prices if, when and as needed. Failure to achieve
such sales could jeopardize the Company's ability to fund its operations and
require it to engage in additional financing alternatives, some of which might
be dilutive. The market price of Boston Scientific common stock is highly
volatile and, as a medical device manufacturer, the Company believes that Boston
Scientific is subject to a number of the same factors affecting its operations
as the Company, as well as additional factors not applicable to the Company.
Readers are encouraged to review the reports filed by Boston Scientific with the
Securities and Exchange Commission for a detailed description of the nature of
Boston Scientific's business and the risks and uncertainties associated with it.
Any significant downward fluctuation in the market price for Boston Scientific
common stock could adversely impact the Company's earnings due to lower amounts
realized on any sales by the Company of such stock and would decrease the value
of the Company's total assets as stated on its balance sheet resulting from a
lower carrying value for the Boston Scientific investment, which as of June 30,
1998, represented approximately 77% of the value of the Company's total assets.
See "-- Uncertainty of Access to Capital;" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

NO PRIOR PUBLIC MARKET; VOLATILITY OF COMMON STOCK PRICE

Prior to the Distribution, there was no public market for the Company's
Common Stock. There can be no assurance that an active trading market will be
sustained after the Distribution, and that analyst coverage or general market
support will be obtained or sustained. Until an orderly market develops, the
price of the Common Stock may fluctuate significantly. The Common Stock price
will be determined by the marketplace and may be influenced by many factors,
including, among others, the depth and liquidity of the market for the Common
Stock, investor perception of the Company and its industry, and general economic
and market conditions. In addition, in recent years, the stock market in
general, and the stock prices of medical device and life sciences companies in
particular, have experienced extreme price fluctuations, sometimes without
regard to the operating performance of particular companies. The market price of
the Common Stock is likely to be highly volatile and may be significantly
affected by factors such as actual or anticipated fluctuations in the Company's
operating results, announcements of technological innovations, new products,
clinical trial results, announcements regarding strategic alliances, domestic
and international government regulation, developments in patent or other
proprietary rights, public concern as to the safety of products developed by the
Company or its competitors or other parties. Additionally, changes in U.S. and
international healthcare policies, future sales of substantial amounts of Common
Stock by existing stockholders, changes in estimates of and comments by
securities analysts and general market and economic conditions may have an
adverse effect on the market price of the Common Stock. In addition, the
realization of any of the risks described herein in "Risk Factors" could have a
dramatic and material adverse impact on the market price of the common stock.
Following a fluctuation in the market price of a corporation's securities,
securities class action litigation has often resulted. There can be

<PAGE> 30

no assurance that such litigation will not occur in the future with respect to
the Company. Such litigation could result in substantial costs and a diversion
of management's attention and resources, which could have a material adverse
impact on the Company's business, financial condition and results of operations.
See "-- Absence of History as an Independent Company;" "History of Operating
Losses; Accumulated Deficit;" "Uncertainty of Future Profitability;" "--
Dilutive Impact of Future Equity Issuances;" and "Business."

RELATIONSHIP BETWEEN THE COMPANY AND COLLAGEN

Conflicts of interest may arise between the Company and Collagen in a number
of areas relating to their past and ongoing relationships, including tax and
employee benefit matters and indemnity arrangements. The Company and Collagen
have entered into the Intercompany Agreements for the purpose of defining
certain relationships between them. The Company believes that the Intercompany
Agreements will minimize conflicts of interest between the Company and Collagen.
However, in the event that conflicts arise, the Company believes that each
entity will have an experienced management infrastructure in place to deal with
such conflicts. Should conflicts persist which cannot be resolved at each
entity's executive level, the Intercompany Agreements provide for arbitration as
a final means of resolution. The terms of such agreements may limit the
Company's operating flexibility. The Company and Collagen may also enter into
material transactions and agreements in the future. There can be no assurance
that any such arrangements and transactions will be at least as favorable as
could be obtained from third parties.

INTENSE COMPETITION

The Company competes with many domestic and foreign medical device,
pharmaceutical and biopharmaceutical companies and organizations across each of
its product categories and areas in which it is conducting research and
development activities. In the hemostatic and biosealant areas, the Company
believes in the United States that it will face strong competition from existing
methodologies for controlling bleeding and sealing wounds resulting from
surgery, such as hemostatic powders and sponges, collagen-based hemostats and
traditional sutures and staples marketed by companies such as Johnson & Johnson,
United States Surgical Corporation and American Home Products Corporation. In
addition, the Company faces competition from more recent products and
technologies, such as those developed by Focal, Inc. ("Focal") and Fusion
Medical Technologies, Inc. ("Fusion"). Outside of the United States, other
competitive products currently being marketed include fibrin sealants, sold in
Europe and the Pacific Rim countries by Immuno AG and Centeon L.L.C. In the
United States, there are several fibrin sealants under development including
those by the American Red Cross, Convatec, a subsidiary of the Bristol-Myers
Squibb Company, Haemacure Corporation and V.I. Technologies, Inc. (Vitex).
Baxter Healthcare Corporation recently received FDA approval for a fibrin
sealant product. In addition to conventional fibrin sealants, there are a number
of other products in late-stage development using either collagen or polymer
technologies, made by Focal and Fusion, as well as another class of sealants
called cyanoacrylates. In the orthopedics area, the Company's Collagraft bone
graft products face competition from synthetic bone graft substitutes from
Interpore International, Inc. and Osteotech, Inc. Additionally, several
companies and institutions are engaged in the development of collagen-based
materials, techniques, procedures and products for use in medical applications
the Company anticipates addressing with its current and proposed products and
research programs.

Many of these companies and organizations have or will have substantially
greater financial, technological, research and development, regulatory and
clinical, marketing and sales and personnel resources than the Company. They may
also have greater experience in developing products, conducting clinical trials,
obtaining regulatory approvals, and manufacturing and marketing such products.
They may also develop alternative technologies and products that are more
effective, easier to use or more economical than those which have been or are
being developed by the Company or that render the Company's technology and
products obsolete and non-competitive. Recently developed technologies or
procedures are, or may in the future be, the basis of competitive products.
There can be no assurance that the Company's current competitors or other
parties will not succeed in developing alternative technologies and products
that are more effective, easier to use or more economical than those which have
been or are being developed by the Company or that would render the

<PAGE> 31

Company's technology and products obsolete and uncompetitive. In such an event,
the Company's business, financial condition and results of operations would be
materially and adversely affected. Competitors may also obtain approval or
clearance by the FDA or foreign regulatory approval organizations, achieve
product commercialization or obtain patent protection earlier than the Company.
Additionally, there can be no assurance that any marketing or other strategic
partners that the Company may engage will not pursue parallel development of
technologies or products relating to or competitive with the Company's planned
product portfolio. Also, to the extent the Company commences manufacturing
activities, it will also face competition with respect to manufacturing
efficiency and marketing capabilities, areas in which it currently has limited
experience. Failure of the Company to successfully address the foregoing factors
and circumstances could have a material adverse impact on the Company, its
financial condition and results of operations. See "Business -- Competition;"
and "Business -- Manufacturing."

UNCERTAINTIES RELATED TO INTELLECTUAL PROPERTY

<PAGE> 32

The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with collaborative partners, vendors, suppliers,
employees and consultants. The Company also has invention or patent assignment
agreements with its employees and certain, but not all, commercial partners and
consultants. There can be no assurance that relevant inventions will not be
developed by a person not bound by an invention assignment agreement. There can
be no assurance that binding agreements will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known or be independently discovered by competitors.
See "-- Competition;" and "Business -- Intellectual Property."

GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVALS

The Company's existing and proposed products, research and development and
planned commercialization activities are subject to regulation by numerous
governmental authorities, principally the FDA and corresponding state and
foreign regulatory agencies. The FDC Act , the regulations promulgated
thereunder, and other federal and state statutes and regulations, govern, among
other things, the preclinical and clinical testing, manufacturing conditions,
device safety, efficacy, labeling and storage, record keeping, advertising and
the promotion of medical devices and drugs. Product development and approval
within this regulatory framework take a number of years and involve the
expenditure of substantial resources.

Additionally, in order for the Company to market its products in Europe and
other foreign countries, the Company and/or its partners, if any, must obtain
required regulatory approvals and comply with extensive regulations governing
safety, quality and manufacturing processes. These regulations vary
significantly from country to country. The time required to obtain approval to
market the Company's products outside the United States may be longer or shorter
than that required in the United States. In order to market the products being
developed by the Company in the member countries of the European Union, the
Company will be required to obtain CE Mark certification. CE Mark certification
is an international symbol of adherence to quality assurance standards and
compliance with applicable European medical device directives. In the first half
of 1998, the Company completed a successful quality systems audit to the ISO
9001/EN46001 and Medical Devices Directive requirements, which is one of the
principal steps in the CE Mark process. The remainder of the CE Mark process
consists primarily of review by the approving body of additional documentation
submitted by the Company to document each product's clinical safety and
performance. Although a quality system audit has been completed, there can be no
assurance that the Company will be successful in completing the remainder of the
CE Mark certification process or obtaining CE Mark certification, in a timely
manner, if at all.

<PAGE> 33

FDC Act or a PMA application under Section 515 of the FDC Act. A 510(k)
clearance will typically be granted by the FDA if it can be established that the
device is substantially equivalent to a "predicate device," which is a legally
marketed Class I or Class II device or a preamendment Class III device (i.e.,
one that has been marketed since a date prior to May 28, 1976) for which the FDA
has not called for PMAs. The FDA has been requiring an increasingly rigorous
demonstration of substantial equivalence and this demonstration may include a
requirement to submit human clinical trial data. It generally takes four to 12
months from the date of a 510(k) submission to obtain clearance, but it may take
longer. The FDA may determine that a medical device is not substantially
equivalent to a predicate device, or that additional information is needed
before a substantial equivalence determination can be made. A "not substantially
equivalent" determination, or a request for additional information, could
prevent or delay the market introduction of new products that fall into this
category. For any devices that are cleared through the 510(k) process,
modifications or enhancements that could significantly affect the safety or
effectiveness, or that constitute a major change in the intended use of the
device, will require new 510(k) submissions.

A PMA application must be filed if a proposed device is not substantially
equivalent to a legally marketed Class I or Class II device, or if it is a
preamendment Class III device for which the FDA has called for PMAs. A PMA
application must be supported by valid scientific evidence to demonstrate the
safety and effectiveness of the device, typically including the results of
clinical trials, bench tests, and laboratory and animal studies. The PMA
application must also contain a complete description of the device and its
components, and a detailed description of the methods, facilities and controls
used to manufacture the device. In addition, the submission includes the
proposed labeling, advertising literature, and any training materials. The PMA
can be expensive, uncertain and lengthy, and a number of devices for which FDA
approval has been sought by other companies have never been approved for
marketing. Upon receipt of a PMA application, the FDA makes a threshold
determination as to whether the application is sufficiently complete to permit a
substantive review. If the FDA determines that the PMA application is
sufficiently complete to permit a substantive review, the FDA will accept the
application for filing. Once the submission is accepted for filing, the FDA
begins an in-depth review of the PMA application. The FDA review of a PMA
application generally takes one to three years from the date the PMA application
is accepted for filing, but may take significantly longer. The review time is
often significantly extended by the FDA asking for more information or
clarification of information already provided in the submission. During the
review period, an advisory committee, typically a panel of clinicians and others
knowledgeable in the applicable field, may be convened to review and evaluate
the application and provide a recommendation to the FDA as to whether the device
should be approved. The FDA accords substantial weight to the recommendation but
is not bound by it. Toward the end of the PMA application review process, the
FDA generally will conduct an inspection of the manufacturer's facilities to
ensure compliance with applicable QSR requirements, which include extensive
requirements relating to product design, manufacturing processes, testing,
control documentation and other quality assurance procedures.

<PAGE> 34

If human clinical trials of a device are required, either for a 510(k)
premarket notification or a PMA application, and the device presents a
"significant risk," the sponsor of the trial must file an IDE application prior
to commencing 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 by the FDA and one or more appropriate Institutional
Review Boards ("IRBs"), human clinical trials may begin at a specific number of
investigational sites with a specific number of patients, as approved by the
FDA. If the device presents a "nonsignificant risk" to the patient, a sponsor
may begin the clinical trial after obtaining approval for the study by one or
more appropriate IRBs, without the need for FDA review. Submission of an IDE
provides no assurance that the FDA will approve the IDE. Even if the IDE is
approved, there can be no assurance that the FDA will determine that the data
derived from the studies support the safety and efficacy of the device or
warrant the continuation of clinical studies. Sponsors of clinical trials are
permitted to sell investigational devices distributed in the course of the
study, provided such compensation does not exceed recovery of the costs of
manufacture, research, development and handling. An IDE supplement must be
submitted to and approved by the FDA before a sponsor or investigator may make a
change to the investigational plan that may affect its scientific soundness or
the rights, safety or welfare of human subjects.

The Company anticipates that its products currently in development will be
regulated as Class III medical devices and will require a PMA prior to being
marketed in the United States. If this belief is true, the Company will need to
obtain for each of its products an IDE in order to conduct clinical trials in
the United States. There can be no assurance that the Company will receive Class
III medical device designation for its products or that it will be able to
obtain IDEs for each of its planned products or that data from such clinical
studies if and when commenced will demonstrate the safety and effectiveness of
the Company's product or will adequately support a PMA application.

In November 1997, the President of the United States signed into law the FDA
Modernization Act of 1997. This legislation makes changes to the device
provisions of the FDC Act and other provisions in the FDC Act affecting the
regulation of devices. Among other things, the changes will affect the IDE,
510(k) and PMA processes, and also will affect device standards and data
requirements, procedures relating to humanitarian and breakthrough devices,
tracking and postmarket surveillance, accredited third party review, and the
dissemination of off-label information. The Company cannot predict how or when
these changes will be implemented or what effect the changes will have on the
regulation of the Company's products.

<PAGE> 35

information to submit an IND for its products or that such data and information
if submitted, would be sufficient for the purposes of commencing clinical
studies of the products. Delays in the receipt of or failure to obtain FDA
authorization to begin or continue clinical trials could have a material adverse
effect on the Company's business, financial condition or results of operations.

The FDA regulates the manufacturing, product testing, and marketing of both
medical devices and drugs. Manufacturers of drugs are required to comply with
applicable GMP and, in the case of medical devices, QSR requirements, which
include requirements relating to product design, manufacturing processes,
product testing, and quality assurance, as well as the corresponding maintenance
of records and documentation. There is no assurance that the Company will be
able to comply with the applicable QSR requirements. In addition, the Company is
required to provide information to the FDA on death or serious injuries alleged
to have been associated with the use of its medical devices, as well as product
malfunctions that would likely cause or contribute to death or serious injury if
the malfunction were to recur. Failure of the Company to comply with the QSR
regulation, or other FDA regulatory requirements, could have a material adverse
effect on the Company's business, financial condition, or results of operations.

CoStasis contains thrombin, which is a FDA-licensed biological drug.
Consequently, the FDA considers CoStasis to be a combination product subject to
jurisdiction by the CBER and the CDRH. The FDA has assigned lead review
responsibility to CDRH following a "Request for Designation" determination by
the FDA in September 1996. The Company believes that this decision was
significant, as fibrin sealants containing human plasma are regulated as
biological drugs, which may substantially increase the duration and complexity
of their regulatory approval processes compared to that of CoStasis. Although
CoStasis is considered to be a combination product, consistent with lead review
responsibility being assigned to CDRH, the product will be regulated primarily
as a device. Consequently, the Company has filed an IDE application for
CoStasis, and it is currently conducting clinical studies pursuant to the IDE.
If the clinical data collected from these studies is satisfactory, the Company
will file a PMA application with the FDA seeking marketing approval for
CoStasis. There can be no assurance that the data from these studies will
demonstrate the safety and effectiveness of CoStasis to the satisfaction of the
FDA, and consequently there can be no assurance that CoStasis will be approved
for commercial marketing by the FDA.

The collagen used in the Company's products is derived from the cow hides of
U.S. cattle. BSE is a disease, commonly known as mad cow disease, initially
reported in cattle in the United Kingdom, characterized by degenerative lesions
of the central nervous system. The source of infections in animals derives from
eating infected sheep-derived feed. While the disease has been reported in
European countries, the Company is not aware of any reports of BSE in U.S.
cattle to date and, currently, the Company relies on a "closed herd" of U.S.
cattle for its bovine collagen-based products. There can be no assurance that
the various foreign or domestic regulatory authorities will not raise issues
regarding BSE or other matters which may adversely affect the Company's ability
to manufacture, market or sell its bovine collagen-based products, which could
have a material adverse effect on the Company's business, financial condition
and results of operations.

DEPENDENCE ON AND VARIABILITY OF THIRD PARTY REIMBURSEMENT

<PAGE> 36

such approvals will be obtained in a timely manner, or at all, and failure to
receive such international reimbursement approvals could have an adverse effect
on market acceptance of the Company's products in the international markets in
which such approvals are sought.

In the United States, health care providers, such as hospitals and
physicians, that purchase medical devices similar to the Company's products,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or part of the
cost of surgical procedures. The Company anticipates that in a prospective
payment system, such as the DRG system utilized by Medicare, and in many managed
care systems used by private health care payors, there will be no separate,
additional reimbursement for the Company's products and therefore no assurance
that reimbursement for the Company's products will be available. Accordingly,
the Company believes that there will be no procedure-specific reimbursement
codes for the Company's products and therefore no assurance that reimbursement
for the Company's products will be available in the United States or in
international markets under either governmental or private reimbursement
systems. Furthermore, the Company could be adversely affected by changes in
reimbursement policies of governmental or private health care payors. Failure by
physicians, hospitals and other users of the Company's products to obtain
sufficient reimbursement from health care payors for procedures in which the
Company's products are used or adverse changes in governmental and private third
party payors' policies toward reimbursement for such procedures would have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company's business may also be materially and
adversely affected by the continuing efforts of government and third-party
payors to contain or reduce the costs of health care through various means.
See "Business -- Third Party Reimbursement."

DILUTIVE IMPACT OF FUTURE EQUITY ISSUANCES

Holders of Common Stock will experience dilution to the extent that
additional shares of Common Stock were issued by the Company and to the extent
that options to purchase Common Stock are exercised. As of September 15, 1998,
the Company has authorized (i) options to purchase 2,607,000 shares of Common
Stock under the 1998 Stock Option Plan, of which options to purchase
approximately 2,000,810 shares of Common Stock was issued and outstanding; (ii)
options to purchase 268,000 shares of Common Stock under the Directors' Plan, of
which options to purchase 173,000 shares of Common Stock was issued and
outstanding; and (iii) 250,000 shares of Common Stock reserved for issuance
under the Company's Employee Stock Purchase Plan, none of which have been
issued.

LIMITED MANUFACTURING CAPACITY

The Company anticipates that it will manufacture and package the final
products for CoStasis and CoSeal and that it will use outside contractors for
other functions, such as non-proprietary, high-volume processes. There can be no
assurance that the Company will be able to attract, train and retain the
required personnel or will be able to increase its manufacturing capability to
manufacture commercial quantities of its planned products in a timely manner, or
at all. Manufacturers often encounter difficulties in scaling up production of
their products, including problems involving production yields, quality control
and assurance, component supply and shortages of qualified personnel and the
Company may encounter similar problems. The Company can make no assurance that
its manufacturing scale-up efforts will be successful, or, that if needed,
high-volume manufacturing can be established or maintained at commercially
reasonable costs on a timely basis, if at all. Any of these factors could have
an material adverse effect on the Company's ability to develop and commercialize
its products, which in turn would have a material adverse effect on the
Company's business, financial condition and results of operations.

<PAGE> 37

diminution in the size of the herd for any reason, including accident or
disease, Collagen's ability to quickly increase the supply of acceptable cattle
is quite limited. Any such diminution would have a material adverse effect on
the Company's ability to sell bovine collagen-based products and, as a result,
the Company's business, financial condition and results of operations. Any such
future shortages of materials or components could have a material adverse effect
on the Company's business, financial condition and results of operations.

The Company is also required to register as a medical device manufacturer
with the FDA and to list its products with the FDA. As such, the Company is
subject to inspections by the FDA for compliance with applicable QSR
requirements, which include elaborate testing, control documentation and other
quality assurance procedures. In addition, prior to international
commercialization, the Company will be required to attain and maintain
compliance with ISO 9001 standards. Failure to either attain or maintain
compliance with the applicable regulatory requirements of various regulatory
agencies would have a material adverse effect on the Company's business,
financial condition and results of operations. Further, the Company and the
third-party manufacturers of its products are required to comply with various
FDA requirements for design, safety, advertising and labeling. The Company has
not yet undergone an FDA QSR inspection and does not anticipate that it will
undergo such an inspection until after submission of its initial PMA application
for its CoStasis hemostat product. See "Business -- Manufacturing."

Complex medical devices, such as the Company's products, can experience
performance problems in the field that require review and possible corrective
action by the manufacturer. There can be no assurance that component failures,
manufacturing errors or design defects that could result in an unsafe condition
or injury to the patient will not occur. If any such failures or defects were
deemed serious, the Company could be required to withdraw or recall products,
which could result in significant costs to the Company. There can be no
assurance that market withdrawals or product recalls will not occur in the
future. Any future product problems could result in market withdrawals, recalls
of products, or product liability litigation which could have a material adverse
affect on the Company's business, financial condition or results of operations.

LACK OF MARKETING AND SALES CAPABILITIES

The Company currently has no experience in marketing or selling its products
under development and does not have a significant marketing and sales staff. In
order to achieve commercial success for any product approved by the FDA, the
Company must either develop a marketing and sales force or enter into
arrangements with third parties to market and sell its products. If the Company
develops its own marketing and sales capabilities, it will compete with other
companies that currently have experienced and well-funded marketing and sales
operations. To the extent that the Company enters into co-promotion or other
marketing and sales arrangements with other companies, any revenues to be
received by the Company will be dependent on the efforts of others, and there
can be no assurance that such efforts will be successful. Additional factors in
achieving market acceptance may include the Company's ability to address
competition from domestic and foreign medical device, pharmaceutical and
biopharmaceutical companies, develop a marketing and sales force, form strategic
partnerships and manufacture price- and cost-effective products. See "Business
- -- Sales, Marketing and Distribution."

UNCERTAINTY OF ABILITY TO ATTRACT AND RETAIN KEY MANAGEMENT,
EMPLOYEES AND CONSULTANTS

The Company is highly dependent on the principal members of its management
and scientific staff. The loss of services of any of these personnel could
impede the achievement of the Company's development objectives. Furthermore,
recruiting and retaining qualified scientific personnel to perform research and
development work in the future will also be critical to the Company's success.
There can be no assurance that the Company will be able to attract and retain
personnel on acceptable terms given the competition among biotechnology,
pharmaceutical and healthcare companies, universities and non-profit research
institutions for experienced scientists. In addition, the Company relies on
members of its Scientific Advisory Board and Clinical Advisory Board and a
significant number of consultants to assist the Company in formulating its
research and development strategy. All of the Company's consultants and the
members of the Company's Scientific Advisory Board and Clinical Advisory Board
are employed by employers other than the Company, and may have

<PAGE> 38

commitments to, or advisory or consulting agreements with, other entities that
may limit their availability to the Company. See "Management."

UNCERTAINTY OF ACCESS TO CAPITAL

The Company may require substantial additional funding in order to finance
its research and product development programs, including for preclinical testing
and clinical trials of its product candidates, for operating expenses and for
the pursuit of regulatory approvals for its product candidates, and may require
additional funding for establishing manufacturing and marketing capabilities in
the future. The Company currently believes that its existing capital resources,
including its holdings in Boston Scientific and interest income from cash
investments, will be sufficient to satisfy its current and projected funding
requirements. The Company's future capital requirements will depend on many
factors, including continued scientific progress in its research and development
programs, the magnitude of these programs, progress with preclinical testing and
clinical trials, the time and costs involved in obtaining regulatory approvals,
if any, the costs involved in filing and prosecuting patent applications and
enforcing patent claims, the impact of competing technological and market
developments, the establishment of strategic alliances, the cost of
manufacturing and of commercialization activities and the cost of product
in-licensing. There can be no assurance that the Company's cash, cash
equivalents and marketable securities, including its Boston Scientific stock,
and interest income earned on cash investments, will be adequate to satisfy its
capital and operating requirements and the Company may need to pursue
opportunities to obtain debt or equity financing. There can be no assurance that
such additional financing will be available on reasonable terms, if at all. Any
additional equity financings would be dilutive to the Company's stockholders. If
adequate funds are not available, the Company may be required to curtail
significantly one or more of its research and development programs or obtain
funds through arrangements that may require it to relinquish rights to certain
of its technologies or product candidates. See "-- Dependence on Boston
Scientific Stock" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

POTENTIAL PRODUCT LIABILITY EXPOSURE; LIMITED INSURANCE COVERAGE

HAZARDOUS MATERIALS; ENVIRONMENTAL MATTERS

The Company's research and development processes involve the controlled use
of hazardous materials, including flammable liquids and corrosive liquids, and
in lesser quantities, corrosive solids, flammable solvents, flammable gases,
oxidizers, air and water reactive compounds, carcinogens and poisons and
radioactive materials. The Company is subject to federal, state and local laws
and regulations governing the use, manufacture, storage, handling and disposal
of such materials and certain waste products. Although the Company believes that
its safety procedures for handling and disposing of such materials comply with
the standards prescribed by such laws and regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated. In
the event of such an accident, the Company could be held liable

<PAGE> 39

for any damages that result and any such liability could exceed the resources of
the Company. The Company believes that it is in compliance in all material
respects with applicable environmental laws and regulations. Accordingly, it
does not expect to make material capital expenditures for environmental control
facilities in the near-term. However, there can be no assurance that it will not
be required to incur significant costs to comply with environmental laws and
regulations in the future, or that the operations, business or assets of the
Company will not be materially and adversely affected by the costs of compliance
with current or future environmental laws or regulations.

POTENTIAL ADVERSE EFFECT OF ANTI-TAKEOVER PROVISIONS

The Company's Certificate of Incorporation does not provide for cumulative
voting in the election of directors. In addition, the Board of Directors of the
Company may issue shares of Preferred Stock without stockholder approval on such
terms as the Board may determine. The Company's Bylaws require advance notice of
matters of business to be brought before meetings of stockholders. The Company's
Certificate of Incorporation prohibits stockholders from acting by written
consent. The rights of the holders of Common Stock will be subject to, and may
be adversely affected by, the rights of the holders of any preferred stock that
may be issued in the future. Further, the Company is subject to Section 203 of
the Delaware General Corporation Law which, subject to certain exceptions,
restricts certain transactions and business combinations between a corporation
and a stockholder owning 15% or more of the corporation's outstanding voting
stock (an "interested stockholder") for a period of three years from the date
the stockholder becomes an interested stockholder.

ABSENCE OF CASH DIVIDENDS

The Company as a stand-alone company has never paid any cash dividends and
does not anticipate paying cash dividends in the foreseeable future. See
"Dividends."

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company is exposed to market risk, including changes to interest rates and
equity investment prices.

INVESTMENT PORTFOLIO

The Company does not use derivative financial instruments in its debt
investment portfolio. The Company places its debt investments in instruments
that meet high credit quality standards, as specified in the Company's
investment policy guidelines; the guidelines also limit the amount of credit
exposure to any one issue, issuer, or type of instrument. The Company does not
expect any material loss with respect to its debt investment portfolio. The
Company's interest income is sensitive to changes in the general level of U.S.
interest rates. Changes in U.S. interest rates affect the interest earned on the
Company's cash equivalents and short-term investments. Based on the Company's
overall interest rate exposure at June 30, 1998, a near term change in interest
rates would not materially affect the fair value of the instruments.

<PAGE> 40

The table below provides information about the Company's debt investment
portfolio in thousands. For debt securities, the table presents principal cash
flows and related weighted average fixed interest rates by expected maturity
dates. The Company's investment policy requires that all investments mature in
400 days or less.

<TABLE>
<CAPTION>
MATURITIES FAIR VALUE
FY1999 FY2000 FY2001 FY2002 TOTAL AT 6/30/98
-------- ------ ------ ------ ------ ----------
(IN `000S)
<S> <C> <C> <C> <C> <C> <C>
DEBT INVESTMENTS
Cash Equivalents $ 218 $ -- $-- $-- $ 218 $ 218
Average Interest Rate 5.6% 5.6%

Short-term Investments $ 1,016 -- -- -- $1,016 $1,016
Average Interest Rate 7.5% 7.5%

Total Debt Investments $ 1,234 -- -- -- $1,234 $1,234
Average Interest Rate 7.2% 7.2%
</TABLE>

As part of its strategic alliance efforts, the Company invests in equity
instruments of biotechnology or biomedical device companies that are subject to
fluctuations in market value from changes in stock prices and thus has material
equity investments at June 30, 1998 with related market risks. The equity
investment portfolio includes investments for which there is no readily
determinable market as of June 30, 1998, such as Pharming, which went public in
July 1998. The Company believes that these are viable investments that will
eventually develop into marketable investments.

Prior to October 1996, the Company's 844,000 shares of common stock of
Innovasive were valued at cost of $4.1 million due to restrictions which
prevented the sale of any of the Company's shares of common stock of Innovasive
Devices. At June 30, 1998, restrictions were no longer applicable on 650,000 of
such shares. The Company carries the portion of its investment in Innovasive
Devices, which can be sold within one year, as an available-for-sale investment
at market value of $6.1 million at June 30, 1998. The remaining 194,000 shares
of Innovasive Devices common stock are still subject to restrictions and thus
continue to be valued at cost of $934,000.

The table below provides information about the Company's equity investment
portfolio (in thousands):

<TABLE>
<CAPTION>
FAIR VALUE
EQUITY INVESTMENTS AT 6/30/98
- ----------------------------------
(IN `000S)
<S> <C>
Boston Scientific $73,979
Ownership % .5%

Innovasive $7,916
Ownership % 9%

Medarex $1,920
Ownership % 1%

Pharming $7,010
Ownership % 6%

Total Portfolio $90,825
=======
</TABLE>

To hedge against fluctuations in the market value of a portion of the Boston
Scientific common stock, the Company entered into costless collar instruments
that expire quarterly from August 1998 through May 2001 and will require
settlement in cash. At June 30, 1998, 725,000 shares, out of approximately 1.0
million held by the Company, were hedged using these collars. The call options
are collateralized by shares of Boston Scientific common stock held by the
Company. At June 30, 1998, the notional amount of the put and call options were
$46 million and $70.7 million, respectively. The fair value of the equity
collars at June 30, 1998 was $96,000.

<PAGE> 41

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL INFORMATION

<TABLE>
<CAPTION>
PAGE
----
COHESION TECHNOLOGIES, INC. CONSOLIDATED FINANCIAL STATEMENTS:

<S> <C>
Report of Ernst & Young LLP, Independent Auditors..................................... 42
Consolidated Balance Sheets as of June 30, 1998 and 1997.............................. 43
Consolidated Statements of Operations for the years ended June 30, 1998, 1997
and 1996............................................................................ 44
Consolidated Statement of Stockholder's and Parent Company Equity (Net Capital
Deficiency) for the years ended June 30, 1998, 1997 and 1996........................ 45
Consolidated Statements of Cash Flows for the years ended June 30, 1998, 1997
and 1996............................................................................ 46
Notes to Consolidated Financial Statements............................................ 47
Supplementary Quarterly Consolidated Financial Data (unaudited)....................... 61

</TABLE>

<PAGE> 42

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Cohesion Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Cohesion
Technologies, Inc. ("the Company"), (a wholly-owned subsidiary of Collagen
Aesthetics, Inc., formerly known as Collagen Corporation), as described in Note
1 to the consolidated financial statements, as of June 30, 1998 and 1997, and
the related consolidated statements of operations, stockholder's and parent
company equity (net capital deficiency) and cash flows for each of the three
years in the period ended June 30, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Cohesion
Technologies, Inc. at June 30, 1998 and 1997, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended June 30, 1998, in conformity with generally accepted accounting
principles.

ERNST & YOUNG LLP

Palo Alto, California
July 31, 1998

<PAGE> 43

COHESION TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
JUNE 30,
-----------------
1998 1997
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 591 $13,706
Short-term investments........................................ 1,016 92
Accounts receivable, less allowance for doubtful accounts
($13 at June 30, 1998 and $2 at June 30, 1997).......... 473 97
Inventories................................................... 81 56
Current deferred taxes........................................ 942 2,608
Other current assets.......................................... 312 942
------- -------
Total current assets................................... 3,415 17,501
Property and equipment, net..................................... 2,072 1,566
Intangible assets, net.......................................... 1,184 1,491
Investment in Boston Scientific Corporation..................... 73,979 83,874
Other investments............................................... 14,707 10,041
Long-term deferred taxes........................................ --- 33
Loans to officers and employees................................. 208 9
Other assets.................................................... 88 89
------- -------
$95,653 $114,604
======= ========
LIABILITIES AND STOCKHOLDER'S AND PARENT COMPANY EQUITY
Current liabilities:
Accounts payable.............................................. $ 792 $ 627
Accrued compensation.......................................... 953 625
Accrued liabilities........................................... 2,390 1,516
Income taxes payable.......................................... 300 2,700
Payable to Collagen Aesthetics, Inc........................... 880 --
------- -------
Total current liabilities.............................. 5,315 5,468
Long-term liabilities:
Deferred income taxes......................................... 31,902 35,052
Other long-term liabilities................................... 21 79
------- -------
Total long-term liabilities............................ 31,923 35,131
Commitments and contingencies
Stockholder's and parent company equity:
Preferred stock, $.001 par value, authorized:
5,000,000 shares, issued and outstanding:
no shares at June 30, 1998 and 10 shares
at June 30, 1997............................................ -- --
Common stock, $.001 par value, authorized:
15,000,000 shares, issued and outstanding:
8,861,040 shares at June 30, 1998 and no shares
at June 30, 1997............................................ -- --
Additional paid-in capital.................................... 9,621 9,621
Parent company equity......................................... 4,961 17,315
Unrealized gain on available-for-sale investments............. 43,833 47,069
------- -------
Total stockholder's and parent company equity.......... 58,415 74,005
------- -------
$95,653 $114,604
======= ========
</TABLE>

The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.

<PAGE> 44

COHESION TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------
1998 1997 1996
--------- --------- -------
<S> <C> <C> <C>
Revenue-- product sales.................. $2,043 $ 2,527 $ 3,612
Costs and expenses:
Cost of sales.......................... 1,162 2,105 2,404
Research and development............... 16,251 9,627 4,268
General and administrative............. 5,526 7,153 3,120
Purchased in-process research and
development.......................... 10,587 -- 3,000
-------- ------- ------
Total costs and expenses....... 33,526 18,885 12,792
-------- ------- ------
Loss from operations..................... (31,483) (16,358) (9,180)
Other income (expense):
Net gain on investments, principally
Boston Scientific Corporation
(Target Therapeutics, Inc.
in 1996)............................ 19,096 9,063 82,093
Net gain on sale of investment in
Prograft Medical, Inc............... -- 15,395 --
Equity in earnings of Target
Therapeutics, Inc.................... -- -- 1,430
Equity in losses of other affiliates .. (9) (813) (1,824)
Interest income........................ 332 566 378
Interest expense....................... -- (377) (2,532)
-------- ------- ------
Income (loss) before provision for
income taxes and minority interest (12,064) 7,476 70,365
Provision (benefit) for income taxes (2,497) 3,162 31,718
Minority interest........................ -- (667) (27)
-------- ------- ------
Net income (loss)........................ $ (9,567) $ 4,981 $38,674
========= ======= ========
</TABLE>

The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.

<PAGE> 45

COHESION TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDER'S AND PARENT COMPANY EQUITY
(NET CAPITAL DEFICIENCY)
YEARS ENDED JUNE 30, 1998, 1997, 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
TOTAL
STOCK-
UNREALIZED HOLDER'S AND
GAIN/(LOSS) PARENT
PREFERRED ON COMPANY
AND ADDITIONAL PARENT AVAILABLE- EQUITY
COMMON PAID-IN COMPANY FOR-SALE (NET CAPITAL
STOCK CAPITAL EQUITY INVESTMENTS DEFICIENCY)
--------- -------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1995 .................... $ -- $ 9,621 $(18,181) $ -- $ (8,560)
Other advances to Collagen Aesthetics, Inc.
(formerly Collagen) ....................... -- -- (5,118) -- (5,118)
Unrealized gain on available-for-sale
securities ................................ -- -- -- 34,549 34,549
Net income .................................. -- -- 38,674 -- 38,674
----- -------- -------- -------- --------
Balance at June 30, 1996 .................... -- 9,621 15,375 34,549 59,545
Other advances to Collagen Aesthetics, Inc.
(formerly Collagen) ....................... -- -- (3,041) -- (3,041)
Unrealized gain on available-for-sale
securities ................................ -- -- -- 12,520 12,520
Net income .................................. -- -- 4,981 -- 4,981
----- -------- -------- -------- --------
Balance at June 30, 1997 .................... -- 9,621 17,315 47,069 74,005
Other advances to Collagen Aesthetics, Inc.
(formerly Collagen) ....................... -- -- (2,787) -- (2,787)
Unrealized loss on available-for-sale
securities ................................ -- -- -- (3,236) (3,236)
Net loss .................................... -- -- (9,567) -- (9,567)
----- -------- -------- -------- --------
Balance at June 30, 1998 .................... $ -- $ 9,621 $ 4,961 $ 43,833 $ 58,415
===== ======== ======== ======== ========
</TABLE>

The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.

<PAGE> 46

COHESION TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) ............................................ $ (9,567) $ 4,981 $ 38,674
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Purchased in-process research and development ............. 10,587 -- 3,000
Depreciation and amortization ............................. 662 564 801
Equity in losses of affiliates ............................ 9 813 393
Gains on investments, net ................................. (19,096) (13,625) (42,547)
Deferred income taxes ..................................... 995 326 (7,508)
Decrease (increase) in assets:
Accounts receivable ..................................... (376) 435 188
Inventories ............................................. (25) -- (37)
Other ................................................... (1,971) 1,166 (1,331)
Increase (decrease) in liabilities:
Accounts payable, accrued liabilities
and other ............................................. 2,247 (463) 1,177
Income taxes payable .................................... (2,400) 408 78
Other long-term liabilities ............................. (57) (679) 611
-------- -------- --------
Total adjustments ............................................ (9,425) (11,055) (45,175)
-------- -------- --------
Net cash used in operating activities ..................... (18,992) (6,074) (6,501)
-------- -------- --------
Cash flows from investing activities:
Net proceeds from sales of Boston Scientific
Corporation/Target Therapeutics, Inc. stock ............... 20,442 5,578 57,950
Net proceeds from sales of other affiliate stock ............. 704 9,771 1,447
Proceeds from sales and maturities of short-term investments.. 1,591 -- --
Purchases of short-term investments .......................... (2,515) -- --
Expenditures for property and equipment ...................... (1,058) (532) (678)
Increase in intangible and other assets ...................... -- (824) (2,042)
Equity investments and loans to affiliates ................... (2,700) (287) (14,337)
Acquisition of shares of Cohesion
Corporation, net of cash balances ......................... (10,587) -- (1,256)
-------- -------- --------
Net cash provided by investing activities ................. 5,877 13,706 41,084
-------- -------- --------
Cash flows from financing activities:
Proceeds from (repayments of) bank borrowings ................ -- (5,000) 5,000
Proceeds from (repayments of) advances from
Collagen Aesthetics, Inc. (formerly Collagen) ............. -- -- (29,000)
-------- -------- --------
Net cash provided by (used in) financing activities ...... -- (5,000) 24,000)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents............ (13,115) 2,632 10,583
Cash and cash equivalents at beginning of year ................. 13,706 11,074 491
-------- -------- --------
Cash and cash equivalents at end of year ....................... $ 591 $ 13,706 $ 11,074
======== ======== ========
</TABLE>

The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.

<PAGE> 47

COHESION TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

Cohesion Technologies, Inc. ("Cohesion" or the "Company") was organized as a
Delaware corporation and a wholly owned subsidiary of Collagen Aesthetics, Inc.
formerly known as Collagen Corporation ("Collagen") in June 1997. In October
1997, Collagen announced that it would proceed to separate its Aesthetic
Technologies Group and its Collagen Technologies Group ("CTG") into two
independent, publicly-traded companies. In connection with the separation of the
two groups, Collagen distributed as a dividend to its stockholders, one share of
the Company's Common Stock for each share of Collagen common stock outstanding
on August 18, 1998 (the "Distribution") (See Note 14, "Subsequent Events"). The
Distribution was designed to separate two distinct businesses with significant
differences in their markets, products, research needs, investment needs,
employee retention and compensation plans and plans for growth. Collagen's Board
believed the separation into two independent companies will enhance the ability
of each to focus on strategic initiatives and new business opportunities,
improve cost structures and operating efficiencies and create incentives that
are more attractive and appropriate for the recruitment and retention of key
employees. As a consequence, Collagen believed that investors will be able to
evaluate better the merits of the two groups of businesses and their future
prospects.

In March 1998, the Board of Directors of Collagen approved certain agreements
between the Company and Collagen (collectively, the "Intercompany Agreements")
which (i) provided for the transfer, effective January 1, 1998, of certain
assets and liabilities relating to the businesses previously conducted by
Collagen's CTG to Cohesion, and (ii) established contractual arrangements
between Collagen and the Company described below under Note 2. CTG's business
activities focused on the design, development, manufacture and commercialization
of innovative resorbable biomaterials, adhesive technologies, and delivery
systems in the fields of tissue repair and regeneration.

The accompanying consolidated financial statements have been prepared using
Collagen's historical cost basis of the assets and liabilities of the various
division activities that comprise Cohesion. The financial statements of Cohesion
include the operating results of Cohesion Corporation, a developer of
proprietary products for hemostasis and tissue adhesion, biosealants and
adhesion barriers for surgical applications, since the acquisition of Cohesion
Corporation by Collagen in fiscal 1996 (see Note 7, "Acquisitions of Cohesion
Corporation").

The consolidated financial statements reflect the results of operations,
financial condition and cash flows of Cohesion as a component of Collagen and
may not be indicative of the actual results of operations and financial position
of Cohesion under separate ownership. The various assets, liabilities, revenues
and expenses associated with CTG have been allocated to the historical financial
statements of Cohesion in a manner consistent with the Intercompany Agreements
as discussed in Note 2 below. Management believes that the consolidated
statements of operations include a reasonable allocation of costs incurred by
Collagen which benefit Cohesion. These allocations of corporate expenses
include, in aggregate, approximately 30% to 35% of the general and
administrative expenses of Collagen for the periods presented, with the
exception of certain Chief Executive Officer ("CEO") expenses and legal costs
related to Collagen's lawsuit with Matrix Pharmaceutical, Inc. ("Matrix"). (See
Notes 1, 8 and 9.) The CEO expenses have been allocated to Cohesion based on the
CEO's level of involvement in Cohesion during each fiscal year presented. All
costs associated with the Matrix lawsuit, which was filed in December 1994 and
settled in May 1997, were allocated based on the focus of the lawsuit during
fiscal 1997, 1996 and 1995. Costs and expenses associated with cost of sales and
research and development were generally allocated to Cohesion on a specific
identification basis.

<PAGE> 48

The consolidated financial statements include an allocation of Collagen
corporate debt and interest expense. In connection with the asset transfer
discussed above, $10.9 million of cash, cash equivalents and short-term
investments remained with Collagen and the remaining cash, cash equivalents and
short-term investments were transferred to the Company at December 31, 1997.
Each debt security was allocated between the companies pro rata to the total
allocation of such investments. All short-term investments for fiscal years 1997
and prior were allocated to Collagen. Substantially all investments in
affiliates, including Boston Scientific Corporation of Natick, Massachusetts
("Boston Scientific") and Innovasive Devices, Inc. of Marlborough, Massachusetts
("Innovasive Devices") were allocated to Cohesion. Trade receivables, notes
receivable, loans to officers and employees, fixed assets and employee related
liabilities were allocated based on specific identification. All equity
accounts, with the exception of the additional paid-in-capital related to Target
Therapeutics, Inc., remained with Collagen. For any assets or liabilities where
it was not practical to use the specific identification method, Cohesion was
allocated 30% of these assets and liabilities. The 30% allocation was based on a
review of the characteristics and activity of these assets and liabilities and
business objectives. In those years that Cohesion had negative cash and cash
equivalent balances, a note payable due to Collagen was recorded. Accordingly,
interest expense was accrued annually at 8% and Cohesion was assumed to have
repaid the note payable balance and the accrued interest the following June
30th. The intercompany receivable/payable balances resulting from Cohesion's
participation in Collagen's central cash management system, after consideration
of the December 31, 1997 contribution of cash, cash equivalents and short-term
investments, is a component of parent company's contributed capital on
Cohesion's balance sheet. The officer separation agreement with Collagen's
former CEO, as described below under Note 8, and the costs associated with the
agreement have been allocated to Cohesion.

Under the terms of the services and supply agreements between Cohesion and
Collagen discussed below, Collagen will supply certain products to Cohesion for
a fee. The cost of sales amounts included in the financial statements are based
on historical costs for the periods presented. The Intercompany Agreements
discussed in Note 2 provide for cost to be determined on a defined formula. If
such prospective arrangements had been in place during the periods presented,
cost of sales would have decreased by $237,000 and $589,000 in fiscal years 1996
and 1997, respectively and increased by $48,000 in fiscal 1998.

Under the terms of the Recombinant Technology and Development License
agreement between Cohesion and Collagen discussed in Note 2 below, Cohesion and
Collagen will collaborate to develop recombinant human collagen and provide for
cost sharing of the project until certain milestones are met. The research and
development ("R&D") expenses included in the financial statements are based on
historical costs for the periods presented. The Intercompany Agreements
discussed in Note 2 provide for costs to be equally shared. If such prospective
arrangements had been in place during the periods presented, R&D expenses, net
of reimbursements from Collagen, would have decreased by $1.0 million, $1.3
million and $703,000 in fiscal years 1998, 1997 and 1996, respectively.

Principles of Consolidation

The consolidated financial statements include the accounts of Cohesion and
its wholly-owned and majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. Cohesion operates in one
industry segment focusing on the development and sale of medical devices.
Investments in unconsolidated subsidiaries, and other equity investments in
which Cohesion has a 20% to 50% interest or otherwise has the ability to
exercise significant influence, are accounted for under the equity method.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

<PAGE> 49

Cash Equivalents, Short-term Investments and Other Investments

Cohesion considers all highly liquid investments with an original maturity
from date of purchase of three months or less to be cash equivalents. Short-term
investments consist principally of bankers acceptances, commercial paper and
master notes and have maturities greater than 90 days, but not exceeding one
year.

Cohesion invests its excess cash in deposits with major banks and in money
market securities of companies with strong credit ratings and from a variety of
industries. These securities are typically short-term in nature and, therefore,
bear minimal risk. Cohesion has not experienced any losses on its money market
investments.

Cohesion determines the appropriate classification of marketable securities
at the time of purchase and re-evaluates such designation as of each balance
sheet date. All of Cohesion's debt and equity securities are classified as
available-for-sale. The carrying value of available-for-sale debt securities
approximates fair value because of the short-term maturity of these investments.
Both realized and unrealized gains and losses on debt securities were immaterial
as of June 30, 1998 and 1997 and for the years ended June 30, 1998, 1997 and
1996. Unrestricted available-for-sale equity securities in which Cohesion has a
less than 20% interest, which includes holdings in Boston Scientific (holdings
in Target Therapeutics, Inc. prior to April 1997) and the unrestricted portion
of the Company's holdings in Innovasive Devices are carried at fair value with
the unrealized gains and losses, net of tax, reported as a separate component of
stockholder's equity. Restricted equity securities in which Cohesion has less
than a 20% interest are carried at cost or estimated realizable value, if less,
and are included in "other investments" in the accompanying balance sheets. In
fiscal 1996, the carrying values of certain restricted equity investments were
reduced by $4.0 million to estimated net realizable value. (See Note 5 -
"Investment in Boston Scientific Corporation"). The cost of securities sold is
based on the specific identification method. The fair value of public equity
securities held is based upon quoted closing market prices. The fair value of
private equity securities held approximates the carrying value based on quoted
market prices for similar securities.

The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are included in interest
income. Interest and dividends on securities classified as available-for-sale
are included in interest income.

Equity Collar Instruments

At June 30, 1998, Cohesion held approximately 1.0 million shares of Boston
Scientific common stock. In order to manage the risk of market fluctuations in
the price of this stock, Cohesion entered into certain costless collar
instruments (the "Collars"), to hedge a portion (725,000 shares at June 30,
1998) of the Boston Scientific equity securities against changes in market
value. A costless collar instrument is a form of equity collar instrument
consisting of a purchased put option and a written call option on a specific
equity security such that the cost of the purchased put and the proceeds of the
written call offset each other; therefore, there is no initial cost or cash
outflow for these instruments. Cohesion purchased the Collars with expiration
dates and numbers of shares so that the potential adverse impact of movements in
market price of the stock will be at least partially offset by an associated
increase in the value of the Collars.

Realized gains and losses on the Collars are recorded in other income
(expense) with the related gains from the sale of the stock. Unrealized gains
and losses on these instruments, net of tax, are recorded as an adjustment to
unrealized gains and losses on available-for-sale investments, a component of
stockholder's and parent company equity, with a corresponding receivable or
payable recorded. Equity collar instruments that do not qualify for hedge
accounting and early termination of these instruments with the sale of the
underlying stock, would be recognized in other income (expense). For early
termination without the sale of the underlying stock, the intrinsic value will
adjust the cost basis of the underlying security.

Inventories

Inventories, which are purchased from Collagen, are valued at the lower of
cost, determined on a standard cost basis which approximates average cost, or
market.

<PAGE> 50

Property and Equipment

Depreciation and amortization of property and equipment, which is stated at
cost, are provided on the straight-line method over estimated useful lives as
follows:

<TABLE>
<S> <C>
Machinery and equipment............. 3 -- 7 years
Leasehold improvements.............. Term of lease
</TABLE>

Intangible Assets

Intangible assets are amortized using the straight-line method. Patents
acquired prior to October 1996 are amortized over a seventeen year period
beginning with the effective date or over the remainder of such period from the
date acquired and patents purchased thereafter are expensed when acquired.
Trademarks acquired prior to fiscal 1996 are amortized over a twenty year period
beginning with the trademark filing dates and trademarks purchased thereafter
are expensed when acquired. The effect of changes in accounting for patents and
trademarks were not material to the accompanying financial statements.

Loans to Officers and Employees

Principal plus accrued interest due from current and former employees totaled
approximately $1.5 million and $1.7 million at June 30, 1998 and 1997,
respectively, prior to reserves. Principal plus accrued interest due from
officers totaled approximately $9,000 at June 30, 1998 and 1997, respectively.
The fair value of the notes held approximates the carrying value based on quoted
market prices for loans with similar terms.

Included within the amounts due from current and former employees at June 30,
1998 and June 30, 1997, and within the amounts due from officers at June 30,
1997, are four promissory notes totaling $1.6 million, prior to reserves, due
from Collagen's former Chairman and Chief Executive Officer, Howard Palefsky.
All such notes are subject to interest at the lower of 10% per annum or the
prime rate. Two loans totaling $425,000 were forgiven on March 15, 1998 and two
loans totaling $1.1 million are to be forgiven on March 15, 1999, but all notes
are repayable immediately if Mr. Palefsky discontinues serving as a consultant
to Cohesion prior to the loan forgiveness dates. Due to uncertainties regarding
collection, loans to Mr. Palefsky were fully reserved as of June 30, 1997, and
the associated expenses were recognized in fiscal 1997.

Summary of Fair Values of Financial Instruments

The table below summarizes the carrying value and fair value of Cohesion's
financial instruments which are all held for purposes other than trading.

<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1998 1997
----------------- ----------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
ASSETS: (IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash Equivalents and Short-term
Investments (see Note 4)............. $1,234 $1,234 $10,599 $10,599
Boston Scientific Stock (see Note 5)... 73,979 73,979 83,874 83,874
Innovasive Devices Stock (see Note 6).. 7,027 7,916 5,670 9,916
Other Equity Securities................ 7,680 7,680 4,371 4,371
Loans to Officers and Employees........ 208 208 9 9
Equity Collar Instruments.............. -- 96 -- --
</TABLE>

Revenue Recognition

Revenue from product sales is recognized at time of shipment, net of
allowances for estimated future returns.

Earnings Per Share

Cohesion computes earnings per share in accordance with Financial Accounting
Standards Board Statement of Financial Accounting Standards No. 128, Earnings
Per Share ("SFAS 128"). Historical per share data for

<PAGE> 51

each of the three years in the period ended June 30, 1998 has not been presented
as no common shares were outstanding until June 25, 1998.

Pro forma share and per share data has been presented below for each of the
two years in the period ended June 30, 1998 assuming the distribution of shares
of the Company's Common Stock to Collagen's stockholders had already occurred
(See Note 14, "Subsequent Events") based on the number of Collagen common shares
and common equivalent shares outstanding for those periods, assuming a
one-for-one exchange ratio in the distribution.

<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Pro forma net income (loss) per share - Basic $(1.07) $.57
Pro forma net income (loss) per share - Diluted $(1.07) $.56

Shares used in calculating per share information - Basic 8,913 8,804
Shares used in calculating per share information - Diluted 8,913 8,930
</TABLE>

Concentration of Credit and Other Risk

Cohesion sells its intermediate products (Vitrogen, Cell Prime, Zygen,
Angiostat and other bulk collagen products) to various universities and
institutions and its Collagraft(R) bone graft matrix implant and Collagraft(R)
bone graft matrix strip ("Collagraft bone graft products") to Zimmer, Inc.
("Zimmer"), Cohesion's marketing partner for Collagraft bone graft products.
Cohesion performs ongoing credit evaluations of its customers and generally does
not require collateral. Cohesion maintains reserves for potential credit losses
and such losses have been within management's expectations.

Cohesion allows, on occasion, its customers to return product for credit, and
also allows customers to return defective or damaged product for credit or
replacement. Written authorization from Cohesion is required to return
merchandise. Some domestic and foreign customers are subject to extended payment
terms. These practices have not had a material effect on Cohesion's working
capital.

As of June 30, 1998, Cohesion held approximately 1.0 million shares of Boston
Scientific common stock valued at over $74.0 million (based on a market price of
$71.63 per share on such date).

All of Cohesion's research and development activities, its corporate
headquarters, and other critical business functions are located near major
earthquake faults. In addition, all of Cohesion's products are manufactured and
stored at Collagen's manufacturing and warehouse facility with Cohesion
currently maintaining only limited amounts of finished product inventory at
these facilities. Both facilities are located near major earthquake faults.
While Cohesion has some limited protection in the form of disaster recovery
programs and basic insurance coverage, Cohesion's operating results and
financial condition would be materially adversely affected in the event of a
major earthquake, fire or other similar calamity affecting these facilities.

Stock based compensation

The Company accounts for stock based compensation using the intrinsic value
method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, compensation cost for stock options is measured as the
excess, if any, of the quoted market price of the Company's stock at the date of
grant over the amount an employee much pay to acquire the stock. The Company has
adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation."

New Accounting Standards

In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income," and Financial Accounting Standard No. 131 ("SFAS 131"), "Disclosures
About Segments of an Enterprise and Related Information," which will be required
to be adopted by Cohesion in fiscal 1999. Adoption of these statements is not
expected to have a significant impact on Cohesion's consolidated financial
position, results of operations or cash flows.

In June 1998, the Financial Accounting Standards Board issued Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133")
which provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. SFAS 133 is effective for
years beginning after June 15, 1999 and is not anticipated to have an impact on
the Company's results of operations or financial condition when adopted.

<PAGE> 52

2. CONTRACTUAL AGREEMENTS WITH COLLAGEN

Cohesion entered into supply, services, research and development, benefits,
tax allocation, and distribution agreements with Collagen effective January 1,
1998. Under the Collagraft Supply Agreement, Collagen will supply Cohesion's
requirements of Collagraft necessary for Cohesion to fulfill its obligations
under its agreement with Zimmer at a price that is the greater of a percentage
of the sales price or a defined multiplier of Collagen's cost. In accordance
with the Collagen Supply Agreement, Collagen will supply Cohesion products,
intermediates and finished materials at a price equal to a multiplier of
Collagen's cost. Under the Services Agreement, which is effective through June
30, 1999, Cohesion shall provide Collagen with services in the following areas:
facilities, telephone, library, investor relations, research and development
services (to the extent not provided for by the research and development
agreement), and clinical and regulatory. Collagen shall provide Cohesion with
certain services in the following areas: financial and tax services, health and
welfare benefits administration and administration of the 401(k) Savings Plan,
administrative, legal, regulatory, quality assurance, medical affairs, and
manufacturing services. Under the Services Agreement with Collagen, Cohesion
will use Collagen's computer systems until June 30, 1999. Subsequent to June 30,
1999, Cohesion may extend its Services Agreement with Collagen or elect to
purchase its own computer systems. In accordance with the Recombinant Technology
and Development License Agreement, Cohesion and Collagen will collaborate to
develop recombinant human collagen and provide for cost sharing for the project
until certain milestones are met. The Benefits Agreement provides for the
continuation or replacement of benefits for the employees transferred to
Cohesion and employees remaining with Collagen. The Tax Allocation Agreement
provides that Collagen will be responsible for all taxes prior to the
Distribution date and Cohesion will be responsible for all of its tax
liabilities subsequent to that date. Under the Vitrogen International
Distribution Agreement, Collagen International, Inc., a subsidiary of Collagen,
shall act as Cohesion's distributor in Germany for Vitrogen.

3. BALANCE SHEET INFORMATION

<TABLE>
<CAPTION>
JUNE 30,
---------------
1998 1997
------ ------
(IN THOUSANDS)
<S> <C> <C>
Other current assets:
Receivables from affiliates............. $ 108 $ 331
Other................................... 204 611
------ ------
$ 312 $ 942
====== ======
Property and equipment:
Machinery and equipment................. $5,438 $4,733
Leasehold improvements.................. 2,874 2,551
------ ------
8,312 7,284
Less accumulated depreciation and
amortization........................... (6,240) (5,718)
------ ------
$2,072 $1,566
====== ======
Intangible assets:
Patents and trademarks.................. $2,265 $2,464
Less amortization....................... (1,081) (973)
------ ------
$1,184 $1,491
====== ======
Accrued liabilities:
Accrued liabilities -- research and
development, general and
administrative and other.............. $2,089 $1,283
Legal fees.............................. 50 78
Employee related liabilities............ 251 155
------ ------
$2,390 $1,516
====== ======
</TABLE>

4. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

The following is a summary of available-for-sale debt securities at amortized
cost which approximates fair value.

<TABLE>
<CAPTION>
JUNE 30,
---------------
1998 1997
------ ------
<S> <C> <C>
Cash Equivalents:
Money market funds.................. $ --- $1,601
Corporate obligations............... 218 8,906
------- -------
</TABLE>

<PAGE> 53

<TABLE>
<CAPTION>
JUNE 30,
---------------
1998 1997
------ ------
<S> <C> <C>
$ 218 $10,507
====== =======
Short-term investments:
Corporate obligations.............. $1,016 $ 92
====== ======
</TABLE>

During the years ended June 30, 1998 and 1997, the Company sold
available-for-sale debt securities with a fair value at the dates of sale of
$1.6 million and none, respectively. Cohesion uses amortized cost as the basis
for recording gains and losses from securities transactions. Contractual
maturities of the debt securities do not exceed one year at June 30, 1998.

5. INVESTMENT IN BOSTON SCIENTIFIC CORPORATION (TARGET THERAPEUTICS, INC.)

Cohesion's investment in Target Therapeutics, Inc. of Fremont, California
("Target") was accounted for under the equity method through November 1995.
During December 1995, Cohesion's ownership interest in Target fell below 20%.
Given that Cohesion did not have the ability to exercise significant influence,
Cohesion began accounting for its investment in Target under the cost method
beginning in December 1995. In fiscal 1996, Cohesion sold 1,792,000 shares of
Target common stock for a pre-tax gain of approximately $85.8 million and in
fiscal 1997, Cohesion sold 330,000 shares of Target common stock for a pre-tax
gain of approximately $9.1 million.

On January 20, 1997, Boston Scientific and Target jointly announced the
signing of a definitive agreement to merge in a tax-free, stock-for-stock
transaction. On April 8, 1997, the merger was completed and, as a result,
Cohesion received 1,365,200 shares of Boston Scientific common stock in exchange
for 1,275,888 shares of Target common stock. Pursuant to the merger agreement,
Cohesion was restricted from selling its shares of Boston Scientific common
stock until the expiration of applicable pooling-of-interests restrictions,
which occurred during the first quarter of fiscal 1998. During the fiscal year
ended June 30, 1998, Cohesion sold 332,340 shares of Boston Scientific common
stock for a pre-tax gain of approximately $19.0 million.

Boston Scientific is a leading manufacturer of catheter-based devices that
can be inserted through small body openings and are used in heart surgery and
other operations. Boston Scientific common stock is quoted on the New York Stock
Exchange under the symbol BSX. On June 30, 1998, the closing price of Boston
Scientific common stock was $71.63 per share.

Cohesion's shares of Boston Scientific common stock are classified as
available-for-sale and have been recorded at the estimated fair value. The
unrealized gains (estimated fair value less cost) on these available-for-sale
securities have been reported as a separate component of stockholder's and
parent company equity, net of tax. The following is a summary of the aggregate
estimated fair value, gross unrealized gains and amortized cost of the Company's
investment in Boston Scientific common stock:

<TABLE>
<CAPTION>
JUNE 30,
---------------
1998 1997
------ ------
(IN THOUSANDS)
<S> <C> <C>
Amortized Cost.............. $ 4,468 $ 5,905
Gross Unrealized Gains...... 69,511 77,969
------- -------
Estimated Fair Value........ $73,979 $83,874
======= =======
</TABLE>

To hedge against fluctuations in the market value of a portion of the Boston
Scientific common stock, Cohesion entered into costless collar instruments that
expire quarterly from August 1998 through May 2001 and will require settlement
in cash. At June 30, 1998, 725,000 shares were hedged under these collars. The
fair value of the purchased puts and the written calls were determined based on
quoted market prices at year end. At June 30, 1998, the notional amount of the
put and call options were $46.0 million and $70.7 million, respectively. The
fair value of the equity collars at June 30, 1998 was $96,000. No shares were
hedged at June 30, 1997. The call options are collateralized by shares of Boston
Scientific common stock held by Cohesion.

<PAGE> 54

6. INVESTMENT IN INNOVASIVE DEVICES, INC.

In October 1995, Cohesion purchased approximately 844,000 shares of common
stock, representing approximately 9% of the outstanding capital stock of
Innovasive Devices for $4.1 million and entered into a collaborative product
development agreement (the "Development Agreement"). Innovasive Devices
develops, manufactures and markets tissue and bone reattachment systems which
are particularly relevant to the sports medicine and arthroscopy segments of the
orthopedic surgery market. Pursuant to the Intercompany Agreements, Cohesion
assumed Collagen's relationship and obligations with Innovasive Devices.
Cohesion and Innovasive Devices are collaborating to develop certain resorbable
mechanical tissue-fixation devices utilizing collagen-based biomaterials for
applications in orthopedic tissue repairs. Pursuant to the terms of the
Development Agreement, Cohesion is performing development activities in
accordance with a project plan and Innovasive Devices is reimbursing Cohesion
for such activities in accordance with the project budget. Accordingly, over the
next several years, the collaboration will require Cohesion's expertise with
collagen-based biomaterials and a small percentage of Cohesion's research and
development expenditures. In the event that marketable products are developed as
a result of this collaboration, Cohesion will have the right (but no obligation)
to manufacture such products.

Prior to October 1996, Cohesion's 844,000 shares of common stock of
Innovasive Devices were valued at cost or $4.1 million due to restrictions which
prevented the sale of any of Cohesion's shares of common stock of Innovasive
Devices. At June 30, 1998, restrictions were no longer applicable on 650,000
shares of common stock which Cohesion held in Innovasive Devices. Cohesion
carries the portion of its investment in Innovasive Devices which can be sold
within one year, as an available-for-sale investment at market value, or $6.1
million at June 30, 1998, reflecting an unrealized gain of $3.0 million ($6.1
million estimated fair value less $3.1 million cost), which has been included in
a separate component of stockholder's and parent company equity, net of tax. The
remaining 194,000 restricted shares of common stock continued to be valued at
cost of $934,000. The investment in Innovasive Devices is included in "other
investments" in the accompanying balance sheets.

During fiscal 1998 and 1997, Cohesion did not sell any of its shares of
common stock of Innovasive Devices. Innovasive Devices common stock is quoted on
The Nasdaq Stock Market under the symbol IDEA. The closing price of Innovasive
Devices' common stock at June 30, 1998, was $9.38 per share. At June 30, 1998,
Cohesion held approximately a 9% ownership position in Innovasive Devices. As of
July 31, 1998, Innovasive's closing price was $7.88 per share, resulting in a
decrease of $975,000 in the estimated fair value of the non-restricted portion
of the Company's investment in Innovasive Devices.

7. ACQUISITIONS OF COHESION CORPORATION

Collagen increased its ownership position in Cohesion Corporation of Palo
Alto, California from approximately 40% to 81% in May 1996 and from 81% to
approximately 99% in December 1997. Cohesion Corporation is a privately-held
company developing novel biomaterials with superior performance characteristics
in the area of hemostats, biosealants, and adhesion prevention barriers for
surgical applications. In connection with Collagen's May 1996, December 1997 and
April 1998 investments and purchases of Cohesion Corporation shares,
substantially all of the $3.0 million and $10.6 million purchase prices,
respectively, were allocated to in-process research and development, which was
expensed at the time of the purchases. The $10.6 million fiscal 1998 purchase
price includes $3.8 million of cash compensation amounts associated with the
purchase of certain vested employee stock options, which amounts were expensed
in accordance with Accounting Principles Board Opinion No. 25. After
consideration of the amounts allocated to in-process technology, there was no
excess of purchase price over the fair value of the net assets acquired and no
goodwill was recorded.

Cohesion determined the amounts to be allocated to in-process technology for
Cohesion Corporation based on whether technological feasibility had been
achieved and whether there was any alternative future use for the technology.
Cohesion concluded that the in-process technology had no alternative future use
after taking into consideration the potential for both usage of the technology
in different products and for resale of the technology. At June 30, 1998, there
were additional vested and unvested options outstanding providing for the
purchase of the remaining shares of Cohesion Corporation common stock. In
September 1998, the Company's

<PAGE> 55

Board of Directors approved a program to cancel these remaining options (see
Note 14, "Subsequent Events").

The unaudited pro forma results of operations of Cohesion assuming the
acquisitions of Cohesion Corporation shares occurred on July 1, 1995, on the
basis described above with all material intercompany transactions eliminated,
are as follows (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------ ------ -------
1998 1997 1996
------ ------ -------
<S> <C> <C> <C>
Revenues................ $2,043 $2,527 $ 3,612
Net income.............. $1,020 $4,081 $41,302
</TABLE>

The unaudited pro forma net income amounts above do not include the charges
for in-process research and development aggregating $13.6 million arising from
the acquisitions of shares of Cohesion Corporation. The unaudited pro forma
information is not necessarily indicative of the actual results of operations
had the transaction occurred at the beginning of the periods indicated, nor
should it be used to project Cohesion's results of operations for any future
dates or periods.

8. COMMITMENTS

Minimum lease payments

Future minimum lease payments to third parties under noncancelable operating
leases at June 30, 1998 are as follows (in thousands):

<TABLE>
<S> <C>
1999................................ $ 636
2000................................ 273
2001................................ 273
2002................................ 273
2003................................ 273
Thereafter.......................... 387
------
Total minimum lease payments.... $2,115
======
</TABLE>

Rental expense was $636,000, $722,000, and $948,000 in fiscal 1998, 1997, and
1996, respectively.

Revolving Line of Credit Agreement

In November 1994, Collagen entered into a $7.0 million revolving line of
credit with a bank, secured by shares of Target common stock. The terms of this
facility contained certain financial covenants. In December 1995, the $7 million
revolving line of credit was increased to $15.0 million. During fiscal 1996,
$5.0 million was borrowed under this agreement. In June 1997, Collagen repaid
the outstanding balance and canceled the revolving line of credit agreement
prior to its expiration date of November 15, 1997. Interest associated with this
agreement was, at Collagen's option, based on either the prime rate plus 1/2% or
the Eurodollar rate plus the lesser of 1 1/4% or the Alternate LIBOR applicable
margin. Interest was payable monthly. Additionally, Collagen was required to
pay, on a quarterly basis, a commitment fee of 3/8 of 1% per annum of the unused
portion. The weighted average interest rate was 8.1% on the outstanding
short-term borrowings at June 30, 1996. The fair value of the borrowings at June
30, 1996 of $5.0 million approximates fair value based on quoted market prices
for similar loans. The revolving line of credit was allocated to Cohesion
because the credit facility was secured by shares of Target common stock, which
were also allocated to Cohesion.

<PAGE> 56

Bonus Agreement

In February 1996, Collagen entered into a cash bonus agreement with
Collagen's Chairman and Chief Executive Officer whereby cash bonuses in the
amounts of $325,000, $305,000, $285,000, $265,000 and $245,000 would be paid to
him on February 13 of each of the following five years beginning in 1997,
providing that he continued to serve Collagen on the applicable payment date. On
February 10, 1997, Mr. Palefsky resigned as Chief Executive Officer and
subsequently resigned as Chairman of the Board of Directors on June 20, 1997,
and as a result, the February 13, 1997 payment and future payments were not
required to be paid under this bonus agreement. The bonus agreement was replaced
by the officer separation agreement. Under the officer separation agreement, Mr.
Palefsky will serve as a consultant during fiscal 1998 and 1999 and as a result
Cohesion has assumed Collagen's obligations under the agreement. As a result,
Cohesion made a payment to Mr. Palefsky during fiscal 1998 totaling $575,000 and
will make a payment of $233,000 in fiscal 1999. These future payments are
expensed as the services are provided.

9. LEGAL MATTERS

In May 1997, Collagen settled its lawsuit with Matrix, which had been pending
since December 1994. The lawsuit involved Collagen's claims of trade secret
misappropriation against Matrix and two former Collagen employees hired by
Matrix in 1992, as well as cross-complaints against Collagen by Matrix and the
two employees for defamation and violation of state unfair competition law.

Collagen granted Matrix a nonexclusive license to certain intellectual
property (which was transferred to Cohesion effective January 1, 1998) for
certain nonmonetary consideration. The lawsuit was settled and dismissed with
prejudice. All claims by and against all parties have been released.

Cohesion is involved in other legal actions arising in the ordinary course of
business. While the outcome of such matters is currently not determinable, it is
management's opinion that these matters will not have a material adverse effect
on Cohesion's consolidated financial position or results of its operations.

10. STOCKHOLDER'S AND PARENT COMPANY EQUITY

Preferred Stock

Cohesion has authorized 5,000,000 shares of preferred stock with a par value
of $0.001 per share. Each share of preferred stock is convertible into one share
of common stock at the option of the holder. Additionally, the preferred shares
automatically convert into common stock concurrent with the closing of an
underwritten public offering of common stock under the Securities Act of 1933 in
which Cohesion receives at least $10,000,000 in gross proceeds.

Preferred stockholders are entitled to noncumulative dividends at an annual
rate of $0.10 per share. Dividends will be paid only when declared by the Board
of Directors out of legally available funds. No dividends have been declared as
of June 30, 1998.

Preferred stockholders are entitled to a liquidation preference of $1.00 per
share plus all declared and unpaid dividends. If, upon liquidation, the assets
of Cohesion are insufficient to permit the payment to the preferred stockholders
of the full liquidation preference, the assets of Cohesion will be distributed
ratably among the preferred stockholders. If the assets are more than sufficient
to pay the full preferences, then, following the payment of the full
preferences, the remaining assets of Cohesion shall be distributed ratably to
any holders of common stock.

Common Stock

On June 25, 1998, each of the Company's ten outstanding shares of preferred
stock converted into 886,104 shares of common stock and the Company's
authorized common stock was increased from 10,000,000 to 15,000,000 shares.

Stock Options

Each employee (including officers), consultant, and nonemployee director of
Collagen or any subsidiary of Collagen who, immediately prior to the
Distribution date, held a vested Collagen stock option, in connection with the
Distribution, will receive two new options in replacement of the original
vested Collagen stock option,

<PAGE> 57
one to acquire shares of Collagen's common stock and the other to acquire shares
of Cohesion's Common Stock. Each new option gives the holder the right to
purchase a number of shares equal to the number of shares in the original
option.

Each employee (including officers), consultant, and nonemployee director of
Collagen or any subsidiary of Collagen who, immediately prior to the
Distribution date, held an unvested Collagen stock option, in connection with
the Distribution, will receive a new option in replacement of the unvested
Collagen stock option to acquire the same number of shares of common stock of
the entity (Collagen or Cohesion) for which such optionee was employed or
retained as a consultant or nonemployee director following the Distribution.

The replacement options described in the two preceding paragraphs are
expected to result in the issuance of options for the purchase of an aggregate
of approximately 1.1 million shares of Cohesion Common Stock. The exercise price
of each new option will be determined in accordance with Emerging Issues Task
Force Issue 90-9 as agreed upon by Collagen's Board and the Cohesion Board (or
any committee thereof) after consultation with legal and accounting advisors.
The exercise price, as adjusted in light of the above considerations, will not
result in any compensation expense to Collagen or Cohesion.
(See Note 14, "Subsequent Events").

Stock Purchase Plan

The Board of Directors of Collagen designated Cohesion and each of Cohesion's
subsidiaries as a designated subsidiary under the Collagen Employee Stock
Purchase Plan (the "Collagen ESPP") as of January 1, 1998. The Collagen ESPP and
the offering period that commenced on January 1, 1998 under the Collagen ESPP
terminated one week prior to the record date for the Distribution and all
employee contributions through such date were used to purchase shares of
Collagen common stock. As of that date, Collagen and Cohesion had adopted new
employee stock purchase plans having such terms as approved by the respective
Board of Directors, and the initial offering periods under each such plan
commenced on or shortly after the Distribution date.

In April 1998, Cohesion's Board of Directors adopted, and Collagen, as the
sole stockholder of Cohesion, approved Cohesion's 1998 Stock Option Plan, the
1998 Employee Stock Purchase Plan and the 1998 Directors' Stock Option Plan and
reserved 2,607,000 shares, 250,000 shares and 268,000 shares of Common Stock,
respectively, for issuance thereunder.

Subsidiary Stock Information

Stock Options

In April 1996, the Board of Directors of Cohesion Corporation approved the
adoption of the 1996 Cohesion Corporation Stock Option Plan which authorized the
issuance of 475,000 shares of Cohesion Corporation common stock under the plan.
In May 1997, the Board of Directors of Cohesion Corporation authorized the
issuance of an additional 300,000 shares of Cohesion Corporation stock under the
plan. The Board of Directors of Cohesion Corporation may grant incentive stock
options or non-statutory stock options to officers, directors, key employees and
consultants to purchase Cohesion Corporation's common stock. The options are
granted at no less than the fair market value at the dates of grant and
generally expire after ten years. Incentive stock options have a one-year cliff
period, at which time 25% of the options become vested with monthly vesting
thereafter, not to exceed a four-year vesting period from the vesting
commencement date. Non-statutory stock options become exercisable on a monthly
basis over a three-year period from the date of grant. The shares issued under
the plan are not convertible into shares of Cohesion, and Cohesion does not have
repurchase rights with respect to such shares (see Note 14, "Subsequent
Events").

At June 30, 1998, the total number of shares of common stock reserved for
issuance under Cohesion Corporation's 1996 Stock Option Plan was 775,000.

<PAGE> 58

Stock option activities under the Cohesion Corporation Stock Option Plan were
as follows:

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
PRICE NUMBER
NUMBER OPTION EXERCISE PRICE PER OF SHARES
OF SHARES RANGE PER SHARE SHARE EXERCISABLE
--------- --------------------- --------- -----------
<S> <C> <C> <C> <C>
Outstanding at May 1, and June 30, 1996 307,000 $0.20 - $0.20 $0.20 39,146
Granted................................ 133,000 0.70 - 0.70 0.70
------- -----
Outstanding at June 30, 1997........... 440,000 0.20 - 0.70 0.35 132,174
Granted................................ 154,000 0.70 - 0.70 0.70
Exercised.............................. (181,233) 0.20 - 0.70 0.23
Forfeitures or expired................. (58,563) 0.20 - 0.70 0.57
------- -----
Outstanding at June 30, 1998........... 354,204 $0.20 - $0.70 $0.54 354,204
======= =====
Available for grant at June 30, 1998... 239,563
=======
</TABLE>

Stock Compensation

Cohesion and Cohesion Corporation have elected to follow Accounting
Principles Board Statement No. 25 ("APB No. 25") and related interpretations in
accounting for their employee stock options because, as discussed below, the
alternative fair value accounting provided for under Financial Accounting
Standards Board Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation ("SFAS 123") requires the use of option valuation
models that were not developed for use in valuing employees stock options. Under
APB No. 25, because the exercise price of the employee stock options equals the
market price of the underlying stock on the date of the grant, no compensation
expense is generally recognized.

Pro forma information regarding net income (loss) is required by SFAS 123 and
determined as if Cohesion and its subsidiaries had accounted for the Cohesion
Corporation employee stock options granted subsequent to Cohesion's acquisition
of a majority ownership in Cohesion Corporation in May 1996 under the fair value
method of that statement. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model for the multiple-option
approach, with the following weighted-average assumptions for 1998, 1997 and
1996: risk-free interest rate of 6.12%, 6.05% and 5.38%, respectively;
volatility factor of the expected market price of Cohesion Corporation's common
stock of .43, .49 and .43, respectively; no dividend payments; and a
weighted-average expected life of the options of 5 years, 5.5 years and 8.56
years, respectively.

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

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to pro forma net income over the options' vesting period.
Cohesion's pro forma information follows (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------------------------
1998 1997 1996
-------- --------- ---------
<S> <C> <C> <C>
Pro forma net income (loss) ........ $ (9,528) $ 4,973 $ 38,674
Pro forma net income (loss) per
share - Basic(1) ................. (1.08) $ .56
Pro forma net income (loss) per
share - Diluted(1) ............... (1.08) $ .56
</TABLE>

(1) Pro forma share and per share data has been presented for each of the two
years in the period ended June 30, 1998, assuming the distribution of shares
of the Company's Common Stock to Collagen's stockholders had already
occurred (See Note 14, "Subsequent Events") based on the number of Collagen
common shares and common equivalent shares outstanding

58
<PAGE> 59
for those periods, assuming a one-for-one exchange ratio in the
distribution.

Because SFAS 123 is applicable only to options granted subsequent to May
1996, its pro forma effect will not be fully reflected until 1999. In addition,
such information does not include the effects of the options of Cohesion to be
issued in replacement of existing Collagen stock options in connection with the
Distribution of Cohesion.

The following table summarizes information about Cohesion Corporation stock
options outstanding at June 30, 1998:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------- -------------------------------
WEIGHTED
AVERAGE NUMBER
WEIGHTED REMAINING EXERCISABLE AS WEIGHTED
RANGE OF NUMBER AVERAGE CONTRACTUAL OF JUNE 30, AVERAGE
EXERCISE PRICES OUTSTANDING EXERCISE PRICE LIFE 1998 EXERCISE PRICE
- --------------- ----------- -------------- ----------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.20 112,456 $0.20 7.75 112,456 $0.20
0.70 241,748 0.70 8.96 241,748 0.70
------- ----- ---- ------- -----
$0.20 - $0.70 354,204 $0.54 8.58 354,204 $0.54
======= ===== ==== ======= =====
</TABLE>

The weighted-average fair value of options granted during the years ended
June 30, 1998, 1997 and 1996 were $.70, $.33 and $.20 per share, respectively.

In April 1998, Cohesion's Board adopted, and Collagen, as the sole
stockholder of Cohesion approved, Cohesion's 1998 Stock Option Plan, the 1998
Employee Stock Purchase Plan and the 1998 Directors' Stock Option Plan and
reserved 2,607,000 shares, 250,000 shares and 268,000 shares of Common Stock,
respectively, for issuance thereunder.

11. INTERNATIONAL SALES, MAJOR CUSTOMER, AND PRODUCTS

Export sales, which were in European countries only, were $129,000, $124,000,
and $83,000 in fiscal 1998, 1997 and 1996, respectively.

During fiscal years 1998, 1997, and 1996, Cohesion realized product sales
from its marketing partner, Zimmer, of $1.5 million, $1.9 million, and $3.1
million, respectively, which represented 75%, 77%, and 86% of product sales.
Zimmer has exclusive marketing rights for Collagraft bone graft products in the
United States and Asia.

12. INCOME TAXES

Cohesion uses the liability method of accounting for income taxes required by
SFAS No. 109. The provision was prepared on the basis that Cohesion filed
separate tax returns in each year.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
Cohesion's deferred tax assets and liabilities as of June 30, 1998 and 1997 are
presented below (in thousands):

<TABLE>
<CAPTION>
JUNE 30,
---------------
1998 1997
------- -------
<S> <C> <C>
Deferred tax liabilities:
Unrealized gain on Boston Scientific stock.... $30,061 $32,507
Investments................................... 1,888 2,507
Intangible assets............................. 1 38
------- -------
Total deferred tax liabilities........ 31,950 35,052
------- -------
Deferred tax assets:
Equity in losses of affiliates................ 3,107 3,190
</TABLE>

<PAGE> 60

<TABLE>
<CAPTION>
JUNE 30,
---------------
1998 1997
------- -------
<S> <C> <C>
State income taxes............................ 19 1,306
Non-deductible accruals....................... 913 1,127
Other......................................... 332 175
Valuation allowance........................... (3,381) (3,157)
------- -------
Total deferred tax assets............. 990 2,641
------- -------
Net deferred tax liabilities.......... $30,960 $32,411
======= =======
</TABLE>

The valuation allowance increased by $224,000 in fiscal 1998 and decreased by
$144,000 in fiscal 1997. Significant components of the provision for income
taxes are as follows (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------
1998 1997 1996
------- ------- --------
<S> <C> <C> <C>
Current:
Federal.................. $(2,875) $1,981 $31,085
State.................... (617) 875 8,141
------- ------ -------
Total current.... (3,492) 2,856 39,226
------- ------ -------
Deferred:
Federal.................. 1,049 203 (6,732)
State.................... (54) 103 (776)
------- ------ -------
Total deferred... 995 306 (7,508)
------- ------ -------
$(2,497) $3,162 $31,718
======= ====== =======
</TABLE>

The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before taxes. The sources and
tax effects of the differences are as follows (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Income (loss) before income taxes ..... $(12,064) $ 7,476 $ 70,365
======== ======== ========
Expected tax at 35% or 34% .......... .. $ (4,222) $ 2,617 $ 24,628
State income tax, net of federal
benefit ........................... (618) 725 4,002
In-process research and development ... 2,375 -- 1,050
Equity in losses of affiliates ........ 25 (278) 1,863
Other ................................. (57) 98 175
-------- -------- --------
$ (2,497) $ 3,162 $ 31,718
======== ======== ========
</TABLE>

13. STATEMENTS OF CASH FLOWS

Supplemental disclosure of cash flow information (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------------------
1998 1997 1996
-------- -------- -------
<S> <C> <C> <C>
Cash paid during the year for:
Interest ........................ $ -- $ 377 $ 2,532
Income taxes (net of refunds).... (65) 2,370 36,763
</TABLE>

14. SUBSEQUENT EVENTS (UNAUDITED)

On August 18, 1998, Cohesion Technologies, Inc., which was a wholly owned
subsidiary of Collagen, was spun-off in a one-for-one distribution of Common
Stock to Collagen's stockholders. The transaction resulted in the distribution
of 100% of the outstanding shares of Cohesion. The distribution of shares was
declared tax-free for U.S. federal income tax purposes in an IRS ruling.
Cohesion has been traded on the NASDAQ National Market under the ticker symbol
CSON subsequent to the Distribution.

In September 1998, the Company's Board of Directors approved a program to
cancel options to purchase shares of the common stock of Cohesion Corporation
(the "Canceled Options"). In connection with such program, the Company will
offer to pay each holder of Canceled Options a per share amount equal to the
excess of $16.70 over the exercise price of the Canceled Option (the "Option
Payment"). The Company will make this Option Payment ratably over the original
vesting period of the Canceled Option so long as the holder thereof remains an
employee or consultant of the Company or Cohesion Corporation. Assuming the
option holders agree to this cancellation program, the Company expects to record
compensation expense of approximately $1.7 million in the quarter ended
September 30 1998, in connection with vested options and up to an additional
$3.9 million of compensation expense to be recognized over the next three fiscal
years.

In September 1998, the Company's Board approved the repurchase of up to 1.0
million shares of the Company's Common Stock at a price of up to $4.25 per
share. As of September 21, 1998, the Company had repurchased 50,000 shares of
Common Stock under this program.

<PAGE> 61

SUPPLEMENTARY QUARTERLY CONSOLIDATED FINANCIAL DATA
(UNAUDITED)

SELECTED QUARTERLY FINANCIAL DATA

<TABLE>
<CAPTION>
Quarters ended June 30 March 31 December 31 September 30
- ----------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
FISCAL 1998
Product sales $ 571 $ 238 $ 526 $ 708
Cost of sales 347 124 279 412
General and administrative expenses 1,149 1,229 1,249 1,341
Research and development expenses 5,500 3,908 3,623 3,837
In-process R&D (1) 57 -- 10,530 ----
Operating loss (6,481) (5,021) (15,155) (4,826)
Net gain on investments, principally
Boston Scientific Corporation 5,358 4,964 2,843 5,931
Net income (loss) (1,053) (33) (12,578) 1,600
Pro forma net income (loss) per share - Basic(2) $ (.12) $ (.01) $ (1.41) $ .18
Pro forma net income (loss) per share - Diluted(2) $ (.12) $ (.01) $ (1.41) $ .18
</TABLE>

<TABLE>
<CAPTION>
Quarters ended June 30 March 31 December 31 September 30
- ----------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
FISCAL 1997
Product sales $ 452 $ 718 $ 494 $ 863
Cost of sales 202 826 405 672
General and administrative expenses 1,908 3,373 761 650
Research and development expenses 2,993 563 1,909 2,002
Operating loss (4,651) (4,044) (2,581) (2,461)
Net gain on investments, principally
Boston Scientific Corporation 15,235 -- 3,038 6,184
Net income (loss) 7,706 2,444 (311) 1,182
Pro forma net income (loss) per share - Basic(2) $ .88 $ .28 $ (.04) $ .13
Pro forma net income (loss) per share - Diluted(2) $ .88 $ .28 $ (.04) $ .13
</TABLE>

(1) Represents charge of $10.6 million for in-process research and development
costs in connection with the acquisition of Cohesion Corporation.

(2) Historical share and per share data has not been presented as no Company
common shares were outstanding until June 25, 1998. Pro forma share and per
share data has been presented assuming the distribution of shares of the
Company's Common Stock to Collagen's stockholders had already occurred based
on the number of Collagen common shares and common equivalent shares
outstanding for those periods, assuming a one-for-one exchange ratio in the
distribution.

The Common Stock of the Company is traded over-the-counter on The Nasdaq Stock
Market under the symbol CSON. The Company does not expect to pay dividends in
the near future.

<PAGE> 62

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

DISCLOSURE

Not Applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE
REGISTRANT

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

Set forth below is certain information as of September 15, 1998 with respect
to the Company's directors and executive officers.

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
David Foster................ 41 Chief Executive Officer, Director
Frank DeLustro, Ph.D........ 50 President and Chief Operating Officer, Director
Ross Erickson............... 53 Vice President, Regulatory Affairs, Clinical
Research and Quality Assurance
Charles Williams............ 55 Vice President, Operations
Alan Schempp................ 46 Vice President, Sales and Marketing
Deborah Webster............. 39 Vice President and Chief Administrative Officer
Sharon Kokubun.............. 42 Vice President, Financial Operations
John Daniels, M.D.(1)(2).... 59 Chairman of the Board
Reid W. Dennis(2)........... 71 Director
Craig W. Johnson(1)......... 50 Director
Craig T. Davenport(2)....... 45 Director
Mark A. Philip, Ph.D(1)..... 43 Director
</TABLE>

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

(1) Member of the Audit Committee.

(2) Member of the Human Resources Committee.

David Foster, Chief Executive Officer and Director. Mr. Foster has served as
Chief Executive Officer of the Company since January 1998. From February 1997 to
December 1997 he served as Senior Vice President and General Manager of the
Collagen Technologies Group. From May 1992 until February 1997, Mr. Foster
served as Chief Financial Officer of Collagen. Mr. Foster serves on the Board of
Directors of Pharming, B.V., and Innovasive Devices, Inc. Mr. Foster has a B.S.
in Mechanical Engineering and an M.B.A. from the University of California at
Berkeley.

Frank DeLustro, Ph.D., President, Chief Operating Officer and Director. Dr.
DeLustro has served as President and Chief Operating Officer of the Company
since January 1998. He served as President and Chief Executive Officer of
Cohesion Corporation from its inception in 1996 until December 1997. Prior to
joining Cohesion Corporation, Dr. DeLustro served at Collagen for 13 years in
positions of increasing responsibility, most recently as Senior Vice President,
Scientific Affairs. Dr. DeLustro has a B.S. in Biology from Fordham University
and a Ph.D. in Immunology/Microbiology from Upstate Medical School, SUNY
(Syracuse). He is the author of over 40 scientific publications and the holder
of 18 U.S. patents.

<PAGE> 63

Ross Erickson, Vice President, Regulatory Affairs, Clinical Research and
Quality Assurance. Mr. Erickson has served as Vice President, Regulatory
Affairs, Clinical Research and Quality Assurance of the Company since January
1998. He was Vice President of Regulatory Affairs and Clinical Affairs at
Cohesion Corporation from May 1996 to December 1997. From January 1987 to April
1996, he held various positions with Collagen and was Vice President of
Regulatory Affairs and Quality Assurance from 1991. Mr. Erickson has a B.A. and
an M.A. from Western Michigan University.

Charles Williams, Vice President, Operations. Mr. Williams has served as
Vice President, Operations of the Company since January 1998. He served as Vice
President, Operations of Cohesion Corporation from March 1997 to December 1997.
Prior to joining Cohesion Corporation, Mr. Williams served as Vice President of
Operations at Collagenesis, Inc., a medical device company, from December 1996
to March 1997, and as Vice President of Operations at Fusion Medical
Technologies, Inc., a medical device company, from March 1995 to November 1996.
From March 1992 to March 1995, Mr. Williams served as Vice President,
Manufacturing Operations at The Liposome Company, a pharmaceutical company. Mr.
Williams has a B.S. in Chemical Engineering from the University of Tennessee and
an M.S. in Biochemical Engineering from Rutgers University.

Alan Schempp, Vice President, Sales and Marketing. Mr. Schempp has served as
Vice President, Sales and Marketing of the Company since January 1998. From
November 1997 to December 1997, he served as Vice President, Marketing and
Business Development of Cohesion Corporation. Prior to that time, he was a
founder and president of Quicksilver Medical, a medical device consulting
company, from June 1996 to September 1997, and a director of Endoscopic Imaging
Systems, a medical device company he co-founded, from June 1995 to June 1996.
Mr. Schempp was a co-founder of and served as Vice President, Sales and
Marketing for Intramed Laboratories, a medical device company, from 1987 to
1995. Mr. Schempp has a B.F.A. from the University of Kansas and an M.B.A. from
the University of Phoenix.

Deborah Webster, Vice President and Chief Administrative Officer. Ms.
Webster has served as Vice President and Chief Administrative Officer of the
Company since January 1998. Ms. Webster joined Collagen in 1982 and served in
various human resource and management positions until 1991, when she was
appointed to Vice President, Human Resources and Administrative Services. Ms.
Webster has a B.A. from the University of California at Berkeley and completed
the Stanford University Executive Program at the Graduate Business School.

Sharon Kokubun, Vice President, Financial Operations. Ms. Kokubun has served
as Vice President, Financial Operations of the Company since January 1998. Ms.
Kokubun joined Collagen in April 1988 as Assistant Controller and was promoted
in February 1994 to Treasurer. Ms. Kokubun is a certified public accountant and
has an M.B.A. in finance from the University of Hawaii.

John Daniels, M.D., Chairman of the Board. Dr. Daniels has been Chairman of
the Company's Board of Directors since January 1998. Dr. Daniels is an Associate
Professor of Medicine/Oncology at the University of Southern California. Dr.
Daniels is also Chairman of the Board and Chief Financial Officer of Balance
Pharmaceuticals, Inc., a pharmaceutical company, and President, Chief Executive
Officer and a director of Regional Therapeutics, Inc. As of August 12, 1998, Dr.
Daniels resigned from the Board of Directors of Collagen on which he had served
since 1977. Dr. Daniels has a B.S. in biology and an M.D. from Stanford
University.

Reid W. Dennis, Director. Mr. Dennis has been a director of the Company
since January 1998. Mr. Dennis served as President of Collagen from February
1976 to March 1978, as Chairman of the Board from March 1978 to February 1995,
and has served as Chairman Emeritus of Collagen since February 1995. Mr. Dennis
is a General Partner of various partnerships associated with Institutional
Venture Partners. As of August 12, 1998, Mr. Dennis resigned from the Board of
Directors of Collagen on which he had served since 1975. Mr. Dennis has a B.A.
in Electrical Engineering and an M.B.A. from Stanford University.

Craig W. Johnson, Director. Mr. Johnson has been a director of the Company
since January 1998. Mr. Johnson has been Chairman and a Director of Venture Law
Group, A Professional Corporation, principal outside counsel to the Company, and
a partner of its predecessor partnership since February 1993. From 1980 to
February 1993, Mr. Johnson was a member of the law firm of Wilson, Sonsini,
Goodrich & Rosati, Professional

<PAGE> 64

Corporation. As of August 12, 1998, Mr. Johnson resigned from the Board of
Directors of Collagen on which he had served since 1991. He also serves on the
Board of Directors of Retix, Inc. Mr. Johnson has a B.A. from Yale University
and a J.D. from Stanford University.

Craig T. Davenport, Director. Mr. Davenport became a director of the Company
in September 1998. Mr. Davenport is currently Chief Executive Officer of the
D.W. Group, a private investment and advisory services company he founded in
1994. Mr. Davenport was at Tokos Medical Corporation, a health care service
company from 1985 to 1993, as President and Chief Operating Officer. Mr.
Davenport worked for American Hospital Supply Corporation, a health care
company, from 1974 to 1984, serving in the capacity of President for both the
American Physicians and American Hospitex divisions as well as various sales
positions in the American Hospital Supply division. He serves on the Board of
Directors of Sapient Health Network, Clinmark DotCom, and Sidelines National
Support Network. Mr. Davenport graduated from Ohio University in 1974 with a
B.C.S. degree with a major in marketing and management.

Mark A. Philip, PhD., Director. Dr. Philip became a director of the Company
in September 1998. Dr. Philip is currently President and Chief Executive Officer
of Pangaea Pharmaceuticals, Inc., a biotechnology company. From 1992 to 1997,
Dr. Philip was President and Chief Executive Officer of Immuno International AG,
a biological pharmaceutical company, and from 1983 to 1992, he held regulatory,
marketing and general management positions at Baxter International, Inc. Dr.
Philip has a B.S. in Biochemistry and Animal Physiology and a Ph.D. in
Hematology and Immunology from Trent Polytechnic/Nottingham City University, and
an M.B.A. from Lake Forest Graduate School of Management.

The Company currently has authorized a Board of Directors of seven. Each
director is elected for a period of one year at the Company's annual meeting of
stockholders and serves until the next annual meeting or until his or her
successor is duly elected and qualified. The executive officers serve at the
discretion of the Board of Directors. There are no family relationships among
any of the directors and/or executive officers of the Company.

DIRECTOR COMPENSATION

The Company currently pays each director who is not an employee (currently
five persons) a monthly retainer of $1,000 ($4,000 in the case of the Chairman
of the Board), a fee of $1,000 for each meeting of the Board attended by such
director, a fee of $250 for each telephonic meeting of the Board in which such
director participates. There is no fee for committee meetings attended by such
director on a date not coinciding with a meeting of the Board. Each nonemployee
director participates in the Company's 1998 Directors' Stock Option Plan,
pursuant to which nonemployee directors are automatically granted options to
purchase shares of Common Stock on the terms and conditions set forth in such
plan.

BOARD COMMITTEES

In March 1998, the Board established the Audit Committee and the
Compensation Committee. In August 1998, the Board changed the name of the
Compensation Committee to the Human Resources Committee. The Audit Committee
recommends engagement of the Company's independent auditors, reviews the scope
of the audit, considers comments made by the independent auditors with respect
to the Company's internal control structure, including systems, procedures and
internal accounting controls and the consideration given thereto by management,
and reviews the Company's internal control structure, including systems,
procedures and internal accounting controls, with the Company's financial and
accounting staff. The Audit Committee currently consists of directors Dr.
Daniels, Mr. Johnson, and Dr. Philip. The Human Resources Committee provides
guidance and commentary for all corporate compensation, benefits, perquisite and
employee (and director) equity programs. It reviews and makes recommendations to
the Board regarding such matters as the Company's compensation of its officers,
all employee equity plans and individual equity grants and bonus plans and bonus
payments. The Human Resources Committee currently consists of Mr. Dennis, Dr.
Daniels and Mr. Davenport.

<PAGE> 65

HUMAN RESOURCES COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The members of the Human Resources Committee of the Company's Board of
Directors are currently Mr. Dennis, Dr. Daniels and Mr. Davenport, none of which
has in over ten years been an officer or employee of the Company.

SCIENTIFIC ADVISORY BOARD

The Company is assisted in its research and development activities by its
Scientific Advisory Board (the "SAB"), composed of leading scientists who review
the Company's research and development activities, discuss technological
advances relevant to the Company and its business, and otherwise assist the
Company, as appropriate. The members of the SAB are listed below.

Francis Castellino, Ph.D. Dr. Castellino is the Kleiderer-Pezold Professor
of Biochemistry and Dean of the College of Arts and Sciences at the University
of Notre Dame in South Bend, Indiana. He has conducted research in the areas of
fibrinolysis and blood coagulation since his arrival at Notre Dame in 1970. His
ongoing efforts to discover and define the structure-function relationships of
coagulation and fibrinolytic enzymes have led him to develop extensive
publications on the expression and identification of proteins and protein
domains. He received a B.S. from the University of Scranton, and an M.S. and a
Ph.D. in Biochemistry from the University of Iowa.

Caroline Damsky, Ph.D. Dr. Damsky is a Professor at the University of
California at San Francisco, Schools of Dentistry and Medicine. Dr. Damsky
conducts research in many areas, including the areas of cellular adhesion and
invasion, adhesion-related signaling mechanisms and adhesive interactions in the
development of cancer. Dr. Damsky received a B.A. from Stanford University, an
M.A. and a Ph.D. from the University of Pennsylvania, performed post-doctoral
work at the University of Pennsylvania and the Wisar Institute, and has authored
over 75 published works.

Jack Lemons, Ph.D. Dr. Lemons is a Professor in the Department of
Biomaterials at the University of Alabama School of Dentistry and a Professor in
the Department of Surgery at the University of Alabama School of Medicine. He is
also a Director of Orthopedic Laboratory Research, a Professor of Biomedical and
Materials Engineering and a Professor of the Joint Materials Science Program at
the University of Alabama. He is also an Adjunct Professor of Prosthodontics at
the University of Pittsburg School of Dental Medicine. He received a B.S., an
M.S. and a Ph.D. from the University of Florida.

Alan S. Michaels, Sc.D. Dr. Michaels is a graduate of the Massachusetts
Institute of Technology and served as Professor of Engineering at that
institution from 1948 to 1966. He currently has his own industrial consulting
practice, Alan Sherman Michaels, Sc.D., Inc. In 1962, he founded and was
President of Amicon Corporation, an enterprise which pioneered the development
of membrane ultrafiltration. Dr. Michaels also founded and was President of
Pharmetrics Inc., in 1970, which was later acquired by Alza Corporation in 1972.
He has been a Professor of Chemical Engineering and Medicine at Stanford
University as well as a Distinguished University Professor at North Carolina
State University and is a member of the National Academy of Engineering.

Francesco Ramirez, Ph.D. Dr. Ramirez is Deputy Director at the Brookdale
Center for Developmental and Molecular Biology, Co-Director of the
Interdisciplinary Graduate School Program in Cellular, Molecular and Biological
Sciences and the Dr. Amy and James Elster Professor of Molecular Biology and
Professor of Pediatrics at the Mount Sinai School of Medicine in New York. Dr.
Ramirez is the author of numerous scientific publications and awards. He
received an M.A. from Liceo Classico Garibaldi and a D.Sc. from the Universita
degli Studi di Palermo, and has authored over 120 published works.

Dean Toriumi, M.D, Dr. Toriumi is an Associate Professor in the Department
of Otolaryngology-Head and Neck Surgery at the University of Illinois at Chicago
and is board-certified in otolaryngology and facial plastic and reconstructive
surgery. He is a member of several professional societies, including the
American Academy of Otolaryngology-Head and Neck Surgery, the American Academy
of Facial Plastic and Reconstructive

<PAGE> 66

Surgery, and the American College of Surgeons. Dr. Toriumi is presently the
Secretary of the American Academy of Facial Plastic and Reconstructive Surgery.
Dr. Toriumi also serves on the editorial boards of several journals, including
Facial Plastic Surgery, Otolaryngology-Head & Neck Surgery, Long-Term Effects of
Medical Implants and Operative Techniques in Otolaryngology-Head & Neck Surgery.

CLINICAL ADVISORY BOARD

The Clinical Advisory Board assists the Company in identifying potential new
uses for its product candidates and helps to refine product formulations to
better address problems encountered during product development.

Arthur Hill, M.D. Dr. Hill is a board certified thoracic and general surgeon
with expertise in thoracic and cardiac surgery. He is a fellow of both the
American College of Surgeons and the American College of Cardiology. Dr. Hill
trained in thoracic surgery at the Stanford University Medical Center and
trained in General Surgery at the University of California at Los Angeles. Dr.
Hill is the author of numerous scientific articles in the areas of thoracic and
cardiac surgery. Dr. Hill received an M.D. from Tufts University and was a Post
Doctoral Fellow of the Cardiovascular Research Institute at the University of
California at San Francisco.

Gail Lebovic, M.A., M.D. Dr. Lebovic is a board-certified general surgeon
with expertise in breast, laparoscopic and endocrine surgery. She is a Fellow of
the American College of Surgeons and is founder and chairperson of the Bay Area
Breast Center. She practices in Palo Alto, California, and is an attending
surgeon at the Stanford University Medical Center and the Plastic Surgery
Center. Dr. Lebovic received an M.D. from the George Washington University
School of Medicine.

Camran Nezhat, M.D. Dr. Nezhat holds clinical faculty appointments in
surgery, gynecology and obstetrics at the Stanford University School of Medicine
and is director of the Stanford Endoscopy Center for Training and Technology.
Dr. Nezhat was a pioneer in the use of video cameras in laparoscopic surgery and
has authored two books and more than 100 articles on this and other areas of
surgery. He is a member of several professional societies, including the
American College of Obstetrics and Gynecologists and American College of
Surgeons, and has received many awards, including the Society of Laparoscopic
Surgeons Excel Award in 1995. Dr. Nezhat received his M.D. from Tehran
University, Iran.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

No director, officer, or beneficial owner of more than 10 percent of any
class of equity securities of the Company registered pursuant to Section 12 of
the Exchange Act of 1934, as amended (the "Exchange Act"), was required to file
reports required by Section 16(a) of the Exchange Act during the fiscal year
ending June 30, 1998.

<PAGE> 67

ITEM 11. EXECUTIVE COMPENSATION

EXECUTIVE COMPENSATION

The following table provides certain summary information concerning the
compensation received for services rendered during the fiscal year ended June
30, 1998 to Collagen Aesthetics, Inc., formerly Collagen Corporation, and to
Cohesion Corporation, as applicable, by the Company's Chief Executive Officer,
David Foster, and each of Frank DeLustro, Ph.D., Ross Erickson, Deborah Webster
and Charles Williams, the other four most highly compensated executive officers
of the Company (the "Named Executive Officers"). Each of such person's aggregate
compensation during the last fiscal year exceeded $100,000. The services
rendered by the Named Executive Officers to Collagen and Cohesion Corporation,
as applicable, were in capacities not equivalent to those to be provided to the
Company. Therefore, the information set forth below may not reflect the
compensation to be paid to such individuals and should not be relied on as being
indicative of the Company's compensation structure and policies.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION AWARDS
ANNUAL COMPENSATION --------------------------------
---------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($)(1) OPTIONS(#)(2) COMPENSATION($)(3)
--------- -------- ------------------ ------------- ------------------
<S> <C> <C> <C> <C>
David J. Foster............................. $183,639 $64,095 -- 15,000(4) $ 626
Chief Executive Officer and Director 15,000(4)
Senior Vice President (Collagen)

Frank DeLustro, Ph.D........................ 187,960 -- -- 20,000(5) 1,933
President and Chief Operating Officer
and Director
President and Chief Executive
Officer (Cohesion Corporation)

Ross Erickson............................... 176,350 -- -- 15,000(5) 1,696
Vice President, Regulatory
Affairs, Clinical Research
and Quality Assurance

Deborah Webster............................. 152,931 55,146 -- 6,500(4) 4,620
Vice President and Chief Administrative 6,500(4)
Officer;
Vice President, Human Resources and
Administration (Collagen)

Charles Williams............................ 159,996 -- -- 5,000(5) 2,430
Vice President, Operations
</TABLE>

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

(1) The value of perquisites or personal benefits is not included in the amounts
disclosed if, in the aggregate for any named individual, it did not exceed
the lesser of $50,000 or ten percent of total salary and bonus reported for
such individual in the Summary Compensation Table.

(2) This table does not reflect options granted subsequent to the close of
fiscal 1998, which may represent grants partially in recognition of fiscal
1998 performance. The option shares and prices reflect the effect of the
restructuring in connection with the Distribution.

(3) Stated amounts represent (a) a Scientific Affairs award to Dr. DeLustro and
(b) a 15-year service award to Ms. Webster. Remaining amounts represent
insurance premiums paid by the Company for term life insurance under the
Company's group life insurance employee benefit.

<PAGE> 68

(4) Represents options to purchase Collagen common stock at $12.65 per share and
options to purchase the Company's Common Stock at $5.17 per share.

(5) Represents options to purchase Cohesion Corporation common stock at $.70 per
share.

OPTION GRANTS

The following table provides certain summary information regarding stock
options granted to the Named Executive Officers during the fiscal year ended
June 30, 1998. As a result of the Distribution, each option to purchase Collagen
common stock granted to the Named Executive Officers listed below was replaced
with either a new option to purchase shares of Collagen common stock, a new
option to purchase shares of the Company Common Stock or new options to purchase
shares of both Collagen common stock and the Company Common Stock, as provided
in one of the Intercompany Agreements ("the Benefits Agreement"). As a result,
their value may depend, in part, on the future value of Collagen common stock as
well as the future value of the Company Common Stock. In September 1998, the
Company's Board of Directors approved a program to cancel options to purchase
shares of the common stock of Cohesion Corporation (the "Canceled Options"). In
connection with such program, the Company will offer to pay each holder of
Canceled Options a per share amount equal to the excess of $16.70 over the
exercise price of the Canceled Option (the "Option Payment"). The Company will
make this Option Payment ratably over the original vesting period of the
Canceled Option so long as the holder thereof remains an employee or consultant
of the Company or Cohesion Corporation. The services rendered by the Named
Executive Officers to Collagen and the Cohesion Corporation, as applicable, were
in capacities not equivalent to those to be provided to the Company. Therefore,
the information set forth below should not be relied on as being indicative of
the Company's compensation structure and policies.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
POTENTIAL
INDIVIDUAL GRANTS(1) REALIZABLE VALUE AT
---------------------------------------------------- ASSUMED ANNUAL
NUMBER OF PERCENT OF RATES OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM($)(2)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION --------------------
NAME GRANTED(#) FISCAL YEAR(%) ($/SHARE) DATE 5% 10%
- ---- ---------- -------------- ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
David J. Foster (Collagen) 15,000 5.74(3) $ 12.65 8/07/07 $119,333 $302,413
15,000 14.87(3) 5.17 8/07/07 48,771 123,595

Frank DeLustro, Ph.D..... 20,000 12.99(4) .70 9/19/07 N/A N/A

Ross Erickson............ 15,000 9.74(4) .70 9/19/07 N/A N/A

Deborah Webster (Collagen) 6,500 2.49(3) 12.65 8/07/07 51,711 131,045
6,500 6.44(3) 5.17 8/07/07 21,134 53,558

Charles Williams......... 5,000 3.25(4) .70 9/19/07 N/A N/A
</TABLE>

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

(1) Consists of stock options granted pursuant to Collagen and Cohesion
Corporation stock option plans. The maximum term of each option granted is
ten years from the date of grant. The exercise price is equal to the fair
market value of the stock on the grant date.

(2) Potential realizable value amounts represent certain assumed rates of
appreciation in stock price for a given exercise price only and assume the
conversion or exchange of all options to purchase Collagen common stock or
the Company's Common Stock. Actual gains, if any, on stock option exercises
and holdings of applicable shares of Collagen common stock or the Company's
Common Stock are dependent on the future performance of the applicable
stock. There is no assurance that the amounts reflected will be realized.
The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the rules of the Securities and Exchange Commission and do
not represent the Company's or Collagen's estimate or

<PAGE> 69

projection of future stock prices. There can be no assurance that the actual
stock price appreciation over the ten-year option term will be at the
assumed 5% and 10% levels or at any other defined level. Unless the market
price of the applicable shares of Collagen common stock or the Company's
Common Stock appreciates over the option term, no value will be realized
from the option grants made to the Named Executive Officers. In September
1998, the Company's Board of Directors approved a program to cancel options
to purchase shares of the common stock of Cohesion Corporation (the
"Canceled Options"). In connection with such program, the Company will offer
to pay each holder of Canceled Options a per share amount equal to the
excess of $16.70 over the exercise price of the Canceled Option (the "Option
Payment"). The Company will make this Option Payment ratably over the
original vesting period of the Canceled Option so long as the holder thereof
remains an employee or consultant of the Company or Cohesion Corporation.

(3) Out of a total of 261,115 and 100,860 options granted (excluding outside
directors) during the last fiscal year to purchase Collagen common stock and
the Company's Common Stock, respectively.

(4) Out of a total of 154,000 options granted during the last fiscal year to
purchase Cohesion Corporation Common Stock.

OPTION EXERCISES AND HOLDINGS

The following table provides certain summary information for each Named
Executive Officer with respect to Collagen and Cohesion Corporation option
exercises for the common stock of Collagen and Cohesion Corporation, as
applicable, for the year ended June 30, 1998. As a result of the Distribution,
each option granted to the Named Executive Officers in Collagen listed below was
replaced with either a new option to purchase shares of Collagen common stock, a
new option to purchase shares of the Company Common Stock or new options to
purchase shares of both Collagen common stock and the Company Common Stock, as
provided in the Benefits Agreement and, as a result, their value may depend, in
part, on the future value of Collagen common stock as well as the future value
of the Company Common Stock. In September 1998, the Company's Board of Directors
approved a program to cancel options to purchase shares of the common stock of
Cohesion Corporation (the "Canceled Options"). In connection with such program,
the Company will offer to pay each holder of Canceled Options a per share amount
equal to the excess of $16.70 over the exercise price of the Canceled Option
(the "Option Payment"). The Company will make this Option Payment ratably over
the original vesting period of the Canceled Option so long as the holder thereof
remains an employee or consultant of the Company or Cohesion Corporation.

The services rendered by the Named Executive Officers to Collagen and
Cohesion Corporation, as applicable, were in capacities not equivalent to those
to be provided to the Company. Therefore, the information set forth below should
not be relied on as being indicative of the Company's compensation structure and
policies. Additionally, it should be noted that while the information set forth
below refers to "exercisable" and "unexercisable" options, all of such options
to purchase shares of Cohesion Corporation may be exercised immediately, and, if
exercised, the unvested portion of the option remains subject to a right of
repurchase from the applicable entity.

<PAGE> 70

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND OPTION VALUES ON JUNE 30, 1998

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL IN-THE-MONEY OPTIONS
SHARES YEAR-END(#) AT FISCAL YEAR-END($)(1)(2)(3)
ACQUIRED ON VALUE (EXERCISABLE/ (EXERCISABLE/
NAME EXERCISE(#) REALIZED($)(3) UNEXERCISABLE) UNEXERCISABLE)
- ---- ----------- -------------- ---------------------- ------------------------------
<S> <C> <C> <C> <C>
David J. Foster(4)........ 0 0 45,160/18,640 $ 10,010/$ 8,270
0 0 45,090/18,710 3,871/ 3,294
Frank DeLustro, Ph.D.(5).. 0 0 56,396/ 284 5,405/ 155
0 0 52,349/ 5,831 850/ 1,824
45,834 756,261 12,500/61,666 24,783/ 48,067
Ross Erickson(6).......... 2,140 14,980 32,694/ 236 3,343/ 109
0 0 29,845/ 4,135 425/ 1,277
26,250 433,125 8,750/40,000 25,983/ 28,980
Deborah Webster(7)........ 2,000 24,250 45,601/11,099 16,131/ 6,263
750 10,734 44,330/11,270 3,469/ 2,546
Charles Williams.......... 0 0 10,937/29,063 174,992/ 465,008
</TABLE>

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

(1) The fair market value of Collagen's common stock as quoted on the Nasdaq
National Stock Market at the close of business on June 30, 1998 was $18.125
per share. The value of unexercised options has been calculated assuming the
ratio of the stock prices as of the Distribution date for Collagen and the
Company, which was 71% and 29%, respectively.

(2) The estimated fair market value for Cohesion Corporation's common stock on
June 30, 1998, as determined by Cohesion Corporation's Board of Directors,
was $16.70.

(3) The "Value Realized" or the unrealized "Value of Unexercised In-the-Money
Options at Fiscal Year-End" represent the aggregate difference between the
market value on the date of exercise or at June 30, 1998, in the case of the
unrealized values, and the applicable exercise price.

(4) Mr. Foster's options referenced in this table are options to purchase
Collagen common stock. The value of unexercised Collagen and Company options
has been calculated assuming the ratio as of the Distribution date, which
was 71% and 29%, respectively.

(5) Dr. DeLustro exercised during fiscal year 1998, 45,834 options to purchase
Cohesion Corporation common stock with an exercise price of $.70. The value
of unexercised Collagen and Company options has been calculated assuming the
ratio as of the Distribution date, which was 71% and 29%, respectively.

(6) Mr. Erickson exercised during fiscal 1998, (i) 2,140 options to purchase
Collagen Corporation common stock with an exercise price of $12.375 and (ii)
26,250 options to purchase Cohesion Corporation with an exercise price of
$.70 per share. The value of unexercised Collagen and Company options has
been calculated assuming the ratio as of the Distribution date, which was
71% and 29%, respectively.

(7) Ms. Webster exercised during fiscal year 1998, 2,000 and 750 options to
purchase Collagen Corporation common stock with an exercise price of $7.25
and $5.375, respectively. The value of unexercised Collagen and Company
options has been calculated assuming the ratio as of the Distribution date,
which was 71% and 29%, respectively.

<PAGE> 71

TREATMENT OF STOCK OPTIONS OUTSTANDING AS OF THE DISTRIBUTION DATE

Options held by Employees and Consultants

Each employee (including officers) and consultant of Collagen or any
subsidiary of Collagen who, immediately prior to August 18, 1998, the
Distribution Date, held a vested but not exercised stock option to purchase
shares of Collagen common stock, in connection with the Distribution, received
two new options in replacement of the original option, one to acquire shares of
Collagen common stock and the other to acquire shares of the Company's Common
Stock. Each new option gave the holder the right to purchase a number of shares
equal to the number of shares in the original option.

Each employee (including officers) and consultant of Collagen or any
subsidiary of Collagen who, immediately prior to the Distribution Date, held an
unvested stock option to purchase shares of Collagen common stock, in connection
with the Distribution, received a new option in replacement of the original
option to acquire the same number of shares of common stock of the entity (the
Company or Collagen) by which such optionee was employed or retained as a
consultant following the Distribution.

The exercise price of each new option was determined in accordance with
Emerging Issues Task Force Issue 90-9 as agreed upon by the Company's Board and
the Collagen Board (or any committee thereof), after consultation with legal and
accounting advisors. The exercise price, as adjusted in light of the above
considerations, was not intended to result in any compensation expense to the
Company or Collagen. All other terms of the new options other than the exercise
price are the same as those of the original options provided, however, that
service as an employee or consultant of Cohesion Corporation or the Company
shall be equivalent to providing service as an employee or consultant of
Collagen. At the option of the Collagen Board or the Company's Board,
out-of-the-money options may be treated differently.

Options for Nonemployee Directors

Each nonemployee director of Collagen or any subsidiary of Collagen who,
immediately prior to the Distribution Date, held a vested but not exercised
option to purchase shares of Collagen common stock, in connection with the
Distribution, received two new options in replacement of the original option,
one to acquire shares of Collagen common stock and the other to acquire shares
of the Company's Common Stock ("Vested Restructured Options"). Each new option
gave the holder the right to purchase a number of shares equal to the number of
shares in the original option. Each nonemployee director of Collagen who,
immediately prior to the Distribution Date, held an unvested stock option to
purchase shares of Collagen common stock, in connection with the Distribution,
received a new option in replacement of the original option to acquire the same
number of shares of Common Stock of the entity (Collagen or the Company) for
which such optionee will serve as a director following the Distribution
("Unvested Restructured Options").

The exercise price of each new option was determined in accordance with
Emerging Issues Task Force Issue 90-9 as agreed upon by the Collagen Board of
Directors and the Company's Board of Directors (or any committees thereof),
after consultation with legal and accounting advisors. The exercise price, as
adjusted in light of the above considerations, was not intended to result in any
compensation expense to

<PAGE> 72

Collagen or the Company. All other terms of the new options are the same as
those of the original options; provided, however, that service as a director of
Cohesion Corporation or the Company shall be equivalent to providing service as
a director of Collagen.

Following the Distribution, each nonemployee director of Collagen and
Cohesion is eligible to participate in the Company's 1998 directors' stock
option plan adopted by the company for which he or she serves as a director and
to receive automatic annual option grants pursuant to such plan.

STOCK PLANS

The Company's Board adopted, and Collagen, as the sole stockholder of the
Company in April 1998, approved the Company's 1998 Stock Option Plan, the 1998
Employee Stock Purchase Plan and the 1998 Director's Stock Option Plan
(collectively, the "Company Plans") and reserved 2,607,000 shares, 250,000
shares and 268,000 shares of Common Stock, respectively, for issuance under such
plans on or after the Distribution. The principal
terms of each of the Company Plans are set forth below.

1998 Stock Option Plan

The Company's 1998 Stock Option Plan (the "Stock Plan") was adopted by the
Board of Directors and approved by Collagen, as the sole stockholder, in April
1998. A total of 2,607,000 shares of Common Stock have been reserved for
issuance under the Stock Plan; 2,000,810 are outstanding as of September 15,
1998. The purposes of the Stock Plan are to attract and retain the best
available personnel to the Company, to provide additional incentives to the
Company's employees and consultants and to promote the success of the Company's
business. The Stock Plan provides for the granting to employees, including
officers and directors, of incentive stock options within the meaning of Section
422 of the Internal Revenue Code of 1986, as amended (the "Code") and for the
granting to employees and consultants including nonemployee directors of
nonstatutory stock options. To the extent an optionee would have the right in
any calendar year to exercise for the first time one or more incentive stock
options for shares having an aggregate fair market value under all plans of the
Company and determined for each share as of the date the option to purchase the
shares was granted in excess of $100,000, any such excess options shall be
treated as nonstatutory stock options. If not terminated earlier, the Stock Plan
will terminate in April 2008.

Options granted under the Stock Plan may be either "incentive stock options"
within the meaning of Section 422 of the Code, or nonstatutory stock options at
the discretion of the Board of Directors and as reflected in the written terms
of the option agreement. The Stock Plan may be administered by the Board of
Directors or a committee of the Board of Directors (the "Administrator"). The
Stock Plan is currently administered by the Human Resources Committee. The
Administrator determines the terms of options granted under the Stock Plan,
including the number of shares subject to the option, exercise price, term and
exercisability. In no event, however, may an individual employee receive option
grants for more than 250,000 shares under the Stock Plan in any fiscal year.
Such limitation shall not take effect until the earliest date required under
Section 162(m) of the Code. The exercise price of all incentive stock options
granted under the Stock Plan must be at least equal to the fair market value of
the Common Stock of the Company on the date of grant. The exercise price of any
incentive stock option granted to an optionee who owns stock representing more
than 10% of the total combined voting power of all classes of outstanding
capital stock of the Company or any parent or subsidiary corporation of the
Company (a "10% Stockholder") must equal at least 110% of the fair market value
of the Common Stock on the date of grant. The exercise price of all nonstatutory
stock options must equal at least 85% of the fair market value of the Common
Stock on the date of grant; provided, however, that the exercise price of any
nonstatutory stock option granted to a Named Executive Officer must equal at
least 100% of the fair market value of the Common Stock on the date of grant.
Payment of the exercise price may be made in cash or other consideration as
determined by the Administrator.

The Administrator determines the term of options, which may not exceed ten
years, or five years in the case of an incentive stock option granted to a 10%
Stockholder. No option may be transferred by the optionee other than by will or
the laws of descent or distribution. Each option may be exercised during the
lifetime of the optionee only by such optionee. The Administrator determines
when options become exercisable. Options

<PAGE> 73

granted under the Stock Plan generally become exercisable at the rate of 24% of
the total number of shares subject to the options twelve months after the date
of grant, and 2% of the total number of shares subject to the options each month
thereafter.

In the event of the sale of all or substantially all of the assets of the
Company, or the merger of the Company with another corporation, then each option
shall be assumed or an equivalent option substituted by the successor
corporation unless the successor corporation does not agree to the assumption or
substitution, in which case each option will terminate upon the consummation of
the merger or sale of assets. The Administrator has the authority to amend or
terminate the Stock Plan as long as such action does not adversely affect any
outstanding option and provided that stockholder approval shall be required for
an amendment to increase the number of shares subject to the Stock Plan, to
change the designation of the class of persons eligible to be granted options,
or to change the limitation on grants to individual employees.

1998 Employee Stock Purchase Plan

The Company's 1998 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors and approved by Collagen as the sole
stockholder in April 1998. A total of 250,000 shares of Common Stock have been
reserved for issuance under the Purchase Plan; none of which are issued as of
August 31, 1998. The Purchase Plan, which is intended to qualify under Section
423 of the Code, will be implemented by a series of overlapping offering periods
of 24 months' duration, with new offering periods (other than the first offering
period) commencing on January 1 and July 1 of each year. Each offering period
will consist of four consecutive purchase periods of six months' duration. The
initial offering period commenced on the Distribution Date and ends on June 30,
2000; the initial purchase period ends on December 31, 1998. The Purchase Plan
will be administered by the Human Resources Committee (comprised of Dr. Daniels,
Mr. Dennis, amd Mr. Davenport, the outside directors of the Company who are not
eligible to participate in the Purchase Plan). Employees, including officers and
employee directors, of the Company, or of any majority-owned subsidiary
designated by the Board, are eligible to participate in the Purchase Plan if
they are employed by the Company or any such subsidiary for at least 20 hours
per week and more than five months per year. The Purchase Plan permits eligible
employees to purchase Common Stock through payroll deductions, which may not
exceed 15% of an employee's compensation, at a price equal to the lower of 85%
of the fair market value of the Company's Common Stock at the beginning of each
offering period or at the end of each purchase period. Employees may end their
participation in the offering at any time during the offering period, and
participation ends automatically on termination of employment with the Company.
If not terminated earlier, the Purchase Plan will have a term of 20 years.

The Purchase Plan provides that, in the event of a merger of the Company
with or into another corporation or a sale of all or substantially all of the
Company's assets, each right to purchase stock under the Purchase Plan will be
assumed or an equivalent right substituted by the successor corporation unless
the Board of Directors shortens the offering period so that employees' rights to
purchase stock under the Purchase Plan are exercised prior to the merger or sale
of assets. The Board of Directors has the power to amend or terminate the
Purchase Plan as long as such action does not adversely affect any outstanding
rights to purchase stock thereunder.

1998 Directors' Stock Option Plan

The 1998 Directors' Stock Option Plan (the "Directors' Plan") was adopted by
the Board of Directors and approved by Collagen as the sole stockholder in April
1998. A total of 268,000 shares of Common Stock have been reserved for issuance
under the Directors' Plan; 173,000 are outstanding as of September 15, 1998. The
Directors' Plan provides for the grant of nonstatutory stock options to
nonemployee directors of the Company. The Directors' Plan is designed to work
automatically without administration; however, to the extent administration is
necessary, it will be performed by the Board of Directors. To the extent they
arise, it is expected that conflicts of interest will be addressed by abstention
of any interested director from both deliberations and voting regarding matters
in which such director has a personal interest.

The Directors' Plan provides that each person who becomes a nonemployee
director of the Company will be granted a nonstatutory stock option to purchase
10,000 shares of Common Stock (the "Initial Option") on the

<PAGE> 74

date on which the optionee first becomes a nonemployee director of the Company.
On July 1 of each year, each nonemployee director of the Company, including
nonemployee directors who did not receive an Initial Option, will be granted an
option to purchase 5,000 shares of Common Stock (an "Annual Option") if, on such
date, he or she has served on the Board of Directors for at least six months.
The Directors' Plan sets neither a maximum nor a minimum number of shares for
which options may be granted to any one nonemployee director, but does specify
the number of shares that may be included in any grant and the method of making
a grant. No option granted under the Directors' Plan is transferable by the
optionee other than by will or the laws of descent or distribution or pursuant
to a qualified domestic relations order, and each option is exercisable, during
the lifetime of the optionee, only by such optionee.

The Directors' Plan provides that the Vested Restructured Options and the
Unvested Restructured Options shall be exercisable in accordance with the terms
under which the vested and unvested options to purchase Collagen common stock
were issued pursuant to the 1990 Directors' Plan of Collagen; provided, however
that service as a director of Cohesion Corporation or the Company shall be
equivalent to providing service as a director of Collagen. The Directors' Plan
further provides that the Initial Option shall become exercisable in
installments as to 25% of the total number of shares subject to the Initial
Option on each of the first, second, third and fourth anniversaries of the date
of grant of the Initial Option, and each Annual Option shall become exercisable
in full on the first anniversary of the date of grant of that Annual Option. If
a nonemployee director ceases to serve as a director for any reason other than
death or disability, he or she may, but only within three months after the date
he or she ceases to be a director of the Company, exercise options granted under
the Directors' Plan to the extent that he or she was entitled to exercise it at
the date of such termination. To the extent that he or she was not entitled to
exercise any such option at the date of such termination, or if he or she does
not exercise such option (which he or she was entitled to exercise) within such
three month period, such option shall terminate.

Options granted under the Directors' Plan have a term of ten years. In the
event of the dissolution or liquidation of the Company, a sale of all or
substantially all of the assets of the Company, the merger of the Company with
or into another corporation or any other reorganization of the Company in which
more than 50% of the shares of the Company entitled to vote are exchanged, each
nonemployee director shall have either (a) a reasonable time within which to
exercise the option, including any part of the option that would not otherwise
be exercisable, prior to the effectiveness of such dissolution, liquidation,
sale, merger or reorganization, at the end of which time the option shall
terminate, or (b) the right to exercise the option, including any part that
would not otherwise be exercisable, or receive a substitute option with
comparable terms, as to an equivalent number of shares of stock of the
corporation succeeding the Company or acquiring its business by reason of such
dissolution, liquidation, sale, merger or reorganization. The Board of Directors
may amend or terminate the Directors' Plan; provided, however, that no such
action may adversely affect any outstanding option. If not terminated earlier,
the Directors' Plan will have a term of ten years.

LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS

Limitation of Liability of the Directors of the Company

The Company's Certificate of Incorporation provides that a director of the
Company will not be personally liable to the Company or its stockholders for
monetary damages for breach of fiduciary duty as a director, except for
liability (a) for any breach of the director's duty of loyalty to the Company or
its stockholders, (b) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (c) under Section 174 of
the Delaware General Corporation Law, which concerns unlawful payments of
dividends, stock purchases or redemptions, or (d) for any transaction from which
the director derived an improper personal benefit. While the Company's
Certificate of Incorporation provides directors with protection from awards for
monetary damages for breaches of their duty of care, it does not eliminate such
duty. Accordingly, the Company's Certificate of Incorporation has no effect on
the availability of equitable remedies such as an injunction or rescission based
on a director's breach of his or her duty of care. The provisions of the
Company's Certificate of Incorporation described above apply to an officer of
the Company only if he or she is a director of

<PAGE> 75

the Company and is acting in his or her capacity as director, and do not apply
to officers of the Company who are not directors. The Company plans to enter
into indemnification agreements with its officers and directors.

Indemnification of Directors and Officers

The Company's Certificate of Incorporation provides that each person who is
or was or has agreed to become a director or officer of the Company, or each
such person who is or was serving or has agreed to serve at the request of the
Company as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, will be indemnified by
the Company, in accordance with the Company's Bylaws, to the fullest extent
permitted from time to time by Delaware law, as the same exists or may hereafter
be amended or any other applicable laws as presently or hereafter in effect. The
Company may be required to indemnify any person seeking indemnification in
connection with a proceeding (or part thereof) initiated by such person only if
such proceeding (or part thereof) was authorized by the Board of Directors or is
a proceeding to enforce such person's claim to indemnification pursuant to the
rights granted by the Company's Certificate of Incorporation or otherwise by the
Company. In addition, the Company may enter into one or more agreements with any
person providing for indemnification greater than or different from that
provided in the Company's Certificate of Incorporation.

The Company's Bylaws provide that each person who was or is made a party or
is threatened to be made a party to or is involved in any action, suit, or
proceeding, whether civil, criminal, administrative or investigative (a
"Proceeding"), by reason of the fact that he or she or a person of whom he or
she is the legal representative is or was a director, officer or employee of the
Company or any such person who is or was serving at the request of the Company
as a director, officer, employee or agent of another corporation or of a
partnership, joint venture, trust or other enterprise, including service with
respect to employee benefit plans, whether the basis of such Proceeding is
alleged action in an official capacity as a director, officer or employee or in
any other capacity while serving as a director, officer or employee, will be
indemnified and held harmless by the Company to the fullest extent authorized by
Delaware law as the same exists or may in the future be amended against all
expense, liability and loss (including attorneys' fees, judgments, fines,
amounts due under the Employee Retirement Income Security Act of 1974, as
amended, excise taxes or penalties and amounts paid or to be paid in settlement)
reasonably incurred or suffered by such person in connection therewith;
provided, however, except as described in the next paragraph with respect to
Proceedings to enforce rights to indemnification, the Company will indemnify any
such person seeking indemnification in connection with a Proceeding (or part
thereof) initiated by such person only if such Proceeding (or part thereof) was
authorized by the Company's Board.

The Company's Bylaws provide that the right to indemnification and the
payment of expenses incurred in defending a Proceeding in advance of its final
disposition conferred in the Company's Bylaws will not be exclusive of any other
right which any person may have or may in the future acquire under any statute,
provision of the Company's Certificate of Incorporation, the Company's Bylaws,
agreement, vote of stockholders or disinterested directors or otherwise.
Pursuant to the Company's Bylaws, if a claim is not paid in full by the Company
within 30 days after a written claim has been received by the Company, the
claimant may at any time thereafter bring suit against the Company to recover
the unpaid amount of the claim and, if successful in whole or in part, the
claimant will also be entitled to be paid the expense of prosecuting such claim.
The Company's Bylaws provide that it will be a defense to any such action (other
than an action brought to enforce a claim for expenses incurred in defending any
Proceeding in advance of its final disposition where the required undertaking,
if any is required, has been tendered to the Company) that the claimant has not
met the standard of conduct which makes it permissible under Delaware law for
the Company to indemnify the claimant for the amount claimed, but the burden of
proving such defense will be on the Company. At present, the Company is not
aware of any pending or threatened litigation or proceeding involving a
director, officer, employee or agent of the Company in which indemnification
would be required or permitted. The Company is not aware of any threatened
litigation or proceeding that might result in a claim for such indemnification.
The Company believes that its charter provisions and indemnification agreements
are necessary to attract and retain qualified persons as directors and officers.

<PAGE> 76

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Based on information as of August 31, 1998, obtained from the Company's
records, Collagen's records, Cohesion Corporation's records and a review of
statements filed with the Securities and Exchange Commission pursuant to
Sections 13(d) and 13(g) of the 1934 Securities Exchange Act, the Company
believes that the following table sets forth certain expected information
regarding the beneficial ownership of the Company's Common Stock as of August
31, 1998, by (a) each of the Company's directors and Named Executive Officers,
(b) all directors and executive officers as a group, and (c) each person who is
known by the Company to own beneficially more than five percent of the Company's
Common Stock.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED (1)(2)
--------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT(%)
- ------------------------------------ --------- ----------
<S> <C> <C> <C>
Wellington Management Company(3).......................... 1,097,100 12.40
75 State Street
Boston, MA 02109

Heartland Advisors, Inc.(4)............................... 1,080,400 12.21
790 North Milwaukee Street
Milwaukee, WI 53202

T. Rowe Price Associates, Inc.(5)......................... 727,400 8.22
100 East Pratt Street
Baltimore, MD 21202

Dimensional Fund Advisors, Inc.(6)........................ 504,050 5.70
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401

Reid W. Dennis(7)......................................... 724,543 8.16
3000 Sand Hill Road
Building 2, Suite 290
Menlo Park, CA 94025

John R. Daniels, M.D.(8).................................. 166,327 1.87

David J. Foster(9)........................................ 81,955 *

Frank DeLustro, Ph.D.(10)................................. 77,065 *

Deborah Webster(11)....................................... 54,188 *

Charles Williams(12)...................................... 0 *

Ross Erickson(13)......................................... 41,070 *

Craig W. Johnson(14)...................................... 86,000 *

Craig T. Davenport........................................ 800 *

Mark A. Philip, Ph.D...................................... 0 *

All directors and executive officers as a group
(12 persons)(15)........................................ 1,248,013 13.67
</TABLE>

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

* Less than one percent of the outstanding shares of Common Stock.

(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. It has been assumed that the persons
named have sole voting and investment power with respect to all shares of
Common Stock shown as beneficially owned by them, subject to community
property laws where applicable and the information contained in the other
footnotes to this table. In September 1998, the Company's Board of
Directors approved a program to cancel options to purchase shares of the
common stock of Cohesion Corporation (the "Canceled Options"). In
connection with such program, the Company will offer to pay each holder of
Canceled Options a per share amount equal to the excess of $16.70 over the
exercise price of the Canceled Option (the "Option Payment"). The Company
will make this Option Payment ratably over the original vesting period of
the Canceled Option so long as the holder thereof remains an employee or
consultant of the Company or Cohesion Corporation.

(2) Percentage of ownership is based on 8,847,588 shares of Common Stock
outstanding on August 31, 1998. The number of shares of Common Stock
beneficially owned includes the shares issuable pursuant to stock

<PAGE> 77

options that are exercisable within 60 days of August 31, 1998. Shares
issuable pursuant to stock options are deemed outstanding for computing the
percentage of the person holding such options but are not outstanding for
computing the percentage of any other person.

(3) Wellington Management Company ("WMI") is an investment advisor registered
with the Securities and Exchange Commission (the "Commission") under the
Investment Advisors Act of 1940, as amended (the "1940 Act"). WMI may be
deemed to beneficially own the stated shares by virtue of its status as a
registered investment advisor to its various investment advisory clients.
Of such amount, WMI may be deemed to have shared voting power with respect
to 517,200 shares and shared dispositive power with respect to 1,097,100
shares. The information presented is based upon information filed with the
Commission on Schedule 13G by the stockholder.

(4) Heartland Advisors, Inc., America's Value Investor ("Heartland Advisors")
is an investment advisor registered with the Commission under the 1940 Act.
Heartland Advisors may be deemed to beneficially own the stated shares by
virtue of its status as a registered investment advisor to its various
investment advisory clients. Of such amount, Heartland Advisors may be
deemed to have sole voting power with respect to 191,400 shares and sole
dispositive power with respect to 1,080,400 shares. The information
presented is based upon information filed with the Commission on Schedule
13G by the stockholder.

(5) T. Rowe Price Associates, Inc. may be deemed to beneficially own the stated
shares by virtue of its status as a registered investment advisor to its
various investment advisory clients. Of such amount, T. Rowe Price
Associates, Inc. may be deemed to have sole voting power with respect to
245,500 shares and sole dispositive power with respect to 717,000 shares.
The information presented is based upon information provided filed with the
Commission on Schedule 13G by the stockholder prior to the Distribution.

(6) Dimensional Fund Advisors, Inc. ("DFA") is an investment advisor registered
with the Commission under the 1940 Act. DFA may be deemed to beneficially
own the stated shares by virtue of its status as a registered investment
advisor to various investment advisory clients. Of such amount, DFA may be
deemed to have sole voting power with respect to 339,650 shares and sole
dispositive power with respect to 504,050 shares. The information presented
is based upon information filed with the Commission on Schedule 13G by the
stockholder prior to the Distribution.

(7) Includes 27,000 shares of the Company's Common Stock issuable upon exercise
of options within 60 days of August 31, 1998; excludes 1,500 shares held by
Mr. Dennis as trustee for Suzanna Weaver Dennis, of which he disclaims any
beneficial ownership and excludes 27,000 shares of Collagen common stock
issuable upon exercise of Collagen options within 60 days of August 31,
1998.

(8) Includes 27,000 shares of the Company's Common Stock issuable upon exercise
of the Company's options within 60 days of August 31, 1998; excludes 2,290
shares of Cohesion Corporation Common Stock issuable upon exercise of
Cohesion Corporation options within 60 days of August 31, 1998 and excludes
27,000 shares of Collagen common stock issuable upon exercise of Collagen
options within 60 days of August 31, 1998.

(9) Includes 47,100 shares of the Company's Common Stock issuable upon exercise
of options within 60 days of August 31, 1998; excludes 45,860 shares of
Collagen common stock issuable upon exercise of Collagen options within 60
days of August 31, 1998.

(10) Includes 56,880 shares of the Company's Common Stock issuable upon exercise
of options within 60 days of August 31, 1998; excludes 56,680 shares of
Collagen common stock issuable upon exercise of Collagen options within 60
days of August 31, 1998 and excludes 26,250 shares of Cohesion Corporation
common stock issuable upon exercise of Cohesion Corporation options within
60 days of August 31, 1998.

(11) Includes 45,710 shares of the Company's Common Stock issuable upon exercise
of options within 60 days of August 31, 1998; excludes 44,890 shares of
Collagen common stock issuable upon exercise of Collagen options within 60
days of August 31, 1998.

<PAGE> 78

(12) Excludes 15,208 shares of Cohesion Corporation common stock issuable upon
exercise of Cohesion Corporation options within 60 days of August 31, 1998.

(13) Includes 33,070 shares of the Company's Common Stock issuable upon exercise
of options within 60 days of August 31, 1998; excludes 32,930 shares of
Collagen common stock issuable upon exercise of Collagen options within 60
days of August 31, 1998 and excludes 17,812 shares of Cohesion Corporation
common stock issuable upon exercise of Cohesion Corporation options within
60 days of August 31, 1998.

(14) Includes 36,000 shares of the Company's Common Stock issuable upon exercise
within 60 days of August 31, 1998; excludes 36,000 shares of Collagen
common stock issuable upon exercise of Collagen options within 60 days of
August 31, 1998 and excludes 7,257 shares of Cohesion Corporation common
stock and 3,243 shares held by VLG Investments ("VLGI"), an investment fund
affiliated with Mr. Johnson. Mr. Johnson disclaims beneficial ownership of
all shares held by VLGI, except to the extent of his pecuniary interest
therein.

(15) Includes an aggregate of 283,000 shares of the Company's Common Stock
issuable upon exercise of the Company's options within 60 days of August
31, 1998. Excludes an aggregate of 280,400 shares of Collagen common stock
issuable upon exercise of Collagen options within 60 days of August 31,
1998 and excludes 69,060 shares of Cohesion Corporation common stock
issuable upon exercise of Cohesion Corporation options within 60 days of
August 31, 1998.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

CERTAIN TRANSACTIONS

CollOptics, Inc.

In December 1992, Collagen purchased 800,000 shares of preferred stock of
CollOptics, Inc. ("CollOptics") for an aggregate of $500,000. In addition,
Collagen granted to CollOptics a license to use Collagen's technology in the
field of refractive surgery for long-term vision correction and entered into
certain other technology-related agreements with CollOptics. In September 1995,
Collagen purchased an additional 1,000,000 shares of CollOptics preferred stock
for an aggregate of $500,000. During fiscal 1997, CollOptics made certain
payments to Collagen, primarily for research and development services and the
reimbursement of expenses paid by Collagen, totaling $500,000. As of June 30,
1998, CollOptics owed Collagen $771,775 for research and development services
and the reimbursement of expenses paid by the Company. David J. Foster, Chief
Executive Officer of the Company and Dr. Frank DeLustro, President and Chief
Operating Officer of the Company, are directors of CollOptics. As of June 30,
1998, Collagen held a 47% equity interest in CollOptics. In connection with the
Distribution, all outstanding shares of CollOptics owned by Collagen and all
agreements between Collagen and CollOptics were transferred to the Company
effective January 1, 1998.

Cohesion Corporation

In November 1993, Collagen purchased from Cohesion Corporation, for
approximately $65,000, 50,000 shares of Preferred Stock ("Cohesion Corporation
Preferred Stock") and 200,000 shares of common stock ("Cohesion Corporation
Common Stock"). In April 1994, Collagen purchased 95,238 shares of Cohesion
Corporation Preferred Stock for approximately $86,000, and in July 1994,
Collagen purchased 104,762 shares of Cohesion Corporation Preferred Stock for
approximately $94,000. Cohesion Corporation was formerly known as Otogen
Corporation ("Otogen") and Dr. Rodney Perkins, a director of Collagen at that
time, was the majority stockholder, Chairman and President of Otogen. In
addition to the purchase of shares, Collagen granted to Cohesion Corporation a
license to use the Company's technology in the fields of otology and
neurosurgical applications, in return for which Collagen was granted an
additional 50,000 shares of Cohesion Corporation Common Stock. Between April
1994 and May 1996, Collagen made an additional equity investment in Cohesion
Corporation of $180,000 and loaned to Cohesion Corporation an aggregate of
approximately $1,540,000. In May

<PAGE> 79

1996, Collagen purchased an additional aggregate of 875,000 shares of Cohesion
Corporation Common Stock and Cohesion Corporation Preferred Stock from Cohesion
Corporation for an aggregate of approximately $5.1 million (including conversion
of Cohesion Corporation's outstanding indebtedness to Collagen) and purchased
275,000 shares of Cohesion Corporation Common Stock and Cohesion Corporation
Preferred Stock from Dr. Perkins for an aggregate of $1,452,500. Collagen also
granted to Cohesion Corporation a license to use certain of Collagen's
technology in the fields of tissue adhesion and anti-adhesion technology,
excluding ophthalmic applications, in return for which Collagen was granted an
additional 75,000 shares of Cohesion Corporation Preferred Stock. In addition,
Collagen agreed to loan Cohesion Corporation up to $5,000,000 in the form of
convertible debt, which loan drawn upon at the direction of the President of
Cohesion Corporation, bore interest at an annual rate of the greater of the
prime lending rate or 10% and was due and payable five years after the date of
the first disbursement, subject to acceleration under certain circumstances. In
connection with the loan transaction, Dr. Perkins granted Collagen an option to
purchase up to 125,000 additional shares of Cohesion Corporation Common Stock
held by Dr. Perkins, which option became exercisable as to 25,000 shares for
each $1,000,000 of the loan commitment that was disbursed. In each of May 1997,
August 1997 and October 1997 Collagen loaned $1,000,000 to Cohesion Corporation
under the loan commitment and purchased 25,000 shares of Cohesion Corporation
Common Stock from Dr. Perkins. In addition, in connection with this transaction,
Collagen agreed to grant Dr. Perkins an option to purchase up to 77,500 shares
of Collagen Common Stock in connection with his continued participation on the
Cohesion Corporation Board of Directors. In connection with the May 1996 stock
purchase transactions, Craig W. Johnson, a director and Secretary of Collagen,
and an investment partnership in which he holds a beneficial interest, purchased
an aggregate of 25,000 shares of Cohesion Corporation Common Stock and Cohesion
Corporation Preferred Stock for an aggregate of $127,750. In June 1996, Dr. John
R. Daniels, a director of Collagen, was appointed to Cohesion Corporation's
Board of Directors. As of June 30, 1997, Collagen held an 81% equity interest in
Cohesion Corporation, and in December 1997 increased its ownership position to
99%. Effective January 1, 1998, Collagen contributed all of its holdings of
Cohesion Corporation capital stock and its research and development programs for
sealant and adhesion barriers to the Company.

Innovasive Devices, Inc.

In October 1995, Collagen purchased 844,000 shares of preferred stock of
Innovasive Devices for $4,100,000. In connection with this investment, Collagen
entered into research and development, distribution and manufacturing and supply
agreements with Innovasive Devices with respect to tissue fixation devices
manufactured from collagen-based materials using Collagen's proprietary
technology. Shortly following its investment in Innovasive Devices, Collagen
purchased from Howard D. Palefsky, the former Chairman and Chief Executive
Officer of Collagen, all of his holdings of Innovasive Devices capital stock
(30,303 shares) for an aggregate of $63,552. During fiscal 1998, pursuant to the
terms of the research and development agreement, Innovasive Devices made
payments to Collagen totaling $289,613 for research and development services and
reimbursement of expenses paid by Collagen. In connection with the Distribution,
all outstanding shares of Innovasive Devices owned by Collagen and all
agreements between Collagen and Innovasive Devices were transferred to the
Company. As of June 30, 1998, Innovasive Devices owed the Company $106,600 for
research and development services and the reimbursement of expenses paid by the
Company. The Company is entitled to elect one member of Innovasive Device's
Board of Directors so long as it holds five percent of Innovasive's capital
stock on a fully diluted basis. As of June 30, 1998, the Company held
approximately nine percent of Innovasive Device's outstanding capital stock. Mr.
Foster was Collagen's representative, and currently is the Company's
representative, on the Innovasive Devices Board of Directors.

Outside Legal Counsel

Since February 1993, Collagen had retained as its principal outside legal
counsel Venture Law Group, A Professional Corporation, a law firm of which Craig
W. Johnson, a director of Collagen, is a director. Prior to such time, Collagen
had retained Wilson, Sonsini, Goodrich & Rosati, Professional Corporation
("WSG&R"), as its principal outside legal counsel since 1977. From 1980 until
February 1993, Mr. Johnson was a member of WSG&R. In connection with the
Distribution, Mr. Johnson, who has been elected to the Company's Board of

<PAGE> 80

Directors, resigned from Collagen's Board of Directors. Mr. Johnson is currently
on the Company's Board of Directors and Venture Law Group is the Company's legal
counsel.

Executive Officers and Directors

In October 1995, Ross Erickson, then an executive officer of Collagen and
currently an executive officer of the Company, borrowed $120,000 from Collagen
pursuant to a secured promissory note. This debt was secured by real property
purchased by Mr. Erickson and all shares of Collagen's stock issued to Mr.
Erickson pursuant to the exercise of stock options. In May 1997, all amounts due
to Collagen under such loan were repaid through the assumption of the loan by
Cohesion Corporation. In October 1997 and December 1997 Ross Erickson repaid to
Cohesion Corporation all amounts owing on such promissory note.

In August 1994, June 1995 and December 1995, Howard D. Palefsky, Collagen's
former Chairman and Chief Executive Officer, borrowed an aggregate of $475,000
from Collagen pursuant to promissory notes secured by all shares of Collagen's
capital stock held by Mr. Palefsky while such debt is outstanding, and bearing
an annual interest rate equal to the lesser of 10% or the prime rate at the
close of each quarter for which interest accrues. In February 1996, Mr. Palefsky
borrowed an additional $1,080,000 from Collagen on an unsecured basis pursuant
to a promissory note bearing an annual interest rate equal to the lesser of 10%
or the prime rate at the close of each quarter for which interest accrues.

In March 1997, Mr. Palefsky entered into an agreement with Collagen in
connection with the severance of his employment relationship with Collagen
pursuant to which, among other things, Mr. Palefsky agreed to provide consulting
services. Pursuant to one of the Intercompany Agreements, the Company has
assumed Collagen's obligations under the agreement. Under the agreement, the
Company will pay Mr. Palefsky a consulting fee of $29,167 during each of the
first 24 months of his consultancy. As additional compensation for services
during his consultancy and for Mr. Palefsky's execution and adherence to a
noncompetition agreement with the Company, the Company agreed to: (i) pay Mr.
Palefsky a bonus of $650,000, (ii) conditioned on completion of the first year
of his consultancy and noncompetition, pay Mr. Palefsky a bonus of $225,000 on
the first anniversary date of the agreement and forgive $425,000 of the
principal and any accrued interest thereon of outstanding loans totaling
$475,000 in principal amount, made to Mr. Palefsky by Collagen and (iii)
conditioned on completion of the second year of Mr. Palefsky's consultancy, the
Company agreed to forgive the balance of the principal and any accrued interest
thereon of the above loans and also to forgive the entire principal balance and
any accrued interest thereon of the loan in the principal amount of $1,080,000
made by Collagen in February 1996 to Mr. Palefsky. During his consultancy, Mr.
Palefsky is also entitled to reimbursement for his reasonable expenses incurred
in connection with rendering consulting services to the Company. Mr. Palefsky's
options to purchase stock of Collagen will continue to vest during his period of
consultancy and shall, in any event, be fully vested on conclusion of the
consultancy.

In December 1997, Charles Williams, Vice President, Operations of the
Company, borrowed $150,000 from Cohesion Corporation, pursuant to a promissory
note bearing an annual interest rate of 8.5%, secured by certain real property
owned by Mr. Williams and all shares of Cohesion Corporation common stock issued
to Mr. Williams upon exercise of stock options currently held or acquired
following the date of the loan by Mr. Williams while the loan amount is
outstanding. As of June 30, 1998, Mr. Williams owed the Company $158,198 for
principal and interest.

Change of Control Agreements

The Company and Collagen entered into certain "change of control"
agreements with certain of the Company's executive officers pursuant to which
all options granted to such executive officers to purchase Collagen common stock
shall immediately vest to the extent that such options would have vested during
the 24 months following the termination date, and all options granted to such
executive officers to purchase common stock of Cohesion Corporation, a
majority-owned subsidiary of the Company, shall immediately vest to the extent
that such options would have vested during the 24 months following the change of
control, in the event that such officer's employment is involuntarily terminated
without cause within a specified period of time

<PAGE> 81

following a change of control of the Company or Collagen. Events constituting a
change of control include (i) any person acquiring 50% or more of the total
voting power represented by the Company's then outstanding voting securities
without the approval of the Company's Board of Directors; (ii) any person
acquiring 50% or more of the total voting power represented by Collagen's then
outstanding voting securities without the approval of Collagen's Board of
Directors; (iii) any merger, sale of assets or liquidation of the Company in
which the Company's outstanding voting securities prior to the transaction cease
to represent at least 50% of the total voting power represented by the voting
securities of the Company or of the surviving entity after the transaction; (iv)
any merger, sale of assets or liquidation of Collagen in which Collagen's
outstanding voting securities prior to the transaction cease to represent at
least 50% of the total voting power represented by the voting securities of
Collagen or of the surviving entity after the transaction; (v) replacing a
majority of the Company's Board of Directors; or (vi) replacing a majority of
Collagen's Board of Directors. The change of control agreements expired by their
own terms on August 18, 1998.

<PAGE> 82

PART IV

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

(a) The following documents are filed as a part of this report:

1. Financial Statements and Schedules

Financial Statements - See Index to Consolidated Financial
Statements at Item 8 of this report.

All schedules have been omitted because they are not required or the
information required to be set forth therein is included in the
Consolidated Financial Statements or notes thereto.

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Exhibits

<TABLE>
<CAPTION>
NUMBER NOTES DESCRIPTION
- ------ ------- -----------
<S> <C> <C>
2.1 (2)(12) Separation and Distribution Agreement dated January 1, 1998, between
the Company and Collagen Corporation.

3.1 (1) Amended and Restated Certificate of Incorporation of the Company.

3.2 (1) Bylaws of the Company.

4.1 (1) Specimen Stock Certificate.

10.1 (2)(13) Collagraft Supply Agreement dated January 1, 1998, between the Company
and Collagen Corporation.

10.2 (2)(14) Collagen Supply Agreement dated January 1, 1998, between the Company
and Collagen Corporation.

10.3 (15) Assignment and License Agreement dated January 1, 1998, between the
Company and Collagen Corporation.

10.4 (2)(16) Recombinant Technology Development and License Agreement dated
January 1, 1998, between the Company and Collagen Corporation.

10.5 (17) Services Agreement dated January 1, 1998, between the Company and
Collagen Corporation.

10.6 (18) Benefits Agreement dated January 1, 1998, between the Company and
Collagen Corporation.

10.7 (19) Tax Allocation and Indemnity Agreement dated January 1, 1998, between
the Company and Collagen Corporation.

10.8 (20) Vitrogen International Distribution Agreement dated January 1, 1998,
between the Company and Collagen Corporation.

10.9 (1)(2) Letter Agreement dated October 1, 1996 between Collagen Corporation
and Genotypes, Inc.

10.10 (1)(11) Form of Indemnification Agreement between the Company and each of its
Officers and Directors.

10.11 (1)(11) 1998 Stock Option Plan.

10.12 (1)(11) 1998 Employee Stock Purchase Plan.

10.13 (1)(11) 1998 Directors' Stock Option Plan.

10.14 (3) Collaborative Research and Distribution Agreement between Collagen
Corporation and
</TABLE>

<PAGE> 83

<TABLE>
<CAPTION>
NUMBER NOTES DESCRIPTION
- ------ ------- -----------
<S> <C> <C>
Zimmer, Inc. dated as of June 26, 1985.

10.15 (4) Amendments dated February 16, 1993 and February 18, 1993 respectively,
to the Product Development and Distribution Agreement dated January
18, 1985 by and between Collagen Corporation and Zimmer, Inc.
and Harbor Investment Partners.

10.17 (6) Lease Renewal for 2500 Faber Place, Palo Alto, dated December 1, 1992
between Collagen Corporation and Leonard Ely, Shirley Ely, Carl
Carlsen and Mary Carlsen.

10.18 (1)(2) Amended and Restated Research, Lease and Supply Agreement dated as
of February 20, 1996 between Collagen Corporation and Pharming B.V.

10.19 (1)(2) Research and Development Agreement dated October 17, 1995 between
Collagen Corporation and Innovasive Devices, Inc.

10.20 (1)(2) Manufacturing and Supply Agreement dated as of October 17, 1995
between Collagen Corporation and Innovasive Devices, Inc.

10.21 (1)(2) Distribution Agreement dated as of October 17, 1995 between Collagen
Corporation and Innovasive Devices, Inc.

10.22 (7) Promissory Note between Howard D. Palefsky and the Registrant dated
February 20, 1996.

10.23 (8)(11) Amended and Restated Secured Loan Agreement between Ross R. Erickson
and Collagen Corporation dated December 31, 1995.

10.24 (9) Loan Agreement between Collagen Corporation and Cohesion Corporation
dated May 24, 1996.

10.25 (10) Agreement between Howard D. Palefsky and Collagen Corporation dated
March 15, 1997.

10.26 (1)(11) Form of Management Continuity Agreement between certain officers of
the Company and Collagen Corporation dated February 7, 1997.

10.27 (1)(2) Intellectual Property and Production Agreement between Genotypes and
Collagen Corporation dated August 15, 1996.

10.28 (1)(11) Secured Loan Agreement between Charles Williams and Cohesion
Corporation dated December 15, 1997.

21.1 List of Subsidiaries.

27.1 Financial Data Schedule.
</TABLE>

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

(1) Incorporated by reference to identically numbered exhibits filed with the
Company's Registration Statement on Form 10, as amended (File No.
000-24103), which became effective on June 26, 1998.

(2) Confidential treatment has been or will be requested as to certain portions
of this Exhibit.

(3) Incorporated by reference to Exhibit 10.24 filed with Collagen
Corporation's Annual Report on Form 10-K for the fiscal year ended June 30,
1985.

(4) Incorporated by reference to Exhibit 10.60 filed with Collagen
Corporation's Annual Report on Form 10-K for the fiscal year ended June 30,
1993.

(5) Incorporated by reference to Exhibit 10.56 filed with Collagen
Corporation's Annual Report on Form 10-K for the fiscal year ended June 30,
1992.

(6) Incorporated by reference to Exhibit 10.63 of Collagen Corporation's Annual
Report on Form 10-K for the fiscal year ended June 30, 1994.

(7) Incorporated by reference to Exhibit 10.79 of Collagen Corporation's
Quarterly Report on Form 10-Q for

<PAGE> 84

the fiscal quarter ended March 31, 1996.

(8) Incorporated by reference to Exhibit 10.76 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended December 31,
1995.

(9) Incorporated by reference to Exhibit 10.82 of Collagen Corporation's Annual
Report on Form 10-K for the fiscal year ended June 30, 1996.

(10) Incorporated by reference to Exhibit 10.88 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1997.

(11) Management contract or compensatory plan or arrangement.

(12) Incorporated by reference to Exhibit 2.1 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(13) Incorporated by reference to Exhibit 10.104 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(14) Incorporated by reference to Exhibit 10.97 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(15) Incorporated by reference to Exhibit 10.103 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(16) Incorporated by reference to Exhibit 10.98 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(17) Incorporated by reference to Exhibit 10.100 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(18) Incorporated by reference to Exhibit 10.101 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(19) Incorporated by reference to Exhibit 10.99 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

(20) Incorporated by reference to Exhibit 10.102 of Collagen Corporation's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998.

<PAGE> 85

SIGNATURES

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

COHESION TECHNOLOGIES, INC.

/s/ David Foster
-----------------------------------------
David Foster
Chief Executive Officer, and Director
(Principal Executive Officer)

Dated: September 28, 1998

<PAGE> 86
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Signature Title Date
- -------------------------------------------------------------------------------------------------------------

/s/ David Foster Chief Executive Officer, and Director (Principal September 28, 1998
- ---------------------------- Executive Officer)
David Foster

/s/ Frank DeLustro, Ph.D. President, Chief Operating Officer and Director September 28, 1998
- ----------------------------
Frank DeLustro, Ph.D.

/s/ Sharon Kokubun Vice President, Financial Operations (Principal September 28, 1998
- ---------------------------- Accounting Officer)
Sharon Kokubun

/s/ John R. Daniels, M.D. Director September 28, 1998
- ----------------------------
John R. Daniels, M.D.

/s/ Reid W. Dennis Director September 28, 1998
- ----------------------------
Reid W. Dennis

/s/ Craig W. Johnson, Esq. Secretary and Director September 28, 1998
- ----------------------------
Craig W. Johnson, Esq.

/s/ Craig T. Davenport Director September 28, 1998
- ----------------------------
Craig T. Davenport

/s/ Mark Philip, Ph.D. Director September 28, 1998
- ----------------------------
Mark Philip, Ph.D.

</TABLE>

86
<PAGE> 87

COHESION TECHNOLOGIES, INC.

FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED JUNE 30, 1998

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBIT PAGE
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
21.1 List of Subsidiaries
27.1 Financial Data Schedule (EDGAR version only)
</TABLE>

<PAGE> 1

EXHIBIT 21.1

COHESION TECHNOLOGIES, INC.

Subsidiaries* of Cohesion Technologies, Inc.

The Registrant owns the following percentages of the outstanding voting
securities of the following corporations, which are included in the Registrant's
consolidated financial statements.

<TABLE>
<CAPTION>
PERCENT
OWNERSHIP OF
OUTSTANDING
VOTING
SECURITIES JURISDICTION OF
NAME @ AUGUST 31, 1998 INCORPORATION
- --------------------------------------------------------------------------------
<S> <C> <C>
Cohesion Corporation 99% California
</TABLE>

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

* Excludes certain subsidiaries, which, considered in the aggregate as a
single subsidiary, did not constitute a significant subsidiary as of June
30, 1998.

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> JUN-30-1998 JUN-30-1997 JUN-30-1996
<PERIOD-START> JUL-01-1997 JUL-01-1996 JUL-01-1995
<PERIOD-END> JUN-30-1998 JUN-30-1997 JUN-30-1996
<CASH> 591 13,706 11,074
<SECURITIES> 1,016 92 0
<RECEIVABLES> 473 97 532
<ALLOWANCES> 13 2 14
<INVENTORY> 81 56 56
<CURRENT-ASSETS> 3,415 17,501 18,986
<PP&E> 8,312 7,284 7,473
<DEPRECIATION> 6,240 5,718 5,936
<TOTAL-ASSETS> 95,653 114,604 97,916
<CURRENT-LIABILITIES> 5,315 5,468 10,523
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 0 0 0
<OTHER-SE> 58,415 74,005 59,545
<TOTAL-LIABILITY-AND-EQUITY> 95,653 114,604 97,916
<SALES> 2,043 2,527 3,612
<TOTAL-REVENUES> 2,043 2,527 3,612
<CGS> 1,162 2,105 2,404
<TOTAL-COSTS> 1,162 2,105 2,404
<OTHER-EXPENSES> 32,364 16,780 10,388
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 0 377 2,532
<INCOME-PRETAX> (12,064) 7,476 70,365
<INCOME-TAX> (2,497) 3,162 31,718
<INCOME-CONTINUING> (9,567) 4,981 38,674
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (9,567) 4,981 38,674
<EPS-PRIMARY> 0 0 0
<EPS-DILUTED> 0 0 0

</TABLE>