BIO-VASCULAR, INC. annual report Securing the Future

Transcription

1 BIO-VASCULAR, INC. annual report 1999 Securing the Future

2 financial highlights (in thousands, except per share data) SUMMARY STATEMENTS OF OPERATIONS DATA: BRANDED SURGICAL PRODUCTS The company s branded tissue-based products and surgical productivity tools are used in cardiac, neurological, vascular, thoracic, ophthalmic and general surgery. Bio-Vascular has a 15-year history of safety and efficacy with its tissue-based products biocompatible patches that are used to seal and strengthen suture or staple sites and repair tissue. They are designed to improve surgical outcomes and shorten hospital stays, ultimately lowering health care costs. The company s surgical productivity tools aid in minimally invasive surgical procedures, primarily coronary and peripheral bypass surgery. Products are manufactured with our proprietary and patented technology and distributed through a worldwide network of distributors and independent sales representatives. MEDICAL DEVICE COMPONENTS The company also designs and manufactures value-added precision micro wire and related component products for leading medical device companies through its Jerneen subsidiary. Components include micro coils, wire forms and spring components used in implantable defibrillation, pacing, interventional medicine and other surgical applications. In addition, Jerneen provides rapid response prototyping and design services to customer partners. For the year ended October Net revenue $ 18,904 $ 12,017 $ 9,694 $ 10,125 $ 10,426 Gross margin 9,461 6,795 5,727 6,682 6,964 Operating income (loss) (794) (1,415 ) (1,305) 571 2,121 Income (loss) from continuing operations (520) (483) (604) 1,219 1,659 Income (loss) per share from continuing operations: Basic (0.06) (0.05) (0.06) Diluted (0.06) (0.05) (0.06) Weighted average shares outstanding: Basic 9,026 9,228 9,499 9,387 7,509 Diluted 9,026 9,228 9,499 9,876 8,062 The above information includes the Company s acquisition of Jerneen in July 1998 and excludes discontinued operations; see Notes 2 and 3, respectively, to the financial statements. Earnings per share amounts have been presented for all years pursuant to the provisions of Statement of Financial Accounting Standard No. 128, Earnings Per Share; see Note 9 to the financial statements. SUMMARY BALANCE SHEET DATA: At October Working capital $ 9,400 $ 11,386 $ 16,906 $ 22,107 $ 24,060 Total assets 24,070 25,982 25,134 37,881 37,303 Long-term obligations 686 1,055 Shareholders equity 20,784 22,430 23,952 35,221 35,355 In connection with the 1997 spin-off of Vital Images Inc., Shareholders Equity was reduced by $10,124,000, which represents the contribution of cash and investments plus the carrying value of Vital Images net assets. 1 Bio-Vascular, Inc. (Nasdaq: BVAS), headquartered in St. Paul, Minnesota, with more than 220 employees, is an innovative medical products company with a growing and diversified product portfolio Quarter-by-quarter over the past three years, Bio-Vascular has made significant progress towards its goal to build a sustainable and valuable business. As the accompanying charts show, revenue growth is more than offsetting declining interest income and rising R&D spending while fueling growth in operating income. Our goal for fiscal 2000 is to extend this progress further and report a positive net income for the year (100) (200) (300) (400) (500) (600) REVENUE $ in millions OPERATING INCOME (LOSS) $ in thousands INTEREST INCOME $ in thousands R & D $ in thousands

3 a letter to our shareholders Last year, I wrote to you about our work establishing fundamental building blocks at Bio-Vascular. These included: Empowering our employees to increase our responsiveness; Instituting an open communications system to enhance our creativity; Defining core values that recognize each employee s contribution; and Minimizing the politics that divert energy away from the business. Without these, we would not enjoy the reputation we have today. We would not have our drive or focus. And we would not have achieved the considerable success of this past year. Our integration of Jerneen proceeded seamlessly and produced incredible results for a first-year acquisition. We paid $5.3 million for this business, which grew at an annual rate of 31 percent, added $7.2 million in revenues to the company and contributed $617,000 of operating income. Jerneen s cash flow from operating activities more than funded the capital requirements to support its growth. Branded products secured a second consecutive year of accelerating growth. In fact, BVI Branded products achieved a fourth-quarter growth rate of 16 percent, the best comparative quarterly growth rate since January During the entire history of the Branded products business, four quarters have exceeded revenue of $3 million, and three of them were in fiscal The acquisition of Jerneen, coupled with the steadily improving performance of BVI Branded products, resulted in revenue of $18.9 million in fiscal 1999, up from $12.0 million in 1998 and nearly double 1997 revenue of $9.7 million. We reduced the company s operating losses by 44 percent. As a result, the company broke even in the second half of the year, despite a significant decrease in non-operating interest income. During fiscal 1999, we used $1.4 million to purchase 484,834 shares of Bio-Vascular stock in a stock buy-back program. This action made us, I expect, the single largest purchaser of Bio-Vascular stock during the year. The stock buy-back program is our statement to our shareholders that we believe in a bright future for this company. We maintain our strong financial position, with $5.6 million in cash at year-end. We are continuing to advance our growth strategies for both businesses: pursuing acquisitions, licensing and distribution opportunities and expanding markets for our current products. This strategy enables us to achieve profitability while investing internally to research and develop market opportunities that we could not dream of purchasing. Jerneen was the first piece in our external growth strategy. We will continue to leverage the success of this business with its rapidly growing revenue, good cash flow and profitability all benefiting the company. At the same time, we are increasing the market presence and The stock buy-back program is our statement to our shareholders that we believe in a bright future for this company. CORE VALUES Evan Johnston, Director of Operations, Bio-Vascular, Inc. 2 At BVI, the core values are so deeply embedded within our culture that I believe I can actually feel them when I walk through the door each morning. These values are not the empty words I have heard at other companies. They are not just words at all, but instead a description of who we are and why we are here. BVI s values create a freedom throughout the company. A freedom to be open, creative, productive. This drives a passion to achieve our goals. Each of us here has a distinct role, performed with singular skills, serving others within and outside of the company. Respect for these unique qualities invites people to share ideas, to further develop their talents and to know they each contribute to our success. Respect for all those we serve, striving to do what we say we are going to do, results in mutual benefit. When issues become difficult, we use our core values as a guide to recalibrate our approach to the solution. They remind us to consider everyone involved, not just ourselves. 3

4 CUSTOMER RELATIONSHIPS Jim Pfau, President, Jerneen At Jerneen, our customer base ranges from major medical manufacturers to start-up companies. A partnership approach and responsiveness are essential at every interval along the spectrum. As we collaborate with customers, we are exceptionally open in our communications while maintaining absolute confidentiality. Whatever the assignment involves a large volume project, technical expertise or cost reduction measures our customers have come to expect excellence. Our Technology Development Center, together with our Rapid Response Unit, provides specialized engineering expertise and fast prototyping turnaround both essential for companies facing product development pressures. When customers visit, they are impressed with the people throughout our organization. We have veteran engineers with experience at major medical manufacturers. Our manufacturing group understands that they re dealing with components for life-impacting products and take the utmost care with their work. We are proud of our ability to keep pace with client needs while handling our growth. We are committed to our customer partners and nothing gets in the way of meeting their needs. DISTRIBUTOR RELATIONSHIPS Michael K. Campbell, Executive Vice President of Sales, PrimeSource Surgical momentum that we have gained for BVI Branded products. These two businesses, with their respective operating platforms and manufacturing capabilities, give us a strong base from which to grow our business. As shareholders, I know you are eager to hear news of our research efforts. We have announced three projects: a small diameter graft for coronary bypass surgery, a sling for the surgical treatment of female urinary stress incontinence and a stent covering to improve stent performance. All three projects involve new and advanced tissue formats which we have been researching and developing for almost two years. Now, they are all entering pre-clinical testing phases. We have begun a feasibility study to select the final prototype for the small diameter graft, another to test the efficacy of the sling and a third related to the stent covering. We have just resumed our own stent study with a different laboratory that offers greater clinical depth in stent procedures. Several stent companies are interested in exploring our covering technology. We filed patent applications this year to protect the intellectual property underlying two of these projects, significant for a company of our size. We expect more to follow. Jerneen s development thrust resulted in the launch of a Technology Development Center (TDC) that provides rapid response prototyping and creative solutions for customers. While we will continue to make a substantial investment in R&D, we plan to write the fiscal 2000 net income number in black ink. Bio-Vascular has earned the respect and trust of the medical community. This achievement is a real benefit and opportunity for all of us. At some point, we expect the stock market, which is depressed for small cap stocks, will catch up with us and recognize what we have accomplished. Thanks for your support and patience while it does. Be proud of the substantial gains your company and its employees have achieved. I look forward to sharing more news through the coming year. Sincerely, It has been our good fortune to have had a relationship with Bio-Vascular since The leadership at BVI has created an environment of empowerment among its employees that stresses freedom to move fast and effectively in a rapidly changing industry. This culture has a focused, long-term, strategic growth view which has resulted in a very high trust level with its distribution network. The confidence BVI has won with its distribution network and its reinvestment into new products and services will ensure the continued successes of BVI. In short, BVI is leading by example walking its talk. 4 M. Karen Gilles President and Chief Executive Officer 5

5 MANAGEMENT S DISCUSSION AND ANALYSIS BIO-VASCULAR, INC. 6 Tissue-Guard Peri-Strips Biograft Surgical Productivity Tools Components State-of-the-Art Facilities State-of-the-Art Expertise/Capabilities Biocompatible, easy-to-handle materials used as patches to reduce blood leakage and strengthen suture lines. Vascu-Guard (peripheral vascular reconstruction), Dura-Guard (neurosurgery), Ocu-Guard (enucleation), Peri-Guard, Supple Peri-Guard, CV Peri-Guard branded surgical products 62% of 1999 revenues Staple-line reinforcement used in lung resection procedures. Improves recovery rates and shortens hospital stays. Peri-Strips Dry, Peri-Strips Used in peripheral vascular reconstruction surgery. Most effective alternative to autologous vessels for limb salvage. Designed to facilitate performance and safety in minimally invasive surgical procedures, primarily coronary and peripheral bypass surgery. Flo-Rester, Bio-Vascular Probe, Flo-Thru Intraluminal Shunt component products and services 38% of 1999 revenues Precision micro wire and related components for: Implantable defibrillation Pacing Guidewires and related components for micro-interventional applications Technology Development Center/Rapid Response Prototyping Unit Aids in component design Provides prototyping services Medical manufacturing facility Cleanroom manufacturing and assembly Micro coils Precision wire grinding Wire straightening and forming Welding, cleaning and finishing Guidewire assembly of Financial Condition and Results of Operations Forward-Looking Statements: Certain statements contained in revenues of $7,223,000 in 1999, up $5,826,000 from revenues of this Annual Report include forward-looking statements within the $1,397,000 contributed during the fourth quarter of The meaning of the Private Securities Litigation Reform Act of All Company reduced its operating loss for the year by $621,000 from forward-looking statements in this document are based on information $1,415,000 in fiscal 1998 to $794,000 in fiscal The consolidated currently available to the Company as of the date hereof, and the net loss for fiscal 1999 was $520,000, or $0.06 per share, as compared with a fiscal 1998 net loss of $483,000, or $0.05 per share, due Company assumes no obligation to update any forward-looking statements. Forward-looking statements involve known and unknown risks, in part to a $563,000 decrease in net interest income from fiscal uncertainties and other factors which may cause the actual results to 1998 to fiscal 1999 which offset the Company s operating income differ materially from any future results, performance or achievements improvements. The Company used cash primarily for stock expressed or implied by such forward-looking statements. Such factors repurchases, capital equipment and the July 1998 purchase of may include, among others, the risk factors listed from time to time in Jerneen, lowering the Company s interest-bearing balances. the Company s filings with the Securities and Exchange Commission, The Company has continued to advance its strategy for growth such as the year-end Annual Report on Form 10-K. at both business units, focusing on opportunities to grow through acquisition, licensing and distribution, expansion of markets for Overview its current products, and internal new product research and The Company develops, manufactures and markets branded development (R&D) activities. proprietary and patented specialty medical products for use in The Company s 1999 product development activities included a thoracic, cardiac, neuro, vascular and ophthalmic surgery. The number of projects, including a small diameter graft, a sling for the Company s branded products include the Tissue-Guard product surgical treatment of female urinary stress incontinence and a stent line, the Biograft peripheral vascular graft, and surgical productivity tools used in cardiac and vascular surgery. The Company s tissue formats which have been in R&D for almost two years. The covering. All three of these projects involve new and advanced wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc. animal testing phases for each of these projects will be continuing (Jerneen) is a value-added, original equipment manufacturer of in fiscal During fiscal 1999, the component products business micro-precision wire-based component products, including opened its Technology Development Center (TDC), which was precision coils, stylets and guidewire components and subassemblies used in the medical industry. addition to rapid response prototyping. Also, the Company s established to provide creative solutions for their customers in The acquisition of Jerneen was completed July 31, 1998, the end product development efforts resulted in the filing of two patents of the Company s fiscal 1998 third quarter. Jerneen s financial during fiscal 1999 to protect new and proprietary technologies. results were included in the Company s consolidated results of One of the applications related to the manufacture and use of stent operations during the fourth quarter of 1998 and all four quarters coverings formed of biological tissues, and the other pertains to the of The Company believes that the addition of Jerneen s Company s new resorbable line of tissue implant materials. The medical component business broadens the Company s participation Company s R&D activities are expected to increase as projects in the medical device industry, increases the Company s immediate under development continue to progress. and long-term revenue potential and achieves a balance of market opportunities consistent with the strategic objectives targeted by Results of Operations the Company. Years Ended October 31, 1999 and 1998 The Company s consolidated net revenue in fiscal 1999 increased Consolidated net revenue in fiscal 1999 increased to a record to a record $18,904,000, up $6,887,000 or 57% from fiscal 1998 net $18,904,000, up $6,887,000 or 57% from fiscal 1998 net revenue of revenue of $12,017,000. $12,017,000. The branded products business reported revenues of The branded products business reported revenues of $11,681,000, $11,681,000, up $1,061,000 from the 1998 revenue level of up $1,061,000 or 10% from the 1998 revenue level of $10,620,000. $10,620,000. The Jerneen component business contributed net Total 1999 branded product net revenue represents the highest revenues of $7,223,000 in 1999, as compared to revenues of $1,397,000 annual revenue in the Company s history recorded by this business contributed during the fourth quarter of Jerneen s net segment. The Jerneen component business contributed net revenues in 1999 represent a 31% increase over 1998 revenues of 7

6 8 $5,560,000, of which the first three quarters were not included in the Company s 1998 results. The 31% revenue growth of the component business unit is attributable to both increased sales unit volume as well as new products resulting from its quick turn prototyping emphasis. The branded products business experienced 25% revenue growth from its surgical productivity tools to $2,560,000 in 1999 from $2,051,000 in Revenue from the Flo-Thru Intraluminal Shunt, which received market clearance in August 1998, accounted for approximately 57% of the increase in surgical productivity tools revenue during the year. The Tissue-Guard product line, exclusive of Peri-Strips, contributed 14% revenue growth in 1999 over 1998 driven by sales of Vascu-Guard and Dura-Guard. While Peri-Strips revenue increased in each of the last three quarters of 1999 compared to the same periods in 1998, competitive activities in the first quarter of the year resulted in a 3% decrease in Peri-Strips revenue in fiscal Sales of Biograft increased 1% to $756,000 in 1999 from $748,000 in 1998 as a result of the Company s efforts to bring attention to the excellent efficacy of this product in limb salvage. The Company s consolidated gross margin percentage decreased to 50% in fiscal 1999 from 57% in fiscal 1998, due primarily to the inclusion of the component products business in the consolidated operating results for the full year in 1999 as compared to one quarter in In 1999, the component products business gross margin was 38% while the branded products business gross margin was 57%. In fiscal 2000, the Company expects an increase in branded business gross margins associated with the positive leverage of existing production fixed costs and a decrease, in percentage terms, in the component business gross margins primarily associated with precious metals handling agreements with key customers. Late in fiscal 1999, Jerneen agreed to purchase critical precious metals on behalf of certain customers for use in Jerneen s manufacturing of products for which it will be paid a handling fee for the incremental personnel and working capital resource commitments it is undertaking. Although the impact is a reduction in the gross margin percentage, the substance of the transactions adds in absolute dollars to the gross margin of the business unit. As a result, the Company expects a decreased consolidated gross margin percentage in fiscal 2000 as compared to This forward-looking statement is influenced primarily by the Company s current estimate of production forecasts and costs and would be impacted by significant increases or decreases in production volumes of the Company s products, by material changes in the Company s product mix and by the accuracy of the Company s estimates of production and other manufacturing costs. Selling, general and administrative (SG&A) expense increased $1,928,000, or 29%, from 1998 to The full year inclusion of the component business accounts for approximately 73% of the overall period-to-period increase in SG&A expense. Since Jerneen has less SG&A infrastructure than does the branded products business, SG&A as a percentage of net revenues decreased from 55% for the 1998 period to 45% for the 1999 period. The remaining SG&A increase is primarily due to increased sales and marketing costs within the branded products segment. R&D expense for the period increased $117,000, or 8%, between 1999 and 1998, to $1,665,000. The inclusion of the engineering and development activities of the component business was the primary reason for the overall period-to-period increase in R&D expense. The Company continued to focus its efforts on new product development, as demonstrated through its allocation of significant resources to R&D at both its branded and component products businesses. The Company s 1999 product development activities included a number of projects, including a small diameter graft, a sling for the surgical treatment of female urinary stress incontinence and a stent covering. All three of these projects involve new and advanced tissue formats which have been in R&D for almost two years. The animal testing phases for each of these projects will be continuing in fiscal During fiscal 1999, the component products business opened its Technology Development Center (TDC), which was established to provide creative solutions for their customers in addition to rapid response prototyping. Also, the Company s product development efforts resulted in the filing of two patents during fiscal 1999 to protect new and proprietary technologies. One of the applications related to the manufacture and use of stent coverings formed of biological tissues, and the other pertains to the Company s new resorbable line of tissue implant materials. The Company s R&D activities and expense are expected to increase as projects under development continue to progress. This forward-looking statement will be influenced primarily by the number of projects and the related R&D personnel requirements, development and regulatory approval path, expected costs and the timing of those costs for each project. The consolidated operating loss in 1999 was reduced by $621,000, or 44%, to $794,000 from an operating loss of $1,415,000 in The component business contributed $617,000 to operating income in 1999, up $555,000 from operating income of $62,000 contributed in the fourth quarter of Other income, primarily net interest income, was $183,000 in 1999 and $746,000 in The $563,000 decrease in net interest income is related to significantly lower average cash and investment balances in 1999, primarily due to cash expenditures for the Company s stock repurchase program, capital additions and the July 1998 Jerneen acquisition, and an increase in interest expense related to acquired capital equipment leases and other liabilities. The Company s loss before income taxes was $611,000 in 1999 as compared to a loss of $669,000 in The Company recorded a benefit from income taxes of $91,000 in 1999, representing an effective tax rate of 15%, as compared to an effective tax rate of 28% in The 1999 effective tax rate is less than the statutory rates primarily due to the impact of permanent differences, including nondeductible goodwill associated with the acquisition of Jerneen, partially offset by the impact of research and experimentation credits. The decrease in the effective tax rate from 1998 to 1999 is primarily due to a lower operating loss before tax benefit combined with an increase in nondeductible goodwill amortization in 1999 as compared to At October 31, 1999, the Company has recorded $165,000 of deferred tax assets as a result of the net operating loss carryforwards generated in recent years. In addition, the Company has $417,000 of deferred tax assets related to certain credit carryforwards, primarily research and experimentation credits, and $265,000 of other net deferred tax assets. The Company expects to fully apply its net deferred tax assets against future taxable income. The Company expects it would have to generate at least $2,400,000 in taxable income in future years to realize the full benefit of the net deferred tax assets recorded at October 31, Net operating loss carryforwards expire from and credit carryforwards expire from The 1999 net loss was $520,000, or $0.06 per share, compared to a net loss of $483,000, or $0.05 per share in Years Ended October 31, 1998 and 1997 Consolidated net revenue increased $2,323,000, or 24%, to $12,017,000 from $9,694,000. The Jerneen component business contributed $1,397,000 to 1998 revenue. Branded product growth came from the Tissue-Guard product line, which grew at a 19% pace, led by sales of Vascu-Guard and Dura-Guard. Aided by international growth of 27%, Peri-Strips revenue increased $318,000, or 11%. Domestic Peri-Strips revenue increased 6% with only a minimal contribution from the National Emphysema Treatment Trial (NETT). Bio-Graft revenue decreased $52,000, or 7%, to $748,000 from $800,000, continuing a trend. Revenue from sales of surgical productivity tools decreased 4% to $2,051,000 from $2,127,000. The Company s gross margin percentage was 57% for 1998 as compared to 59% for In 1998, the component product line margin was 37%, while the branded products margin was 59%. The gross margin in the fourth quarter of 1998, the first quarter including the operations of both businesses, was 52%. SG&A expense increased $888,000, or 15%, between 1998 and The inclusion of the component business beginning in the fourth quarter of 1998 accounted for nearly half of the overall year-to-year increase in SG&A expense. The remaining increase was due to the continuing investment in personnel in the areas of regulatory and clinical affairs, product development, and sales and marketing required to advance the Company s revenue growth initiatives. SG&A expense as a percentage of net revenues, however, decreased from 60% in 1997 to 55% in 1998, due mainly to Jerneen having less SG&A infrastructure as compared to the branded products business. R&D expense increased $290,000, or 23%, between 1998 and 1997 to $1,548,000. The product development activities in 1998 focused on both near and long-term opportunities. The near-term opportunities included leveraging current tissue expertise through product line expansions while long-term projects included a focus on proactively seeking to obsolete current technology. During fiscal 1998, the Company s product development efforts resulted in 510(k) marketing clearance from the FDA for three new products. The operating loss in 1998 was $1,415,000 as compared to an operating loss of $1,305,000 for The component business contributed $62,000 to operating income in Other income, primarily net interest income, was $746,000 in 1998 and $1,066,000 in The $320,000 decrease in interest income is related to lower average investment balances in 1998, primarily due to 1998 cash expenditures of $4,095,000 for the Company s stock repurchase program and $5,224,000 associated with the Jerneen acquisition. As a result, continuing operations had a loss before income taxes of $669,000 in 1998 as compared to $239,000 in Operating activities generated positive cash flow of $322,000 in The Company s benefit for income taxes in 1998 was $186,000. The 1998 effective tax rate of 28% was less than the statutory rates primarily due to the impact of permanent differences including nondeductible goodwill, partially offset by the impact of research and experimentation credits. The Company recorded a tax provision of $365,000 in 1997 due to a $421,000 write-off of an income tax asset associated with net operating loss carryforwards of its former subsidiary, Vital Images. The 1998 loss from continuing operations was $483,000, or $0.05 per share, compared to $604,000, or $0.06 per share in In 1997, the Company also recorded a loss from discontinued operations of $920,000, or $0.10 per share. Liquidity and Capital Resources Cash, cash equivalents and marketable securities were $5,596,000 at October 31, 1999, as compared to $8,374,000 at October 31, 1998, a reduction of $2,778,000. Major uses of available cash during 1999 totaling $2,738,000 were the repurchase of common stock and the purchase of equipment and leasehold improvements. Operating activities provided cash of $740,000 in 1999 as compared to providing cash of $322,000 in 1998, with the component 9

7 products business incrementally providing $678,000 in operating cash flow during 1999 over the prior year. Operating cash flows provided by the branded products business decreased from 1998 to 1999 primarily as a result of changes in working capital activities. Cash was provided by operations in 1999 through non-cash expenses in excess of the loss from operations, partially offset by increases in working capital used for inventories and accounts receivable. The Company invested $1,334,000 in equipment and leasehold improvements, primarily related to manufacturing processes. As a result of interest rate yield curves during 1999, net investments in marketable securities totaling $3,991,000 were liquidated and invested in short-term, highly liquid cash equivalents. The cash reserves are maintained to provide for current and future financing and other investing activities. Financing activities used $2,024,000 of cash during 1999, including $616,000 used to repay a bank note and other long-term obligations and $1,404,000 used to repurchase 484,834 shares of Company common stock under the Company s stock repurchase program. The repurchase program was completed during fiscal The program will have a positive impact on earnings per share in periods of profitability. However, while the Company is generating losses, the stock repurchases have a dilutive impact on current earnings per share. The Company has long-term obligations of $686,000 at October 31, 1999, requiring payments through The Company believes existing cash and cash equivalents will be sufficient to satisfy its cash requirements for the foreseeable future. This forward-looking statement, as well as the Company s longterm cash requirements, will be a function of a number of variables, including R&D priorities, acquisition opportunities and the growth and profitability of the business. or, in the case of Year 2000 problems with business partners, undisclosed, and the extent of any future problems caused by the failure of computer hardware or software to recognize the year 2000 as a leap year. There can be no assurance that any such issues will not result in material cost to the Company or have a material, adverse impact on its business, financial condition or results of operations. CONSOLIDATED BALANCE SHEETS BIO-VASCULAR, INC. as of October 31, 1999 and 1998 (in thousands, except share and per share data) Inflation Management believes inflation has not had a material effect on the Company s operations or on its consolidated financial condition. Foreign Currency Transactions Substantially all of the Company s foreign transactions are negotiated, invoiced and paid in U.S. dollars. Fluctuations in currency exchange rates in other countries may therefore reduce the demand for the Company s products by increasing the price of the Company s products in the currency of the countries in which the products are sold. Assets Current assets: Cash and cash equivalents $ 5,596 $ 4,383 Marketable securities ,991 Accounts receivable, net ,123 2,456 Inventories, net ,576 2,306 Deferred income taxes Other Total current assets ,000 13,883 Equipment and leasehold improvements, net ,936 4,354 Goodwill and other intangible assets, net ,594 7,241 Deferred income taxes Total assets $ 24,070 $ 25,982 Quantitative and Qualitative Disclosures About Market Risk The principal financial instruments the Company maintains are in accounts receivable and long-term obligations. The Company believes that the interest rate, credit and market risk related to these accounts is not significant. The Company manages the risk associated with these accounts through periodic reviews of the carrying value for non-collectibility of assets and establishment of appropriate allowances in connection with the Company s internal controls and policies. Liabilities and Shareholders Equity Current liabilities: Accounts payable $ 680 $ 460 Accrued expenses ,551 1,421 Current maturities of long-term obligations Total current liabilities ,600 2,497 Capital lease obligations Other liabilities Total liabilities ,286 3,552 New Accounting Standards In fiscal 1999, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, Comprehensive Income, and SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. (See Note 1 to consolidated financial statements for further information). In June 1998, SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued. SFAS No. 133 establishes accounting and reporting standards for derivative and hedging activities. SFAS No. 133 is effective for all fiscal years beginning after June 15, The Company s management is currently evaluating the potential impact of adopting SFAS No. 133 on the Company s consolidated financial statements. Commitments (Note 7) 10 Year 2000 Matters The Year 2000 problem refers to the potential for computational errors or system malfunctions by computer hardware or software that fail to properly recognize dates beginning with January 1, 2000, or which fail to recognize the year 2000 as a leap year. In anticipation of this problem, the Company instituted and followed a Year 2000 readiness program intended to identify, evaluate and address its Year 2000 exposure. At the time that this report was prepared (shortly after the new year), the Company had not experienced any material Year 2000 problems with its internal systems, and was not aware of any such problems experienced by its customers, vendors and other service providers. As a result, no material adverse impact of the Year 2000 problem on the Company s business and operations was expected, based upon the information then available to the Company. However, this forward-looking statement will be impacted by the extent to which latent Year 2000 problems remain undiscovered, Shareholders equity: Preferred stock: authorized 5,000,000 shares of $.01 par value; none issued or outstanding at October 31, 1999 and Common stock: authorized 20,000,000 shares of $.01 par value; issued and outstanding, 8,960,633 and 9,317,183 at October 31, 1999 and 1998, respectively Additional paid-in capital ,661 28,696 Unearned compensation (601) (514 ) Unrealized marketable securities holding gain Accumulated deficit (6,366) (5,846) Total shareholders equity ,784 22,430 Total liabilities and shareholders equity $ 24,070 $ 25, The accompanying notes are an integral part of the consolidated financial statements.

8 CONSOLIDATED STATEMENTS OF OPERATIONS for the years ended October 31, 1999, 1998 and 1997 (in thousands, except per share data) BIO-VASCULAR, INC. Net revenue $ 18,904 $ 12,017 $ 9,694 Cost of revenue ,443 5,222 3,967 Gross margin ,461 6,795 5,727 Operating expenses: Selling, general and administrative ,590 6,662 5,774 Research and development ,665 1,548 1,258 Operating loss (794) (1,415 ) (1,305) Other income, net, primarily interest ,066 Loss from continuing operations before provision for (benefit from) income taxes (611 ) (669) (239 ) Provision for (benefit from) income taxes (91) (186) 365 Loss from continuing operations (520) (483) (604) Discontinued operations: Loss on disposal of discontinued business, net of income taxes (920) Net loss $ (520) $ (483) $ (1,524) Basic and diluted earnings per share: Continuing operations $ (0.06) $ (0.05) $ (0.06) Discontinued operations (0.10 ) Net loss $ (0.06) $ (0.05) $ (0.16 ) CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND SHAREHOLDERS EQUITY for the years ended October 31, 1999, 1998 and 1997 (in thousands, except share data) Additional Unrealized Marketable Securities BIO-VASCULAR, INC. Common Stock Paid -In Unearned Holding Accumulated Shares Par Value Capital Compensation Gain (Loss) Deficit Total Balance at October 31, ,484,898 $ 95 $ 39,500 $ (485) $ (51) $ (3,839) $ 35,220 Stock option activity, net of tax benefit , (332) 324 Employee Stock Purchase Plan activity , Employee restricted stock activity , Non-employee restricted stock activity , (113 ) 31 Stock repurchased by the Company (36,900) (1) (149) (150) Distribution of net investment in Vital Images (10,584) 460 (10,124) Comprehensive loss: Unrealized marketable securities holding gain, net Net loss (1,524) (1,524) Comprehensive loss (1,472) Balance at October 31, ,563, ,665 (447) 1 (5,363) 23,952 Stock option activity, net of tax benefit , Employee Stock Purchase Plan activity , Employee restricted stock activity , (135 ) 114 Non-employee restricted stock activity Stock repurchased by the Company (978,266) (10) (4,085) (4,095) Stock issued in conjunction with the acquisition of Jerneen , ,595 2,600 Net and comprehensive loss (483) (483) 12 Balance at October 31, ,317, ,696 (514 ) 1 (5,846) 22,430 Stock option activity, net of tax benefit (1) (1) Employee Stock Purchase Plan activity , Employee restricted stock activity , (124 ) 184 Non-employee restricted stock activity , Stock repurchased by the Company (484,834) (5) (1,399) (1,404) Comprehensive loss: Unrealized marketable securities holding loss, net (1) (1) Net loss (520) (520) Comprehensive loss (521) 13 Balance at October 31, ,960,633 $ 90 $ 27,661 $ (601) $ $ (6,366) $ 20,784 The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements.

9 CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended October 31, 1999, 1998 and 1997 BIO-VASCULAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS BIO-VASCULAR, INC. (in thousands) Cash Flows from Operating Activities: Net loss $ (520) $ (483) $ (1,524) Net loss from discontinued operations (920) Loss from continuing operations (520) (483) (604) Business Description and Summary of 1 Significant Accounting Policies: Business Description: Bio-Vascular, Inc. ( Bio-Vascular or the Company ) develops, manufactures and markets branded proprietary and patented specialty medical products for use in thoracic, cardiac, neuro, vascular and ophthalmic surgery. The Company s branded products include the Tissue-Guard product line, the Biograft peripheral vascular graft and surgical productivity tools used in cardiac and vascular surgery. Tissue-Guard products are made from bovine pericardium (the thin membrane surrounding the heart of cattle) processed using proprietary tissue-fixation technology. The Tissue-Guard products, made in various configurations, are used in a wide variety of surgical procedures and are designed to reinforce, reconstruct and repair tissue and prevent leaks of air, blood and other body fluids. The Company s wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc. ( Jerneen ), is a value-added, original equipment manufacturer of micro-precision wire-based component products, including precision coils, stylets and guidewire components and sub-assemblies used in the medical industry. The Company acquired Jerneen in July Marketable Securities: Investments having original maturities in excess of three months are classified as marketable securities and generally consist of commercial paper, U.S. Government or U.S. Government-backed obligations. Investments are classified as short-term or long-term in the balance sheet based on their maturity date. At October 31, 1999, the Company did not have any marketable securities. At October 31, 1998, all of the Company s marketable securities were classified as available-for-sale. Available-for-sale investments are recorded at market value with net unrealized holding gains and losses included as a separate component of shareholders equity. Adjustments to reconcile loss from continuing operations to net cash provided by (used in) operating activities: Depreciation and amortization of equipment and leasehold improvements Amortization of goodwill and other intangible assets Provision for uncollectible accounts Provision for inventory obsolescence Non-cash compensation Deferred income taxes (123 ) (166 ) 239 Inventories: Inventories, which are comprised of component parts, subassemblies and finished goods, are valued at the lower of first-in, first-out (FIFO) cost or market. On a quarterly basis, the Company compares the amount of the inventories on hand with its latest forecasted requirements to determine its reserves for excess or obsolete inventories. Changes in operating assets and liabilities: Accounts receivable (681 ) 139 (380) Inventories (388) (485) 237 Other current assets Accounts payable and accrued expenses (65) 297 Net cash provided by continuing operations ,051 Net cash used in discontinued operations (1,861) Net cash provided by (used in) operating activities (810 ) Equipment and Leasehold Improvements: Equipment and leasehold improvements are stated at cost. Depreciation and amortization are calculated using the straightline method over the estimated useful lives of the related assets. Furniture, fixtures and computer equipment are depreciated over a 3- to 7-year life and manufacturing equipment is depreciated over a 5- to 10-year life. Leasehold improvements are amortized over the life of the related facility leases or the assets, whichever is shorter. Major replacements and improvements are capitalized and maintenance and repairs which do not improve or extend the useful lives of the respective assets are charged to operations. The asset and related accumulated depreciation or amortization accounts are adjusted for asset retirements and disposals with the resulting gain or loss, if any, recorded in the Consolidated Statements of Operations at the time of disposal. 14 Cash Flows from Investing Activities: Purchase of equipment and leasehold improvements (1,334) (964) (654 ) Investments in marketable securities (987) (8,675 ) (9,000) Proceeds upon maturity of marketable securities ,978 13,159 13,750 Proceeds upon sale of marketable securities ,750 Purchase of Jerneen, net of cash acquired (Note 2) (59) (2,816 ) Investments in patents and trademarks (101 ) (67) (43) Discontinued operations, net (2,328) Net cash provided by investing activities ,497 3,387 1,725 Basis of Consolidation: The consolidated financial statements include the accounts of Bio-Vascular, Inc. and its wholly-owned subsidiary, Jerneen, after elimination of intercompany accounts and transactions. Use of Estimates: The preparation of consolidated 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. 15 Cash Flows from Financing Activities: Proceeds from issuance of bank note Repayments on bank note (261 ) (14 ) Net proceeds related to stock-based compensation plans (4) Repurchase of the Company s common stock (1,404) (4,095) (150 ) Repayment of capital lease obligations (230) (53) Repayments of other long-term obligations (125 ) (34) Repayment of debt in conjunction with the acquisition of Jerneen (2,408) Net cash (used in) provided by financing activities (2,024 ) (6,093) 115 Net change in cash and cash equivalents ,213 (2,384) 1,030 Cash and cash equivalents at beginning of year ,383 6,767 5,737 Cash and cash equivalents at end of year $ 5,596 $ 4,383 $ 6,767 Long-Lived Assets: The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset in question may not be recoverable. Impairment losses are recorded whenever indicators of impairment are present. Cash and Cash Equivalents: Cash and cash equivalents consist of cash and highly liquid investments purchased with an original maturity of three months or less. Cash equivalents at October 31, 1999 and 1998 consisted primarily of commercial paper and one money market fund. The accompanying notes are an integral part of the consolidated financial statements.