KENSEY NASH CORP - 10-Q Quarterly Report

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

FORM 10-Q

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

For the Quarterly Period Ended: MARCH 31, 2004

OR

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

For the Transition Period From __________ to __________.

Commission File Number: 0-27120

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

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

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

Registrant's telephone number, including area code: (610) 524-0188

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No__

Indicate by check mark whether the registrant is an accelerated filer
(as defined in rule 12b-2 of the Exchange Act ). Yes X No__

As of April 30, 2004, there were 11,471,746 outstanding shares of
Common Stock, par value $.001, of the registrant.

KENSEY NASH CORPORATION
QUARTER ENDED MARCH 31, 2004

INDEX

PAGE
----

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
as of March 31, 2004 (Unaudited) and June 30, 2003............................ 3

Condensed Consolidated Statements of Operations for
the three and nine months ended March 31, 2004
and 2003 (Unaudited).......................................................... 4

Condensed Consolidated Statements of Stockholders' Equity for the
nine months ended March 31, 2004 (Unaudited) and
for the year ended June 30, 2003............................................... 5

Condensed Consolidated Statements of Cash Flows
for the nine months ended March 31, 2004 and 2003 (Unaudited)................. 6

Condensed Notes to Consolidated Financial Statements (Unaudited)................ 7

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 13

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................. 27

ITEM 4. CONTROLS AND PROCEDURES................................................................. 27

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................................................ 28

SIGNATURES ................................................................................................ 29

EXHIBITS................................................................................................... 30

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
KENSEY NASH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------

MARCH 31,
2004 JUNE 30,
(UNAUDITED) 2003
------------ ------------

ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 12,173,648 $ 15,040,857
Investments 42,370,049 33,370,540
Trade receivables, net of allowance for doubtful accounts of $28,483
and $131,582 at March 31, 2004 and June 30, 2003, respectively 4,103,514 3,760,286
Royalties receivable 6,183,819 4,571,006
Other receivables (including approximately $11,000 and $41,000 at
March 31, 2004 and June 30, 2003, respectively, due from employees) 458,500 578,491
Inventory 4,451,637 3,481,322
Deferred tax asset, current portion 627,316 2,097,147
Prepaid expenses and other 1,725,410 2,564,179
------------ ------------

Total current assets 72,093,893 65,463,828
------------ ------------

PROPERTY, PLANT AND EQUIPMENT, AT COST:
Leasehold improvements 9,529,888 6,737,363
Machinery, furniture and equipment 17,967,364 14,492,068
Construction in progress 1,165,016 2,927,955
------------ ------------

Total property, plant and equipment 28,662,268 24,157,386
Accumulated depreciation (13,275,697) (10,757,669)
------------ ------------

Net property, plant and equipment 15,386,571 13,399,717
------------ ------------
OTHER ASSETS:
Deferred tax asset, non-current portion - 1,017,513
Acquired patents, net of accumulated amortization of $1,619,987 and
$1,422,718 at March 31, 2004 and June 30, 2003, respectively 2,476,379 2,673,648
Goodwill 3,284,303 3,284,303
------------ ------------

Total other assets 5,760,682 6,975,464
------------ ------------

TOTAL $ 93,241,146 $ 85,839,009
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts payable $ 1,786,567 $ 2,111,421
Accrued expenses 3,447,534 2,926,604
Current portion of debt 434,260 836,989
Deferred revenue 136,129 195,060
------------ ------------

Total current liabilities 5,804,490 6,070,074
------------ ------------

LONG TERM PORTION OF DEBT - 219,147
DEFERRED TAX LIABILITY, NON-CURRENT 189,142 -
------------ ------------

Total liabilities 5,993,632 6,289,221
------------ ------------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 100,000 shares authorized,
no shares issued or outstanding at March 31, 2004 and June 30, 2003 - -
Common stock, $.001 par value, 25,000,000 shares authorized,
11,340,024 and 11,366,975 shares issued and outstanding at
March 31, 2004 and June 30, 2003, respectively 11,340 11,367
Capital in excess of par value 75,395,349 76,356,345
Retained earnings 11,962,454 3,200,450
Accumulated other comprehensive loss (121,629) (18,374)
------------ ------------

Total stockholders' equity 87,247,514 79,549,788
------------ ------------

TOTAL $ 93,241,146 $ 85,839,009
============ ============

See notes to condensed consolidated financial statements.

3

KENSEY NASH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
- --------------------------------------------------------------------------------

THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------------------- ---------------------------------
2004 2003 2004 2003

REVENUES:
Net sales $ 9,402,745 $ 7,249,690 $ 24,756,449 $ 18,765,321
Research and development 135,099 246,678 462,208 611,311
Royalty income 6,237,616 4,171,353 16,660,906 11,725,845
------------ ------------ ------------ ------------
Total revenues 15,775,460 11,667,721 41,879,563 31,102,477
------------ ------------ ------------ ------------

OPERATING COSTS AND EXPENSES:
Cost of products sold 4,275,791 3,239,491 11,155,622 8,560,081
Research and development 4,308,411 3,690,769 12,633,967 10,245,484
Selling, general and administrative 2,222,779 1,885,142 6,255,144 5,090,324
------------ ------------ ------------ ------------
Total operating costs and expenses 10,806,981 8,815,402 30,044,733 23,895,889
------------ ------------ ------------ ------------

INCOME FROM OPERATIONS 4,968,479 2,852,319 11,834,830 7,206,588
------------ ------------ ------------ ------------

OTHER INCOME:
Interest income 270,516 266,938 851,531 954,789
Interest expense (15,225) (34,536) (55,825) (120,291)
Other (expense) income (3,286) (501) 2,333 (110)
------------ ------------ ------------ ------------
Total other income - net 252,005 231,901 798,039 834,388
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 5,220,484 3,084,220 12,632,869 8,040,976
Income tax expense (1,735,092) (1,125,596) (3,870,865) (2,838,969)
------------ ------------ ------------ ------------
NET INCOME $ 3,485,392 $ 1,958,624 $ 8,762,004 $ 5,202,007
============ ============ ============ ============

BASIC EARNINGS PER SHARE $ 0.31 $ 0.18 $ 0.77 $ 0.48
============ ============ ============ ============
DILUTED EARNINGS PER SHARE $ 0.28 $ 0.17 $ 0.72 $ 0.46
============ ============ ============ ============

WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 11,402,803 10,814,830 11,401,459 10,775,696
============ ============ ============ ============

DILUTED WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 12,265,534 11,556,775 12,245,510 11,403,112
============ ============ ============ ============

See notes to condensed consolidated financial statements.

4

KENSEY NASH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------

See notes to condensed consolidated financial statements.

5

KENSEY NASH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
- --------------------------------------------------------------------------------

NINE MONTHS ENDED
MARCH 31,
---------------------------------
2004 2003

OPERATING ACTIVITIES:
Net income $ 8,762,004 $ 5,202,007
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 3,121,623 2,211,196
Tax benefit from exercise of stock options 501,668 325,405
Changes in assets and liabilities which provided (used) cash:
Accounts receivable (1,836,050) (1,268,791)
Deferred tax asset 2,487,344 1,470,626
Prepaid expenses and other current assets 789,548 (604,217)
Inventory (970,315) (975,854)
Accounts payable and accrued expenses 196,076 3,172,172
Deferred revenue (58,931) 29,590
Deferred tax liability, non-current 189,142
------------ ------------
Net cash provided by operating activities 13,182,109 9,562,134
------------ ------------

INVESTING ACTIVITIES:
Additions to property, plant and equipment (4,504,882) (2,893,534)
Sale of investments 11,280,000 33,325,000
Purchase of investments (20,756,396) (30,133,847)
------------ ------------
Net cash (used in) provided by investing activities (13,981,278) 297,619
------------ ------------

FINANCING ACTIVITIES:
Repayments of long term debt (621,876) (1,053,541)
Purchase of restricted investments - (48,927)
Sale of restricted investments - 2,161,999
Stock repurchase (2,998,274) -
Proceeds from exercise of stock options 1,524,205 1,279,733
------------ ------------
Net cash (used in) provided by financing activities (2,095,945) 2,339,264
------------ ------------

EFFECT OF EXHANGE RATE ON CASH 27,905 (5,642)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,867,209) 12,193,375
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 15,040,857 3,632,395
------------ ------------

CASH AND CASH EQUIVALENTS, END OF PERIOD $ 12,173,648 $ 15,825,770
============ ============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 55,825 $ 120,291
============ ============
Cash paid for income taxes $ 210,332 $ 53,597
============ ============

SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITY:
Increase in prepaid expense related to
non-employee stock options (See Note 4) $ 11,378 $ 375,550
============ ============

See notes to condensed consolidated financial statements.

6

KENSEY NASH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 -- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

BASIS OF PRESENTATION

The condensed consolidated balance sheet as of March 31, 2004, condensed
consolidated statements of operations for the three and nine months ended
March 31, 2004 and 2003, condensed consolidated statement of stockholders'
equity for the nine months ended March 31, 2004 and condensed consolidated
statements of cash flows for the nine months ended March 31, 2004 and 2003
of Kensey Nash Corporation (the Company) have not been audited by the
Company's independent auditors. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position at March 31, 2004 and June 30, 2003,
results of operations for the three and nine months ended March 31, 2004 and
2003, stockholders' equity for the nine months ended March 31, 2004 and for
the year ended June 30, 2003 and cash flows for the nine months ended March
31, 2004 and 2003 have been made.

Certain information and footnote disclosures normally included in the
Company's annual financial statements, prepared in accordance with
accounting principles generally accepted in the United States of America,
have been condensed or omitted. These condensed consolidated financial
statements should be read in conjunction with the financial statements and
notes thereto included in the Company's consolidated financial statements
filed with the Securities and Exchange Commission (SEC) in the Company's
Annual Report on Form 10-K for the fiscal year ended June 30, 2003. The
results of operations for the three and nine month periods ended March 31,
2004 are not necessarily indicative of operating results for the full year.

Certain reclassifications have been made to prior period balances to conform
to the current period presentation.

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Kensey Nash
Corporation, Kensey Nash Holding Company and Kensey Nash GmbH. All
intercompany transactions and balances have been eliminated. The Company was
incorporated in Delaware on August 6, 1984. Kensey Nash Holding Company,
incorporated in Delaware in January 1992, was formed to hold title to
certain Company patents and has no operations. Kensey Nash GmbH,
incorporated in Germany in January 2002, was formed for the purpose of
European sales and marketing of the TriActiv(R) Balloon Protected Flush
Extraction System (the TriActiv) which was commercially launched in Europe
in May 2002.

The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
necessarily requires management to make estimates and assumptions. These
estimates and assumptions, which may differ from actual results, will affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the dates of the financial statements, as well as
the reported amounts of revenue and expense during the periods presented.

CASH, CASH EQUIVALENTS AND INVESTMENTS
Cash and cash equivalents represent cash in banks and short-term investments
having an original maturity of less than three months. The Company's
investment portfolio consists primarily of high quality U.S. government,
municipal and corporate obligations with maturities ranging from 3-13 years.
Also, the portfolio includes certain municipal variable rate demand
obligations that have maturities ranging from 7 to

7

30 years. These municipal variable-rate demand obligations are putable
weekly and callable on a monthly basis. The portfolio includes only
available for sale marketable securities with secondary or resale markets.
See Comprehensive Income below for the treatment of unrealized holding
gains and losses.

The following is a summary of available-for-sale securities at March 31,
2004 and June 30, 2003.

MARCH 31, 2004
---------------------------------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------------------ ESTIMATED
DESCRIPTION COST GAIN LOSS FAIR VALUE
----------------------------------- ----------- ----------- ----------- -----------

U.S. Government Agency Obligations $ 2,308,438 $ - $ (108,544) $ 2,199,894
U.S. Corporate Obligations 2,421,000 63,635 - 2,484,635
Municipal Obligations 37,921,907 106,411 (342,798) 37,685,520
----------- ----------- ----------- -----------
Total Investments $42,651,345 $ 170,046 $ (451,342) $42,370,049
=========== =========== =========== ===========

YEAR ENDED JUNE 30, 2003
---------------------------------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------------------ ESTIMATED
DESCRIPTION COST GAIN LOSS FAIR VALUE
----------------------------------- ----------- ----------- ----------- -----------

U.S. Government Agency Obligations $ 5,740,071 $ 70,192 $ (111,227) $ 5,699,036
U.S. Corporate Obligations 2,421,000 60,456 (5,829) 2,475,627
Municipal Obligations 25,292,038 81,081 (177,242) 25,195,877
----------- ----------- ----------- -----------
Total Investments $33,453,109 $ 211,729 $ (294,298) $33,370,540
=========== =========== =========== ===========

EXPORT SALES
There were $120,823 and $338,507 in export sales from the Company's U.S.
operations to unaffiliated customers in Europe and Asia in the three and
nine months ended March 31, 2004, respectively. Export sales for the three
and nine months ended March 31, 2003 were $1,750 and $190,496, respectively.

REVENUE RECOGNITION
The Company recognizes revenue under the provisions of Staff Accounting
Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements (SAB
101). Accordingly, sales revenue is recognized when the related product is
shipped. All product is shipped free-on-board shipping point. Revenue under
research and development contracts is recognized as the related expenses are
incurred. Royalty revenue is recognized as the related product is sold. The
Company recognizes substantially all of its royalty revenue under its
Licensing Agreement with St. Jude Medical and its agreement with Orthovita,
at the end of each month when the Company is advised of end-user sales
dollars for the month. Royalty payments are received within 45 days of the
end of each calendar quarter. Advance payments received for products or
services are recorded as deferred revenue and are recognized when the
product is shipped or services are performed.

EARNINGS PER SHARE
Earnings per share are calculated in accordance with SFAS No. 128, Earnings
per Share, which requires the Company to report both basic and diluted
earnings per share (EPS). Basic and diluted EPS are computed using the
weighted average number of shares of common stock outstanding, with common
equivalent shares from options included in the diluted computation when
their effect is dilutive.

8

STOCK-BASED COMPENSATION
Stock-based compensation cost is accounted for under SFAS No. 123,
Accounting for Stock-Based Compensation (SFAS 123), which permits (i)
recognition of the fair value of stock-based awards as an expense, or (ii)
continued application of the intrinsic value method of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). The
Company accounts for its stock-based employee and director compensation
plans under the recognition and measurement principles of APB 25. Under this
intrinsic value method, compensation cost represents the excess, if any, of
the quoted market price of the Company's common stock at the grant date over
the amount the grantee must pay for the stock. The Company's policy is to
grant stock options with an exercise price equal to the fair market value of
the Company's common stock at the date of grant. Options granted to
non-employees, as defined under SFAS 123, are recorded as compensation
expense. See Note 4 for options granted to non-employees in July 2003 and
October 2002.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment to FASB Statement
No. 123, Accounting for Stock-Based Compensation (SFAS 148). The Company
implemented the "disclosure only" provisions of SFAS No. 148 in the quarter
ended December 31, 2002. Accordingly, no compensation cost has been
recognized for the Company's two stock option plans. Had compensation cost
for the plans been determined based on the fair market value of the options
at the grant date, consistent with the provisions of SFAS No. 123, as
amended by SFAS No. 148, the Company's net income and earnings per share for
the three and nine months ended March 31, 2004 and 2003 would have been
reduced to the pro forma amounts below:

THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------- ----------------------------
2004 2003 2004 2003

Net income, as reported $3,485,392 $1,958,624 $8,762,004 $ 5,202,007
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (343,382) (451,609) (1,025,275) (1,357,066)
---------- ---------- ---------- -------------
Pro forma net income $3,142,010 $1,507,015 $7,736,729 $ 3,844,941
========== ========== ========== =============
Earnings per share:
Basic - as reported $ 0.31 $ 0.18 $ 0.77 $ 0.48
========== ========== ========== =============
Basic - pro forma $ 0.28 $ 0.14 $ 0.68 $ 0.36
========== ========== ========== =============
Diluted - as reported $ 0.28 $ 0.17 $ 0.72 $ 0.46
========== ========== ========== =============
Diluted - pro forma $ 0.26 $ 0.13 $ 0.63 $ 0.34
========== ========== ========== =============

COMPREHENSIVE INCOME
The Company accounts for comprehensive income under the provisions of SFAS
No. 130, Reporting Comprehensive Income (SFAS 130). Accordingly, accumulated
other comprehensive income (loss) is shown in the consolidated statements of
stockholders' equity at March 31, 2004 and June 30, 2003, and is comprised
of unrealized gains and losses on the Company's available-for-sale
securities and foreign currency translation adjustments. The tax effect of
other comprehensive income for the nine months ended March 31, 2004 and for
the fiscal year ended June 30, 2003 was $67,567 and $68,073, respectively.

GOODWILL
Goodwill represents the excess of cost over the fair value of the
identifiable net assets of THM Biomedical, Inc. (THM), a company acquired in
September 2000. Effective July 1, 2001, the Company adopted SFAS No. 141,
Business Combinations (SFAS 141) and SFAS No. 142, Goodwill and Other
Intangible Assets

9

(SFAS 142). SFAS 141 requires that the purchase method of accounting be used
for all business combinations subsequent to June 30, 2001 and specifies
criteria for recognizing intangible assets acquired in a business
combination. Under SFAS 142, goodwill and intangible assets with indefinite
useful lives are no longer amortized, but are subject to annual impairment
tests. The Company has established its annual impairment testing date to be
June 30th of each fiscal year. The most recent annual impairment test for
the fiscal year ended June 30, 2003 indicated that goodwill was not
impaired. Intangible assets with definite useful lives continue to be
amortized over their respective useful lives.

PATENTS
The costs of internally developed patents are expensed when incurred due to
the long development cycle for patents and the Company's inability to
measure the recoverability of these costs when incurred. The entire cost of
acquired patents is being amortized over the remaining period of economic
benefit, ranging from 6 to 11 years at March 31, 2004. The gross carrying
amount of such patents at March 31, 2003 was $4,096,366 with accumulated
amortization of $1,619,987. Amortization expense on these patents was
$65,757 and $197,269 for the three and nine month periods ended March 31,
2004, respectively. Amortization expense on the Company's acquired patents
is estimated at $263,026 for each of the years ending June 30, 2004, 2005,
2006, 2007 and 2008.

NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers'
Disclosures about Pensions and Other Postretirement Benefits - an amendment
of FASB Statements No. 87, 88, and 106 (SFAS 132 revised), which improves
financial statement disclosures for defined benefit plans. The change
replaces existing FASB disclosure requirements for pensions and requires
additional disclosures about the assets, obligations, cash flows, and net
periodic benefit cost of defined benefit pension plans and other defined
benefit postretirement plans. The project was initiated by the FASB in
response to concerns raised by investors and other users of financial
statements about the need for greater transparency of pension information.
The guidance is effective for fiscal years ending after December 15, 2003,
and for the first fiscal quarter of the year following initial application
of the annual disclosure requirements. The Company's adoption of SFAS 132
revised will provide enhanced disclosures of 401(k) matching contributions
and have no impact on the Company's financial position or results of
operations.

NOTE 2 -- INVENTORY

Inventory is stated at the lower of cost (determined by the average cost
method, which approximates first-in, first-out) or market. Inventory
primarily includes the cost of materials utilized in the processing of the
Company's products and was as follows:

MARCH 31, JUNE 30,
2004 2003
---------- ----------

Raw materials $2,931,014 $2,109,149
Work in process 873,183 765,388
Finished goods 647,440 606,785
---------- ----------

Total $4,451,637 $3,481,322
========== ==========

NOTE 3 -- DEBT

On September 1, 2000, in conjunction with the acquisition of THM Biomedical,
the Company incurred a note payable in the amount of $4.5 million (the
Acquisition Obligation). The Acquisition Obligation was due in equal
quarterly installments of $281,250 beginning on December 31, 2000 and ending
on September 30, 2004. Accordingly, the present value of the cash payments
(discounted based upon the Company's then available borrowing rate of 7.5%)
of $3,833,970 was recorded as a liability on the Company's consolidated
financial statements, with a remaining balance of $434,260 as of March 31,
2004, of which the entire

10

amount was current at March 31, 2004. During the quarter ended March 31,
2003, the Company repaid certain debt holders, thereby reducing the
Company's remaining quarterly installments to $223,256 through September 30,
2004.

NOTE 4 -- CONSULTING CONTRACTS

In October 2002, the Company granted options to purchase 50,000 shares of
common stock to a physician pursuant to a five-year consulting agreement
related to the development of a carotid artery application for the TriActiv.

In July 2003, the Company granted options to purchase 1,500 shares of common
stock to a physician pursuant to a two-year consulting agreement related to
the development of orthopaedic applications for the Company's porous and
non-porous tissue fixation and regeneration devices and drug delivery
devices.

The Company calculated the fair value of these non-employee options in
accordance with SFAS No.123, as $375,550 and $11,378 for the October 2002
and July 2003 grants, respectively, using the Black-Scholes option-pricing
model. These amounts were recorded as prepaid consulting expense and
increases to additional paid in capital in the quarters ended December 31,
2002 and September 30, 2003, respectively. The prepaid expense is being
amortized to research and development expense over the terms of the
agreements. Accordingly, $20,200 and $60,600 was recorded as a component of
research and development expense for the three and nine months ended March
31, 2004, respectively. In the comparable periods of the prior year the
research and development expense associated with these consulting contracts
was $18,778 and $37,555 for the three and nine months ended March 31, 2003,
respectively and related only to the first consulting agreement mentioned
above.

NOTE 5 -- STOCK REPURCHASE PROGRAM

On October 23, 2003, the Company announced that its board of directors had
approved a program to repurchase up to 400,000 of its issued and outstanding
shares of Common Stock over six months from the date of the board approval.

In the second quarter of fiscal year 2004, the Company had repurchased and
retired 140,500 shares of common stock under the program at a cost of
approximately $3.0 million or an average market price of $21.34 per share.
The Company financed the repurchases using its available cash.

No additional repurchases were made during the quarter ended March 31, 2004
and through the remainder of the program which expired on April 23, 2004.

NOTE 6 -- INCOME TAXES

As of June 30, 2003, the Company had net operating loss (NOL) carryforwards
for state tax purposes totaling $20.0 million, which will expire through
2013. In addition, the Company had a foreign NOL of $0.3 million as of June
30, 2003, which will not expire.

During the quarter ended September 30, 2003, the Company recorded a
qualified research and development tax credit of approximately $310,000.
This was in addition to the $1.5 million tax credit recorded in the fourth
quarter of fiscal 2003. In connection with this research and development tax
credit, the Company recorded an additional $50,500 of professional service
fees as a component of selling, general and administrative expenses during
the quarter ended September 30, 2003.

11

NOTE 7 -- RETIREMENT PLAN

The Company has a 401(k) Salary Reduction Plan and Trust (the 401(k) Plan)
in which all employees that are at least 21 years of age are eligible to
participate. Contributions to the 401(k) Plan are made by employees through
an employee salary reduction election. The Company has a 25% discretionary
matching contribution, on up to 6% of an employee's total compensation, for
all employee contributions. Employer contributions to the 401(k) plan for
the three and nine months ended March 31, 2004 were $35,553 and $101,971,
respectively. In the three and nine months ended March 31, 2003 employer
contributions were $30,077 and $83,011, respectively.

12

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis should be read in conjunction with our
consolidated financial statements and the related notes included in this report
and our audited consolidated financial statements and the related notes
contained in our Annual Report on Form 10-K for the fiscal year ended June 30,
2003, as filed with the Securities and Exchange Commission.

OVERVIEW

We are a leader in interventional cardiology medical technology and have
significant experience and expertise in the design, development, manufacture and
processing of absorbable biomaterials for medical applications. The
Angio-Seal(TM)Vascular Closure Device (Angio-Seal), of which we were the
original designer, developer and manufacturer, is currently the leader in the
arterial puncture closure device market. The Angio-Seal device is designed to
seal and close femoral artery punctures made during diagnostic and therapeutic
cardiovascular catheterizations. St. Jude Medical, Inc. (St. Jude Medical)
acquired the worldwide license to the Angio-Seal device in March of 1999. St.
Jude Medical develops, manufactures, markets and distributes the product
worldwide.

Additionally, we have developed the TriActiv(R) Balloon Protected Flush
Extraction System (the TriActiv), a device designed to provide embolic
protection during diseased saphenous vein graft (SVG) treatment. The TriActiv
was commercially launched in Europe in May 2002 and enrollment in the U.S.
pivotal clinical study (the PRIDE study) was completed in March 2004. Future
generations of the TriActiv currently in development and in clinical trials are
being designed to address additional markets. These future applications are
expected to include the treatment of diseased carotid, native coronary and
peripheral arteries, including the removal of thrombus, and acute myocardial
infarction (AMI) (a heart attack).

We also have significant experience in designing, developing, manufacturing and
processing proprietary biomaterials products for the orthopaedics (sports
medicine and spine), cardiology, drug/biologics delivery, periodontal, general
surgery and wound care markets. We intend to continue to leverage our
proprietary knowledge and expertise in all of these markets to develop new
products and technologies and to explore additional applications for our
existing products.

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

Net Sales. Net sales is comprised of sales of absorbable biomaterials products
and the TriActiv.

Biomaterials. The biomaterials component of net sales, which comprises 99%
of total net sales, represents the sale of our biomaterials products to
customers for use in the following markets: orthopaedics (sports medicine
and spine), cardiology, drug/biologics delivery, periodontal, general
surgery and wound care. The two most significant components of our
biomaterials sales are the absorbable components of the Angio-Seal, supplied
to St. Jude Medical, and our orthopaedic product sales. Our orthopaedic
product sales to date have consisted primarily of sales to Arthrex, Inc.
(Arthrex), a privately held orthopaedics company for whom we manufacture a
wide array of sports medicine products. In the next fiscal year and beyond,
we anticipate our sales of bone grafting and spine products to Orthovita,
Inc. (Orthovita), a publicly held orthopaedic biomaterials company, to
become a more significant portion of our total biomaterials sales. Below is
a chart of the trends in our Angio-Seal and orthopaedic sales:

13

THREE MONTHS
ENDED NINE MONTHS ENDED
SALES OF: FISCAL 2003 MARCH 31, 2004 MARCH 31, 2004
--------------------------------------------------------------------------

Angio-Seal Components 54% 35% 39%
--------------------------------------------------------------------------
Orthopaedic Products 42% 61% 58%
--------------------------------------------------------------------------

The decline in the Angio-Seal components as a percentage of total
biomaterials sales is related to the on-going transition of the manufacture
of the absorbable polymer anchor from us to St. Jude Medical (based on
discussions with St. Jude Medical, we believe their current plans are for us
to remain a supplier of approximately 20% of the future anchor requirements
for the Angio-Seal) offset in part by increases in sales of the collagen
component related to increased sales volume of the Angio-Seal device. We
will continue to supply a minimum of 50% of the collagen component for the
device under a three year contract with St. Jude Medical, which currently
expires in December 2005.

The increase in our orthopaedic products sales as a percentage of total
biomaterials sales is primarily related to the growth of sales to Arthrex,
which represented 36% of total biomaterials sales for the year ended June
30, 2003 and 45% and 47%, respectively, for the three and nine months ended
March 31, 2004. In addition, in the quarter ended March 31, 2004, we shipped
our first commercial products to Orthovita who launched these products in
March 2004. These sales represented approximately 13% and 5% of our total
biomaterials sales for the three and nine months ended March 31, 2004,
respectively.

We expect the growth in our overall biomaterials sales, which was 31% and
32% in the three and nine months ended March 31, 2004, respectively over the
comparable periods in 2003, will continue because of greater acceptance by
the medical community of biomaterials and technological advances which have
expanded the applications for our biomaterials products. Due to this greater
acceptance, we have been able to expand our biomaterials customer and
product base by initiating new partnerships within the medical device
industry as well as expanding the product lines for our current customers.

TriActiv. The TriActiv was commercially launched in Europe in the fourth
quarter of fiscal 2002. We are selling direct to the market in Germany and
through distributors throughout the rest of Europe. We currently have
distribution agreements for sales in Ireland, Switzerland, Austria, Italy,
Netherlands and the United Kingdom. We have entered into two distribution
agreements since January 1, 2004, and are in the process of identifying
additional distributors for markets in Europe and Asia. The TriActiv sales
were less than 1% of our total sales for the three and nine months ended
March 31, 2004. We anticipate the TriActiv will become a more significant
component of net sales during our fiscal year ended June 30, 2005 and beyond
as we gain new customers in the European markets, introduce new versions and
applications of the product and launch the product in the U.S. market. We
currently anticipate commercial launch of the TriActiv in the U.S. in the
first half of fiscal 2005, subject to U.S. regulatory approval.

We received European Community approval (CE Mark) to market the second
generation TriActiv device, the TriActiv(R) FX Embolic Protection System
(the TriActiv FX), in November 2003. This second generation device
incorporates several important ease of use design enhancements including an
integrated, fully disposable flush and extraction system, a new balloon
inflator that simplifies catheter exchanges during the procedure, and a
monorail flush catheter to enhance device usage and reduce procedure time.
We expect to initiate European marketing of the TriActiv FX in the first
half of fiscal 2005.

Research and Development Revenue. Research and development revenue was derived
from a National Institute of Standards and Technology (NIST) grant in the three
months ended March 31, 2004 and from both the NIST

14

grant and a National Institute of Health (NIH) grant in the nine months ended
March 31, 2004. In November 1999, we received our first NIST grant. Since that
time we have been awarded a second NIST grant and an NIH grant. Under the first
NIST grant, a $1.2 million grant over a three year period, we were researching
cartilage regeneration utilizing our porous tissue matrix (PTM) technology.
Although we continue to independently develop this technology, we received all
remaining funds under this grant in our second quarter of fiscal 2003. In
October 2001 we received the second NIST grant, a $1.9 million grant over a
three year period, under which we are researching a synthetic vascular graft,
also utilizing our PTM technology. This project is expected to continue through
early fiscal 2005. In January 2003, we received from NIH, $100,000 over a one
year period, under which we were researching sustained or controlled release of
chemotherapeutic drugs for the treatment of breast cancer utilizing our PTM
technology. This grant was completed in early fiscal 2004, but we are continuing
to independently develop this drug delivery technology for commercial use and
expectations of future grant applications.

Royalty Income. Our royalty income consists of royalties received from St. Jude
Medical and Orthovita. Royalties from St. Jude Medical are received on every
Angio-Seal unit sold worldwide. We anticipate sales of the Angio-Seal will
continue to grow as St. Jude Medical continues to expand its sales and marketing
efforts, including its recent launch of the Angio-Seal product line in the
Japanese market, and releases future generations of the Angio-Seal system,
including its launch of the Self Tightening Suture (STS) Plus version of the
device in the U.S. and Europe. Our royalty rate as of March 31, 2004 was 9%. The
original rate of 12% was contractually reduced from 12% to 9%, in accordance
with our License Agreements, during the fiscal quarter ended December 31, 2000
when a cumulative one million Angio-Seal units had been sold. There was one
further contracted decrease in the royalty rate, to 6%, upon reaching four
million cumulative units sold. This final rate reduction occurred in April 2004.
As of March 31, 2004, we believe continued Angio-Seal unit growth will partially
offset this 33% decline in royalty rate for a net reduction in royalty income in
fiscal year 2005 from 2004 of approximately 15-20%. We therefore expect that
royalty income from the Angio-Seal will continue to be a significant source of
revenue. As of March 21, 2004 approximately 3,970,000 Angio-Seal units had been
sold.

In March 2003, we entered into an agreement with Orthovita under which we will
develop and commercialize products based on Orthovita's proprietary, ultra
porous VITOSS(TM) bone void filler material in combination with our proprietary
biomaterials. The products will have applicatons in the bone grafting and spinal
surgery markets. Under the agreement, the products will be co-developed, Kensey
Nash will manufacture the products and Orthovita will market and sell the
products worldwide. Orthovita launched the initial bone grafting and spinal
product line, VITOSS Foam, in the third quarter of fiscal 2004. Under the
agreement, Kensey Nash receives a royalty on Orthovita's total end-user sales.
As a result of the commercial launch of these products in March, we recorded our
first royalty payment in our third fiscal quarter 2004. We believe the unique
technology associated with the VITOSS Foam products and the size and strength of
the spine market will result in the Orthovita component of royalty income
becoming more significant over the next several quarters and beyond.

Cost of Products Sold. The gross margin on sales percentage was consistent
during the three months ended March 31, 2004 compared to the three months ended
March 31, 2003 and increased slightly during the nine months ended March 31,
2004 over the comparable periods in 2003. We have experienced higher volume of
our sales of biomaterials products and greater manufacturing efficiencies, which
has lowered our unit costs in many of our product lines. However we also
initiated a new product line during the third fiscal quarter 2004, the Orthovita
VITOSS Foam products. During the initial phases of production of this product
line we incurred higher costs due to the learning curve associated with new
products. Our expectations for the gross margin after maturity of this product
line are expected to be in line with our overall gross margins for the company
as a whole. We anticipate the gross margin on our biomaterials products will
continue to improve with expected increases in sales volume and efficiencies
gained in new product lines. These improvements could potentially be offset by
initial margins on the TriActiv product line in our first year of U.S. sales.

15

Research and Development Expenses. Research and development expenses consist of
expenses incurred for the development of our proprietary technologies, such as
the TriActiv, absorbable and nonabsorbable biomaterials products and
technologies and other development programs, including expenses under the NIST
and NIH programs. In December 2001, we began our TriActiv U.S. pivotal clinical
study, the PRIDE study, a planned 500-800 patient randomized trial at up to 80
sites in the U.S and Europe. We completed enrollment in the PRIDE study during
March 2004. We enrolled a total of 894 patients in the PRIDE study, including
roll-in patients, at 68 sites in the U.S. and 10 sites in Europe. Submission of
data from the trial to the Food and Drug Administration (FDA) for 510(k)
approval is expected in June 2004. If we are granted approval from the FDA, we
will market and sell the device in the U.S., either directly or through a
strategic partner, in the first half of fiscal 2005. We also completed a six
patient pilot study, the TRACER study, on the carotid artery application for the
TriActiv in September 2003. This study was completed at one clinical site in
Costa Rica. The TriActiv carotid application device was successfully used to
provide protection from potential stroke-causing emboli by actively removing
debris during carotid stenting procedures. We plan to begin enrollment in a CE
Mark study for the TriActiv carotid application during fiscal 2005. We cannot
make any assurances as to the successful completion of these trials or
subsequent regulatory approval for the TriActiv or for future applications in
the U.S. or in Europe.

Clinical efforts in pursuit of FDA approval and continuing development of the
TriActiv, as well as our continued development of proprietary biomaterials
products and technologies, require significant research and development
spending. We anticipate research and development expense will continue to
increase as we pursue commercialization of the TriActiv in the U.S., and explore
opportunities for other indications related to the TriActiv as well as our other
technologies, including the continued development of proprietary biomaterials
technologies. While we believe research and development expense will increase in
absolute dollars, we believe that it will decrease as a percentage of total
revenue as our revenue continues to grow. Research and development expense was
27% and 30%, of total revenue, respectively, for the three and nine months ended
March 31, 2004 compared to 32% and 33% of total revenue for the three and nine
months ended March 31, 2003, respectively.

Selling, General and Administrative. Selling, general and administrative
expenses include general and administrative costs, including activities of our
finance, human resource and business development departments, as well as costs
related to the sales and marketing of our products. The general and
administrative component of selling, general and administrative expenses has
increased over the same period in 2003. This increase is a result of the overall
growth of our business as well as expenses incurred related to compliance with
new SEC and corporate governance regulations. The sales and marketing component
of selling, general and administrative expenses has also increased over the same
period in 2003. This increase relates to increased sales efforts for the
TriActiv in Europe, which was commercially launched in May 2002, and the move
toward commercialization of the TriActiv in the U.S. In January 2002, we
received CE Mark approval from the European regulatory authority for the
TriActiv, which allows commercial sale of the product in the European Union. We
established a subsidiary in Germany, Kensey Nash Europe GmbH where we maintain a
European sales and marketing team. This team consisted of three clinical
specialists and four sales people as of March 31, 2004, and will continue to add
personnel to this team as we believe is required to meet our clinical and sales
goals. This team is selling the product direct in the German market and supports
our distributor relationships in the rest of Europe. We anticipate sales and
marketing expenses will continue to increase as we await U.S. regulatory
approval of the TriActiv. If approved, we will market and sell the TriActiv in
the U.S. either directly or through a strategic partner. Our initial estimates
of the cost of a direct sales plan would increase selling expense in fiscal 2005
by $2.5 million to $3.0 million, including personnel and marketing expenses,
over fiscal 2004. We also continue to expand our marketing efforts for our
biomaterials business.

16

Income Tax Expense. Our original estimates of our effective income tax rate were
approximately 32% for fiscal year 2004 compared with 22.5% for the year ended
June 30, 2003. In the prior year our effective tax rate was reduced from its
estimated 34.5% to 22.5% in the fourth quarter of fiscal 2003 primarily as a
result of a $1.5 million tax credit related to qualified research and
development activities of the Company. We have reduced our original estimate of
our effective tax rate of 32% for fiscal 2004 to 30% as a result of several
factors including estimates of our current year research and development tax
credit as well as eligible accelerated depreciation and stock option exercise
activity.

CRITICAL ACCOUNTING POLICIES

Our "critical accounting policies" are those that require application of
management's most difficult, subjective, or complex judgments, often as a result
of the need to make estimates about matters that are inherently uncertain and
may change in future periods. It is not intended to be a comprehensive list of
all of our significant accounting policies. In many cases, the accounting
treatment of a particular transaction is specifically dictated by accounting
principles generally accepted in the United States of America, with no need for
management's judgment in their application. There are also areas in which the
selection of an available alternative policy would not produce a materially
different result. We have identified the following as our critical accounting
policies: revenue recognition, accounting for stock-based compensation,
allowance for doubtful accounts, inventory, and income taxes.

Revenue Recognition. We recognize revenue under the provisions of Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements
(SAB 101). Accordingly, sales revenue is recognized when the related product is
shipped. All of our shipments are free-on-board (F.O.B.) shipping points.
Revenue under research and development contracts is recognized as the related
expenses are incurred. Royalty revenue is recognized as the related product is
sold. Advance payments received for products or services are recorded as
deferred revenue and are recognized when the product is shipped or services are
performed.

Stock-Based Compensation. We account for stock-based compensation costs under
SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), as amended
by SFAS No. 148 which permits (i) recognition of the fair value of stock-based
awards as an expense, or (ii) continued application of the intrinsic value
method of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). We account for its stock-based employee and
director compensation plans under the recognition and measurement principles of
APB 25. Under this intrinsic value method, compensation cost represents the
excess, if any, of the quoted market price of our common stock at the grant date
over the amount the grantee must pay for the stock. Our policy is to grant stock
options at the fair market value at the date of grant. Therefore, we have not
recognized any compensation expense for options granted to employees. We account
for stock-based awards to non-employees using the fair value method in
accordance with SFAS No. 123, which requires using the Black-Scholes
option-pricing model to determine the fair value of the option at the original
grant date. Options granted to non-employees, as defined under SFAS 123, (as
amended by SFAS No. 148) and Emerging Issues Task Force (EITF) 96-18 "Accounting
for Equity Instruments that are Issued to Other Than Employees for Acquiring or
in Conjunction with Selling, Goods or Services," are recorded as expense over
the service period. We did not grant any options to non-employees for the three
months ended March 31, 2004. See Note 4 to the condensed consolidated financial
statements included in this quarterly report for information regarding options
granted to non-employees in July 2003 and October 2002.

Allowance for Doubtful Accounts. Our allowance for doubtful accounts is
determined using a combination of factors to ensure that our trade receivables
balances are not overstated due to uncollectibility. We maintain a bad debt
reserve for all customers based on a variety of factors, including the length of
time receivables are past due, trends in overall weighted average risk rating of
the total portfolio, significant one-time events and historical experience with
each customer. Also, we record additional reserves for individual accounts when
we

17

become aware of a customer's inability to meet its financial obligations to us,
such as in the case of bankruptcy filings or deterioration in the customer's
operating results or financial position. If circumstances related to specific
customers change, our estimates of the recoverability of receivables would be
adjusted. We believe our allowance at March 31, 2004 is sufficient to cover all
existing accounts receivable.

Inventory. Our inventory is stated at the lower of cost or market. Adjustments
to inventory are made at the individual part level for estimated excess,
obsolescence or impaired balances, to reflect inventory at the lower of cost or
market. Factors influencing these adjustments include: changes in demand, rapid
technological changes, product life cycle and development plans, component cost
trends, product pricing, physical deterioration and quality issues. Revisions to
these adjustments would be required if any of these factors differ from our
estimates.

Income Taxes. Our estimated effective tax rate includes the impact of certain
research and development tax credits, accelerated depreciation credits and
assumptions related to stock option exercise activity. Material changes in or
differences from our estimates of these three factors could impact our estimate
of our effective tax rate.

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED MARCH 31, 2004 AND 2003

The following table summarizes our operating results for the three months ended
March 31, 2004 compared to the three months ended March 31, 2003.

THREE MONTHS ENDED PERCENT
-------------------------------------------------- CHANGE FROM
% OF PRIOR PERIOD
($ MILLIONS) MARCH 31, TOTAL MARCH 31, % OF TOTAL TO CURRENT
20004 REVENUES 2003 REVENUES PERIOD
-------------------------------------------------------------------

Total Revenues $ 15.8 100% $ 11.7 100% 35%
------- -------- --------- -------- -------
Net Sales $ 9.4 60% $ 7.2 59% 30%
------- -------- --------- -------- -------
Research & Development $ 0.1 1% $ 0.2 1% (45%)
Revenue
------- -------- --------- -------- -------
Royalty Income $ 6.2 39% $ 4.2 40% 50%
------- -------- --------- -------- -------
Cost of Products Sold $ 4.3 27% $ 3.2 27% 32%
------- -------- --------- -------- -------
Research & Development
Expense $ 4.3 27% $ 3.7 30% 17%
------- -------- --------- -------- -------
Selling, General &
Administrative Expense $ 2.2 14% $ 1.9 15% 18%
------- -------- --------- -------- -------
Interest Income $ 0.3 2% $ 0.3 2% 1%
------- -------- --------- -------- -------

Total Revenues. Total revenues increased 35% to $15.8 million in the three
months ended March 31, 2004 from $11.7 million in the three months ended March
31, 2003.

Net Sales. Net sales of products increased 30% to $9.4 million from $7.2
million for the three months ended March 31, 2004 and 2003, respectively as
we continued to increase sales to existing customers and expand sales to new
customers. This increase was primarily attributable to increased sales of
our orthopaedic products, specifically sports medicine and spine products.
Orthopaedic sales increased 68% to $5.7 million in the three months ended
March 31, 2004 from $3.4 million for the three months ended March 31, 2003.
These sales were offset slightly by a decrease in our cardiology biomaterial
product

18

sales. Cardiology biomaterial sales decreased by 5% to $3.3 million from
$3.5 million for the three months ended March 31, 2004 and 2003. This
expected decrease related to sales of the polymer anchor component of the
Angio-Seal product which declined to $1.2 million from $1.5 million for the
three months ended March 31, 2004 and 2003, respectively. We believe several
factors will more than compensate for the continuing decline in sales of
this one component, as demonstrated in our third quarter of fiscal 2004.
These factors include the growth in our orthopaedic sales, including spine
products, and growth in sales to our other existing biomaterials customers
as well as the addition of new customers, such as Orthovita in the third
quarter. Net sales for the three months ended March 31, 2004 and March 31,
2003 consisted almost entirely of biomaterials sales, as the TriActiv sales
were less than 2% of total sales in both periods.

Research and Development Revenues. Research and development revenues
decreased 45% to $135,000 from $247,000 for the three months ended March 31,
2004 and 2003, respectively. The revenues for the three months ended March
31, 2004 consisted of amounts generated under our NIST synthetic vascular
graft grant. The decrease from the prior year primarily reflected a decrease
in reimbursements under the synthetic vascular graft grant, which generated
$135,000 in revenue for the three months ended March 31, 2004 compared to
$222,000 for the three months ended March 31, 2003. This decrease was
attributable to the timing of animal studies which are a significant
component of the total reimbursement under the grant. Specifically, an
animal study concluded prior to the second quarter of fiscal 2004 and
another animal study started in late third fiscal quarter of 2004, in
contrast to the second quarter of fiscal 2003 where an animal study was
being conducted throughout that quarter. The NIH breast cancer drug delivery
grant, which was received in January 2003, contributed $25,000 in revenue in
the three months ended March 31, 2003 and $0 in revenue for the three months
ended March 31, 2004, because this project concluded in October 2003.

Royalty Income. Royalty income increased 50% to $6.2 million from $4.2
million in the three months ended March 31, 2004 and 2003, respectively.
This increase was primarily due to the increase in Angio-Seal royalties from
St. Jude Medical. The increase reflected a greater number of units sold as
well as an increase in the average selling price for the Angio-Seal. Royalty
units increased 45% as approximately 359,000 Angio-Seal units were sold to
end-users during the three months ended March 31, 2004 compared to
approximately 248,000 units sold during the three months ended March 31,
2003. The average worldwide selling price increased to $190 from $186 in the
three months ended March 31, 2004 and 2003, respectively, partially due to
the strength of the Euro versus the U.S. dollar. We believe that the
increases in units are due to St. Jude Medical's continued sales and
marketing efforts, which are resulting in greater market share and overall
increased adoption of vascular closure devices in the market. St. Jude
Medical launched the most recent generation of the Angio-Seal product line,
the STS Plus platform in September 2003 (commanding a premium price over
the previous version of the device). Also included in royalty income for
the three months ended March 31, 2004 are royalties related to products
sold under our agreement with Orthovita.

Cost of Products Sold. Cost of products sold increased 32% to $4.3 million in
the three months ended March 31, 2004 from $3.2 million in the three months
ended March 31, 2003. Gross Margin on sales of 55% remained consistent in the
three months ended March 31, 2003 and 2004. We have experienced higher volumes
of our sales of biomaterials products and greater manufacturing efficiencies,
which has lowered our unit costs in many of our product lines, however, we
initiated a new product line during the third fiscal quarter 2004, Orthovita's
VITOSS Foam products. During the initial phases of production of this product
line we incurred higher costs due to the learning curve associated with new
products.

19

Research and Development Expenses. Research and development expenses increased
17% to $4.3 million in the three months ended March 31, 2004 compared to $3.7
million in the three months ended March 31, 2003. This increase was partially
attributable to our continued development efforts on the TriActiv, including
clinical trial expenses, as well as to continued development of our biomaterials
technologies. While research and development expenses continued to increase in
dollars, they decreased as a percentage of total revenue to 27% from 32% for the
three month periods ended March 31, 2004 and March 31, 2003, respectively.

Research and development expenses related to the TriActiv increased $148,000, or
6%, to $2.7 million in the three months ended March 31, 2004 from $2.6 million
in the three months ended March 31, 2003. Expense increases occurred in clinical
trial costs ($131,000), personnel costs ($179,000) and patent counsel fees and
other consulting costs ($106,000), all of which were to support the final
efforts on our PRIDE clinical study and the growth in the development efforts on
future generations of the TriActiv. These cost increases were partially offset
by a $341,000 decrease in various product design costs related to the TriActiv.
Over the past year, there have been many new design features/ease of use
improvements for the TriActiv product line. As of the third fiscal quarter 2004,
many of these design enhancements had been implemented and therefore the
expenses related to these improvements were not at the significant level it had
been over the prior year.

We also continued our development efforts on our biomaterials products,
including our work under the second NIST grant. Biomaterials-related spending
increased $470,000, or 41%, to $1.6 million in the three months ended March 31,
2004 from $1.1 million in the three months ended March 31, 2003 related
primarily to increases in personnel costs totaling $282,000, and facility costs,
including rent, electric and depreciation of $154,000 to support our continued
development of potential new products and processes for our current and
prospective customers. We expect research and development expenses to increase
as we investigate and develop new products, conduct clinical trials and seek
regulatory approvals for our proprietary products.

Selling, General and Administrative Expense. Selling, general and administrative
expense increased 18% to $2.2 million in the three months ended March 31, 2004
from $1.9 million in the three months ended March 31, 2003. This was primarily
the result of general and administrative expenses, which increased $246,000 to
$1.1 million in the three months ended March 31, 2004 from $881,000 in the three
months ended March 31, 2003. This was attributable to a $162,000 increase in
personnel expense, as well as professional service and public company expenses,
which increased by a total of $49,000 professional service and public company
fees include audit fees, director and officer liability(D&O) insurance, and
board of directors' fees primarily as a result of new SEC and governmental
regulations in addition to our continued growth.

Sales and marketing expenses increased $92,000 to $1.1 million in the three
months ended March 31, 2004 from $1.0 million in the three months ended March
31, 2003. This increase related primarily to the TriActiv European sales and
marketing efforts, which increased $74,000 mainly due to a marketing clinical
study in support of third party reimbursement of TriActiv in Europe. The
clinical study expenses increased $59,000 to $144,000 in the three months ended
March 31, 2004 from $85,000 in the three months ended March 31, 2003. This study
is expected to conclude early in the first quarter of fiscal 2005.

Net Interest Income. Interest expense decreased 56% to $15,000 in the three
months ended March 31, 2004 from $35,000 in the three months ended March 31,
2003. This decrease was the result of a lower average debt principal balance.
Interest income increased by 1% to $271,000 in the three months ended March 31,
2004 from $267,000 in the three months ended March 31, 2003. Although our cash
and investment balances have increased by 33%, this increase was almost entirely
offset by lower interest rates on our investment portfolio.

20

COMPARISON OF NINE MONTHS ENDED MARCH 31, 2004 AND 2003

The following table summarizes our results for the nine months ended March 31,
2004 compared to the nine months ended March 31, 2003.

- -------------------------------------------------------------------------------------------------------------------
PERCENT
NINE MONTHS ENDED CHANGE FROM
----------------------------------------------------------------- PRIOR PERIOD
MARCH 31, % OF TOTAL MARCH 31, % OF TOTAL TO CURRENT
($ MILLIONS) 2004 REVENUES 2003 REVENUES PERIOD
- -------------------------------------------------------------------------------------------------------------------

Total Revenues $41.9 100% $31.1 100% 35%
===================================================================================================================
Net Sales $24.8 59% $18.8 60% 32%
- -------------------------------------------------------------------------------------------------------------------
Research & Development $ 0.5 1% $ 0.6 2% (24%)
Revenue
- -------------------------------------------------------------------------------------------------------------------
Royalty Income $16.7 40% $11.7 38% 42%
- -------------------------------------------------------------------------------------------------------------------
Cost of Products Sold $11.2 27% $ 8.6 28% 30%
- -------------------------------------------------------------------------------------------------------------------
Research & Development
Expense $12.6 30% $10.2 33% 23%
- -------------------------------------------------------------------------------------------------------------------
Selling, General &
Administrative Expense $ 6.3 15% $ 5.1 16% 23%
- -------------------------------------------------------------------------------------------------------------------
Interest Income $ 0.9 2% $ 1.0 3% (11%)
- -------------------------------------------------------------------------------------------------------------------

Revenues. Revenues increased 35% to $41.9 million in the nine months ended March
31, 2004 from $31.1 million in the nine months ended March 31, 2003.

Net Sales. Net sales of products increased 32%, to $24.8 million from $18.8
million for the nine months ended March 31, 2004 and 2003, respectively.
This increase was primarily attributable to increased sales of our
biomaterial orthopaedic products, specifically sports medicine and spine
products. Orthopaedic sales increased 89% to $14.2 million in the nine
months ended March 31, 2004 from $7.5 million for the nine months ended
March 31, 2003. These sales were offset in part by a decrease in our
biomaterial cardiology product sales. Cardiology sales decreased by 6% to
$9.6 million from $10.3 million for the nine months ended March 31, 2004 and
2003, respectively. This expected decrease related to sales of the anchor
component of the Angio-Seal product, which declined to $2.9 million from
$4.3 million for the nine months ended March 31, 2004 and 2003,
respectively. Net sales for the nine months ended March 31, 2004 and March
31, 2003 consisted almost entirely of biomaterials sales, as TriActiv sales
were less than 1% of total sales in both periods.

Research and Development Revenues. Research and development revenues
decreased 24% to $462,000 from $611,000 for the nine months ended March 31,
2004 and 2003, respectively. The revenues for the nine months ended March
31, 2004 consisted of amounts generated under our NIST synthetic vascular
graft grant and our NIH drug delivery grant. In the prior year, revenues
were generated under the NIST articular cartilage and vascular graft
development grants as well as the NIH drug delivery grant. The decrease from
the prior year nine month period primarily reflected the completion of the
NIST cartilage grant in October 2002, which resulted in a $193,000 decrease
from the comparable period in the prior year. Offsetting this decrease in
part was an increase of 4% in the synthetic vascular graft grant, which
generated $408,000 in revenue for the nine months ended March 31, 2004
compared to $393,000 for the nine months ended March 31, 2003. Also
contributing to the revenue was our NIH breast cancer drug delivery grant.
NIH grant revenues increased 115% to $54,000 for the nine months ended March
31, 2004 compared to $25,000 for the nine months ended March 31,2003. This
project concluded in October 2003.

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Royalty Income. Royalty income increased 42% to $16.7 million from $11.7
million in the nine months ended March 31, 2004 and 2003, respectively. This
increase was primarily due to the increase in Angio-Seal royalties from St.
Jude Medical. Angio-Seal royalty units increased 40% as approximately
976,000 units were sold to end-users during the nine months ended March 31,
2004 compared to approximately 695,000 units sold during the nine months
ended March 31, 2003. We believe that the increases in units are due to St.
Jude Medical's continued sales and marketing efforts, which are resulting in
greater market share, and overall increased adoption of vascular closure
devices in the market. St. Jude Medical launched the most recent generation
of the Angio-Seal product line, the STS Plus platform in September
2003 (commanding a premium price over the previous version of the device).
Also included in royalty income for the nine months ended March 31, 2004 are
royalties related to products sold under our agreement with Orthovita.

Cost of Products Sold. Cost of products sold increased 30% to $11.2 million in
the nine months ended March 31, 2004 from $8.6 million in the nine months ended
March 31, 2003. Gross margin increased 100 basis points, from 54% to 55%, in the
nine months ended March 31, 2003 and 2004, respectively. We have experienced
higher volumes in sales of our biomaterials products and greater manufacturing
efficiencies, which has lowered our unit costs in many of our product lines.
This increase in gross margin was partially offset by the initiation of a new
product line during the third fiscal quarter of 2004, Orthovita's VITOSS Foam
products.

Research and Development Expenses. Research and development expenses increased
23% to $12.6 million in the nine months ended March 31, 2004 from $10.2 million
in the nine months ended March 31, 2003. This increase was mainly attributable
to our continued development efforts on the TriActiv system, including clinical
trial expenses. Research and development expense related to the TriActiv
increased $1.2 million, or 18%, to $8.0 million in the nine months ended March
31, 2004 from $6.8 million in the nine months ended March 31, 2003. These
increases were attributable primarily to direct clinical trial expenses
($891,000), personnel expenses ($172,000), legal and consulting expenses
($91,000) and clinical trial insurance ($50,000), all of which supported the
completion of the PRIDE study and growth in the development efforts of future
generations of the TriActiv. Research and development expenses as a percentage
of revenue decreased from 33% to 30% for the nine month period ended March 31,
2003 and March 31, 2004, respectively.

We also continued our development efforts on our biomaterials products,
including our work under the NIST grant and the conclusion of the NIH grant.
Biomaterials-related spending increased $1.2 million, or 34%, to $4.6 million in
the nine months ended March 31, 2004 from $3.4 million in the nine months ended
March 31, 2003. These increases related primarily to increases in personnel
costs ($607,000), animal studies and product testing ($138,000) facility costs,
including rent, electric and depreciation ($369,000) and patent legal fees
($33,000). All of these costs supported our continued development of potential
new products and processes for our current and prospective customers.

Selling, General and Administrative. Selling, general and administrative expense
increased 23% to $6.3 million in the nine months ended March 31, 2004 from $5.1
million in the nine months ended March 31, 2003. This was primarily the result
of sales and marketing expenses, which increased 30%, or $693,000, to $3.0
million in the nine months ended March 31, 2004 from $2.4 million in the nine
months ended March 31, 2003. This related primarily to the TriActiv European
sales and marketing efforts which increased $553,000 over the comparable prior
year period. This was partially due to a $267,000 increase in the costs of our
clinical study to support reimbursement of the product in Europe, on which
expenses were $482,000 and $214,000 in the nine months ended March 31, 2004 and
2003, respectively. In addition, there were increases in personnel expenses
($197,000), professional fees, which include our payroll,

22

customer service and accounting fees, ($42,000) and travel and convention
expenses ($37,000). The increase in sales and marketing expenses was also
related to U.S. pre-launch efforts on the TriActiv. U.S. sales and marketing
expenses which increased $141,000 in the year over year periods related to
personnel costs, including travel costs, totaling $148,000.

In addition, general and administrative expenses increased 17%, or $471,000, to
$3.2 million in the nine months ended March 31, 2004 from $2.7 million in the
nine months ended March 31, 2003. This was attributable to a $248,000 increase
in personnel costs, including travel costs, as well as professional services and
public company expenses, which include legal fees, D&O insurance, and board of
directors fees, and increased $246,000 over the prior year period. These
increases are primarily the result of new SEC and governmental regulations in
addition to our continued growth. Audit and tax fees also increased $155,000
related to Sarbanes-Oxley Section 404 internal control compliance and fees
relating to the development tax credit project that began in the fourth quarter
of our fiscal year ended June 30, 2003. Offsetting these increases was a
$216,000 decrease in the allowance for doubtful accounts. We were carrying a
receivables reserve for an amount due from a company that had filed for
bankruptcy. The outstanding balance has since been paid and the specific reserve
was no longer needed.

Net Interest Income. Interest expense decreased 54% to $56,000 in the nine
months ended March 31, 2004 from $120,000 in the nine months ended March 31,
2003. This decrease was the result of a lower average debt principal balance.
Interest income decreased to $852,000 in the nine months ended March 31, 2004
from $955,000 in the nine months ended March 31, 2003. Although our cash and
investment balances increased, this increase was more than offset by lower
interest rates on our investment portfolio.

LIQUIDITY AND CAPITAL RESOURCES

Our cash, cash equivalents and investments were $54.5 million at March 31, 2004
an increase of $6.1 million from our balance of $48.4 million at June 30, 2003,
the end of our prior fiscal year. In addition, our working capital was $66.3
million at March 31, 2004, an increase of $6.9 million from our working capital
of $59.4 million at June 30, 2003.

Net cash provided by our operating activities was $13.2 million and $9.6 million
in the nine months ended March 31, 2004 and 2003, respectively. In the nine
months ended March 31, 2004, we had net income of $8.8 million, a tax benefit
from the exercise of stock options of $502,000, non-cash depreciation and
amortization of $3.1 million. In addition, changes in asset and liability
balances provided $797,000 of cash. The increase in cash provided by the change
in assets and liabilities was primarily due to the utilization of our deferred
tax asset coupled with a reduction in prepaid and other assets partially offset
by an increase in accounts receivable and inventory. The inventory increase was
primarily due to increased production requirements for the fourth quarter of
fiscal 2004 for biomaterials. The decrease in our prepaid and other assets was
directly attributable to pre-payments related to our clinical trial contracts.
These prepaid balances are expensed when the service is performed. As we
completed enrollment in our PRIDE study, many of the related services have been
performed and pre-payments expensed. In the nine months ended March 31, 2003,
changes in asset and liability balances provided $1.8 million of cash, in
addition to net income of $5.2 million, a tax benefit from exercise of stock
options of $325,000 and non-cash depreciation and amortization of $2.2 million.

Cash used in investing activities was $14 million for the nine month period
ended March 31, 2004. This was the result of purchase and redemption activity
within our investment portfolio. We had $11.3 million of investments mature or
be called. We subsequently purchased new investments with these proceeds as well
as invested an additional $9.5 million of our cash or cash equivalents, for
total investment purchases of $20.8 million. See Note 1 to the condensed
consolidated financial statements included in this quarterly report for a
description of our available-for sale securities. See discussion below for cash
used in purchasing property, plant and equipment.

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We have an $8.0 million capital spending plan for fiscal 2004, of which $4.5
million had been spent on leasehold improvements to fit-out additional leased
space and to reconfigure existing space, machinery, equipment and furniture and
fixtures through March 31, 2004. These expenditures were primarily related to
the expansion of our research and development capabilities ($575,000), expansion
and upgrade of our MIS technology ($219,000) and the continued expansion of our
manufacturing capabilities for our biomaterials and the TriActiv product lines
($3.6 million).

To address our current and future facilities requirements, during the fourth
quarter of fiscal 2004 we will be entering into agreements for the purchase of
land and construction of a new facility. The new facility will be located in the
general vicinity of our existing facility. Long term, the proposed building site
will accommodate a 220,000 square foot facility and thus provide for our future
growth and continued expansion. Our construction plan will have three phases.
Phase one will include the construction of a 160,000 square foot building shell
and the fit-out of 90,000 square feet of space for our manufacturing and quality
assurance operations and personnel. Phase one will begin in June of 2004,
continue for a period of eighteen to twenty four months and have a total
estimated cost of $25 million, including the land purchase. Phase two would
increase the total building size to 175,000 square feet and is anticipated to be
complete by the end of five years. This second phase would allow the complete
transition of all of our personnel and operations to the new facility within
five years. Phase three would complete the building to the maximum of 220,000
square feet, when necessary. We intend to finance the construction of this
building from current available cash on hand or liquid investments. We expect
our capital expenditures to exceed our $8.0 million plan by year-end as we will
be beginning the facility project in June of 2004.

We have $434,260 of current debt due in equal quarterly installments of $223,256
through September 30, 2004. We believe we have adequate cash balances at March
31, 2004 to repay the remaining amounts under this obligation through its
maturity in September 2004.

The exercise of stock options provided cash of $1.5 million for the nine months
ended March 31, 2004. We believe that option exercises will continue through
fiscal 2004 due to the strength in our share price compared to the average
exercise price of outstanding options.

We plan to continue to spend substantial amounts to fund clinical trials, to
gain regulatory approvals and to continue to expand research and development
activities, particularly for the TriActiv and our biomaterials products. In
addition, we will continue to add additional manufacturing facilities to support
the continued growth of our biomaterials business and expected commercial launch
of the TriActiv. We believe our current cash and investment balances, in
addition to cash generated from operations, will be sufficient to meet our
operating, financing and capital requirements through at least the next 12
months. Our future capital requirements and the adequacy of available funds will
depend, however, on numerous factors, including market acceptance of our
existing and future products; the successful commercialization of products in
development and costs associated with that commercialization; progress in our
product development efforts; the magnitude and scope of such efforts; progress
with pre-clinical studies, clinical trials and product clearance by the FDA and
other agencies; the cost and timing of our efforts to expand our manufacturing,
sales, and marketing capabilities; the cost of filing, prosecuting, defending
and enforcing patent claims and other intellectual property rights; competing
technological and market developments; and the development of strategic
alliances for the marketing of certain of our products.

The terms of any future equity financing may be dilutive to our stockholders and
the terms of any debt financing may contain restrictive covenants that limit our
ability to pursue certain courses of action. Our ability to obtain financing is
dependent on the status of our future business prospects, as well as conditions
prevailing in the relevant capital markets. No assurance can be given that any
additional financing will be available to us, or will be available to us on
acceptable terms' should such a need arise.

Our estimate of the time periods for which our cash and cash equivalents will be
adequate to fund operations is a forward looking statement within the meaning of
Private Securities Litigation Reform Act of 1995 and is subject to risks and
uncertainties. Actual results may differ materially from those contemplated in
such forward-looking statements. In addition to those described above, factors
which may cause such a difference are set forth below under the caption "Risks
Related to Our Business" below, as well as under the heading "Risk Factors" in
our Annual Report on Form 10-K for our fiscal year ended June 30, 2003.

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RESEARCH AND DEVELOPMENT TAX CREDIT

During the first quarter of our fiscal 2004, we recorded a research and
development tax credit of approximately $310,000. This was in addition to the
$1.5 million tax credit we recorded in the fourth quarter of fiscal 2003 and
represents the additional portion of the credit. The tax credit relates to our
qualified research and development activities. In connection with the research
and development tax credit, we recorded an additional $50,500 of professional
service fees as a component of selling, general and administrative expenses
during the nine months ended March 31, 2004, as discussed above.

STOCK REPURCHASE PROGRAM

On October 23, 2003, we announced that our board of directors had approved a
program to repurchase up to 400,000 of our issued and outstanding shares of
Common Stock over six months from the date of the board approval.

In the second quarter of fiscal year 2004, we had repurchased and retired
140,500 shares of common stock under the program at a cost of approximately $3.0
million or an average market price of $21.34 per share. We financed the
repurchases using our available cash.

No additional repurchases were made during the quarter ended March 31, 2003 and
through the remainder of the program that expired on April 23, 2004.

DEBT

On September 1, 2000, we incurred an obligation in the amount of $4.5 million in
conjunction with the acquisition of THM, a developer of porous, biodegradable,
tissue-engineering devices for the repair and replacement of musculoskeletal
tissues. The obligation was due in equal quarterly installments of $281,250,
which began on December 31, 2000 and end on September 30, 2004. Accordingly, the
present value of the cash payments (discounted based upon our available
borrowing rate of 7.5%) of $3.9 million was recorded as a liability on our
financial statements, with a remaining balance of $434,260 as of March 31, 2004,
of which the entire amount was current at March 31, 2003. During the quarter
ended March 31, 2003, we had repaid certain debt holders, thereby reducing our
remaining quarterly installments to $223,256 through September 2004.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report includes forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934. We have based these forward-looking
statements largely on our current expectations and projections about future
events and trends affecting our business. In this report, the words "believe,"
"may," "will," "estimate," "continue," "should," "anticipate," "intend,"
"expect," "plan" and similar expressions, as they relate to us, our business or
our management, are intended to identify forward-looking statements, but they
are not exclusive means of identifying them.

A number of risks, uncertainties and other factors could cause our actual
results, performance, financial condition, cash flows, prospects and
opportunities to differ materially from those expressed in, or implied by, the
forward-looking statements. These risks, uncertainties and other factors
include, among other things:

o general economic and business conditions, both nationally and in our
markets;

o our expectations and estimates concerning future financial performance
and financing plans;

25

o the impact of competition;

o anticipated trends in our business and the businesses of our
customers;

o existing and future regulations affecting our business;

o strategic alliances and acquisition opportunities; and

o other risk factors listed under "Risks Related to Our Business" below.

Except as expressly required by the federal securities laws, we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise after the date of
this report. Our results of operations in any past period should not be
considered indicative of the results to be expected for future periods.
Fluctuations in operating results may also result in fluctuations in the price
of our common stock.

RISKS RELATED TO OUR BUSINESS

There are many risk factors that could adversely affect our business, operating
results and financial condition and/or the market price of our common stock.
These risk factors, most of which have been described in detail in our Annual
Report on Form 10-K for the fiscal year ended June 30, 2003 under "Risk
Factors," include but are not limited to:

o our ability to successfully commercialize the TriActiv in the European
Union;
o our ability to obtain regulatory approval for the TriActiv in the United
States;
o subsequent to U.S. regulatory approval, our ability to successfully
commercialize the TriActiv in the United States;
o the completion of additional clinical trials in both the U.S. and Europe to
support regulatory approval of future generations of the TriActiv device;
o our ability to obtain any additional required funding for future development
and marketing of the TriActiv, as well as our biomaterials products;
o our reliance on revenues, including both royalty income and product sales,
from the Angio-Seal product line;
o the performance of St. Jude Medical as the manufacturer, marketer and
distributor of the Angio-Seal product;
o our dependence on the continued growth and success of our biomaterials
products and customers;
o our dependence on our biomaterials customers for marketing and obtaining
regulatory approval for their products;
o the competitive markets for our products and our ability to respond more
quickly than our competitors to new or emerging technologies and changes in
customer requirements;
o the acceptance of our products by the medical community;
o our dependence on key customers, vendors and personnel;
o the use of hazardous materials, which could expose us to future
environmental liabilities;
o our ability to expand our management systems and controls to support
anticipated growth;
o potential dilution of ownership interests of our stockholders by stock
issuances in future acquisitions or strategic alliances;
o risks related to our intellectual property, including patent and proprietary
rights and trademarks; and
o risks related to our industry, including potential for litigation, product
liability claims, ability to obtain reimbursement for our products and our
products' exposure to extensive government regulation;

26

o adherence and compliance with corporate governance laws, regulations and
other obligations affecting our business.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our interest income and expense are sensitive to changes in the general level of
interest rates. In this regard, changes in interest rates affect the interest
earned on our cash, cash equivalents and investments.

Our investment portfolio consists primarily of high quality U.S. government,
municipal and corporate securities with maturities ranging from 3-13 years.
Also, the portfolio includes certain municipal variable rate demand obligations
that have maturities ranging from 7 to 30 years. These municipal variable-rate
demand obligations are putable weekly and callable on a monthly basis. We
mitigate default risk by investing in what we believe are safe and high credit
quality securities and by monitoring the credit rating of investment issuers.
Our portfolio includes only marketable securities with secondary or resale
markets. We have an audit committee approved investment strategy which provides
guidance on the duration and types of our investments. These available-for-sale
securities are subject to interest rate risk and decrease in market value if
interest rates increase. At March 31, 2004, our total portfolio consisted of
approximately $42.4 million of investments. While our investments may be sold at
anytime because the portfolio includes available-for-sale marketable securities
with secondary or resale markets, we generally hold securities until the earlier
of their call date or their maturity. Therefore, we do not expect our results of
operations or cash flows to be materially impacted due to a sudden change in
interest rates. We had $434,260 in outstanding debt at March 31, 2004, related
to the acquisition of THM. Such debt contains a fixed interest rate provision of
7.5% and is thus not subject to risk related to fluctuation in interest rates.

ITEM 4. CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, of the design and operation of our disclosure controls and procedures.
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that, as of March 31, 2004, our disclosure controls and
procedures were effective to provide reasonable assurance that the information
required to be disclosed by us in the reports filed or submitted under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms.

We are in the process of evaluating our compliance with Section 404 of the
Sarbanes-Oxley Act of 2002 (Section 404). Under the current SEC rules, we will
be required to be in compliance with Section 404 as of June 30, 2005.

There was not any change in the Company's internal control over financial
reporting during the quarter ended March 31, 2004 that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.

Any control system, no matter how well designed and operated, can provide only
reasonable (not absolute) assurance that its objectives will be met.
Furthermore, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, have been detected or that we
will be in compliance with Section 404 as of June 30, 2005.

27

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

A. Exhibits.

31.1 Certification of Chief Executive Officer pursuant to Exchange Act
Rule 13a-14(a).

31.2 Certification of Chief Financial Officer pursuant to Exchange Act
Rule 13a-14(a).

32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.

32.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.

B. Reports on Form 8-K.

We filed a Form 8-K on January 20, 2004 to furnish our press release
announcing our financial position and results of operations as of, and
for the three and six month periods ended December 31, 2003 (pursuant
to Item 12 of Form 8-K).

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SIGNATURES

Pursuant to the requirements 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.

KENSEY NASH CORPORATION

Date: May 17, 2004 By: /s/ Wendy F. DiCicco, CPA
--------------------------------------------
Wendy F. DiCicco, CPA
Chief Financial Officer
(Principal Financial and Accounting Officer)

29