<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

(Mark One)

|X|  Annual report pursuant to section 13 or 15(d) of the Securities Exchange
     Act of 1934 [No Fee Required] for the fiscal year ended December 31, 2001
     or

[_]   Transition report pursuant to section 13 or 15(d) of the Securities
     Exchange Act of 1934 [No Fee Required] for the transition period from
         to    .

                         Commission file number 0-24517

                                 ORTHOVITA, INC.
             (Exact name of registrant as specified in its charter)

                                  Pennsylvania
                         (State or other jurisdiction of
                         incorporation or organization)

                                   23-2694857
                      (I.R.S. Employer Identification No.)

                             45 Great Valley Parkway
                              Malvern, Pennsylvania
                    (Address of principal executive offices)

                                      19355
                                   (Zip Code)

            Registrant's telephone number, including area code: (610) 640-1775

                Securities registered pursuant to Section 12(b) of the Act:

        (Title of class)              Name of each exchange on which registered
         --------------               -----------------------------------------
                 None                                  None

                  Securities registered pursuant to Section 12(g) of the Act:

                         Common Stock, par value $.01 per share
                                   (Title of class)
<PAGE>

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

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

     As of March 22, 2002, the aggregate market value of the Common Stock held
by non-affiliates of the registrant was $22,491,090. Such aggregate market value
was computed by reference to the closing sale price of the Common Stock as
reported on the Nasdaq National Market on such date. For purposes of making this
calculation only, the registrant has defined affiliates as including all
directors, executive officers and beneficial owners of more than ten percent of
the registrant's Common Stock.

     As of March 22, 2002, there were 20,874,536 shares of the registrant's
Common Stock outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE:

     As stated in Part III of this annual report on Form 10-K, portions of the
following document are incorporated herein by reference:

     Definitive proxy statement to be filed within 120 days after the end of the
fiscal year covered by this annual report on Form 10-K.

     Unless the context indicates otherwise, the terms "Orthovita" and "Company"
refer to Orthovita, Inc. and, where appropriate, one or more of its
subsidiaries.

                                      2
<PAGE>

                                TABLE OF CONTENTS

                                     PART I

<TABLE>
<S>            <C>                                                                               <C>
ITEM 1.        Business........................................................................  4-15
ITEM 2.        Properties......................................................................   15
ITEM 3.        Legal Proceedings...............................................................  15-16
ITEM 4.        Submission of Matters to a Vote of Security Holders.............................   16
</TABLE>

                                     PART II

<TABLE>
<S>            <C>                                                                              <C>
ITEM 5.        Market for Registrant's Common Equity And Related Shareholder Matters...........   16
ITEM 6.        Selected Consolidated Financial Data............................................   17
ITEM 7.        Management's Discussion and Analysis of Financial Condition and Results of
               Operations...................................................................... 18-35
ITEM 7A.       Quantitative and Qualitative Disclosure About Market Risk....................... 35-36
ITEM 8.        Financial Statements and Supplemental Data......................................   36
ITEM 9.        Changes In and Disagreements with Accountants on Accounting and Financial
               Disclosure......................................................................   36
</TABLE>

                                    PART III

<TABLE>
<S>            <C>                                                                                <C>
ITEM 10.       Directors and Executive Officers of the Registrant..............................   36
ITEM 11.       Executive Compensation..........................................................   36
ITEM 12.       Security Ownership of Certain Beneficial Owners and Management..................   36
ITEM 13.       Certain Relationships and Related Transactions..................................   36
</TABLE>

                                     PART IV

<TABLE>
<S>                <C>                                                                          <C>
ITEM 14.           Exhibits, Financial Statement Schedules, and Reports on Form 8-K............ 37-40

SIGNATURES                                                                                        41
</TABLE>

                                      3
<PAGE>

                                     PART I

ITEM 1.   BUSINESS

The use of the words "Orthovita", the "Company", "we", "us" or "our" herein
refers to Orthovita, Inc. In addition to historical facts or statements of
current conditions, this report contains forward-looking statements. When used
in this Form 10-K, the words "may," "will," "expect," "anticipate," "intend,"
"plan," "believe," "seek," "estimate" and similar expressions are generally
intended to identify forward-looking statements, but are not the exclusive
expressions of forward-looking statements. Forward-looking statements involve
risks and uncertainties; therefore, readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
made. Furthermore, we undertake no obligation to publicly update any forward-
looking statements. We claim the protections afforded by the Private Securities
Litigation Reform Act of 1995, as amended, for our forward-looking statements.
The following risk factors are addressed in the "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Certain Risks
Related to Our Business" section of this Form 10-K. These forward-looking
statements are based on current expectations of future events that involve risks
and uncertainties, including without limitation, the following risk factors that
could cause actual events or results to differ materially from those expressed
or implied by forward-looking statements including without limitations:

                  -  We are dependent on the commercial success of CORTOSS and
                     VITOSS;
                     - We may be unable to increase sales of our approved
                       products;
                     - We may not be able to operate an effective sales and
                       distribution network;
                     - We may not train a sufficient number of surgeons to
                       create demand for our products.
                     - If health care providers cannot obtain third-party
                       reimbursement for procedures using our products, we may
                       never become profitable;
                  -  We have experienced negative cash flows since our
                     inception;
                  -  If we fail to obtain and maintain regulatory approvals
                     necessary to sell our products, sales could be delayed or
                     never realized;
                  -  If we do not manage commercial scale manufacturing
                     capability and capacity for our products, our product
                     sales may suffer;
                  -  It may be difficult to operate in international markets;
                  -  If losses continue in the long term, it could limit our
                     growth and slow our generation of revenues;
                  -  If we fail to meet our obligations under a revenue sharing
                     agreement, the investor could foreclose on certain assets
                     that are essential to our operations, and we may be
                     required to repurchase from an investor its right to
                     receive revenues on certain of our product sales;
                  -  Our results of operations may fluctuate due to factors out
                     of our control;
                  -  Our business will be damaged if we are unable to protect
                     our proprietary rights to the technologies used in our
                     products;
                  -  We may lack the financial resources needed to respond to
                     technological changes and other actions by competitors;
                  -  We may acquire technologies or companies in the future, and
                     these acquisitions could result in dilution to our
                     shareholders;
                  -  Provisions of Pennsylvania law or our Articles of
                     Incorporation may deter a third party from seeking to
                     obtain control of us;
                  -  Our executive officers and directors own a large percentage
                     of our voting stock and could exert significant influence
                     over matters;
                  -  We do not intend to pay cash dividends;
                  -  Our stock price is volatile;
                  -  If our shares are delisted from the Nasdaq National Market,
                     it may be difficult to sell your investment in our company;
                  -  If we are sued in a product liability action, we could be
                     forced to pay substantial damages;
                  -  Our business could suffer if we cannot attract and retain
                     the services of key employees.

                                      4
<PAGE>

Orthovita, Inc. ("Orthovita" or the Company) is a Pennsylvania corporation with
proprietary technologies applied to the development of biostructures, which are
synthetic, biologically active, tissue engineering products for restoration of
the human skeleton. Our focus is on developing products for use in spine surgery
and in the repair of osteoporotic fractures. We are also addressing a broad
range of clinical needs in the trauma market.

We have developed several products to date:

         -     VITOSS(TM)Scaffold Synthetic Cancellous Bone Void Filler;

               - IMBIBE(TM)Bone Marrow Aspirate Syringe to be used with VITOSS;

         -     CORTOSS(TM)Synthetic Cortical Bone Void Filler;

               - ALIQUOT(TM) Microdelivery System to be used with CORTOSS.

In addition, we are developing RHAKOSS(TM) Synthetic Bone Spinal Implants.

VITOSS is a resorbable, beta-tricalcium phosphate scaffold used as a bone void
filler in trauma and spinal procedures. CORTOSS is a high-strength,
bone-bonding, self-setting composite intended for use in the augmentation of
screws used in a variety of orthopaedic procedures and in vertebral
augmentation. RHAKOSS is under development as a high-strength, bone-bonding
preformed composite. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets.

We received regulatory clearance for VITOSS in the U.S. from the United States
Food and Drug Administration ("FDA") in December 2000 and the CE Mark in the
European Union from our notified body in July 2000. The CE Mark permits us to
sell VITOSS in all of the countries of the European Union, as well as in other
countries, such as Switzerland and Israel, that have adopted the European
Union's regulatory standards. These regulatory approvals allow us to market
VITOSS for use as a cancellous bone void filler for bony voids or gaps of the
skeletal system, including the extremities, spine and pelvis. We also received
regulatory approval in March 2001 to sell VITOSS for this use in Australia. We
launched VITOSS in Europe in October 2000 and in the United States in February
2001. In April 2001, we entered into an agreement with Japan Medical Dynamic
Marketing, Inc. ("MDM"), an orthopaedic company in Japan, under which MDM will
initiate clinical studies necessary to apply for regulatory approval to market
VITOSS in Japan. In September 2001, we received regulatory clearance in the
United States from the FDA to market IMBIBE for use as a bone marrow aspiration
syringe. IMBIBE provides spine and trauma surgeons with a simple method for
harvesting a patient's own bone marrow, mixing it with VITOSS and delivering the
mixture to the bone graft site.

We received the CE Mark for CORTOSS in October 2001 in the European Union and
regulatory approval in March 2001 in Australia which allows us to sell CORTOSS
in these territories for use in screw augmentation procedures. Screw
augmentation is a procedure for the fixation of bone screws used in patients
with weak bone caused by osteoporosis. We initiated a limited launch of CORTOSS
in Europe in December 2001. In addition, we are conducting post-marketing human
clinical studies in Europe for the use of CORTOSS in hip compression screw
augmentation. We are also pursuing clinical studies of CORTOSS in Europe seeking
to expand its label to include its use in vertebral augmentation. During 2001,
we received conditional approval from the FDA to conduct a pilot clinical study
in the U.S. for the use of CORTOSS for vertebral augmentation. In addition,
during 2002, we received approval from the FDA to conduct a pivotal clinical
study in the U.S. for the use of CORTOSS for long bone screw augmentation. There
can be no assurance that the data from any such clinical trials will support FDA
clearance or approval to market this product for these uses.

Our ALIQUOT Microdelivery System facilitates effective delivery of our CORTOSS
product directly to the surgical site. A two-part system of catheter and
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation procedures.

RHAKOSS is designed to mimic the strength and flexibility characteristics of
bone, as well as its radiolucency, which means its degree of transparency to
x-rays and other radiation. RHAKOSS can be manufactured into any size or shape
to optimize anatomic fit. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets. We initiated
pre-clinical studies for our RHAKOSS spinal implants in December 2000 and our
goal is to initiate human clinical studies in Europe in 2002.

                                      5
<PAGE>

We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are utilizing this network for CORTOSS in Europe,
Australia and Israel. If MDM is successful in obtaining approval to market
VITOSS, it will distribute, sell and market VITOSS in Japan. We plan to seek a
similar arrangement for CORTOSS in Japan.

We incorporated in Pennsylvania in 1992. Our principal offices are located at 45
Great Valley Parkway, Malvern, Pennsylvania 19355.

ORTHOVITA'S RESEARCH & DEVELOPMENT

We employ biomaterials technologies, including composite engineering, polymer
science solutions, chemistry and ceramic glass sciences to create novel
biomaterials. We then use the new biomaterials to develop unique synthetic
biologically active products engineered to restore the human skeleton. Patents
have been issued and patent applications filed to protect our key biomaterial
developments. As of March 22, 2002, we own or control four issued U.S. patents,
two allowed U.S. patent applications, ten pending U.S. patent applications and
numerous counterparts of certain of these patents and pending patent
applications worldwide, including Canada, Europe, Mexico and Japan.

Our products under development to date have been the result of our internal
research and development activities. We incurred approximately $7,203,000,
$7,500,000 and $5,274,000 in research and development expenses in 2001, 2000 and
1999, respectively.

OUR PRODUCT PIPELINE AND RELATED CLINICAL APPLICATIONS

As further discussed in Government Regulation below, our products and product
candidates are subject to extensive regulation as medical devices by the FDA and
regulatory authorities in Europe and other jurisdictions. Product approval
applications for our products must be supported by valid scientific evidence
that typically includes clinical trial data, to demonstrate the safety and
effectiveness of the device.

VITOSS SCAFFOLD SYNTHETIC CANCELLOUS BONE VOID FILLER

VITOSS is a resorbable, beta-tricalcium, phosphate scaffold used as a bone void
filler in trauma and spinal procedures. The highly porous physical structure of
VITOSS allows it to be rapidly saturated with marrow, blood and nutrients
providing the cells and signals that are required for bone growth and
remodeling. VITOSS provides a three dimensional structure which, we believe,
allows bone growth. VITOSS is covered by two U.S. issued patents and other U.S.
and foreign patent applications are pending.

We received regulatory clearance for VITOSS in the U.S. from the FDA in December
2000 and the CE Mark in the European Union from our notified body in July 2000.
The CE Mark permits us to sell VITOSS in all of the countries of the European
Union, as well as in other countries, such as Switzerland and Israel, that have
adopted the European Union's regulatory standards. These regulatory approvals
allow us to market VITOSS for use as a cancellous bone void filler for bony
voids or gaps of the skeletal system, including the extremities, spine and
pelvis. We also received regulatory approval in March 2001 to sell VITOSS for
this use in Australia. We launched VITOSS in Europe in October 2000 and in the
United States in February 2001.

Bone Defect Repair. Injury or trauma to the bone, as well as degenerative
conditions, disease and aging, affect the health and viability of the human
skeleton. These conditions often result in the need for the repair of bone
defects through a bone grafting procedure. Approximately 500,000 bone-grafting
procedures on a worldwide basis are performed each year in the spine,
extremities and pelvis, representing a potential market we estimate at
approximately $300 million.

Spinal Fusions.  Many patients affected by severe back pain due to degeneration
of one or more discs are treated with a spinal fusion procedure. We estimate
that 400,000 spinal fusions are done annually on a worldwide basis. Spinal
fusion involves the fusing together of adjoining vertebrae in cases where the
patient has advanced disc degeneration or spinal instability. This procedure
involves surgical incision in the patient's back or abdomen. Fusions frequently
require the removal of the affected disc material and the surgical attachment of
a metal implant or a spinal fusion cage to join the two surrounding vertebrae.
The metal implant or spinal fusion cage is usually packed with bone grafting
material to help promote the union of the two adjacent vertebrae. Bone grafting
material is either

                                      6
<PAGE>

autograft material, which is often obtained or harvested from the iliac crest
region of the patient's own hip, or allograft material, which is obtained from a
cadaver, or synthetically derived materials such as VITOSS.

The autograft harvest is an additional procedure that extends surgical time,
adding to costs and increasing blood loss and patient risk of infection or
adverse reaction from the additional time under anesthesia. Of equal concern,
harvesting bone for autograft sometimes causes protracted pain that may
necessitate a trip back to the surgeon several months after the surgical
procedure. Using VITOSS may avoid these potential complications of autograft
harvest procedures. In addition, VITOSS avoids any patient and surgeon concerns
regarding the use of cadaver derived allograft material.

Iliac Crest Repair. The bone grafting material used to pack the metal implant
and cages used in spinal fusion procedure is often autograft material, obtained
or "harvested" from the iliac crest region of the patient's own hip through an
operating procedure. This procedure leaves an open space in the iliac crest,
which is often painful and slow healing. We estimate that each year, autograft
material is used in approximately 200,000 spinal fusion procedures worldwide
and that harvested material is used in another 100,000 non-spinal fusion related
procedures worldwide.

VITOSS can be used to repair the bone void left by the harvest procedure at the
time of surgery and may reduce pain and speed healing time. In post marketing
studies of VITOSS for iliac crest repair, initial results indicate the use of
VITOSS performs well in the formation of new bone. VITOSS also resulted in a
reduction of incidence of post-operative bleeding and post-operative pain at the
harvest site.

Trauma.  Physical trauma such as falls and accidents can result in bone fracture
or damage. Fractures of broken bones are often realigned with hardware, such as
plates, rods and screws. Once the hardware has been used to recreate the
skeletal anatomy, there are often defects or voids in the bone which remain.
Those voids require the use of bone graft material. The goal of bone grafting in
trauma applications is to rapidly heal the damaged bone. We estimate
approximately 100,000 trauma related bone graft repairs are performed annually
on a worldwide basis. Autograft, cadaver allograft, as well as synthetic
scaffolds, like VITOSS, are used for trauma related bone graft repairs.

VITOSS has been used as a bone void filler in a variety of trauma applications,
including those of the long bone, extremity, and pelvic bone repairs. In
addition, VITOSS has been used to fill bone void defects due to trauma in
cancelleous fractures of the wrist, ankle, tibia and femur.

IMBIBE provides spine and trauma surgeons with a simple method for harvesting a
patient's own bone marrow, mixing it with VITOSS and delivering the mixture to
the bone graft site.

CORTOSS SYNTHETIC CORTICAL BONE VOID FILLER

CORTOSS is a high-strength, bone-bonding, self-setting composite, engineered
specifically to mimic the strength characteristics of human cortical bone. For
patients with poor bone healing capacity, as seen in osteoporotic patients,
CORTOSS has been developed to be used in a variety of surgical procedures to
provide structural stability and reinforcement of the bones after surgery. The
surgeon's goal is to repair the patient's bone and provide mobility to the
patient as quickly as possible. Prolonged bed rest or inactivity often results
in decreased overall health for older, osteoporotic patients. In order to gain
mobility quickly, structural stability must be provided in a short period of
time.

CORTOSS's simple mix-on-demand design allows for minimum waste and maximum ease
of use and flexibility for the surgeon. CORTOSS is an injectable substance that
is delivered aseptically through a prefilled, unit dose, disposable cartridge.
Delivery of CORTOSS to the surgical site may be started and stopped for a
prolonged period of time throughout the surgical procedure. Polymerization is
initiated when CORTOSS is expressed through the static mix-tip and hardens
within minutes. Laboratory tests demonstrate that CORTOSS exhibits compressive
strength similar to human cortical bone. CORTOSS provides two stages of
fixation: immediate mechanical interlock into porous bone, followed by intimate
bone growth along the contours of the surface. CORTOSS develops a calcium
phosphate-rich surface, which is equivalent in composition and structure to bone
mineral. Six month CORTOSS histology (preclinical studies) shows direct,
intimate bony contact. CORTOSS is covered by two U.S. issued patents and other
U.S. and foreign patent applications are pending.

                                      7
<PAGE>

We received the CE Mark for CORTOSS in October 2001 in the European Union and
regulatory approval in March 2001 in Australia which allows us to sell CORTOSS
in these territories for use in screw augmentation procedures. Screw
augmentation is a procedure for the fixation of bone Screws used in patients
with weak bone caused by osteoporosis. We initiated a limited launch of CORTOSS
in Europe in December 2001. In addition, we are conducting post-marketing human
clinical studies in Europe for the use of CORTOSS in hip compression screw
augmentation. We are also pursuing clinical studies of CORTOSS in Europe seeking
to expand its label to include its use in vertebral augmentation. During 2001,
we received conditional approval from the FDA to conduct a pilot clinical study
in the U.S. for the use of CORTOSS for vertebral augmentation. In addition,
during 2002, we received approval from the FDA to conduct a pivotal clinical
study in the U.S. for the use of CORTOSS for long bone screw augmentation. There
can be no assurance that the data from any such clinical trials will support FDA
clearance or approval to market this product for these uses.

Screw Augmentation. We estimate that worldwide each year, approximately
1,500,000 orthopaedic procedures are performed using internal fixation devices
that involve screws. About 1,000,000 of these involve long bone fractures that
are treated with metal plates and screws; the remainder involve hip fractures
treated with compression screws and spinal fractures treated with pedicle
screws.

Our ALIQUOT Microdelivery System facilitates effective delivery of our CORTOSS
product directly to the surgical site. A two-part system of catheter and
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation procedures.

         Long Bone Screw Augmentation. In long bone fractures, screws are placed
         into the plate and serve to compress the fracture, permitting faster
         healing. We estimate these screws "strip" or fail to hold in
         approximately 150,000 osteoporotic patients each year due to poor bone
         quality, as is often the case in osteoporotic bone. Where screws fail
         to hold, current treatment options include: (i) replacement of the
         screw with a screw of larger diameter, which may further weaken the
         bone and is not always possible because of the size of the screw holes
         and/or the bone, (ii) replacing the plate with a longer plate with more
         screw holes to span the failed screw holes, which adds considerable
         time to the procedure, creates a larger wound area, increases the risk
         of other screws failing due to their removal and reimplantation, and in
         certain situations is anatomically not possible, (iii) leaving the
         plate with the failed screws as it is and giving the patient a non-load
         bearing cast for a prolonged period of time, which increases the risk
         of post-operative complications related to immobilization, such as deep
         venous thrombosis, or (iv) augmenting the screws with PMMA bone cement,
         which is cumbersome and time consuming because it needs to be manually
         mixed and transferred into a syringe for application and, after mixing
         there only is a small time window in which it can be used before it
         sets, making it difficult to augment more than one screw at a time.
         Additionally, PMMA bone cement is not approved by the FDA for this
         indication.

         The use of CORTOSS to anchor the screw in a quick and efficient way
         will allow the full function of the screw to be restored. We are not
         aware of any cement products that have received FDA approval or CE
         marking that would be in competition with CORTOSS for this indication.

         A 37-patient multi-center clinical study in Europe of patients
         undergoing surgery to repair bone fractures demonstrated that CORTOSS
         allowed the successful use of metal screws in the repair procedures
         despite patients' poor bone quality. The three-month study showed
         CORTOSS restored the holding power of 98 percent of previously failed
         bone screws, permitting the use of a plate to stabilize the fracture
         and healing in all 37 patients with no adverse events related to
         CORTOSS reported.

         During 2002, we received approval from the FDA to conduct a pivotal
         clinical study in the United States for the use of CORTOSS for long
         bone screw augmentation. There can be no assurance that the data from
         any such clinical trials will support FDA clearance or approval to
         market this product for these uses.

         Pedicle Screw Augmentation.  Many spinal surgeries today have become
         possible only due to the availability of instrumentation systems that
         allow manipulation and fixation of the individual elements of the
         spine. These instrumentation systems are attached to the spine by means
         of screws placed in the pedicle region of the vertebrae. In patients
         with sub-optimal bone quality, such as osteoporotic patients, the
         purchase or "bite" of these screws may be insufficient to maintain the
         integrity of the construction.

         There are approximately 280,000 patients in which pedicle screws are
         placed each year on a worldwide basis. We estimate that approximately
         35,000 may require the augmentation of screws due to osteoporosis. We
         do not know of any approved product for this procedure.

                                      8
<PAGE>

         We believe CORTOSS has the potential to ensure secure fixation of the
         screws, allowing the instrumentation systems to restore maximum
         fixation and stabilize the spine. We believe CORTOSS's mix-on-demand
         delivery system makes its use here convenient and practical.

         Compression Screw Augmentation. We estimate approximately 750,000 hip
         fractures occur annually worldwide, of which an estimated 250,000 are
         repaired using compression screw augmentation.

         Many osteoporotic patients, particularly elderly women, suffer a
         fracture of the hip whereby the head or the "ball" of the hip and
         socket of the femur leg bone is separated from the rest of the bone.
         These fractures are often treated through the use of compression hip
         screws, which are placed through the bone and into the femoral head to
         stabilize and compress the fracture to permit healing. The healing of a
         fracture is directly proportional to the degree of stabilization. The
         failure of screws to purchase or hold is common, especially in
         osteoporotic bone. Additionally in many cases, even after the screw
         gains initial hold, the screw's sharp thread edges may cause the screw
         to cut through the bone and fail to hold. Such a failure during or
         after the surgical procedure will result in the need for an artificial
         hip implant.

         We believe the use of CORTOSS to anchor the screw in a quick and
         efficient way will allow the full function of the screw to be restored.
         We are not aware of any products approved for this indication that
         would be in competition with CORTOSS.

         In two separate clinical studies in Europe, CORTOSS has been used to
         increase the holding power of screws in the bone and to protect the
         bone from the screw's sharp threads. The first study included 25
         patients with subtrochanteric fractures, which had been treated with
         dynamic hip screws. The holding power of the screw was shown to
         increase significantly in all patients. This holding power was
         evidenced by an increase in torque resistance. To date, none of the
         augmented screws has shown movement. A second clinical study, which
         included 21 patients with intra-capsular fractures of the hip,
         evaluated the effect of CORTOSS for the augmentation of two parallel
         screws used to reduce and fix the hip fracture. Initial results
         indicate a potential reduction in the normally high failure rate for
         this technique. This has the potential to reduce the need for a second
         corrective surgery.

         Vertebral Augmentation. We estimate there are approximately 700,000
         patients worldwide with compression of the vertebrae due to fractures
         caused by osteoporosic bone or bone cancer resulting in severe pain and
         immobility. Of these, approximately 260,000 fractures are diagnosed.
         The traditional treatments, e.g., bed rest, bracing, narcotics or
         injections, do not address the underlying fracture. Vertebral
         augmentation is a procedure for repairing the fractured vertebrae,
         which can be performed on an outpatient or short-stay basis. Vertebral
         augmentation has been reported to provide almost immediate pain relief
         in over 90% of osteoporotic patients. Early relief of pain provided by
         vertebral augmentation allows patients to maintain better functional
         capacity. Functional capacity, in turn, is believed to be directly
         related to the ability to live independently and unassisted. We are not
         aware of any products that have received FDA approval or European
         approval for use in this procedure; however, surgeons currently use
         PMMA "off-label".

         We believe that CORTOSS may have several advantages over PMMA in
         vertebral augmentation, such as its ability to be seen by physicians
         when using imaging equipment in performing the procedure without adding
         additional materials such as barium, its lower temperature setting
         time, its higher compression strength and its ability to be mixed on
         demand. We have initiated clinical studies of CORTOSS in vertebral
         augmentation in Europe and believe these are the only controlled
         studies in this field. Upon completion of these studies, if successful,
         we intend to seek to expand CORTOSS's clearance for use in Europe to
         include vertebral augmentation.

During 2001, we received conditional approval from the FDA to conduct a pilot
clinical study in the United States for the use of CORTOSS for vertebral
augmentation. There can be no assurance that the data from any such clinical
trials will support FDA clearance or approval to market this product for this
use.

RHAKOSS SYNTHETIC BONE SPINAL IMPLANTS

RHAKOSS is under development as a synthetic bone-bonding, load-bearing, spinal
implant product for use in spinal repair procedures including vertebral
interbody fusion and spine reconstruction. We believe that RHAKOSS Implants
represent a potential

                                      9
<PAGE>

alternative to titanium/carbon fiber cages and allograft cadaver bone implants.
RHAKOSS is designed to mimic the radiolucency of bone, as well as the strength
and flexibility characteristics of bone, and can be manufactured into any size
or shape to optimize anatomic fit. We are developing RHAKOSS to combine the
best features of first generation interbody fusion devices while eliminating
many of the disadvantages of some currently available materials, such as
inconsistent structural integrity, inability to visualize the graft material,
lack of mechanical bonding to bone, potential concerns about disease
transmission and potential limited supply. RHAKOSS can be injection molded or
machined, thus generating an unlimited supply and consistent material
performance.

Spinal Fusion. The current worldwide market estimate for interbody fusion
devices including titanium cages, carbon fiber cages and cadaver bone dowels and
spacers is approximately $445 million. We believe RHAKOSS implants potentially
offer the surgeon and patient the consistency of engineered synthetics, with
similar characteristics to those of human bone implants. We have completed the
final formulation, initial acute pre-clinical studies and the design of the
RHAKOSS synthetic implants. Our goal is to initiate RHAKOSS human clinical
studies in 2002 in Europe.

PATENTS AND PROPRIETARY INTELLECTUAL PROPERTY

An integral part of our product development strategy is to seek protection for
our product technologies and manufacturing methods through the use of United
States and foreign patents. We have filed or intend to file applications as
appropriate for patents covering our technologies, products and processes. We
cannot be certain that any of our patent applications will be issued, or if
issued, that they will not be challenged by third parties. We cannot be certain
that we were the first creator of inventions covered by pending patent
applications or that we were the first to file patent applications for such
inventions for the following reasons:
    .  patent applications filed prior to December 2000 in the United States are
       maintained in secrecy until issued;
    .  patent applications filed after November 2000 are maintained in secrecy
       until eighteen months from the date of filing;
    .  publication of discoveries in the scientific or patent literature tends
       to lag behind actual discoveries.

Further, there can be no assurance that the claims allowed under any issued
patents will be sufficiently broad as to protect our proprietary position in the
technology. In addition, there can be no assurance that any patents issued to us
will not be challenged, invalidated or circumvented, or that the rights granted
thereunder will provide commercially useful competitive advantages to us. As of
March 22, 2002, we own or control four issued U.S. patents, two allowed U.S.
patent applications, ten pending U.S. patent applications and numerous
counterparts of certain of these patents and pending patent applications
worldwide, including Canada, Europe, Mexico and Japan.

PHYSICIAN ADVISORY PANELS

We have two physician advisory panels. Our Surgeon Clinical Panel is comprised
of international physician experts that provide advice and guidance to us in our
product development programs regarding potential clinical uses of our products.
Our Scientific Advisory Board is made up of international physician experts that
guide us regarding design and scientific issues. Certain members of the
physician panels have received options to purchase our Common Stock, a practice
that we may continue in the future.

MANUFACTURING AND PRODUCT SUPPLY

The manufacture of our products is subject to regulation and periodic inspection
by various regulatory bodies for compliance with Good Manufacturing Practice
("GMP") regulations, Quality System Requirements ("QSR"), International
Standards Organization ("ISO") 9000 Series standards and equivalent
requirements.

Our VITOSS and CORTOSS manufacturing facilities produce commercial products and
are certified as meeting the requirements of ISO 9001 and European Norm ("EN")
46001 for the period July 1, 2000 through July 1, 2003, and are subject to
inspection by the FDA for compliance with FDA device manufacture requirements.
In addition to the need for regulatory approval, in order to commercialize
CORTOSS in the U.S., its manufacturing facility is also subject to inspection by
the FDA. We are manufacturing IMBIBE and ALIQUOT through outside third-party
contract manufacturers. Our third-party manufacturers are ISO 9001 certified or
have been audited by us and determined to meet our quality system requirements.

                                      10
<PAGE>

Our ability to manufacture VITOSS and CORTOSS is dependent on a limited number
of specialty suppliers of certain raw materials. The failure of a supplier to
continue to provide us with these materials at a price or quality acceptable to
us, or at all, would have a material adverse effect on our ability to
manufacture these products. Moreover, our failure to maintain strategic reserve
supplies of each significant single-sourced material used to manufacture VITOSS,
CORTOSS and certain products that we may develop in the future may result in a
breach of our material financing agreements.

SALES AND MARKETING

We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are utilizing this network in Europe, Australia and Israel
for CORTOSS. If our partner in Japan is successful in obtaining clearance to
market VITOSS, it will distribute, sell and market VITOSS in Japan. We plan to
seek a similar arrangement with a partner for CORTOSS in Japan.

We have arrangements with independent distributors throughout Europe, one
distributor in Australia and one distributor in Israel with a combined sales
force of over 200 representatives. These distributors purchase products directly
from us, warehouse inventory of products purchased from us and hold title to the
products purchased. In the U.S., we are represented by approximately 45 sales
agencies with over 275 sales representatives in the aggregate. Sales agencies in
the U.S. do not warehouse inventory. U.S. sales agencies are paid commissions by
us for selling our products to the end user customers. The independent
distributors outside of the U.S. and the end user customers in the U.S. do not
have the right to return or exchange any products that they have purchased from
us.

COMPETITION

Extensive research efforts and rapid technological change characterize the
market for products in the orthopaedic market. We face intense competition from
medical device and medical products companies. Our products could be rendered
noncompetitive or obsolete by competitors' technological advances. We may be
unable to respond to technological advances through the development and
introduction of new products. Moreover, many of our existing and potential
competitors have substantially greater financial, marketing, sales,
distribution, manufacturing and technological resources than us and as a result
may adversely impact our influence over the distribution channels for our
products. These competitors may also be in the process of seeking FDA or other
regulatory approvals, or patent protection, for new products. Our competitors
could, therefore, commercialize new competing products in advance of our
products. There can be no assurance that we will be able to compete successfully
against current or future competitors or that competition will not have a
material adverse effect on our business, financial condition and results of
operations.

We believe VITOSS will face competition from products currently on the market or
that may enter the market in the near future such as recombinant signaling
growth factors. These proteins have the potential to significantly alter the
bone grafting market. The first of these proteins is expected to enter the bone
grafting market in the U.S. and Europe during 2002.

There are no known products that have received FDA approval or a CE Mark for
screw augmentation and vertebral augmentation that would be in competition with
CORTOSS for these indications; however, we may face off-label use of PMMA bone
cement products. RHAKOSS will compete against products which are established in
the market place, including those manufactured from metal carbon fiber and
cadaver bone.

GOVERNMENT REGULATION

In order to market our products, we must apply for, be granted and maintain all
necessary regulatory approvals in each applicable jurisdiction. To date, we have
received regulatory clearance for VITOSS in the United States from the FDA under
a 510(k) (see below) in December 2000 and the CE Mark in the European Union from
our notified body in July 2000. We also received regulatory approval to sell
VITOSS, in March 2001, in Australia. The CE Mark permits us to sell our approved
products in all of the countries of the European Union, as well as, in other
countries such as Switzerland and Israel, that have adopted the European Union's
regulatory standards. In September 2001, we received regulatory clearance in the
United States from the FDA under a 510(k) to market our IMBIBE product for use
as a bone marrow aspiration syringe. We received the CE Mark for CORTOSS in
October 2001 in the European Union and regulatory approval in March 2001 in
Australia which allows us to sell CORTOSS in these territories for use in
securing screws


                                      11
<PAGE>

in patients with weak bone caused by osteoporosis. During 2002, we submitted for
review a technical file to our notified body in order to obtain CE Certification
for ALIQUOT.

During 2002, we received approval from the FDA to conduct a pivotal clinical
study in the United States for the use of CORTOSS for long bone screw
augmentation. In addition, during 2001, we received conditional approval from
the FDA to conduct a pilot clinical study in the United States for the use of
CORTOSS for vertebral augmentation. There can be no assurance that the data from
any such clinical trials will support FDA clearance or approval to market this
product for these uses.

Our VITOSS and CORTOSS manufacturing facilities produce commercial products and
are certified as meeting the requirements of ISO 9001 and EN 46001 for the
period July 1, 2000 through July 1, 2003 and are subject to inspection by the
FDA for compliance with FDA device manufacture requirements. In addition to the
need for regulatory approval, in order to commercialize CORTOSS in the U.S., its
manufacturing facility is also subject to inspection by the FDA. We are
manufacturing IMBIBE and ALIQUOT through outside third-party contract
manufacturers. Our third-party manufacturers are ISO 9001 certified or have been
audited by us and determined to meet our quality system requirements.

United States

The medical devices that we manufacture and market, or intend to market, are
subject to extensive regulation by the FDA. Pursuant to the Federal Food, Drug
and Cosmetic Act ("FFD&C Act") and the regulations promulgated thereunder, the
FDA regulates the clinical testing, manufacture, labeling, distribution and
promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of marketing approvals and criminal prosecution.

In the United States, medical devices are classified into one of three classes
(Class I, II or III) on the basis of the controls deemed necessary by the FDA to
reasonably assure their safety and effectiveness. Under FDA regulations, Class I
devices, the least regulated category, are subject to general controls and Class
II devices are subject to general and special controls. Generally, Class III
devices are those that must receive premarket approval by the FDA to ensure
their safety and effectiveness. Our IMBIBE product is a Class II device and
ALIQUOT is a Class IIA device.

Before a new device can be introduced into the market, the manufacturer must
generally obtain market clearance through a 510(k) notification or premarket
approval through a premarket approval application ("PMA"). A 510(k) clearance
will be granted if the submitted information establishes that the proposed
device is "substantially equivalent" to a legally marketed Class I or II medical
device, or to a Class III medical device for which the FDA has not called for a
PMA. The FDA may determine that a proposed device is not substantially
equivalent to a legally marketed device, or that additional information or data
are needed before a substantial equivalence determination can be made. A request
for additional data may require that clinical studies be performed to establish
the device's "substantial equivalence."

Commercial distribution of a device for which a 510(k) notification is required
can begin only after the FDA issues an order finding the device to be
"substantially equivalent" to a predicate device. Pursuant to the FFD&C Act, the
FDA must make a determination with respect to a 510(k) submission within 90 days
of its receipt. The FDA may, and often does, extend this time frame by
requesting additional data or information.

A "not substantially equivalent" determination, or a request for additional
information, could delay or prevent the market introduction of new products for
which we file such notifications. For any of our products that are cleared
through the 510(k) process, modifications or enhancements that could
significantly affect the safety or efficacy of the device or that constitute a
major change to the intended use of the device will require new 510(k)
submissions. The FDA has implemented a policy under which certain device
modifications may be submitted as a "Special 510(k)," which will require only a
30-day review. Special 510(k) s are limited to those device modifications that
do not affect the intended use or alter the fundamental scientific technology of
the device and for which substantial equivalence can be demonstrated through
design controls.

A PMA must be filed if a proposed device is not substantially equivalent to a
legally marketed Class I or Class II device, or if it is a Class III device for
which FDA has called for PMA. A PMA must be supported by valid scientific
evidence that typically includes

                                      12
<PAGE>

extensive data, including preclinical and clinical trial data, to demonstrate
the safety and effectiveness of the device, as well as extensive manufacturing
information.

FDA review of a PMA generally takes one to two years from the date the PMA is
accepted for filing, but may take significantly longer. The review time is often
significantly extended should the FDA ask for more information or clarification
of information already provided in the submission.

During the PMA review period, an advisory committee, typically a panel of
clinicians, will likely be convened to review and evaluate the application and
provide recommendations to the FDA as to whether the device should be approved.
The FDA is not bound by the recommendations of the advisory panel. Toward the
end of the PMA review process, the FDA generally will conduct an inspection of
the manufacturer's facilities to ensure that they are in compliance with
applicable good manufacturing practices, or Quality System requirements.

If the FDA's evaluations of both the PMA and the manufacturing facilities are
favorable, the FDA will either issue an approval letter or an "approvable
letter," which usually contains a number of conditions which must be met in
order to secure final approval of the PMA. When and if those conditions have
been fulfilled to the satisfaction of the FDA, the agency will issue an approval
letter, authorizing commercial marketing of the device for certain indications.
If the FDA's evaluation of the PMA or manufacturing facilities is not favorable,
the FDA will deny approval of the PMA or issue a "not approvable letter." The
FDA may also determine that additional clinical trials are necessary, in which
case PMA approval may be delayed up to several years while additional clinical
trials are conducted and submitted in an amendment to the PMA. The PMA process
can be expensive, uncertain and lengthy, and a number of devices for which other
companies have sought FDA approval have never been approved for marketing.

Modifications to a device that is the subject of an approved PMA (including
modifications to its labeling or manufacturing process) may require approval by
the FDA of PMA supplements or new PMAs. Supplements to a PMA often require the
submission of the same type of information required for an initial PMA, except
that the supplement is generally limited to that information needed to support
the proposed change from the product covered by the original PMA.

If clinical trials of a device are required in connection with either a 510(k)
notification or a PMA and the device presents a "significant risk," the sponsor
of the trial (usually the manufacturer or the distributor of the device) is
required to file an investigational device exemption ("IDE") application prior
to commencing clinical trials. The IDE application must be supported by data,
typically including the results of animal and laboratory testing. If the IDE
application is reviewed and approved by the FDA and one or more appropriate
Institutional Review Boards ("IRBs"), clinical trials may begin at a specific
number of investigational sites with a specific number of patients, as approved
by the FDA. If the device presents a "non-significant risk" to the patient, a
sponsor may begin the clinical trials after obtaining approval for the study by
one or more appropriate IRBs, but not the FDA. For "significant risk" devices,
an IDE supplement must be submitted to and approved by the FDA before a sponsor
or an investigator may make a change to the investigational plan that may affect
its scientific soundness or the rights, safety or welfare of human subjects. IRB
approval may be required for changes in the investigational plan for both
non-significant risk and significant risk devices.

Any products manufactured or distributed by us pursuant to FDA clearances or
approvals are subject to extensive regulation by the FDA, including reporting
and record keeping requirements. Device manufacturers are required to register
their establishments and list their devices with the FDA and certain state
agencies, and are subject to periodic inspections by the FDA and certain state
agencies. The FFD&C Act requires devices to be manufactured in accordance with
GMP regulations that impose certain procedural and documentation requirements
upon us with respect to manufacturing and quality assurance activities. Medical
devices are also subject to post-market reporting requirements for deaths or
serious injuries when the device may have caused or contributed to the death or
serious injury, and for certain device malfunctions that would be likely to
cause or contribute to a death or serious injury if the malfunction were to
recur. If safety or efficacy problems occur after the product reaches the
market, the FDA may impose severe limitations on the use of any approved or
cleared product.

Labeling and promotion activities are subject to scrutiny by the FDA and, in
certain instances, by the Federal Trade Commission. The FDA actively enforces
regulations prohibiting marketing of products for unapproved or uncleared uses.
We, as well as our products, are also subject to a variety of state laws and
regulations in those states or localities where our products are or will be
marketed. Any applicable state or local regulations may hinder our ability to
market our products in those states or localities. Manufacturers are also

                                      13
<PAGE>

subject to numerous federal, state and local laws relating to such matters as
safe working conditions, manufacturing practices, environmental protection, fire
hazard control and disposal of hazardous or potentially hazardous substances.
There can be no assurance that we will not be required to incur significant
costs to comply with such laws and regulations now or in the future or that such
laws or regulations will not have a material adverse effect upon our ability to
do business.

We are currently manufacturing VITOSS and CORTOSS in the United States and
distributing VITOSS in the United States, Europe, Australia and Israel and
CORTOSS in Europe and Australia. We are manufacturing IMBIBE through outside
third-party contract manufacturers for distribution in the United States.
VITOSS, as well as any other products that we manufacture or distribute
following the approval thereof by the FDA, will be subject to extensive
regulation by the FDA. If safety and efficacy problems occur after the product
reaches the market, the FDA may impose severe limitations on the use of any
approved product. Moreover, modifications to the approved or cleared product may
require the submission of a new premarket approval application or a premarket
application supplement, or a new 510(k) notification. We may not be successful
in obtaining the approval or clearance of any new premarket approval
applications, necessary premarket approval application supplements, or new
510(k) notifications in a timely manner, if at all. Noncompliance with
applicable requirements can result in, among other things, fines, injunctions,
civil penalties, recall or seizure of products, total or partial suspension of
production, failure of the government to grant premarket clearance or premarket
approval for devices, withdrawal of marketing approvals and criminal
prosecution.

Europe

In order to sell our products within the European Union, we are required to
achieve compliance with the requirements of the European Union Medical Devices
Directive (the "MDD") and affix a CE marking on our products to attest such
compliance. To achieve this, our products must meet the "essential requirements"
defined under the MDD relating to safety and performance and we must
successfully undergo a verification of our regulatory compliance ("conformity
assessment") by an independent notified body. We have selected the TNO, or the
Netherlands Organization for Applied Scientific Research, as our notified body.
The nature of the conformity assessment will depend on the regulatory class of
our products. Under European law, our products, other than IMBIBE and ALIQUOT,
are likely to be in Class III. In the case of Class III products, we must (as a
result of the regulatory structure which we have elected to follow) establish
and maintain a complete quality system for design and manufacture as described
in Annex II of the MDD (this corresponds to a quality system for design in ISO
9001 and EN 46001 standards). Our notified body has audited our quality system
and determined that it meets the requirements of the MDD. In addition, the
notified body must approve the specific design of each device in Class III. As
part of the design approval process, the notified body must also verify that the
products comply with the essential requirements of the MDD. In order to comply
with these requirements, we must, among other things, complete a risk analysis
and may be required to present sufficient clinical data. The clinical data
presented by us must provide evidence that the products meet the performance
specifications claimed by us, provide sufficient evidence of adequate assessment
of unwanted side effects and demonstrate that the benefits to the patient
outweigh the risks associated with the device. We will be subject to continued
surveillance by the notified body and will be required to report any serious
adverse incidents to the appropriate authorities. We also will be required to
comply with additional national requirements that are beyond the scope of the
MDD.

THIRD-PARTY REIMBURSEMENT

Successful sales of our products in the United States and other markets will
depend on the availability of adequate reimbursement from third-party payers. In
the United States, healthcare providers, such as hospitals and surgeons that
purchase medical devices for treatment of their patients, generally rely on
third-party payers to reimburse all or part of the costs and fees associated
with the procedures performed with these devices. Both public and private
insurance reimbursement plans are central to new product acceptance. The Health
Care Financing Administration Centers for Medicare and Medicaid Services ("CMS,"
formerly the Health Care Financing Administration or "HCFA") administers the
policies and guidelines for coverage and reimbursement of health care providers
treating Medicare beneficiaries in the United States through local fiscal
intermediaries and carriers. Medicaid, designed to pay providers for care given
to medically needy persons, is dually funded by federal and state appropriations
and is administered by each state in the United States. If a procedure or
service is deemed "medically necessary" under applicable Medicare or Medicaid
rules, providers may be reimbursed under Medicare or Medicaid for the service.
The United States Medicare inpatient reimbursement system is a prospective
reimbursement system whereby rates are set in advance, fixed for a specific
fiscal period, constitute full institutional payment for the designated health
service and generally do not vary with hospital treatment costs. Medicare also
reimburses outpatient services based on a predetermined fee schedule. Similarly,
some states reimburse certain healthcare providers for inpatient services under
their Medicaid programs by using prospective rates for diagnosis-related groups
of illnesses. Therefore, healthcare providers may refuse to use our products if
reimbursement is inadequate.

                                      14
<PAGE>

Inadequate reimbursement by private insurance companies and government programs
could significantly reduce usage of our products. In addition, an increasing
emphasis on managed care in the U.S. has placed, and we believe will continue to
place, greater pressure on medical device pricing. Such pressures could have a
material adverse effect on our ability to sell our products and to raise
capital. Failure by hospitals and other users of our products to obtain coverage
or reimbursement from third-party payers or changes in governmental and private
third-party payers' policies toward reimbursement for procedures employing our
products would reduce demand for our products.

Member countries of the European Union operate various combinations of centrally
financed health care systems and private health insurance systems. The relative
importance of government and private systems varies from country to country. The
choice of devices is subject to constraints imposed by the availability of funds
within the purchasing institution. Medical devices are most commonly sold to
hospitals or health care facilities at a price set by negotiation between the
buyer and the seller. A contract to purchase products may result from an
individual initiative or as a result of a competitive bidding process. In either
case, the purchaser pays the supplier, and payment terms vary widely throughout
the EU. Failure to obtain favorable negotiated prices with hospitals or health
care facilities could adversely affect sales of our products.

In Japan, at the end of the regulatory approval process, the Ministry of Health,
Labor and Welfare ("MHW") makes a determination of the reimbursement level of
the product. The MHW can set the reimbursement level for our products at their
discretion, and we may not be able to obtain regulatory approval in Japan or if
such approval is granted, we may not obtain a favorable per unit reimbursement
level.

PRODUCT LIABILITY AND INSURANCE

We manufacture medical devices that are used on patients in surgery, and we may
be subject to product liability lawsuits. While we have not experienced any
product liability claims to date, there can be no assurance that product
liability claims will not be asserted against us. Under certain of our
agreements with our distributors and agencies, we indemnify the distributor or
agency from product liability claims. Any product liability claim brought
against us, with or without merit, could result in the increase of our product
liability insurance rates or the inability to secure coverage in the future. In
addition, we would have to pay any amount awarded by a court in excess of policy
limits. We maintain product liability insurance in the annual aggregate amount
of up to $10 million, although our insurance policies have various exclusions.
Thus, we may be subject to a product liability claim for which we have no
insurance coverage, in which case we may have to pay the entire amount of any
award.

EMPLOYEES

As of December 31, 2001, we had 70 full-time employees, with 65 employees at our
Malvern, Pennsylvania headquarters and 5 employees in Europe. We had an average
of 65, 51 and 42 employees in 2001, 2000 and 1999, respectively. The increase in
number of employees for the period from 1999 through 2001 is attributed
primarily to continued development of manufacturing, marketing and sales
capabilities. In general, we consider our relations with our employees to be
good.

ITEM 2.   PROPERTIES

Our headquarters are located at the Great Valley Corporate Center in Malvern,
Pennsylvania, which is a suburb of Philadelphia. We conduct all of our principal
activities at two adjacent facilities that total 32,000 square feet. Our
manufacturing and research and development facility is leased through July 2012,
and our administrative facility is leased through July 2007. We also have our
international sales and marketing activities based in our administrative office
in Leuven, Belgium.

ITEM 3.   LEGAL PROCEEDINGS

In July 1992, we obtained a license from FBFC International, a Belgian company,
that allowed us to manufacture and sell the BIOGRAN dental grafting product. We
sold the rights to sell our BIOGRAN product line to Implant Innovations, Inc.
("3i") in March 2000. In July 1994, U.S. Biomaterials Corporation filed with the
U.S. Patent and Trademark Office ("PTO") a Request for Reexamination of the U.S.
patent held by FBFC for BIOGRAN, of which we had been the exclusive licensee.
FBFC filed a response in this proceeding, establishing that the claims of the
FBFC patent were properly allowed. As a result, a Certificate of Reexamination
was issued by the PTO confirming the patentability of all claims of the FBFC
patent

                                      15
<PAGE>

without amendment. However, U.S. Biomaterials Corporation instituted a
nullification proceeding against the European counterpart to FBFC's U.S.
patent. The opposition division of the European Patent Office tentatively
decided in FBFC's favor, but the matter is still proceeding under an appeal. In
connection with the BIOGRAN sale to 3i, 3i has assumed control of this matter
and we have agreed to reimburse 3i for the associated legal costs and to
provide them with certain indemnification with respect to the matter. We do not
believe there are any material liabilities with respect to the indemnification
for this matter.

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

We did not submit any matters to a vote of security holders during the fourth
quarter of 2001.

                                     PART II

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

Our Common Stock is quoted on both the Nasdaq National Market ("Nasdaq") and
Nasdaq Europe under the symbol "VITA". We began trading on Nasdaq on August 2,
2000. The following table reflects the ranges of high and low sale prices for
our Common Stock as reported on the Nasdaq and Nasdaq Europe for the stated
periods.

                                           Nasdaq              Nasdaq Europe
                                           ------              -------------
                                      High        Low        High         Low
                                    --------    -------    --------     -------
2001:
     First Quarter.............         $ 6.56     $ 3.50     $ 6.00      $ 3.30
     Second Quarter............           5.56       3.70       5.25        3.55
     Third Quarter.............           3.76       2.00       3.65        1.90
     Fourth Quarter............           3.41       1.30       3.50        1.35
2000:
     First Quarter.............      ---        ---           $ 9.50      $ 4.50
     Second Quarter............      ---        ---             7.80        4.80
     Third Quarter.............         $ 8.13     $ 5.50       7.90        5.80
     Fourth Quarter............           6.38       3.56       6.40        3.05

As of March 22, 2002 there were 153 holders of record of our Common Stock. Since
a portion of our Common Stock is held in "street" or nominee name, we are unable
to determine the exact number of beneficial holders. On March 22, 2002, the last
reported sale price of the common stock as reported Nasdaq and Nasdaq Europe was
$2.26 and $2.10 per share, respectively. We have never declared or paid cash
dividends on our Common Stock and do not anticipate paying any cash dividends in
the foreseeable future.

On December 20, 2001, we sold 625,000 shares of our Common Stock to S.A.C.
Capital Associates, LLC ("S.A.C."), and 500,000 shares of our Common Stock to
SDS Merchant Fund, L.P ("SDS"). The aggregate consideration we received for
these shares consisted of $2,700,000 in cash, plus the surrender and
cancellation of outstanding warrants to purchase an aggregate of 1,125,000
shares of our Common Stock held by S.A.C. and SDS. The issuance of these
securities was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933 and Rule 506 of Regulation D as an issuer transaction not
involving a public offering.

                                      16
<PAGE>

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

     The following table presents selected historical consolidated financial
data that have been derived from the consolidated financial statements of
Orthovita, Inc. and subsidiaries as of and for each of the five years in the
period ended December 31, 2001 which have been audited by Arthur Andersen LLP,
independent public accountants. This data should be read in conjunction with
our consolidated financial statements, including notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," included in this report.

<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                        -------------------------------------------------------
                                                    2001              2000           1999            1998           1997
                                                 ---------         ---------      ----------      ----------  -------------
<S>                                                <C>             <C>             <C>            <C>           <C>
Statement of Operations Data:
Product sales /(1)/......................           $  3,940,395    $    740,660    $ 1,054,120    $ 2,780,658   $ 3,311,540
Cost of sales /(2)/......................                719,373         170,041        324,590        927,792     1,096,848
Operating expense........................             17,474,630      15,191,162     10,755,317      7,897,961     9,998,945
Other income.............................               (88,189)       (214,273)      (529,193)      (344,307)     (228,336)
Net gain on sale of product line /(1)/...              (375,000)     (3,070,921)            --             --            --
Accretion of preferred stock.............                   --              --              --         391,213       536,517
                                                 --------------- --------------- --------------  ------------- -------------
Net loss applicable to common
   Shareholders..........................          $(13,790,419)   $(11,335,349)   $(9,496,594)   $(6,092,001)  $(8,092,434)
                                                 =============== =============== ==============  ============= =============
Net loss per common share, basic and
   Diluted...............................              $  (0.82)        $ (0.92)      $  (0.83)     $   (0.73)     $  (1.60)
                                                 =============== =============== ==============  ============= =============
Shares used in computing net loss per
   common share, basic and diluted.......             16,841,970      12,281,117     11,411,896      8,314,679     5,050,397
                                                 =============== =============== ==============  ============= =============
</TABLE>

<TABLE>
<CAPTION>
                                                                           As of December 31,
                                                        -------------------------------------------------------
                                                    2001              2000           1999            1998           1997
                                                 ---------         ---------      ----------      ----------  -------------
<S>                                                <C>             <C>             <C>            <C>             <C>
Balance Sheet Data:
Cash, cash equivalents and short-term
   investments...........................          $ 12,906,557    $ 3,814,992     $ 8,873,545     $ 15,355,808   $ 2,257,902
Total assets.............................            21,212,843     10,188,367      11,321,446       18,888,632     4,862,010
Working capital (deficit)................            12,713,603        747,835       4,118,730       14,471,102    (1,080,859)
Long-term liabilities....................             5,634,626      1,307,425         616,726          737,427       832,991
Redeemable convertible preferred
   stock.................................                   --             --              --               --      7,383,090
Total shareholders' equity (deficit).....            12,670,441      5,129,615       5,646,669       15,528,575    (7,712,696)
</TABLE>

/(1)/    For 2001, product sales primarily represent VITOSS sales in the U.S.,
         Europe, Australia and Israel. For 2000, product sales represent VITOSS
         sales in Europe and BIOGRAN product sales prior to the sale of the
         BIOGRAN product line. On March 22, 2000, we sold the BIOGRAN dental
         grafting product line to Implant Innovations, Inc. ("3i") for
         $3,900,000 (See Note 11 of Notes to Consolidated Financial Statements).
/(2)/    Cost of Sales for the year ended December 31, 2000 primarily reflects
         cost of sales of BIOGRAN, since prior to European approval of VITOSS in
         July 2000, costs of producing VITOSS were charged to Research &
         Development expenses.

                                      17
<PAGE>

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

FORWARD-LOOKING STATEMENTS

The use of the words "Orthovita", the "Company", "we", "us" or "our" herein
refers to Orthovita, Inc. In addition to historical facts or statements of
current conditions, this report contains forward-looking statements. When used
in this Form 10-K, the words "may," "will," "expect," "anticipate," "intend,"
"plan," "believe," "seek," "estimate" and similar expressions are generally
intended to identify forward-looking statements, but are not the exclusive
expressions of forward-looking statements. Forward-looking statements involve
risks and uncertainties; therefore, readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
made. Furthermore, we undertake no obligation to publicly update any forward-
looking statements. We claim the protections afforded by the Private Securities
Litigation Reform Act of 1995, as amended, for our forward-looking statements.
Some of the factors that could cause actual events or results to differ
materially from those expressed or implied by forward-looking statements are
addressed in the "Certain Risks Related to Our Business" section which is below.

OVERVIEW

Orthovita, Inc. ("Orthovita" or the Company) is a Pennsylvania corporation with
proprietary technologies applied to the development of biostructures, which are
synthetic, biologically active, tissue engineering products for restoration of
the human skeleton. Our focus is on developing products for use in spine surgery
and in the repair of osteoporotic fractures. We are also addressing a broad
range of clinical needs in the trauma market. We have developed several products
to date:

     -     VITOSS(TM)Scaffold Synthetic Cancellous Bone Void Filler;

           -   IMBIBE(TM)Bone Marrow Aspirate Syringe to be used with VITOSS;

     -     CORTOSS(TM)Synthetic Cortical Bone Void Filler;

           -   ALIQUOT(TM) Microdelivery System to be used with CORTOSS.

In addition, we are developing RHAKOSS(TM) Synthetic Bone Spinal Implants.

VITOSS is a resorbable, beta-tricalcium phosphate scaffold used as a bone void
filler in trauma and spinal procedures. CORTOSS is a high-strength,
bone-bonding, self-setting composite intended for use in the augmentation of
screws used in a variety of orthopaedic procedures and in vertebral
augmentation. RHAKOSS is under development as a high-strength, bone-bonding
preformed composite. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets.

We received regulatory clearance for VITOSS in the U.S. from the United States
Food and Drug Administration ("FDA") in December 2000 and the CE Mark in the
European Union from our notified body in July 2000. The CE Mark permits us to
sell VITOSS in all of the countries of the European Union, as well as in other
countries, such as Switzerland and Israel, that have adopted the European
Union's regulatory standards. These regulatory approvals allow us to market
VITOSS for use as a cancellous bone void filler for bony voids or gaps of the
skeletal system, including the extremities, spine and pelvis. We also received
regulatory approval in March 2001 to sell VITOSS for this use in Australia. We
launched VITOSS in Europe in October 2000 and in the United States in February
2001. In April 2001, we entered into an agreement with Japan Medical Dynamic
Marketing, Inc. ("MDM"), an orthopaedic company in Japan, under which MDM will
initiate clinical studies necessary to apply for regulatory approval to market
VITOSS in Japan. In September 2001, we received regulatory clearance in the
United States from the FDA to market IMBIBE for use as a bone marrow aspiration
syringe. IMBIBE provides spine and trauma surgeons with a simple method for
harvesting a patient's own bone marrow, mixing it with VITOSS and delivering the
mixture to the bone graft site.

We received the CE Mark for CORTOSS in October 2001 in the European Union and
regulatory approval in March 2001 in Australia which allows us to sell CORTOSS
in these territories for use in screw augmentation procedures. Screw
augmentation is a procedure for the fixation of bone screws used in patients
with weak bone caused by osteoporosis. We initiated a limited launch of CORTOSS
in Europe in December 2001. In addition, we are conducting post-marketing human
clinical studies in Europe for the use of CORTOSS in hip compression screw
augmentation. We are also pursuing clinical studies of CORTOSS in Europe seeking
to expand its label to include its use in vertebral augmentation. During 2001,
we received conditional approval from the FDA to conduct a pilot clinical

                                      18
<PAGE>

study in the U.S. for the use of CORTOSS for vertebral augmentation. In
addition, during 2002, we received approval from the FDA to conduct a pivotal
clinical study in the U.S. for the use of CORTOSS for long bone screw
augmentation. There can be no assurance that the data from any such clinical
trials will support FDA clearance or approval to market this product for these
uses.

Our ALIQUOT Microdelivery System facilitates effective delivery of our CORTOSS
product directly to the surgical site. A two-part system of catheter and
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation procedures.

RHAKOSS is designed to mimic the strength and flexibility characteristics of
bone, as well as its radiolucency, which means its degree of transparency to
x-rays and other radiation. RHAKOSS can be manufactured into any size or shape
to optimize anatomic fit. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets. We initiated
pre-clinical studies for our RHAKOSS spinal implants in December 2000 and our
goal is to initiate human clinical studies in Europe in 2002.

We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are utilizing this network for CORTOSS in Europe,
Australia and Israel. If MDM is successful in obtaining approval to market
VITOSS, it will distribute, sell and market VITOSS in Japan. We plan to seek a
similar arrangement for CORTOSS in Japan.

CRITICAL ACCOUNTING POLICIES

Our discussions and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities, revenues and expenses and disclosures of contingent assets and
liabilities as of the date of the financial statements. On an on-going basis, we
evaluate our estimates, including, but not limited to, those related to accounts
receivable and inventories. We use authoritative pronouncements, historical
experience and other assumptions as the basis for making estimates. Actual
results could differ from those estimates. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our consolidated financial statements.

Revenue

Revenue from product sales is recognized upon the receipt of a valid order and
shipment to our distributor customers in Europe, Australia and Israel. In the
U.S., product sales revenue is recognized upon the receipt of a valid order and
shipment of the product to the end user hospital. We do not allow product
returns or exchanges. In addition, collection of the customers' receivable
balance must be deemed probable. We maintain an accounts receivable allowance
for an estimated amount of losses that may result from customers' inability to
pay for product purchased. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.

Inventory

Inventory is stated at the lower of cost or market value using the first-in
first-out basis, or FIFO, method. If market value declines, we would write down
our inventory, if necessary, by estimating the potential for future loss based
on a variety of factors, including the quantity of particular items, their
prospect for replacement or obsolescence and the remaining shelf life. If actual
market conditions were to be less favorable than those projected by management
and demand decreased, inventory write-downs would be required. As of December
31, 2001, we have not needed to write down our inventory.

Revenue Interest Obligation

During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Capital Royalty Acquisition Fund, L.P. ("Paul Royalty") in
which we sold a revenue interest and 2,582,645 shares of our Common Stock.

The net proceeds of the financing were first allocated to the fair value of the
Common Stock on the date of the transaction, and the $5,222,107 remainder of the
net proceeds was allocated to the revenue interest obligation. Given that the
products subject to the revenue interest have only recently been approved and
marketed or are still under development, we, as of December 31, 2001 and for the
foreseeable future, cannot make a reasonable estimate of their future sales
levels and the related revenue interest obligation. Accordingly, in 2002 and the
foreseeable future, we will charge revenue interest expense payments due under
the revenue interest obligation as incurred.

On March 22, 2002, the agreement with Paul Royalty was modified whereby they
exchanged 860,882 shares of our Common Stock for elimination of certain
potential credits allowable to us against our revenue interest obligation, as
well as, a reduction in the repurchase price (described below in Certain Risks
Related to Our Business). This modification will be accounted for as a treasury
stock transaction with a decrease to shareholders' equity and an increase to the
revenue interest obligation based upon the fair market value of the Common Stock
on the date of the modification to the transaction, or $2.26 per share or
$1,946,454 in the aggregate.
<PAGE>

Income Taxes

We account for income taxes in accordance with SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected tax
consequences of events that have been recognized in the financial statements or
tax returns. SFAS No. 109 requires that deferred tax assets and liabilities be
recorded without consideration as to their realizability. The deferred tax asset
includes the cumulative temporary difference related to certain research, patent
and organizational costs, which have been charged to expense in our Statements
of Operations contained in this Form 10-K but have been recorded as assets for
federal tax return purposes. These tax assets are amortized over periods
generally ranging from 5 to 20 years for federal tax purposes. The portion of
any deferred tax asset for which it is more likely than not that a tax benefit
will not be realized must then be offset by recording a valuation allowance
against the asset. A valuation allowance has been established against all of our
deferred tax assets since the realization of the deferred tax asset is not
assured given our history of operating losses.

Stock Options

We apply Accounting Principal Board Opinion No. 25, "Accounting for Stock Issued
to Employees," ("APB 25") and the related interpretations in accounting for our
stock option plans. Under APB 25, compensation cost related to stock options is
computed based on the intrinsic value of the stock option at the date of grant,
reflected by the difference between the exercise price and the fair value of our
Common Stock. Under SFAS No. 123, "Accounting for Stock-Based Compensation,"
compensation cost related to stock options is computed based on the value of the
stock options at the date of grant using an option valuation methodology,
typically the Black-Scholes model. SFAS No. 123 can be applied either by
recording the Black-Scholes model value of the options or by continuing to
record the APB 25 value and by disclosing SFAS No. 123. We have applied the pro
forma disclosure requirement of SFAS No. 123, "Accounting for Stock-Based
Compensation".

Research & Development Costs

In accordance with SFAS No. 2 "Accounting for Research and Development Costs,"
we expense all research and development expenses as incurred.

CERTAIN RISKS RELATED TO OUR BUSINESS

We are dependent on the commercial success of CORTOSS and VITOSS.

We are highly dependent on successfully selling our products which have received
regulatory approval. We expect approvals for our products under development, if
obtained at all, to take several years. To date, we have received regulatory
approval to market VITOSS and CORTOSS for specified uses in the European Union
and Australia and countries adhering to the regulatory standards of the European
Union. We have also received regulatory clearance to market VITOSS in the United
States. Certain factors that could affect sales of VITOSS and CORTOSS include
the following:

         We may be unable to increase sales of our approved products.

         Because our products have only recently been approved and the markets
         for our products are evolving, we cannot accurately predict either the
         future growth rate of product sales if any, or the ultimate size of
         these markets. Surgeons will not use our products unless they
         determine, based on experience, clinical data and recommendations from
         prominent surgeons and mentors, that our products are safe and
         effective. In addition, surgeons may be slow to change their medical
         treatment practices because of perceived liability risks arising from
         the use of new products and the uncertainty of third party
         reimbursement for our products.

         Market acceptance of our products will largely depend on our ability to
         demonstrate their relative safety, efficacy, cost-effectiveness and
         ease of use. Our products are based on new technologies that have not
         been previously used and must compete with more established treatments
         currently accepted as the standards of care. The attributes of some of
         our products may require some changes in surgical techniques that have
         become standard within the medical community, and there may be
         resistance to change. Therefore, for these products, we must be able to
         convince surgeons who currently favor existing

                                      20
<PAGE>

         techniques to switch to new procedures that would use our products.
         Many surgeons will not purchase our products until there is
         sufficient, long-term clinical evidence to convince them to alter
         their existing treatment methods. We believe our initial product
         sales have been made to a group of early adopting surgeons.

         We have generated minimal revenues from product sales into the
         orthopaedic spine and trauma markets since we launched VITOSS and
         CORTOSS, our first orthopaedic products to be approved. Certain factors
         which may limit our ability to increase sales include:

         -our dependence on the efforts of independent agents and distributors
         to promote the use of our products, over which we have limited control,
         and our dependence on the continued publication of independent
         pre-clinical and clinical data to support the use of our products,
         -our need to train a sufficient number of surgeons to create demand for
         our products, and
         -the need of payors to authorize insurance reimbursement for procedures
         using our products.

         We may not be able to operate an effective sales and distribution
         network.

         We have assembled a network of independent stocking distributors in
         Europe, Australia and Israel and commissioned sales agencies in the
         U.S. in order to market VITOSS, and we are utilizing this network for
         CORTOSS in Europe, Australia and Israel. We also intend to distribute
         VITOSS and CORTOSS through a third party strategic alliance in Japan if
         they are approved there. Any failure to maintain and manage our
         distribution network will impair our ability to generate sales and
         become profitable.

         We are dependent upon these distributors and agencies for the sale of
         our products. There can be no assurance that the distributors and
         agencies will perform their obligations in their respective territories
         as expected, or that we will continue to derive any revenue from these
         arrangements. We cannot assure that our interests will continue to
         coincide with those of our distributors and agencies. In addition, we
         cannot assure that they will not develop, independently or with
         alternative companies, other products that could compete with our
         products.

         The independent U.S. agencies selling VITOSS generally sell products
         from other orthopaedic companies. A single agency may sell to end user
         hospitals VITOSS, as well as, metal plates and screws and titanium
         spinal cages. Should any of these other orthopaedic companies add a
         bone graft material to their product line, our independent agencies
         could decide to eliminate VITOSS and terminate their arrangement with
         us. Our sales could be adversely affected if one or more of our
         successful agencies eliminated VITOSS from their product line and
         terminated their agency arrangements with us.

         In addition, our ability to penetrate the markets that we intend to
         serve is highly dependent upon the quality and breadth of the other
         product lines which our distribution network carries, the components of
         which may change from time to time, and over which we have little or no
         control. The complete product line represented by the distributors and
         agencies, including our products, is an important factor in the
         distributors' or agencies' ability to penetrate the market.

         We may not train a sufficient number of surgeons to create demand for
         our products.

         It is critical to the commercial success of our products that our
         independent distributors and agents succeed in training a sufficient
         number of surgeons and in providing them adequate instruction in the
         use of our products. This training requires a commitment of time and
         money by surgeons, which they may be unwilling to give. Even if
         surgeons are willing, if they are not properly trained, they may misuse
         or ineffectively use our products. This may result in unsatisfactory
         patient outcomes, patient injury, negative publicity or lawsuits
         against us, any of which could damage our business and reduce product
         sales.

         If health care providers cannot obtain third-party reimbursement for
         procedures using our products, or if such reimbursement is inadequate,
         we may never become profitable.

         Successful sales of our products in the United States and other markets
         will depend on the availability of adequate reimbursement from
         third-party payors. In the United States, healthcare providers, such as
         hospitals and surgeons that purchase medical devices for treatment of
         their patients, generally rely on third-party payors to reimburse all
         or part of the costs and fees associated with the procedures performed
         with these devices. Both public and private insurance

                                      21
<PAGE>

         reimbursement plans are central to new product acceptance. The Health
         Care Financing Administration Centers for Medicare and Medicaid
         Services ("CMS," formerly the Health Care Financing Administration or
         "HCFA") administers the policies and guidelines for coverage and
         reimbursement of health care providers treating Medicare beneficiaries
         in the United States through local fiscal intermediaries and carriers.
         Medicaid, designed to pay providers for care given to medically needy
         persons, is dually funded by federal and state appropriations and is
         administered by each state in the United States. If a procedure or
         service is deemed "medically necessary" under applicable Medicare or
         Medicaid rules, providers may be reimbursed under Medicare or Medicaid
         for the service. The United States Medicare inpatient reimbursement
         system is a prospective reimbursement system whereby rates are set in
         advance, fixed for a specific fiscal period, constitute full
         institutional payment for the designated health service and generally
         do not vary with hospital treatment costs. Medicare also reimburses
         outpatient services based on a predetermined fee schedule. Similarly,
         some states reimburse certain healthcare providers for inpatient
         services under their Medicaid programs by using prospective rates for
         diagnosis-related groups of illnesses. Therefore, healthcare providers
         may refuse to use our products if reimbursement is inadequate.

         Inadequate reimbursement by private insurance companies and government
         programs could significantly reduce usage of our products. In addition,
         an increasing emphasis on managed care in the U.S. has placed, and we
         believe will continue to place, greater pressure on medical device
         pricing. Such pressures could have a material adverse effect on our
         ability to sell our products. Failure by hospitals and other users of
         our products to obtain coverage or reimbursement from third-party
         payors or changes in governmental and private third-party payors'
         policies toward reimbursement for procedures employing our products
         would reduce demand for our products.

         Member countries of the European Union operate various combinations of
         centrally financed health care systems and private health insurance
         systems. The relative importance of government and private systems
         varies from country to country. The choice of devices is subject to
         constraints imposed by the availability of funds within the purchasing
         institution. Medical devices are most commonly sold to hospitals or
         health care facilities at a price set by negotiation between the buyer
         and the seller. A contract to purchase products may result from an
         individual initiative or as a result of a competitive bidding process.
         In either case, the purchaser pays the supplier, and payment terms vary
         widely throughout the EU. Failure to obtain favorable negotiated prices
         with hospitals or health care facilities could adversely affect sales
         of our products.

         In Japan, at the end of the regulatory approval process, the Ministry
         of Health, Labor and Welfare ("MHW") makes a determination of the
         reimbursement level of the product. The MHW can set the reimbursement
         level for our products at their discretion, and we may not be able to
         obtain regulatory approval in Japan or if such approval is granted, we
         may not obtain a favorable per unit reimbursement level.

We have experienced negative operating cash flows since our inception and have
funded our operations primarily from proceeds received from sales of our Common
Stock.

We do not expect sales to generate cash flow in excess of operating expenses for
at least the next several years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating and investing
activities. We believe that our existing cash of approximately $12,907,000 as of
December 31, 2001 will be sufficient to meet our currently estimated operating
and investing requirements into early 2003; however, if we do not raise
additional cash during 2002, we may be required to curtail or limit certain
marketing support and research and development activities in order to remain
compliant with our Paul Royalty financial covenants. A curtailment of certain
activities would delay development of certain of our products. We will need to
raise additional funds by the fourth quarter of 2002 to meet the Nasdaq National
Market's continuing listing requirements if the bid price per share of our
Common Stock remains below $3.00 per share. We may seek to obtain additional
funds through equity or debt financings, or strategic alliances with third
parties either alone or in combination with equity. These financings could
result in substantial dilution to the holders of our Common Stock or require
debt service and/or royalty payment arrangements. Any such required financing
may not be available in amounts or on terms acceptable to us. Factors that may
cause our future capital requirements to be greater than anticipated include:

         -unforeseen developments during our preclinical and clinical trials;
         -timing of receipt of required regulatory approvals;
         -unanticipated expenditures in research and development or
          manufacturing activities;
         -delayed market acceptance of our products;
         -unanticipated expenditures in the acquisition and defense of
          intellectual property rights; or
         -the failure to develop strategic alliances for the marketing of some
          of our products.

                                      22
<PAGE>

If adequate financing is not available, we may be required to delay, scale back
or eliminate certain operations. In addition, although we have no present
commitments or understandings to do so, we may seek to expand our operations and
product line via acquisitions or joint ventures. Any such acquisitions or joint
ventures may increase our capital requirements.

If we fail to obtain and maintain the regulatory approvals necessary to sell our
products, sales could be delayed or never realized.

The jurisdictions in which we will seek to market our products will regulate
these products as medical devices. In most circumstances, we and our
distributors and agents must obtain regulatory approvals and otherwise comply
with extensive regulations regarding safety, quality and efficacy standards.
These regulations vary from country to country, and the regulatory review can be
lengthy, expensive and uncertain. We may not obtain or maintain the regulatory
approvals necessary to market our products in our targeted markets. Moreover,
regulatory approvals that are obtained may involve significant restrictions on
the anatomic sites and types of procedures for which our products can be used.
In addition, we may be required to incur significant costs in obtaining or
maintaining our regulatory approvals. If we do not obtain or maintain regulatory
approvals to enable us to market our products in the U.S. or elsewhere, or if
the approvals are subject to significant restrictions, we may never generate
significant revenues. The regulatory requirements in some of the jurisdictions
where we currently market or intend to market our products are outlined below.

United States

Regulation by FDA. The FDA regulates the clinical testing, manufacturing,
labeling, sale, distribution and promotion of medical devices. Before we may
market our products in the U.S., we generally must obtain from the FDA either
market clearance through a Section 510(k) premarket notification or premarket
approval through a premarket approval application. The amount of time and
expenses associated with obtaining a clearance under the Section 510(k)
notification process is usually less than that under the premarket approval
application process. In December 2000, we received notice that the FDA granted
Section 510(k) marketing clearance for VITOSS. The FDA granted Section 510(k)
marketing clearance for IMBIBE in September 2001.

During 2001, we received conditional approval from the FDA to conduct a pilot
clinical study in the U.S. for the use of CORTOSS for vertebral augmentation. In
addition, during 2002, we received approval from the FDA to conduct a pivotal
clinical study in the U.S. for the use of CORTOSS for long bone screw
augmentation. There can be no assurance that the data from any such clinical
trials will support FDA clearance or approval to market this product for these
uses.

We are currently manufacturing VITOSS and CORTOSS in the United States and
distributing VITOSS in the United States, Europe, Australia and Israel and
CORTOSS in Europe and Australia. We are manufacturing IMBIBE and ALIQUOT through
outside third-party contract manufacturers. VITOSS, as well as any other
products that we manufacture or distribute following the approval thereof by the
FDA, will be subject to extensive regulation by the FDA. If safety or efficacy
problems occur after the product reaches the market, the FDA may impose severe
limitations on the use of any approved product. Moreover, modifications to the
approved or cleared product may require the submission of a new premarket
approval application or a premarket approval application supplement, or a new
510(k) notification. We may not be successful in obtaining the approval or
clearance of any new premarket approval applications, necessary premarket
approval application supplements, or new 510(k) notifications in a timely
manner, if at all. Noncompliance with applicable requirements can result in,
among other things, fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production, failure of the government
to grant premarket clearance or premarket approval for devices, withdrawal of
marketing approvals and criminal prosecution.

European Union and Other International Markets

General. International sales of medical devices are subject to the regulatory
requirements of each country in which the products are sold. Accordingly, the
introduction of our products in markets outside the U.S. will be subject to
regulatory clearances in those jurisdictions. The regulatory review process
varies from country to country. Many countries also impose product standards,
packaging and labeling requirements and import restrictions on devices. In
addition, each country has its own tariff regulations, duties and tax
requirements. The approval by foreign government authorities is unpredictable
and uncertain, and can be expensive. Our ability to market our products could be
substantially limited due to delays in receipt of, or failure to receive, the
necessary approvals or clearances.

                                      23
<PAGE>

Requirement of CE marking in the European Union. To market a product in the
European Union, we must be entitled to affix a CE marking, an international
symbol of adherence to quality assurance standards and compliance with
applicable European medical device directives. A CE marking allows us to market
a product in all of the countries of the European Union, as well as in other
countries, such as Switzerland and Israel, that have adopted the European
Union's regulatory standards. To date, we have received a CE marking for the use
of VITOSS as a bone void filler and for the use of CORTOSS in screw
augmentation. Additionally, we are completing clinical trials with CORTOSS for
vertebral augmentation. There can be no assurance that we will receive CE
markings for CORTOSS for any other indications for use or any of our other
products.

Requirement of approval in Japan. In order to market our products in Japan, we
must obtain the approval of the Japanese Ministry of Health, Labor and Welfare.
We will need to conduct clinical trials for VITOSS and CORTOSS in Japan to
obtain approval there for those two products. Accordingly, we entered into a
third party strategic alliance to conduct clinical trials, obtain the necessary
regulatory approvals and market our VITOSS product in Japan. There can be no
assurance that we will ultimately obtain the approvals necessary to market our
products in Japan. While we intend to seek a similar strategic alliance for
CORTOSS in Japan, we cannot assure that we will succeed in achieving such an
alliance.

If we do not manage commercial scale manufacturing capability and capacity for
our products, our product sales may suffer.

We have completed construction of our VITOSS and CORTOSS manufacturing
facilities and have successfully produced commercial product. Our VITOSS and
CORTOSS manufacturing facilities are certified as meeting the requirements of
ISO 9001 and European Norm 46001 for the period July 1, 2000 through July 1,
2003, and are subject to inspection by the FDA for compliance with FDA device
manufacture requirements. We are manufacturing IMBIBE and ALIQUOT through
outside third-party contract manufacturers. In order to commercialize CORTOSS in
the United States, its manufacturing facility is subject to inspection by the
FDA.

Our product sales depend upon, among other things, our ability to manufacture
our products in commercial quantities, in compliance with regulatory
requirements and in a cost-effective manner. The manufacture of our products is
subject to regulation and periodic inspection by various regulatory bodies for
compliance with quality standards. There can be no assurance that the regulatory
authorities will not, during the course of an inspection of existing or new
facilities, identify what they consider to be deficiencies in meeting the
applicable standards and request or seek remedial action.

Failure to comply with such regulations or a delay in attaining compliance may
result in:

-warning letters;
-injunctions suspending our manufacture of products;
-civil and criminal penalties;
-refusal to grant premarket approvals, CE marks or clearances to products that
     are subject to future or pending submissions;
-product recalls or seizures of products; and
-total or partial suspensions of production.

Our ability to manufacture VITOSS and CORTOSS is dependent on a limited number
of specialty suppliers of certain raw materials. The failure of a supplier to
continue to provide us with these materials at a price or quality acceptable to
us, or at all, would have a material adverse effect on our ability to
manufacture these products. Moreover, our failure to maintain strategic reserve
supplies of each significant single-sourced material used to manufacture VITOSS,
CORTOSS and certain products that we may develop in the future may result in a
breach of our material financing agreements. Although we believe that we
maintain good relationships with our suppliers, there can be no guarantee that
such supplies and services will continue to be available with respect to our
current and future commercialized products.

It may be difficult to operate in international markets.

We operate in international markets and a number of risks are inherent in
international operations. For example, international sales and operations may be
limited or disrupted by the imposition of governmental controls, difficulties in
managing international operations, and fluctuations in foreign currency exchange
rates. The international nature of our business subjects us and our

                                      24
<PAGE>

representatives, agents and distributors to the laws and regulations of the
jurisdictions in which they operate, and in which our products are sold.

If losses continue in the long term, it could limit our growth and slow our
generation of revenues.

To date, we have not been profitable. We have incurred substantial operating
losses since our inception and, at December 31, 2001, had an accumulated deficit
of approximately $61,600,000. These losses have resulted principally from:
         -the development and patenting of our technologies;
         -preclinical and clinical studies;
         -preparation of submissions to the FDA and foreign regulatory bodies;
         -the development of manufacturing, sales and marketing capabilities;
          and
         -unforeseen competitor developments which adversely effect our
          distribution channels.

We expect to continue to incur significant operating losses in the future as we
continue our product development efforts, expand our marketing and sales
activities and further develop our manufacturing capabilities. We may not ever
successfully commercialize our products in development. We may never be able to
achieve or maintain profitability in the future and our products may never be
commercially accepted or generate sufficient revenues.

If we fail to meet our obligations under a revenue sharing agreement, we may be
required to repurchase from an investor its right to receive revenues on certain
of our product sales and the investor could foreclose on certain assets that are
essential to our operations.

During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Royalty. We will use the proceeds realized from this
financing for clinical development, marketing programs, and working capital
relating to our VITOSS, CORTOSS and RHAKOSS products. In this financing, we sold
Paul Royalty a revenue interest and sold 2,582,645 shares of our Common Stock,
for aggregate gross proceeds of $10,000,000. The Common Stock was recorded at
its market value of $4,777,893 and a revenue interest obligation related to the
revenue interest of $5,222,107 was recorded.

The net proceeds of the financing were first allocated to the fair value of the
Common Stock on the date of the transaction, and the $5,222,107 remainder of the
net proceeds was allocated to the revenue interest obligation. Given that the
products subject to the revenue interest have only recently been approved and
marketed or are still under development, we, as of December 31, 2001 and for the
foreseeable future, cannot make a reasonable estimate of their future sales
levels and the related revenue interest obligation. Accordingly, in 2002 and the
foreseeable future, we will charge as new expense payments due under the
revenue interest obligation are incurred.

On March 22, 2002, the agreement with Paul Royalty was modified whereby they
exchanged 860,882 shares of our Common Stock for elimination of certain
potential credits allowable to us against our revenue interest obligation, as
well as, a reduction in the repurchase price. This modification will be
accounted for as a treasury stock transaction with a decrease to shareholders'
equity and an increase to the revenue interest obligation based upon the fair
market value of the Common Stock on the date of the modification to the
transaction, or $2.26 per share or $1,946,454 in the aggregate.

The revenue interest provides for Paul Royalty to receive 3.5% on the first
$100,000,000 of annual sales plus 1.75% of annual sales in excess of
$100,000,000 of our VITOSS, CORTOSS and RHAKOSS products in North America and
Europe through 2016, subject to certain adjustments. Our obligation to pay the
revenue interest is secured by our licenses, patents and trademarks relating to
our VITOSS, CORTOSS and RHAKOSS products, in North America and Europe, and the
12% royalty interest we pay to Vita Licensing, Inc., our wholly-owned
subsidiary, on the sales of our products (collectively, the "Pledged Assets").
We are also required to maintain:

-cash and cash equivalent balances equal to or greater than the product of (i)
1.5 and (ii) total operating losses, net of non-cash charges, for the preceding
fiscal quarter; and
-total shareholders' equity of at least $8,664,374; provided, however, that
under the provisions of the agreement with Paul Royalty when calculating
shareholders' equity for the purposes of the financial covenants, the
revenue interest obligation is included in shareholders' equity.

As of December 31 2001, we were in compliance with all financial covenants.
However, if we fail to maintain such balances and shareholders' equity, Paul
Royalty can demand that we repurchase its revenue interest.

In addition to the financial covenants described above, Paul Royalty has the
right to cause us to repurchase their revenue interest upon the occurrence of
certain events, including:

-a judicial decision that has a material adverse effect on our business,
operations, assets or financial condition;
-the acceleration of our obligations or the exercise of default remedies by a
secured lender under certain debt instruments;
-a voluntary or involuntary bankruptcy that involves us or our
wholly owned subsidiary, Vita Special Purpose Corp.;
-our insolvency;
-A change in control of our company;

                                      25
<PAGE>

-the breach of a representation, warranty or certification made by us in the
agreements with Paul Royalty that, individually or in the aggregate, would
reasonably be expected to have a material adverse effect on our business,
operations, assets or financial condition, and such breach is not cured within
30 days after notice thereof from Paul Royalty.

We may not have sufficient cash funds to repurchase the revenue interest upon a
repurchase event. The exact amount of the repurchase price is dependent upon
certain factors, including when the repurchase event occurs. The repurchase
price targets an internal rate of return for Paul Royalty's $10,000,000
investment ranging up to 45% net of revenue interest amounts paid by us to Paul
Royalty during the term of the revenue sharing agreement. If we were unable to
repurchase the revenue interest upon a repurchase event, Paul Royalty could
foreclose on the Pledged Assets, and we could be forced into bankruptcy. Paul
Royalty could also foreclose on the Pledged Assets if we are insolvent or are
involved in a voluntary or involuntary bankruptcy. No repurchase events or
foreclosures have occurred as of December 31, 2001. As of December 31, 2001, if
the repurchase event had been triggered and Paul Royalty exercised their right
to require us to repurchase their revenue interest, we would have owed Paul
Royalty $10,871,750.

The March 2002 amendment reduced by $3,333,333 the amount that would be due to
Paul Royalty should certain repurchase events occur in the future and which
resulted in Paul Royalty requiring us to repurchase the revenue interest
obligation. Had the amendment to the arrangement been executed prior to December
31, 2001 and had a repurchase event been triggered, as of December 31, 2001, we
would have owed Paul Royalty $7,538,417 rather than $10,871,750. If we know that
we will not be in compliance, we will be required to accrete the revenue
interest obligation to the repurchase amount. As of December 31, 2001, we
believe that we will remain in compliance for the foreseeable future with all
covenants and terms of the revenue interest obligation.

Our results of operations may fluctuate due to factors out of our control.

VITOSS, IMBIBE and CORTOSS are currently our only products which have received
regulatory approvals for sale. VITOSS is cleared for sale under a CE Mark in the
European Union and under a 510(k) marketing clearance in the United States.
IMBIBE is cleared for sale under a 510(k) in the United States. CORTOSS is
cleared for sale under a CE Mark in the European Union. We began selling VITOSS
in Europe in the fourth quarter of 2000 and began selling VITOSS in the U.S.
late in the first quarter of 2001. Orthovita began sales of CORTOSS in Europe
and IMBIBE in the United States at the end of 2001. Future levels of CORTOSS and
IMBIBE product sales are difficult to predict. VITOSS product sales are
difficult to predict at this early stage of the product launch process and
VITOSS sales to-date may not be indicative of future sales levels. VITOSS and
CORTOSS sales levels in Europe may fluctuate due to the timing of any
distributor stocking orders and VITOSS and IMBIBE sales levels may fluctuate in
the U.S. due to the timing of orders from hospitals. Our results of operations
may fluctuate significantly in the future as a result of a number of factors,
many of which are outside of our control. These factors include, but are not
limited to:

         -the timing of governmental approvals for our products;
         -unanticipated events associated with clinical and pre-clinical trials
          of our products;
         -the medical community's acceptance of our products;
         -the timing in obtaining adequate third party reimbursement of our
          products;
         -the success of products competitive with ours;
         -our ability to enter into strategic alliances with other companies;
         -expenses associated with development and protection of intellectual
          property matters;
         -establishment of commercial scale manufacturing capabilities;
         -world events effecting logistics and elective surgery trends;
         -the timing of expenses related to commercialization of new products;
          and
         -competitive disruptions to our distribution channels from business
          development arrangements.

The results of our operations may fluctuate significantly from quarter to
quarter and may not meet expectations of securities analysts and investors. This
may cause our stock price to be volatile.

Our business will be damaged if we are unable to protect our proprietary rights
to the technologies used in our products, and we may be subject to intellectual
property infringement claims by others.

We rely on patent protection, as well as a combination of copyright, trade
secret and trademark laws, nondisclosure and confidentiality agreements and
other contractual restrictions to protect our proprietary technology. However,
these measures afford only limited protection and may not adequately protect our
rights. For example, our patents may be challenged, invalidated or circumvented
by third parties. As of March 22, 2002, we own or control four issued U.S.
patents, two allowed patents and ten pending patent applications in the United
States, and several counterparts of certain of these patents and pending patent
applications in Europe, Canada, Mexico and Japan. There can be no assurance that
patents will issue from any of the pending patent applications. Since patent
applications filed prior to December 2000 in the United States are maintained in
secrecy until issued and patent applications filed in the United States after
November 2000 are maintained in secrecy for 18 months, and since publication of
discoveries in the scientific or patent literature tends to lag behind actual
discoveries, we cannot be certain that we or any of our licensors were the first
creator of inventions covered by pending patent applications or that we or any
of our licensors were the first to

                                      26
<PAGE>

file patent applications for the relevant inventions. If we do receive a
patent, it may not be broad enough to protect our proprietary position in the
technology or to be commercially useful to us. In addition, if we lose any key
personnel, we may not be able to prevent the unauthorized disclosure or use of
our technical knowledge or other trade secrets by those former employees.
Furthermore, the laws of foreign countries may not protect our intellectual
property rights to the same extent as the laws of the U.S. Finally, even if our
intellectual property rights are adequately protected, litigation may be
necessary to enforce our intellectual property rights, which could result in
substantial costs to us and result in a diversion of management attention. If
our intellectual property is not adequately protected, our competitors could
use the intellectual property that we have developed to enhance their products
and compete more directly with us, which could damage our business.

In addition, to determine the priority of inventions, we may have to participate
in interference proceedings declared by the U.S. Patent and Trademark Office or
in opposition, nullity or other proceedings before foreign agencies with respect
to any of our existing patents or patent applications or any future patents or
applications, which could result in substantial cost to us. Further, we may have
to participate at substantial cost in International Trade Commission proceedings
to abate importation of goods that would compete unfairly with our products. In
addition to the risk of failing to adequately protect our proprietary rights,
there is a risk that we may become subject to a claim that we infringe upon the
proprietary rights of others. Although we do not believe that we are infringing
the rights of others, third parties may claim that we are doing so. In addition,
because patent applications can take many years to issue, there may be
applications now pending of which we are unaware, which may later result in
issued patents that our products infringe. There is a substantial amount of
litigation over patent and other intellectual property rights in the medical
device industry generally, and in the spinal market segments particularly. If
the holder of patents brought an infringement action against us, the cost of
litigating the claim could be substantial and divert management attention. In
addition, if a court determined that one of our products infringed a patent, we
could be prevented from selling that product unless we could obtain a license
from the owner of the patent. A license may not be available on terms acceptable
to us or at all. Modification of our products or development of new products to
avoid infringement may require us to conduct additional clinical trials for
these new or modified products and to revise our filings with the FDA, which is
time consuming and expensive. If we were not successful in obtaining a license
or redesigning our product, our business could suffer.

Enforceability of Patents. Under Title 35 of the United States Code as amended
by the General Agreement on Tariffs and Trade implementing the Uruguay Round
Agreement Act of 1994, ("Title 35"), patents that issue from patent applications
filed prior to June 8, 1995 will enjoy a 17-year period of enforceability as
measured from the date of patent issue, or a 20-year period of enforceability as
measured from the earliest effective date of filing, whichever is longer.
Patents that issue from applications filed on or after June 8, 1995 will enjoy a
20-year period of enforceability as measured from the date the patent
application was filed or the first claimed priority date, whichever is earlier.
Patents that issue from applications filed on or after June 8, 1995 may be
extended under the term extension provisions of Title 35 for a period of up to
five years to compensate for any period of enforceability lost due to
interference proceedings, government secrecy orders or successful appeals to the
Board of Patent Appeals and Interferences or the Federal courts. Under the Drug
Price Competition and Patent Term Restoration Act of 1984, including amendments
implemented under Title 35, the period of enforceability of the first patent for
a product or use may be extended for up to five years to compensate the patent
holder for the time required for FDA regulatory review of the product. Any
extension under the Patent Term Restoration Act and any extension under Title 35
are cumulative. We may not be able to take advantage of all of the patent term
extension provisions of these laws, and these extensions may not adequately
restore the time lost to the FDA approval process. If the current law is changed
to shorten the duration of patent protection, our ability to protect our
proprietary information and sustain the commercial viability of our products
will decrease. The possibility of shorter terms of patent protection, combined
with the lengthy FDA review process and possibility of extensive delays in such
process, could effectively reduce the term during which a marketed product could
be protected by patents.

FBFC Patent Challenge. In July 1992, we obtained a license from FBFC
International, a Belgian company, that allowed us to manufacture and sell our
BIOGRAN dental grafting products. We sold the rights to sell the BIOGRAN product
line in March 2000 to Implant Innovations, Inc., or 3i. In July 1994, U.S.
Biomaterials Corporation filed with the U.S. Patent and Trademark Office a
Request for Reexamination of a patent held by FBFC for BIOGRAN, of which we were
the exclusive licensee. FBFC filed a response in this proceeding, establishing
that the claims of the FBFC patent were properly allowed. As a result, a
Certificate of Reexamination was issued by the U.S. Patent and Trademark Office
confirming the patentability of all claims of the FBFC patent without amendment.
However, U.S. Biomaterials Corporation also instituted a nullification
proceeding against the European counterpart to the FBFC's U.S. patent. The
opposition division of the European Patent Office tentatively decided in FBFC's
favor, but the matter is still proceeding under an appeal. In connection with
the BIOGRAN sale to 3i, 3i assumed control of this matter and we

                                      27
<PAGE>

agreed to reimburse 3i for the associated legal costs and to provide a limited
indemnity with respect to the matter. We do not believe there are any material
liabilities with respect to the indemnification for this matter.

We may lack the financial resources needed to respond to technological changes
and other actions by competitors, obtain regulatory approvals for our products
and efficiently market our products.

Extensive research efforts and rapid technological change characterize the
market for products in the orthopaedic market. We anticipate that we will face
intense competition from medical device, medical products and pharmaceutical
companies. Our products could be rendered noncompetitive or obsolete by
competitors' technological advances. We may be unable to respond to
technological advances through the development and introduction of new products.
Moreover, many of our existing and potential competitors have substantially
greater financial, marketing, sales, distribution, manufacturing and
technological resources than us. These competitors may be in the process of
seeking FDA or other regulatory approvals, or patent protection, for their
respective products. Our competitors could, therefore, commercialize competing
products in advance of our products. They may also enjoy substantial advantages
over us in terms of:

     -research and development expertise;
     -experience in conducting clinical trials;
     -experience in regulatory matters;
     -manufacturing efficiency;
     -name recognition;
     -sales and marketing expertise;
     -established distribution channels; and
      established relationships with health care providers and payors.

As a result of the above, our plans for market acceptance of our products may be
adversely impacted.

We may acquire technologies or companies in the future, and these acquisitions
could result in dilution to our shareholders and disruption of our business.

Entering into an acquisition could divert management attention. We also could
fail to assimilate the acquired company, which could lead to higher operating
expenses. Finally, our shareholders could be diluted if we issue shares of our
stock to acquire another company or technology.

Provisions of Pennsylvania law or our Articles of Incorporation may deter a
third party from seeking to obtain control of us or may affect your rights as a
common stock holder.

Certain provisions of Pennsylvania law could make it more difficult for a third
party to acquire us, or could discourage a third party from attempting to
acquire us. These provisions could limit the price that certain investors might
be willing to pay in the future for shares of our common stock. In addition, our
Articles of Incorporation enable our board of directors to issue shares of
preferred stock having rights, privileges and preferences as are determined by
the board of directors. This provision may discourage, delay or prevent a merger
or acquisition that a shareholder may consider favorable. The rights of the
holders of any preferred stock that may be issued in the future may adversely
affect your rights as a holder of common stock. We have no current plans to
issue any shares of preferred stock.

Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval, including takeover attempts.

Our executive officers and directors, and their respective affiliates, own as of
March 22, 2002, approximately 15.2% of our outstanding Common Stock.
Accordingly, these shareholders may, as a practical matter, be able to exert
significant influence over matters requiring approval by our shareholders,
including the election of directors and the approval of mergers or other
business combinations. This concentration could have the effect of delaying or
preventing a change in control.

                                      28
<PAGE>

We do not intend to pay any cash dividends.

We have never declared nor paid dividends on our Common stock. We currently
intend to retain any future earnings for funding growth and, therefore, do not
intend to pay any cash dividends in the foreseeable future.

Our stock price may be volatile.

Our stock price, like that of many early stage medical technology companies, may
be volatile. In general, equity markets, including Nasdaq, have from time to
time experienced significant price and volume fluctuations that are unrelated to
the operating performance of particular companies or existing economic
conditions. These broad market fluctuations may adversely affect the market
price of our common stock. The following factors could also cause our stock
price to be volatile or decrease:

         -fluctuations in our results of operations;
         -under-performance in relation to analysts' estimates or financial
          guidance provided by us;
         -changes in the financial guidance we provide to the investment
          community;
         -changes in stock market analyst recommendations regarding our stock;
         -announcements of technological innovations or new products by us or
          our competitors;
         -issues in establishing commercial scale manufacturing capabilities;
         -unanticipated events associated with clinical and pre-clinical trials;
         -FDA and international regulatory actions regarding us or our
          competitors;
         -determinations by governments and insurance companies regarding
          reimbursement for medical procedures using our or our competitors'
          products;
         -the medical community's acceptance of our products;
         -product sales growth rates;
         -product recalls;
         -disruptions to our distribution channels as a result of competitive
          market changes;
         -developments with respect to patents or proprietary rights;
         -public concern as to the safety of products developed by us or by
          others;
         -changes in health care policy in the United States and
          internationally;
         -acquisitions or strategic alliances by us or our competitors;
         -business conditions affecting other medical device companies or the
          medical device industry generally; and
         -general market conditions, particularly for companies with small
          market capitalizations.

If our shares are delisted from the Nasdaq National Market, it may be difficult
to sell your investment in our company.

From June 1998 until August 1, 2000, our Common Stock traded exclusively on the
Nasdaq Europe Exchange (formerly known as EASDAQ). Since August 1, 2000, our
Common Stock has traded on both the Nasdaq Europe Exchange and the Nasdaq
National Market. The trading volume of our Common Stock is, and may continue to
be, limited. To continue to be listed on the Nasdaq National Market, we must
continue to meet, with certain exceptions, one of two separate continued listing
standards with specified maintenance criteria, including:

-specified levels for total assets;
-market value of the public float;
-a minimum bid price per share; and
-total market capitalization.

We believe that we satisfy the current requisite Nasdaq National Market listing
requirements. However, if the minimum bid price of our common stock fell below
$1.00, we could face delisting from the Nasdaq National Market. In addition,
there are amendments to the Nasdaq marketplace rules scheduled to take effect on
November 1, 2002 that will replace the net tangible assets standard with an
equity standard. These amendments may require us to raise more capital than what
is necessary to fund our operations should the bid price per share for our
Common Stock remain below $3.00 per share. The additional capital may be not be
available on satisfactory terms, if at all. Any additional equity capital raised
could result in substantial dilution to our shareholders. Should we fail to meet
the Nasdaq

                                      29
<PAGE>

National Market listing requirements in the future, our stock could then list on
the over-the-counter exchange, which would further limit the trading volume and
liquidity of our stock and adversely impact the stock price per share.

If we are sued in a product liability action, we could be forced to pay
substantial damages and the attention of our management team may be diverted
from operating our business.

We manufacture medical devices that are used on patients in surgery, and we may
be subject to a product liability lawsuit. In particular, the market for spine
products has a history of product liability litigation. Under certain of our
agreements with our distributors and agencies, we indemnify the distributor or
agency from product liability claims. Any product liability claim brought
against us, with or without merit, could result in the increase of our product
liability insurance rates or the inability to secure coverage in the future. In
addition, we would have to pay any amount awarded by a court in excess of policy
limits. We maintain product liability insurance in the annual aggregate amount
of up to $10 million, although our insurance policies have various exclusions.
Thus, we may be subject to a product liability claim for which we have no
insurance coverage, in which case we may have to pay the entire amount of any
award. Even in the absence of a claim, our insurance rates may rise in the
future to a point where we decide not to carry this insurance. A meritless or
unsuccessful product liability claim would be time-consuming and expensive to
defend and could result in the diversion of management's attention from our core
business. A successful product liability claim or series of claims brought
against us in excess of our coverage could have a material adverse effect on our
business, financial condition and results of operations.

Our business could suffer if we cannot attract and retain the services of key
employees.

We depend substantially upon the continued service and performance of our
existing executive officers. We rely on key personnel in formulating and
implementing our product research, development and commercialization strategies.
Our success will depend in large part on our ability to attract and retain
highly skilled employees. We compete for such personnel with other companies,
academic institutions, government entities and other organizations. We may not
be successful in hiring or retaining qualified personnel. If one or more of our
key employees resigns, the loss of that employee could harm our business. If we
lose any key personnel, we may not be able to prevent the unauthorized
disclosure or use of our technical knowledge or other trade secrets by those
former employees. We have employment agreements with David S. Joseph, our
Chairman, Bruce A. Peacock, our Chief Executive Officer and President, and each
of our Vice Presidents.

                                      30
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

We have experienced negative operating cash flows since our inception, and we
have funded our operations primarily from the proceeds received from sales of
our Common Stock. Cash, cash equivalents and short-investments increased
$9,091,565 from December 31, 2000 to 2001 due primarily to proceeds received
from the sale of Common Stock. As of December 31, 2001 and 2000, cash, cash
equivalents and short-term investments consisted of the following:

<TABLE>
<CAPTION>
                                                                    Gross           Unrealized
                                                                  Unrealized          Gross          Fair Market
                                              Original Cost         Gains             Losses            Value
                                             --------------         -----             ------            -----
<S>                                              <C>                   <C>               <C>           <C>
December 31, 2001:
Cash and cash equivalents..................      $12,906,557           $   --            $   --        $12,906,557
                                                 ------------          --------          --------      -----------
                                                 $12,906,557           $   --            $   --        $12,906,557
                                                 ============          ========          ========      ===========
Percentage of total assets.................                                                                  60.8%
                                                                                                       ==========

December 31, 2000:
Cash and cash equivalents..................      $ 3,614,626           $   --            $   --       $ 3,614,626
Short-term investments.....................          199,886                                 --           200,366
                                                 ------------          --------          --------      ----------
                                                                          480
                                                 $ 3,814,512           $  480            $   --       $ 3,814,992
                                                 ============          ========          ========      ==========
Percentage of total assets.................                                                                  37.4%
                                                                                                       ==========
</TABLE>

We invest excess cash in highly liquid investment-grade marketable securities
including corporate commercial paper and U.S. government agency bonds.

The following is a summary of selected cash flow information:

<TABLE>
<CAPTION>
                                                                       Year Ended December 31,
                                                             2001              2000              1999
                                                             ----              ----              ----
<S>                                                      <C>                <C>                <C>
Net cash used in operating activities.................   $ (14,785,792)     $ (13,066,702)     $ (7,460,789)
Net cash (used in) provided by investing activities...        (895,523)         6,440,248         7,614,063
Net cash provided by financing activities.............      24,950,020          7,842,251         1,472,122
Effects of exchange rate changes on cash and cash
   equivalents........................................          23,226            (88,514)           19,883
                                                         -------------      --------------     -------------
Net increase in cash and cash equivalents.............   $   9,291,931      $   1,127,283      $  1,645,279
                                                         =============      ==============     =============
</TABLE>

NET CASH USED IN OPERATING ACTIVITIES

OPERATING CASH INFLOWS-

Operating cash inflows for 2001 have been derived from VITOSS product sales. We
have also received cash inflows from interest income on cash equivalents and
short-term investments. Operating cash inflows for 2000 also include BIOGRAN
product sales realized prior to the close of the sale of all rights to our
BIOGRAN dental grafting product line in March 2000 and from interest income on
cash equivalents and short-term investments.

OPERATING CASH OUTFLOWS-

Our operating cash outflows have continued to be primarily used for development,
manufacturing scale-up qualification, pre-clinical and clinical activities in
preparation for regulatory filings of our products in development. In addition,
funds have been used for the production of inventory, increase in sales and
marketing staffing, development of marketing materials and payment of sales
commissions related to the commercialization of VITOSS and CORTOSS products.

                                      31
<PAGE>

OPERATING CASH FLOW REQUIREMENTS OUTLOOK--

We do not expect sales to generate cash flow in excess of operating expenses for
at least the next several years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating activities.
We began selling VITOSS in Europe in the fourth quarter of 2000 and began
selling VITOSS in the United States late in the first quarter of 2001. During
the third quarter of 2001, we received a 510(k) FDA regulatory clearance to
market the IMBIBE Bone Marrow Aspirate Syringe in the United States. Late in the
fourth quarter of 2001, we began selling CORTOSS in Europe for the fixation of
bone screws under a CE Mark. Future cash flow levels from VITOSS, CORTOSS and
IMBIBE product sales are difficult to predict at this early stage of the
products' launches. VITOSS sales to date may not be indicative of future sales
levels. VITOSS and CORTOSS sales levels in Europe may fluctuate due to the
timing of any distributor stocking orders and may experience seasonal slowdowns
during the summer months. Sales of VITOSS and IMBIBE in the U.S. may fluctuate
due to the timing of orders from hospitals. Any future cash flows from CORTOSS
are dependent upon the successful launch of the product in Europe during 2002.
We initiated a controlled launch of CORTOSS on a country-by-country basis in
Europe which began during December 2001. We expect to have CORTOSS available in
most of the major markets in Europe by the middle of 2002.

There may be future quarterly fluctuations in spending. We expect sales
commission expense may increase at a higher rate than any increase in VITOSS
product sales in the United States. In addition, we expect increases in the use
of cash to build inventory and fund receivables. We also expect to continue to
use cash in operating activities associated with research and development,
including clinical trials for CORTOSS and RHAKOSS, manufacturing scale-up
qualification, and pre-launch marketing activities in support of our other
products under development as well as to the associated marketing and sales
activities with VITOSS in the United States, and with VITOSS and CORTOSS in
Europe, Australia and Israel.

Finally, we have entered into and may enter additional financing arrangements
where we pay revenue sharing amounts on the sales of certain products. These
arrangements can increase expenses related to the sale of our products.

NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES

We have invested $1,470,389 and $3,306,335 for the year ended December 31, 2001
and 2000, respectively, primarily for the purchase of leasehold improvements,
manufacturing equipment and research and development equipment in order to
further expand our product development and manufacturing capabilities.

During the twelve months ended December 31, 2001 and 2000, $199,866 and
$6,246,583, respectively, were provided by the net sale of investment grade
marketable securities. Additionally, during 2000, we received $3,900,000, of
which $400,000 was held in escrow until March 2001, in connection with
the sale of the BIOGRAN dental grafting product line to Implant Innovations,
Inc. During March 2001, $375,000 of the escrow account was released with the
remaining $25,000 held for costs related to certain patent litigation.

INVESTING CASH OUTLOOK--

Of the approximately $1,470,000 invested in 2001, approximately $581,000 was
invested in leasehold improvements associated with the scale-up to the
manufacturing facilities for VITOSS and CORTOSS, which is substantially
completed. We anticipate capital spending for improvements to manufacturing
processes at these facilities. Accordingly, we expect the rate at which we
invest funds in 2002 related to improvements to our leased office and
manufacturing facilities to be relatively stable compared to 2001. We anticipate
new capital spending will be required in support of the RHAKOSS program.

NET CASH PROVIDED BY FINANCING ACTIVITIES

During December 2001, we sold 1,125,000 shares of our Common Stock to two
investors in a private equity financing. The aggregate consideration we received
for these shares consisted of $2,700,000 in cash, plus the surrender and
cancellation of outstanding warrants to purchase an aggregate of 1,125,000
shares of our Common Stock held by the two investors.

                                      32
<PAGE>

During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Royalty. In this financing, we sold Paul Royalty a revenue
interest and sold 2,582,645 shares of our Common Stock. The Common Stock was
recorded at its market value of $4,777,893 and a revenue interest obligation
related to the revenue interest of $5,222,107 was recorded. This arrangement was
subsequently modified in March 2002 (see "Certain Risks Related to our
Business).

In October 2001, we repaid to our bank our $500,000 capital financing term loan.

During April 2001, we entered into a Development and Distribution Agreement with
Japan Medical Dynamic Marketing, Inc. ("MDM"), a Japanese orthopaedic company.
In connection with this arrangement, we sold 189,394 shares of Common Stock at
$5.28 per share to MDM, raising net proceeds of $1,000,000. Additionally, during
April 2001, we sold 740,000 shares of our Common Stock at $4.00 per share in a
private equity financing raising net proceeds of approximately $2,692,000.

During March 2001, we sold 1,975,000 shares of our Common Stock at $4.00 per
share in a private equity financing raising net proceeds of approximately
$7,290,000. In addition, during January 2001, we sold 566,894 shares of our
Common Stock and warrants to purchase 566,894 shares of Common Stock at an
exercise price of $4.41 per share raising net proceeds of approximately
$2,413,000.

During the 2001 we received $88,772 from stock option and warrant exercises and
purchases of Common Stock under our Employee Stock Purchase Plan. In addition,
$628,549 was used to repay capital lease obligations during 2001.

FINANCING REQUIREMENTS OUTLOOK

The extent and timing of proceeds from future stock option and warrant
exercises, if any, are primarily dependent upon our Common Stock's market price,
as well as the exercise prices and expiration dates of the stock options and
warrants.

We do not expect sales to generate cash flow in excess of operating expenses for
at least the next several years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating and investing
activities. We believe that our existing cash of approximately $12,907,000 as of
December 31, 2001 will be sufficient to meet our currently estimated operating
and investing requirements into early 2003; however, if we do not raise
additional cash during 2002, we may be required to curtail or limit certain
marketing support and research and development activities in order to remain
compliant with our Paul Royalty financial covenants. A curtailment of certain
activities would delay development of certain of our products. We will need to
raise additional funds by the fourth quarter of 2002 to meet the Nasdaq National
Market's continuing listing requirements if the bid price per share of our
Common Stock remains below $3.00 per share. We may seek to obtain additional
funds through equity or debt financings, or strategic alliances with third
parties either alone or in combination with equity. These financings could
result in substantial dilution to the holders of our Common Stock or require
debt service and/or royalty payment arrangements. Any such required financing
may not be available in amounts or on terms acceptable to us.

RESULTS OF OPERATIONS

This section should be read in conjunction with the detailed discussion under
"Liquidity and Capital Resources." And as described therein, we expect to
continue to incur significant operating losses in the future as we continue our
product development efforts.

Comparison of the Year Ended December 31, 2001 to the Year Ended December
31, 2000

Product Sales. Product sales for the year ended December 31, 2001 were
approximately $3,940,000 compared to approximately $741,000 for the year ended
December 31, 2000. Product sales for 2001 consisted primarily of VITOSS sales in
the U.S., Europe, Australia and Israel and initial CORTOSS sales in Europe
during the fourth quarter of 2001. Product sales for 2000 consisted of
approximately $533,000 from the sales of BIOGRAN product realized prior to the
sale of the BIOGRAN product line in March 2000. The remaining $208,000 of
product sales occurred during the fourth quarter of 2000 and related to the
initiation of sales of VITOSS in Europe.

                                      33
<PAGE>

Gross Profit. Our gross profit for the year ended December 31, 2001 and 2000 was
approximately $3,221,000 and $571,000, respectively, or 82% and 77% of product
sales, respectively. BIOGRAN cost of sales was approximately $164,000 or a 69%
gross profit margin for the year ended December 31, 2000. All of the VITOSS sold
in Europe during 2000 was produced prior the receipt of its CE Certification in
July 2000. In accordance with SFAS No. 2 "Accounting for Research and
Development Costs," the costs of producing that material was recorded as
research and development expense prior to July 2000 and, accordingly, are not
reflected in cost of sales. Accordingly, VITOSS cost of sales for the year ended
December 31, 2000 of $6,000 is not indicative of margins to be realized in
future periods.

Operating Expenses. Operating expenses for the year ended December 31, 2001 were
approximately $17,475,000 compared to approximately $15,191,000 for 2000.
General & administrative expenses for twelve months ended December 31, 2001,
were comparable to the same period in 2000. Selling and marketing expenses for
same twelve-month periods from 2000 to 2001 increased as a result of commission
expense paid to the independent commissioned sales agencies in the U.S. on
VITOSS product sales, increased staffing and other spending related to the
support of product sales. Research and development expenses decreased for the
twelve months ended December 31, 2001, as compared to the same period in 2000
primarily as a result of the completion of certain process development
activities primarily related to CORTOSS and the initiation of commercial scale
manufacturing .

Other Income (Expense). Net other income includes interest income, interest
expense and revenue interest expense. We recorded approximately $88,000 of net
other income for the year ended December 31, 2001 compared to approximately
$214,000 of net other income for the year ended December 31, 2000. The decrease
in net other income between 2001 and 2000 is attributed to lower average
interest rates earned on invested cash and revenue interest expense, in 2001, as
a result of the arrangement with Paul Royalty.

Net Gain On Sale of Product Line. In connection with the sale of the BIOGRAN
dental grafting product line to 3i in March 2000, we received $3,900,000, of
which $400,000 was held in escrow until March 2001. We realized a net gain on
the transaction of approximately $375,000 and $3,071,000 for the years ended
December 31, 2001 and 2000, respectively.

Net Loss. As a result of the foregoing factors, our net loss for the year ended
December 31, 2001 was approximately $13,790,000 compared to a net loss of
approximately $11,335,000 for 2000.

Comparison of the Year Ended December 31, 2000 to the Year Ended December 31,
1999

Product Sales. Product sales for the year ended December 31, 2000 were
approximately $741,000 compared to approximately $1,054,000 for the year ended
December 31, 1999. Product sales for 2000 consisted of $533,000 from the sales
of BIOGRAN product realized prior to the sale of the BIOGRAN product line in
March 2000. The remaining $208,000 of product sales occurred during the fourth
quarter of 2000 and relate to the initiation of sales of VITOSS in Europe. Sales
in Europe during 2000 were to distributors.

Gross Profit. Our gross profit for the year ended December 31, 2000 was
$571,000, or 77% of net revenues, compared to $730,000, or 69% of net revenues,
for 1999. BIOGRAN cost of sales was approximately $164,000 or a 69% gross profit
margin for the year ended December 31, 2000. All of the VITOSS sold in Europe
during 2000 was produced prior the receipt of its CE Certification in July 2000.
In accordance with SFAS No. 2 "Accounting for Research and Development Costs,"
the costs of producing that material was recorded as research and development
expense prior to July 2000 and, accordingly, are not reflected in cost of sales.
Accordingly, VITOSS cost of sales for the year ended December 31, 2000 of $6,000
is not indicative of margins to be realized in future periods.

Operating Expenses. Operating expenses for the year ended December 31, 2000 were
approximately $15,191,000 compared to approximately $10,755,000 for 1999. The
increase in general and administrative expenses year-over-year is primarily a
result of an increase in the number of employees during 2000. Selling and
marketing expenses increased year-over-year as a result of the development and
printing of marketing and sales literature in support of VITOSS product launch.
The increase from 1999 to 2000 in research and development expenses is
attributable to the expanded development of our product pipelines and
pre-clinical and clinical activities of CORTOSS and RHAKOSS.

                                      34
<PAGE>

Other Income (Expense). Net other income includes interest income and interest
expense. We recorded $214,000 of net other income for the year ended December
31, 2000 compared to $529,000 of net other income for the year ended December
31, 1999. The decrease in net other income between 1999 and 2000 is attributed
to lower average cash balances year over year.

Net Gain On Sale of Product Line. We received $3,900,000, of which $400,000 was
being held in escrow until March 23, 2001, in connection with the sale of the
BIOGRAN dental grafting product line to 3i in March 2000. We realized a net gain
on the transaction of approximately $3,071,000.

Net Loss. As a result of the foregoing factors, our net loss for the year ended
December 31, 2000 was approximately $11,335,000 compared to a net loss of
approximatley $9,497,000 for 1999.

COMMITMENTS AND CONTINGENCIES

We lease office space and equipment under non-cancelable operating leases. For
the years ended December 31, 2001, 2000 and 1999, lease expense was
approximately $422,000, $321,000 and $305,000, respectively. As of December 31,
2001, future minimum rent payments through the expiration of these leases are
approximately $373,000 in 2002, $362,000 in 2003, $357,000 in 2004, $357,000 in
2005, $357,000 in 2006, and $1,477,000 in 2007 and thereafter.

During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Royalty. In this financing, we sold Paul Royalty a revenue
interest and sold 2,582,645 shares of our Common Stock, for aggregate gross
proceeds of $10,000,000. The Common Stock was recorded at its market value of
$4,777,893 and a revenue interest obligation related to the revenue interest of
$5,222,107 was recorded. The revenue interest provides for Paul Royalty to
receive 3.5% on the first $100,000,000 of annual sales plus 1.75% of annual
sales in excess of $100,000,000 of our VITOSS, CORTOSS and RHAKOSS products in
North America and Europe through 2016, subject to certain adjustments.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Risk

The functional currency for our European branch operation is the Euro.
Accordingly, in accordance with SFAS No. 52 "Foreign Currency Translation," all
assets and liabilities related to this operation are translated at the current
exchange rates at the end of each period. The resulting translation adjustments
are accumulated in a separate component of shareholders' equity. Revenues and
expenses are translated at average exchange rates in effect during the period
with foreign currency transaction gains and losses, if any, included in results
of operations.

Market Risk

We may be exposed to market risk through changes in market interest rates that
could affect the value of our short-term investments. Interest rate changes
would result in unrealized gains or losses in the market value of the short-term
investments due to differences between the market interest rates and rates at
the inception of the short-term investment.

We held no investments as of December 31, 2001. As of December 31, 2000, our
investments consisted primarily of commercial paper, United States government
agency bonds and high credit quality corporate bonds. The impact on our future
interest income and

                                      35
<PAGE>

future changes in investment yields will depend on the gross amount of our
investments and various external economic factors.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

The consolidated financial statements of the Company and its subsidiaries and
supplementary data required by this item are attached to this annual statement
on Form 10-K beginning on page F-1.

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

     None.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information concerning directors and compliance with Section 16(a) of the
Securities Exchange Act of 1934 called for by Item 10 of Form 10-K will be set
forth under the captions "Nominees for the Board of Directors" and "Section
16(a) Reports" in our definitive proxy statement, to be filed within 120 days
after the end of the fiscal year covered by this annual report on Form 10-K, and
is incorporated herein by reference.

ITEM 11.   EXECUTIVE COMPENSATION

See Item 12.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information called for by Items 11 and 12 of Form 10-K will be set forth
under the captions "Executive Compensation: Report of the Compensation
Committee," "Summary Compensation Table," and "Holders of 5% or More of
Orthovita's Stock and Directors' and Officers' Ownership of Orthovita's Stock,"
respectively, in our definitive proxy statement, to be filed within 120 days
after the end of the fiscal year covered by this annual report on Form 10-K, and
is incorporated herein by reference.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

To compensate Randal Betz, M.D. for serving as the leader of our Surgeon
Clinical Panel, we paid Dr. Betz $40,000 during each of our 2001, 2000 and 1999
fiscal years. In addition, Dr. Betz was granted stock options in May 2001, which
have an estimated value of approximately $30,000, for serving on our Board of
Directors.

                                      36
<PAGE>

                                     PART IV

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

     (a)  Documents filed as part of this Report

     1.   Financial Statements The following financial statements and notes
     thereto which are attached hereto beginning on page F-1 have been
     incorporated by reference into Item 8 of this part of the annual report on
     Form 10-K:

<TABLE>
<CAPTION>
                                                                                               Page
                                                                                               ----
      <S>                                                                                      <C>
     Report of Independent Public Accountants                                                  F-1

     Consolidated Balance Sheets as of December 31, 2001 and 2000                              F-2

     Consolidated Statements of Operations for years ended December 31, 2001, 2000 and 1999    F-3

     Consolidated Statements of Shareholders' Equity for the years ended
        December 31, 2001, 2000 and 1999                                                       F-4

     Consolidated Statements of Cash Flows for the years ended December 31,
        2001, 2000 and 1999                                                                    F-5

     Notes to Consolidated Financial Statements                                                F-6
</TABLE>

     2.   Financial Statement Schedules. All schedules are omitted because they
     are inapplicable, or not required, or the information is shown in the
     Financial Statements or notes thereto.

     3.   Exhibits.    (see (c) below).

     (b)  Reports on Form 8-K.

     The Company filed a Current Report on Form 8-K on November 13, 2001, which
     it amended by filing a Current Report on Form 8-K/A on November 27, 2001,
     announcing the October 16, 2001 agreement for a sale of a product sales
     revenue interest and a sale of shares of common stock to Paul Capital
     Royalty Acquisition Fund, L.P. for aggregate proceeds of $10 million.

     (c) Exhibits

     The following is a list of exhibits filed as part of this annual report on
     Form 10-K. Where so indicated, exhibits which were previously filed are
     incorporated by reference. For exhibits incorporated by reference, the
     location of the exhibit in the previous filing is indicated in
     parentheses.

<TABLE>
<S>       <C>
3.1       Amended and Restated Articles of Incorporation of the Company /(3)/
3.2       Amended and Restated Bylaws of the Company /(3)/
4.1       Specimen of Common Stock Certificate of the Company /(10)/
4.2       Registration Rights Agreement dated August 22, 2000 among the Company, Brown Simpson Partners I, Ltd.,
          Janney Montgomery Scott LLC, Emerging Growth Equities, Ltd. and VFT Special Ventures Ltd. /(4)/
4.3       Form of Registration Rights Agreement among the Company, Emerging Growth Equities, Ltd. and each of the
          investors named therein /(6)/
          Registration Rights Agreement dated March 29, 2001 between the Company and Japan Medical Dynamic
          Marketing, Inc. /(6)/
4.4       Registration Rights Agreement dated December 20, 2001 among the Company, SDS Merchant Fund, L.P. and
          S.A.C. Capital Associates, LLC /(8)/
</TABLE>

                                      37
<PAGE>

<TABLE>
<S>       <C>
4.5       Warrant to Purchase Shares of Common Stock dated as of November 3, 1999 in favor of Progress Capital,
          Inc. /(10)/
4.6       Warrant to Purchase 31,779 Shares of Common Stock dated August 22, 2000 in favor of Janney Montgomery
          Scott LLC /(4)/
4.7       Warrant to Purchase 31,780 Shares of Common Stock dated August 22,  2000 in favor of VFT Special
          Ventures Ltd. /(4)/
4.8       Warrant to Purchase 566,894 Shares of Common Stock dated January 18, 2001 in favor of Rennes Fondation
          /(10)/
4.9       Warrant to Purchase 59,250 Shares of Common Stock dated March 19, 2001 in favor of Emerging Growth
          Equities, Ltd. /(5)/
4.10      Warrant to Purchase 22,200 Shares of Common Stock dated March 19, 2001 in favor of Emerging Growth
          Equities, Ltd. /(6)/
4.11      Form of Warrant to Purchase Shares of Common Stock dated May 18,  2001 granted to S.A.C. Capital
          Associates, LLC and SDS Merchant Fund, L.P. /(7)/
4.12      Warrant to Purchase 50,000 Shares of Common Stock dated October 23, 2001 in favor of Tucker Anthony
          Incorporated /(1)/
10.1      Employment Agreement dated as of December 31, 1999 between the Company and Bruce A. Peacock
          /(10)/
10.2      Addendum to Employment Agreement dated January 1, 2001 between the Company and Bruce A. Peacock /(10)/
10.3      Addendum to Employment Agreement dated January 1, 2002 between the Company and Bruce A. Peacock /(1)/
10.4      Employment Agreement dated as of December 31, 1999 between the Company and David S. Joseph
          /(10)/
10.5      Addendum to Employment Agreement dated January 1, 2001 between the Company and David S. Joseph /(10)/
10.6      Addendum to Employment Agreement dated January 1, 2002 between the Company and David S. Joseph /(1)/
10.7      Employment Agreement dated as of July 1, 2000 between the Company and Dr. Erik M. Erbe /(10)/
10.8      Addendum to Employment Agreement dated as of January 1, 2002 between the Company and Dr. Erik M. Erbe
          /(1)/
10.9      Master Equipment Lease Agreement dated as of July 11, 1997 between the Company and Finova Technology
          Finance, Inc. /(2)/
10.10     Amendment to the Master Equipment Lease Agreement dated as of April 15, 1999 between the Company and
          Finova Technology Finance, Inc. /(9)/
10.11     1993 Stock Option Plan /(3)/
10.12     Amended and Restated 1997 Equity Compensation Plan /(3)/
10.13     Amended and Restated Employee Stock Purchase Plan /(3)/
10.14     Revenue Interests Assignment Agreement dated as of October 16, 2001 among Vita Special Purpose Corp.,
          the Company and Paul Capital Royalty Acquisition Fund, L.P. /(12)/
10.15     Assignment dated as of October 16, 2001 between Vita Special Purpose Corp. and Paul Capital Royalty
          Acquisition Fund, L.P. /(11)/
10.16     Security Agreement dated as of October 16, 2001 between Vita Special Purpose Corp. and Paul Capital
          Royalty Acquisition Fund, L.P. /(11)/
10.17     Pledge Agreement dated as of October 16, 2001 between Vita Licensing, Inc. and Paul Capital Royalty
          Acquisition Fund, L.P. /(11)/
10.18     Stock Purchase Agreement dated as of October 16, 2001 between the Company and Paul Capital Royalty
          Acquisition Fund, L.P. /(11)/
10.19     Third Amended and Restated Line of Credit dated October 25, 2000 between the Company and Progress Bank
          /(10)/
10.20     Capital Expenditure Loan Note dated October 25, 2000 between the Company and Progress Bank /(10)/
10.21     Asset Sale Agreement dated as of February 10, 2000 between the Company and Implant Innovations, Inc.
          /(9)/
</TABLE>
                                      38
<PAGE>

<TABLE>
<S>       <C>
10.22     Development and Distribution Agreement dated March 29, 2001 between the Company and Japan Medical
          Dynamic Marketing, Inc. /(1)/
10.23     Subscription Agreement dated July 10, 2000 between the Company and Rennes Fondation /(10)/
10.24     Subscription Agreement dated August 22, 2000 between the Company and Brown Simpson Partners I,
          Ltd. /(4)/
10.25     Subscription Agreement dated as of October 4, 2000 between the Company and Raimund Gabriel /(10)/
10.26     Subscription Agreement dated as of January 18, 2001 between the Company and Rennes Fondation /(10)/
10.27     Form of Subscription Agreement between the Company and each of the purchasers named therein /(6)/
10.28     Subscription Agreement dated March 29, 2001 between the Company and Japan Medical Dynamic Marketing,
          Inc. /(6)/
10.29     Subscription Agreement dated as of December 20, 2001 between the Company and S.A.C. Capital Associates,
          LLC /(8)/
10.30     Subscription Agreement dated as of December 20, 2001 between the Company and SDS Merchant Fund, L.P. /(8)/
10.31     Amendment to Revenue Interests Assignment Agreement and Stock Purchase Agreement dated March 22, 2002 among
          the Company, Paul Capital Royalty Acquisition Fund, L.P. and Vita Special Purpose Corp. /(1)/
21.1      Subsidiaries /(1)/
23.1      Consent of Arthur Andersen LLP /(1)/
24.1      Power of Attorney /(1)/ (included in the signature page)
99.1      Letter to the Commission Regarding Arthur Andersen
</TABLE>

/(1)/  Filed herewith.

/(2)/  Filed as an Exhibit to the Company's Registration Statement on Form S-1
       (File No. 333-51689) filed on May 1, 1998 and incorporated herein by
       reference.

/(3)/  Filed as an Exhibit to Amendment No. 3 to the Company's Registration
       Statement on Form S-1 (File No. 333-51689) filed on June 15, 1998 and
       incorporated herein by reference.

/(4)/  Filed as an Exhibit to the Company's Registration Statement on Form
       S-3 (File No.  333-47386)  filed on October 5, 2000 and incorporated
       herein by reference.

/(5)/  Filed as an Exhibit to the Company's Registration Statement on Form S-3
       (File No. 333-59288) filed on April 20, 2001 and incorporated herein by
       reference.

/(6)/  Filed as an Exhibit to Amendment No. 1 to the Company's Registration
       Statement on Form S-3  (File No. 333-59288) filed on May 4, 2001 and
       incorporated herein by reference.

/(7)/  Filed as an Exhibit to Amendment No. 2 to the Company's Registration
       Statement on Form S-3  (File No. 333-59288) filed on May 24, 2001
       and incorporated herein by reference.

/(8)/  Filed as an Exhibit to the Company's Registration Statement on Form S-3
       (File No.  333-84622) filed on March 20, 2002 and incorporated herein by
       reference.

                                      39
<PAGE>

/(9)/  Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
       year ended December 31, 1999 and incorporated herein by reference.

/(10)/ Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
       year ended December 31, 2000 and incorporated herein by reference.

/(11)/ Filed as an Exhibit to the Company's Current Report on Form 8-K filed on
       November 13, 2001 and incorporated herein by reference.

/(12)/ Filed as an Exhibit to the Company's Current Report on Form 8-K/A filed
       on November 27, 2001 and incorporated herein by reference.

Copies of the exhibits are available to shareholders (upon payment of a $.20 per
page fee to cover the Company's expenses in furnishing the exhibits) from
Investor Relations, Orthovita, Inc., 45 Great Valley Parkway, Malvern,
Pennsylvania 19355.

                                      40
<PAGE>

                                   SIGNATURES

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

                                           ORTHOVITA, INC.

Date: April 1, 2002
                                           /s/   BRUCE A. PEACOCK
                                           By: Bruce A. Peacock
                                           Chief Executive Officer and President

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

Each person in so signing also makes, constitutes and appoints Bruce A.
Peacock, Chief Executive Officer of Orthovita, Inc. and subsidiaries and
Joseph M. Paiva, Vice President and Chief Financial Officer of Orthovita, Inc.
and subsidiaries, and each of them acting alone, as his true and lawful
attorneys-in-fact, in his name, place and stead, to execute and cause to be
filed with the Securities and Exchange Commission any or all amendments to this
report.

       Signature                         Capacity                      Date
 -------------------------     ---------------------------------   -------------

  /s/ BRUCE A. PEACOCK      Chief Executive Officer and President  April 1, 2002
     Bruce A. Peacok        (principal executive officer)

   /s/ DAVID S. JOSEPH      Chairman                               April 1, 2002
     David S. Joseph

   /s/ JOSEPH M. PAIVA      Vice President and Chief Financial     April 1, 2002
     Joseph M. Paiva        Officer (principal financial and
                            accounting officer)
/s/ RANDAL R. BETZ, M.D.    Director                               April 1, 2002
  Randal R. Betz, M.D.

 /s/ MORRIS CHESTON, JR.    Director                               April 1, 2002
   Morris Cheston, Jr.

/s/ PAUL DUCHEYNE, PH.D.    Director                               April 1, 2002
  Paul Ducheyne, Ph.D.

   /s/ JAMES M. GARVEY      Director                               April 1, 2002
     James M. Garvey

  /s/ ROBERT M. LEVANDE     Director                               April 1, 2002
    Robert M. Levande

/s/ JOS B. PEETERS, PH.D.   Director                               April 1, 2002
  Jos B. Peeters, Ph.D.

                                      41
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Orthovita, Inc.:

     We have audited the accompanying consolidated balance sheets of Orthovita,
Inc. (a Pennsylvania corporation) and subsidiaries as of December 31, 2001 and
2000, and the related consolidated statements of operations, and shareholders'
equity and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Orthovita, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.

                                                    /s/ ARTHUR ANDERSEN LLP

Philadelphia, Pennsylvania
January 22, 2002
(except with respect to the matter discussed in
Note 7, as to which the date is March 22, 2002)

                                      F-1
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                         December 31
                                                                                 2001                    2000
                                                                                 ----                    ----
                                 ASSETS
<S>                                                                               <C>                    <C>
CURRENT ASSETS:
     Cash and cash equivalents (Notes 3, 6 and 7).......................          $ 12,906,557            $  3,614,626
     Short-term investments (Notes 3 and 6).............................                     -                 200,366
     Restricted cash (Note 11)..........................................                     -                 400,000
     Accounts receivable................................................               983,467                  80,050
     Inventories (Note 4)...............................................             1,606,333                 182,399
     Other current assets...............................................               125,022                  21,721
                                                                                  ------------            ------------
          Total current assets..........................................            15,621,379               4,499,162
                                                                                  ------------            ------------
PROPERTY AND EQUIPMENT, net (Note 5)....................................             5,433,353               5,321,228
                                                                                  ------------            ------------
OTHER ASSETS (Note 6)...................................................               158,111                 367,977
                                                                                  ------------            ------------
                                                                                  $ 21,212,843            $ 10,188,367
                                                                                  ============            ============

                  LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
     Current portion of long-term capital lease obligations (Note 8)....          $    482,420            $    654,063
     Accounts payable...................................................             1,010,423               1,156,533
     Accrued compensation and related expenses..........................               624,168                 734,820
     Deferred gain (Note 11)............................................                     -                 400,000
     Other accrued expenses.............................................               790,765                 805,911
                                                                                  ------------            ------------
          Total current liabilities.....................................             2,907,776               3,751,327
                                                                                  ------------            ------------
LONG-TERM LIABILITIES:
     Other long term liabilities........................................                62,000                       -
     Capital lease obligations (Note 8).................................               350,519                 807,425
     Bank term loan (Note 6)............................................                     -                 500,000
     Revenue interest obligation (Note 7)...............................             5,222,107                       -
                                                                                  ------------            ------------
          Total long-term liabilities...................................             5,634,626               1,307,425
                                                                                     ---------            ------------

COMMITMENTS AND CONTINGENCIES (Notes 13 and 14)

SHAREHOLDERS' EQUITY (Note 10):
      Preferred Stock, $.01 par value, 20,000,000 shares authorized,
       no shares issued and outstanding.................................                    --                      --
      Common stock, $.01 par value, 50,000,000 shares authorized,                      208,745
        20,874,536 and 13,426,988 shares issued and outstanding.........                                       134,270
     Additional paid-in capital.........................................            74,066,082              52,929,538
     Deferred compensation .............................................                     -                 (97,500)
     Accumulated deficit................................................           (61,599,522)            (47,809,103)
     Accumulated other comprehensive loss...............................                (4,864)                (27,590)
                                                                                  ------------            ------------
          Total shareholders' equity....................................            12,670,441               5,129,615
                                                                                  ------------            ------------
                                                                                  $ 21,212,843            $ 10,188,367
                                                                                  ============            ============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F-2
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                     Year Ended December 31
                                                                      2001                2000                  1999
                                                                      ----                ----                  ----
<S>                                                                   <C>                   <C>                   <C>
PRODUCT SALES (Note 11)                                               $ 3,940,395            $  740,660           $  1,054,120
                                                                      -----------            ----------            -----------

COST OF SALES (Note 4)                                                    719,373               170,041                324,590
                                                                      -----------            ----------            -----------

          Gross profit.........................................         3,221,022               570,619                729,530
                                                                      -----------            ----------            -----------

OPERATING EXPENSES:
General and administrative.....................................         4,361,183             4,333,094              3,674,515
Selling and marketing..........................................         5,910,505             3,357,903              1,807,212
Research and development ......................................         7,202,942             7,500,165              5,273,590
                                                                      -----------            ----------            -----------
          Total operating expenses.............................        17,474,630            15,191,162             10,755,317
                                                                      -----------           -----------            -----------

          Operating loss.......................................       (14,253,608)          (14,620,543)           (10,025,787)
INTEREST EXPENSE...............................................          (154,074)             (151,161)              (110,601)
REVENUE INTEREST EXPENSE (Note 7)..............................           (65,750)                 --                       --
INTEREST INCOME................................................           308,013               365,434                639,794
NET GAIN ON SALE OF PRODUCT LINE (Note 11).....................           375,000             3,070,921                     --
                                                                      -----------           -----------            -----------

NET LOSS APPLICABLE TO COMMON SHAREHOLDERS.....................     $ (13,790,419)        $ (11,335,349)          $ (9,496,594)
                                                                    ==============        ==============          =============

NET LOSS PER COMMON SHARE, BASIC AND DILUTED...................         $    (.82)            $   (.92)             $     (.83)
                                                                        =========             ========              ===========

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING, BASIC
  AND DILUTED..................................................        16,841,970           12,281,117              11,411,896
                                                                       ==========           ==========              ==========
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F-3
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                      Additional
                                                                            Common      Paid-in        Deferred      Accumulated
                                                                            Stock       Capital      Compensation      Deficit
                                                                            -----      --------      ------------     -------
<S>                                                                        <C>         <C>                    <C>   <C>
BALANCE, DECEMBER 31, 1998......................                          $ 113,727   $ 42,289,024               -- $ (26,977,160)
  Exercise of Common Stock options and warrants to   purchase Common
     Stock and Common Stock purchased under the Employee Stock
     Purchase Plan..............................                              1,088        363,123               --            --
  Issuance of Common Stock options and warrants for services                    --         185,664               --            --
  Repurchase of Common Stock                                                   (720)      (348,920)              --            --
  Receipt of Common Stock in repayment of loan                                 (779)      (486,096)              --            --
  Comprehensive loss:
    Net loss  ..................................                                --             --                --    (9,496,594)
  Other comprehensive loss:
    Unrealized loss on short-term investments, net                              --             --                --            --
    Currency translation adjustment.............                                --             --                --            --
    Comprehensive loss..........................                                --             --                --            --
                                                                          ----------   -----------   ---------------  ------------
BALANCE, DECEMBER 31, 1999......................                            113,316     42,002,795                    (36,473,754)
                                                                                                                 --
  Exercise of Common Stock options and warrants to purchase Common
    Stock and Common Stock purchased under the Employee Stock
    Purchase Plan...............................                              3,347      1,112,145               --            --
  Issuance of Common Stock options and warrants for services                     --        510,431               --            --
  Sale of 1,715,679 shares of Common Stock and warrants                      17,157      9,034,292               --            --
   Amortization of deferred compensation                                        --              --    $     172,825            --
   Issuance of Common Stock under restricted stock award                        450        269,875        (270,325)            --
  Comprehensive loss:
    Net loss  ..................................                                --             --                --   (11,335,349)
  Other comprehensive loss:
    Unrealized gain on short-term investments, net                              --             --                --            --
    Currency translation adjustment.............                                --             --                --            --
    Comprehensive loss..........................                                --             --                --            --
                                                                          ----------  ------------    ------------- --------------
BALANCE, DECEMBER 31, 2000......................                            134,270     52,929,538         ( 97,500)  (47,809,103)
  Exercise of Common Stock options and warrants to purchase Common
     Stock and Common Stock purchased under the Employee Stock
     Purchase Plan                                                              455         88,317              --            --
  Issuance of Common Stock options and warrants for services                    --         354,557              --            --
  Sale of 7,402,013 shares of Common Stock and warrants                      74,020     20,693,670              --            --
  Amortization of deferred compensation                                         --             --            97,500           --
  Comprehensive loss:
    Net loss  .................................                                 --             --                --   (13,790,419)
  Other comprehensive loss:
    Unrealized gain on short-term investments, net   .                          --             --                --            --
    Currency translation adjustment.............                                --             --                --            --
    Comprehensive loss..........................                                --             --                --            --
                                                                          ----------  ------------    ------------- --------------
BALANCE, DECEMBER 31, 2001......................                          $ 208,745   $ 74,066,082    $          -- $ (61,599,522)
                                                                          ==========  ============    ============= ==============

<CAPTION>
                                                                             Accumulated
                                                                            Comprehensive    Comprehensive
                                                                           Income (Loss)     (Loss) Income       Total
                                                                           --------------    --------------      -----
<S>                                                                                <C>          <C>           <C>
BALANCE, DECEMBER 31, 1998......................                                  $ 102,984                   $ 15,528,575
  Exercise of Common Stock options and warrants to purchase Common
     Stock and Common Stock purchased under the Employee Stock
     Purchase Plan..............................                                        --              --         364,211
  Issuance of Common Stock options and warrants for services                            --              --         185,664
  Repurchase of Common Stock                                                            --              --        (349,640)
  Receipt of Common Stock in repayment of loan                                          --              --        (486,875)
  Comprehensive loss:
    Net loss  ..................................                                        --      $(9,496,594)    (9,496,594)
  Other comprehensive loss:
    Unrealized loss on short-term investments, net                                  (60,267)        (60,267)       (60,267)
    Currency translation adjustment.............                                    (38,405)        (38,405)       (38,405)
                                                                                                -----------
    Comprehensive loss..........................                                        --      $(9,595,266)           --
                                                                                  ---------     ===========   ------------
BALANCE, DECEMBER 31, 1999......................                                      4,312                      5,646,669

  Exercise of Common Stock options and warrants to purchase Common
    Stock and Common Stock purchased under the Employee Stock
    Purchase Plan...............................                                        --              --       1,115,492
  Issuance of Common Stock options and warrants for services                            --              --         510,431
  Sale of 1,715,679 shares of Common Stock and warrants                                 --              --       9,051,449
   Amortization of deferred compensation                                                --              --         172,825
   Issuance of Common Stock under restricted stock award                                --              --             --
  Comprehensive loss:
    Net loss  ..................................                                        --     $(11,335,349)   (11,335,349)
  Other comprehensive loss:
    Unrealized gain on short-term investments, net                                      480             480            480
    Currency translation adjustment.............                                    (32,382)        (32,282)       (32,382)
                                                                                                -----------

    Comprehensive loss..........................                                        --     $(11,367,251)           --
                                                                                  ----------    ===========   ------------
BALANCE, DECEMBER 31, 2000......................                                    (27,590)                     5,129,615
  Exercise of Common Stock options and warrants to purchase Common
     Stock and Common Stock purchased under the Employee Stock Purchase
     Plan                                                                               --              --          88,772
  Issuance of Common Stock options and warrants for services                            --              --         354,557
  Sale of  7,402,013 shares of Common Stock and warrants                                --              --      20,767,690
   Amortization of deferred compensation                                                --              --          97,500
  Comprehensive loss:
    Net loss  .................................                                         --     $(13,790,419)   (13,790,419)
  Other comprehensive loss:
    Unrealized gain on short-term investments, net   .                                  500             500            500
    Currency translation adjustment.............                                     22,226          22,226         22,226
                                                                                                -----------
    Comprehensive loss..........................                                        --     $(13,767,693)           --
                                                                                  ----------    ===========   ------------
BALANCE, DECEMBER 31, 2001......................                                  $  (4,864)                  $ 12,670,441
                                                                                  ==========                  ============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F-4
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                              Year Ended December 31
                                                                                  2001            2000              1999
                                                                                ------------     ------------    ------------
<S>                                                                            <C>             <C>               <C>
OPERATING ACTIVITIES:
     Net loss  ......................................................          $(13,790,419)   $(11,335,349)     $(9,496,594)
     Adjustments to reconcile net loss to net cash used in operating activities--
          Depreciation and amortization..............................              1,345,572         953,683          631,696
          Amortization of deferred compensation......................                 97,500         172,825               --
          Common stock options and warrants issued for services rendered...          354,557         510,431          185,664
          Net gain on sale of product line.................................        (375,000)     (3,070,921)               --
          Loss on disposal of property and equipment...............                   12,692              --               --
                                                                                ------------    ------------     ------------

                    Net cash used in operations.........................        (12,355,098)    (12,769,331)      (8,679,234)
          (Increase) decrease in--
               Accounts receivable...................................              (903,417)        (20,539)         (36,791)
               Other receivables.....................................                     --              --          744,959
               Inventories...........................................            (1,423,934)        (35,129)          181,981
               Other current assets..................................              (103,301)         58,948            57,664
               Other assets..........................................                209,866       (264,836)         (17,747)
          Increase (decrease) in--
               Accounts payable......................................              (146,110)       (171,292)          946,681
               Accrued patent defense costs..........................                     --              --        (402,977)
               Other liabilities.....................................               (48,652)       (202,043)        (128,865)
               Other accrued expenses................................               (15,146)         337,520        (126,460)
                                                                                ------------    ------------     ------------
                    Net cash used in operating activities............           (14,785,792)    (13,066,702)      (7,460,789)
                                                                                ------------    ------------     ------------
INVESTING ACTIVITIES:
     Purchase of investments.........................................                      -       (199,886)     (10,346,255)
     Proceeds from sale of investments...............................                199,866       6,446,469       18,314,180
      Proceeds from sale of product line.............................                      -       3,900,000               --
      Decrease (increase) in restricted cash.........................                375,000       (400,000)               --
     Purchases of property and equipment..............................            (1,470,389)     (3,306,335)        (353,862)
                                                                                ------------    ------------     ------------
                  Net cash (used in) provided by investing activities.             (895,523)       6,440,248        7,614,063
                                                                                ------------    ------------     ------------
FINANCING ACTIVITIES:
     (Repayments) proceeds of short-term bank borrowings.............                    --      (2,000,000)        2,000,000
     Proceeds from debt..............................................                    --          500,000               --
     Repayment of debt...............................................              (500,000)       (141,837)        (108,649)
     Proceeds from revenue interest obligation.......................              5,222,107              --               --
     Repayments of capital lease obligations.........................              (628,549)       (682,853)        (433,800)
     Proceeds from exercise of common stock options and warrants and
     common stock purchased under the Employee  Stock Purchase Plan                   88,772       1,115,492          364,211
     Repurchase of common stock......................................                     --              --        (349,640)
     Proceeds from sale of common stock and warrants.................             20,767,690       9,051,449               --
                                                                                ------------    ------------     ------------
                    Net cash provided by financing activities........             24,950,020       7,842,251        1,472,122
                                                                                ------------    ------------     ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
   CASH EQUIVALENTS..................................................                 23,226        (88,514)           19,883
                                                                                ------------    ------------     ------------
NET INCREASE IN CASH AND CASH
   EQUIVALENTS.......................................................              9,291,931       1,127,283        1,645,279
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR.........................              3,614,626       2,487,343          842,064
                                                                                ------------    ------------     ------------
CASH AND CASH EQUIVALENTS, END OF YEAR...............................           $ 12,906,557    $  3,614,626      $ 2,487,343
                                                                                ============    ============     ============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F-5
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   THE COMPANY:

Orthovita, Inc. ("Orthovita" or the "Company") is a Pennsylvania corporation
with proprietary technologies applied to the development of biostructures, which
are synthetic, biologically active, tissue engineering products for restoration
of the human skeleton. Our focus is on developing products for use in spine
surgery and in the repair of osteoporotic fractures. We are also addressing a
broad range of clinical needs in the trauma market. We have developed several
products to date:

     .   VITOSS(TM)Scaffold Synthetic Cancellous Bone Void Filler;

         .   IMBIBE(TM)Bone Marrow Aspirate Syringe to be used with VITOSS;

     .   CORTOSS(TM)Synthetic Cortical Bone Void Filler;

         .   ALIQUOT(TM) Microdelivery System to be used with CORTOSS.

In addition, we are developing RHAKOSS(TM) Synthetic Bone Spinal Implants.

VITOSS is a resorbable, beta-tricalcium, phosphate scaffold used as a bone void
filler in trauma and spinal procedures. CORTOSS is a high-strength,
bone-bonding, self-setting composite intended for use in the augmentation of
screws used in a variety of orthopaedic procedures and in vertebral
augmentation. RHAKOSS is under development as a high-strength, bone-bonding
preformed composite. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets.

We received regulatory clearance for VITOSS in the U.S. from the United States
Food and Drug Administration ("FDA") in December 2000 and the CE Mark in the
European Union from our notified body in July 2000. The CE Mark permits us to
sell VITOSS in all of the countries of the European Union, as well as in other
countries, such as Switzerland and Israel, that have adopted the European
Union's regulatory standards. These regulatory approvals allow us to market
VITOSS for use as a cancellous bone void filler for bony voids or gaps of the
skeletal system, including the extremities, spine and pelvis. We also received
regulatory approval, in March 2001, to sell VITOSS for this use in Australia. We
launched VITOSS in Europe in October 2000 and in the United States in February
2001. In April 2001, we entered into a agreement with Japan Medical Dynamic
Marketing, Inc. ("MDM"), an orthopaedic company in Japan, under which MDM will
initiate clinical studies necessary to apply for regulatory approval to market
VITOSS in Japan. In September 2001, we received regulatory clearance in the
United States from the FDA to market IMBIBE for use as a bone marrow aspiration
syringe. IMBIBE provides spine and trauma surgeons with a simple method for
harvesting a patient's own bone marrow, mixing it with VITOSS and delivering the
mixture to the bone graft site.

We received the CE Mark for CORTOSS in October 2001 in the European Union and
regulatory approval in March 2001 in Australia which allows us to sell CORTOSS
in these territories for use in screw augmentation procedures. Screw
augmentation is a procedure for the fixation of bone screws used in patients
with weak bone caused by osteoporosis. We initiated a limited launch of CORTOSS
in Europe in December 2001. In addition, we are conducting post-marketing human
clinical studies in Europe for the use of CORTOSS in hip compression screw
augmentation. We are also pursuing clinical studies of CORTOSS in Europe seeking
to expand its label to include its use in vertebral augmentation. During 2001,
we received conditional approval from the FDA to conduct a pilot clinical study
in the U.S. for the use of CORTOSS for vertebral augmentation. In addition,
during 2002, we received approval from the FDA to conduct a pivotal clinical
study in the U.S. for the use of CORTOSS for long bone screw augmentation. There
can be no assurance that the data from any such clinical trials will support FDA
clearance or approval to market this product for these uses.

Our ALIQUOT Microdelivery System facilitates effective delivery of our CORTOSS
product directly to the surgical site. A two-part system of catheter and
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation procedures.

RHAKOSS is designed to mimic the strength and flexibility characteristics of
bone, as well as its radiolucency, which means its degree of transparency to x-
rays and other radiation. RHAKOSS can be manufactured into any size or shape to
optimize anatomic fit. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets. We initiated pre-
clinical studies for our RHAKOSS spinal implants in December 2000 and our goal
is to initiate human clinical studies in 2002 in Europe.

                                      F-6
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are utilizing this network for CORTOSS in Europe,
Australia and Israel. If MDM is successful in obtaining clearance to market
VITOSS, it will distribute, sell and market VITOSS in Japan. We plan to seek a
similar arrangement for CORTOSS in Japan.

We incorporated in Pennsylvania in 1992 and began operations in 1993. Our
principal offices are located at 45 Great Valley Parkway, Malvern, Pennsylvania
19355.

Our operations are subject to certain risks including but not limited to the
need to successfully commercialize both VITOSS in the U.S., Europe, Australia
and Israel and CORTOSS in Europe and Australia. We also need to successfully
develop, obtain regulatory approval for, and commercialize CORTOSS in the U.S.
and RHAKOSS in the U.S. and Europe. We have incurred losses each year since our
inception in 1993 and we expect to continue to incur losses for at least the
next several years. As of December 31, 2001, we had an accumulated deficit of
$61,599,522. Our products under development may never be commercialized or if
commercialized, may never generate substantial revenue. We do not expect sales
to generate cash flow in excess of operating expenses for at least the next
several years, if at all. We expect to continue to use cash, cash equivalents
and short-term investments to fund operating and investing activities. We
believe that our existing cash of $12,906,557 as of December 31, 2001 will be
sufficient to meet our currently estimated operating and investing requirements
into early 2003; however, if we do not raise additional cash during 2002, we may
be required to curtail or limit certain marketing support and research and
development activities in order to remain compliant with certain financial
covenants (see Note 7). A curtailment of certain activities would delay
development of certain of our products. We will need to raise additional funds
by the fourth quarter of 2002 to meet the Nasdaq National Markets continuing
listing requirements if the bid price per share of our Common Stock remains
below $3.00 per share. We may seek to obtain additional funds through equity or
debt financings, or strategic alliances with third parties either alone or in
combination with equity. These financings could result in substantial dilution
to the holders of our Common Stock or require debt service and/or royalty
payment arrangements. Any such required financing may not be available in
amounts or on terms acceptable to us.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Preparation of Financial Statements and Use of Estimates

Our consolidated financial statements have been prepared using United States
generally accepted accounting principles. This preparation requires that we make
assumptions and estimates that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
We believe our more significant estimates and judgments involve accounting
policies affecting the areas of revenue recognition, inventories, revenue
interest obligation accounting, income taxes and accounting for certain equity
transactions.

Basis of Consolidation

The consolidated financial statements include the accounts of Orthovita, Inc.,
our European branch operations, and our wholly owned subsidiaries including,
Vita Licensing, Inc., which was established to hold all intellectual property.
We have eliminated all intercompany balances in consolidation.

Net Loss Per Common Share

We have presented net loss per common share pursuant to Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share." Basic net loss per
share excludes potentially dilutive securities and is computed by dividing net
loss applicable to common shareholders by the weighted average number of shares
of Common Stock outstanding for the period. Diluted net loss per common share
data is generally computed assuming the conversion or exercise of all dilutive
securities such as Common Stock options and warrants; however, Common Stock
options and warrants were excluded from our computation of diluted net loss per
common share for the years ended December 31, 2001, 2000 and 1999 because they
were anti-dilutive due to our losses.

                                      F-7
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Revenue Recognition

Revenue from product sales is recognized upon the receipt of a valid order and
shipment to our distributor customers in Europe, Australia and Israel. In the
U.S., product sales revenue is recognized upon the receipt of a valid order and
shipment of the product to the end user hospital. We do not allow product
returns or exchanges. In addition, collection of the customers' receivable
balance must be deemed probable. We maintain an accounts receivable allowance
for an estimated amount of losses that may result from customers' inability to
pay for product purchased. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.

Inventory

Inventory is stated at the lower of cost or market value using the first-in
first-out basis, or FIFO, method. We would write down our inventory, if
necessary, by estimating the potential for future loss based on a variety of
factors, including the quantity of particular items, their prospect for
replacement or obsolescence and the remaining shelf life. If actual market
conditions were to be less favorable than those projected by management and
demand decreased, inventory write-downs would be required. As of December 31,
2001 we have not needed to write down our inventory.

Revenue Interest Obligation

During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Capital Royalty Acquisition Fund, L.P. ("Paul Royalty") in
which we sold a revenue interest and 2,582,645 shares of our Common Stock.

The net proceeds of the financing were first allocated to the fair value of the
Common Stock on the date of the transaction, and the $5,222,107 remainder of the
net proceeds was allocated to the revenue interest obligation. Given that the
products subject to the revenue interest have only recently been approved and
marketed or are still under development, we, as of December 31, 2001 and for the
foreseeable future, cannot make a reasonable estimate of their future sales
levels and the related revenue interest obligation. Accordingly, in 2002 and the
foreseeable future, we will charge revenue interest expense as payments due
under the revenue interest obligation are incurred.

On March 22, 2002, the agreement with Paul Royalty was modified whereby they
exchanged 860,882 shares of our Common Stock for elimination of certain
potential credits allowable to us against our revenue interest obligation, as
well as, a reduction in the repurchase price (see Note 7). This modification
will be accounted for as a treasury stock transaction with a decrease to
shareholders' equity and an increase to the revenue interest obligation based
upon the fair market value of the Common Stock on the date of the modification
to the transaction, or $2.26 per share or $1,946,454 in the aggregate.

Income Taxes

We account for income taxes in accordance with SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected tax
consequences of events that have been recognized in the financial statements or
tax returns. SFAS No. 109 requires that deferred tax assets and liabilities be
recorded without consideration as to their realizability. The deferred tax asset
includes the cumulative temporary difference related to certain research, patent
and organizational costs, which have been charged to expense in our Statements
of Operations contained in this Form 10-K but have been recorded as assets for
federal tax return purposes. These tax assets are amortized over periods
generally ranging from 5 to 20 years for federal tax purposes. The portion of
any deferred tax asset for which it is more likely than not that a tax benefit
will not be realized must then be offset by recording a valuation allowance
against the asset. A valuation allowance has been established against all of our
deferred tax assets since the realization of the deferred tax asset is not
assured given our history of operating losses.

                                      F-8
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Accounting for Stock Issued to Employees

We apply Accounting Principal Board Opinion ("APB") No. 25, "Accounting for
Stock Issued to Employees," and the related interpretations in accounting for
our stock option plans.

Research and Development Costs

In accordance with SFAS No. 2 "Accounting for Research and Development Costs,"
we expense all research and development expenses as incurred.

Foreign Currency Translation

The functional currency for the Company's branch operation in Europe is the
Euro. In accordance with SFAS No. 52, "Foreign Currency Translation," assets and
liabilities related to this foreign operation are translated at the current
exchange rates at the end of each period. The resulting translation adjustments
are accumulated as a separate component of shareholders' equity. Revenues and
expenses are translated at average exchange rates in effect during the period
with foreign currency transaction gains and losses, if any, included in results
of operations.

Supplemental Cash Flow Information

During 2001, 2000 and 1999, respectively, we issued options and warrants for the
purchase of 203,000, 117,500 and 41,100 shares of Common Stock with various
exercise prices to certain vendors in consideration for services valued at
$354,557, $510,431 and $185,664, respectively.

In 1999, we received 77,900 shares of our Common Stock valued at $486,875, and
in addition we received $103,800 in cash for full repayment of a loan.

In 2000 and 1999, we incurred capital lease obligations of $997,489, and
$609,851, respectively. We did not incur any capital lease obligations in 2001.
In 2001, 2000 and 1999, cash paid for interest was $219,824, $151,161 and
$110,601, respectively. The Company paid no income taxes in 2001, 2000 and 1999.

Recent Accounting Pronouncements

The Financial Accounting Standards Board's ("FASB") SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities", established accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts, and hedging activities. Previously hedging activities relating
to changes in foreign exchange rates were addressed in SFAS No. 52, "Foreign
Currency Translation". SFAS No. 80, "Accounting for Futures Contracts" addressed
the use of futures contracts in other hedging activities. Those two Statements
addressed only certain derivative instruments and differed in the criteria
required for hedge accounting. We did not have any derivative transactions
during 2001.

The FASB's SFAS No. 141, "Business Combinations", established financing
accounting and reporting for business combinations which supersedes APB Opinion
No. 16, "Business Combinations", and SFAS No. 38, "Accounting for Preacquisition
Contingencies of Purchased Enterprises". SFAS No. 141 requires that all business
combinations be accounted for using the purchase method of accounting. The
provisions apply to all business combinations initiated after June 30, 2001. We
did not have any business combinations during 2001.

                                      F-9
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The FASB's SFAS No. 142, "Goodwill and Other Intangible Asset", established
financial accounting and reporting for acquired goodwill and other intangible
assets and supersedes APB Opinion No. 17, "Intangible Assets". SFAS No. 142
addresses how intangible assets that are acquired individually or with a group
of other assets should be accounted for in financial statements upon their
acquisition, and after they have been initially recognized in the financial
statements. The provisions of SFAS No. 142 are effective for fiscal years
beginning after December 31, 2001. We do not have any acquired goodwill or other
intangible assets.

The FASB's SFAS No. 143, "Accounting for Asset Retirement Obligations" required
that the fair value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made, with the associated asset retirement costs capitalized
as part of the carrying amount of the long-lived asset. We do not have any asset
retirement obligations.

The FASB's SFAS No. 144, "Accounting for the Impairment or Disposal of Long-
Lived Assets", is effective for fiscal years beginning after December 15, 2001
and interim periods within those fiscal periods. SFAS No. 144 supersedes FASB
Statement No. 121 and parts of APB Opinion No. 30, " Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions
Relating to Extraordinary Items", however, SFAS No. 144 retains the requirement
of APB Opinion No. 30 to report discontinued operations separately from
continuing operations and extends that reporting to a component of an entity
that either has been disposed of (by sale, abandonment or in a distribution to
owners) or is classified as held for sale. SFAS No. 144 addresses financial
accounting and reporting for the impairment of certain long-lived assets and for
long-lived assets to be disposed of. We have adopted SFAS No. 144 and have
evaluated the useful life of our long-lived assets. We do not have any
impairment or disposals of long-lived assets.

3.   CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:

We invest excess cash in highly liquid investment-grade marketable securities
including corporate commercial paper and U.S. government agency bonds. For
financial reporting purposes, we consider all highly liquid investment
instruments purchased with an original maturity of three months or less to be
cash equivalents. As of December 31, 2000, we invested all excess cash in cash
equivalents and short-term investments; however, if long-term investments are
held, such investments are considered available-for-sale and, accordingly,
unrealized gains and losses are included as a separate component of
shareholders' equity. As further discussed in Note 7, our covenants under our
revenue interest agreement require us to maintain specified levels of aggregate
cash, cash equivalents and short-term investments.

As of December 31, 2001 and 2000, cash and cash equivalents and short-term
investments consisted of the following:

                                             Gross        Gross          Fair
                               Original    Unrealized   Unrealized      Market
                                 Cost         Gains       Losses         Value
                                 ----         -----        ------        -----
December 31, 2001:
Cash and cash equivalents..    $12,906,557   $     --      $    --   $12,906,557
                               -----------   --------      -------   -----------
                               $12,906,557   $     --      $    --   $12,906,557
                               ===========   ========      =======   ===========
December 31, 2000:
Cash and cash equivalents..    $ 3,614,626   $     --      $    --   $ 3,614,626
Short-term investments.....        199,886        480           --       200,366
                               -----------   --------      -------   -----------
                               $ 3,814,512   $    480      $    --   $ 3,814,992
                               ===========   ========      =======   ===========

                                     F-10
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

4.   INVENTORIES:

Inventories are stated at the lower of cost or market on a first-in, first-out
basis. As of December 31, 2001 and 2000, inventories consisted of the following:

                                              December 31
                                                2001                2000
                                                ----                ----
Raw materials .....................       $  108,960            $  2,042
Work-in-process....................          752,079             180,357
Finished goods.....................          745,294                  --
                                          ----------            --------
                                          $1,606,333            $182,399
                                          ==========            ========

All of the approximately $208,000 of VITOSS sold in Europe during 2000 was
produced prior the receipt of its CE Certification in July 2000. In accordance
with SFAS No. 2 "Accounting for Research and Development Costs," the
approximately $77,000 of costs to produce that material was recorded as research
and development expense prior to July 2000 and, accordingly, are not reflected
in cost of sales. As of December 31, 2000, we maintained inventory on hand of
approximately $45,000 that was charged to research and development expense prior
to July 2000. This inventory was sold during 2001.

5.   PROPERTY AND EQUIPMENT:

Property and equipment, including assets held under capitalized lease
obligations, are recorded at cost. Depreciation is calculated on a straight-line
basis over the estimated useful life of each asset, primarily three to five
years. The useful life for leasehold improvements is generally the remaining
term of the facility lease. Expenditures for major renewals and improvements are
capitalized and expenditures for maintenance and repairs are charged to
operations as incurred.

Property and equipment consisted of the following:
                                                         December 31
                                                             2001          2000
                                                             ----          ----
Machinery and equipment..............................  $3,371,746    $2,804,893
Furniture, computer, marketing, and office equipment.   1,663,060     1,356,970
Leasehold improvements...............................   4,037,637     3,456,526
                                                        ---------   ------------
                                                        9,072,443     7,618,389
Less--Accumulated depreciation ....................... (3,639,090)   (2,297,161)
                                                       -----------  ------------
                                                       $5,433,353    $5,321,228
                                                       ===========  ============

In the year ended December 31, 2000, we acquired certain property and equipment
under capitalized lease obligations which are reflected in the above table. We
did not acquire property and equipment under capitalized lease obligations in
2001. Total assets under capital lease are $2,819,745 and $2,836,080 with
related accumulated amortization of $1,651,065 and $1,107,574 at December 31,
2001 and 2000, respectively (see Note 8).

6.   BORROWINGS:

A $1,500,000 bank credit arrangement was due to expire on June 30, 2002 but was
terminated, at our request, during October 2001. As of December 31, 2000, no
amounts were outstanding under the bank credit arrangement. In addition, as of
December 31, 2000, a $500,000 capital expenditure term note ("Term Note") was
outstanding and was repaid in full without penalty in October 2001.

The Term Note and line of credit bore interest at an annual rate of the prime
rate plus 1.0%. Both the line of credit and Term Note were secured by our
general assets and a $250,000 bank certificate of deposit which was included in
Other Assets as of December 31, 2000. The bank certificate of deposit, which
secured our credit arrangement, was released as collateral during October 2001.

                                     F-11
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

7.   REVENUE INTEREST OBLIGATION:

     During October 2001, we completed a $10,000,000 product development and
     equity financing with Paul Royalty. We will use the proceeds realized from
     this financing for clinical development, marketing programs, and working
     capital relating to our VITOSS, CORTOSS and RHAKOSS products. In this
     financing, we sold Paul Royalty a revenue interest and sold 2,582,645
     shares of our Common Stock, for aggregate gross proceeds of $10,000,000.
     The Common Stock was recorded at its market value of $4,777,893 and a
     revenue interest obligation related to the revenue interest of $5,222,107
     was recorded.

     The net proceeds of the financing were first allocated to the fair value of
     the Common Stock on the date of the transaction, and the $5,222,107
     remainder of the net proceeds was allocated to the revenue interest
     obligation. Given that the products subject to the revenue interest have
     only recently been approved and marketed or are still under development,
     we, as of December 31, 2001 and for the forseeable future, cannot make a
     reasonable estimate of their future sales levels and the related revenue
     interest obligation. Accordingly, in 2002 and the foreseeable future, we
     will charge revenue interest expense as payments due under the revenue
     interest obligation are incurred.

     On March 22, 2002, the agreement with Paul Royalty was modified whereby
     they exchanged 860,882 shares of our Common Stock for elimination of
     certain potential credits allowable to us against our revenue interest
     obligation, as well as, a reduction in the repurchase price. This
     modification will be accounted for as a treasury stock transaction with a
     decrease to shareholders' equity and an increase to the revenue interest
     obligation based upon the fair market value of the Common Stock on the date
     of the modification to the transaction of $2.26 per share or $1,946,454.

     The revenue interest provides for Paul Royalty to receive 3.5% on the first
     $100,000,000 of annual sales plus 1.75% of annual sales in excess of
     $100,000,000 of our VITOSS, CORTOSS and RHAKOSS products in North America
     and Europe through 2016, subject to certain adjustments. Our obligation to
     pay the revenue interest is secured by our licenses, patents and trademarks
     relating to our VITOSS, CORTOSS and RHAKOSS products, in North America and
     Europe, and the 12% royalty interest we pay to Vita Licensing, Inc., our
     wholly-owned subsidiary, on the sales of our products (collectively, the
     "Pledged Assets"). We are also required to maintain:

     -cash and cash equivalent balances equal to or greater than the product of
     (i) 1.5 and (ii) total operating losses, net of non-cash charges, for the
     preceding fiscal quarter; and

     -total shareholders' equity of at least $8,664,374; provided, however, that
     under the provisions of the agreement with Paul Royalty when calculating
     shareholders' equity for the purposes of the financial covenants, the
     revenue interest obligation is included in shareholders' equity.

     As of December 31 2001, we were in compliance with all financial covenants.
     However, if we fail to maintain such balances and shareholders' equity,
     Paul Royalty can demand that we repurchase its' revenue interest.

     In addition to the financial covenants described above, Paul Royalty has
     the right to cause us to repurchase their revenue interest upon the
     occurrence of certain events, including:

     -a judicial decision that has a material adverse effect on our business,
     operations, assets or financial condition;
     -the acceleration of our obligations or the exercise of default remedies by
     a secured lender under certain debt instruments;
     -a voluntary or involuntary bankruptcy that involves us or our wholly owned
     subsidiary, Vita Special Purpose Corp.;
     -our insolvency;
     -a change in control of our company;
     -the breach of a representation, warranty or certification made by us in
     the agreements with Paul Royalty that, individually or in the aggregate,
     would reasonably be expected to have a material adverse effect on our
     business, operations, assets or financial condition, and such breach is not
     cured within 30 days after notice thereof from Paul Royalty.

     We may not have sufficient cash funds to repurchase the revenue interest
     upon a repurchase event. The exact amount of the repurchase price is
     dependant upon certain factors, including when the repurchase event occurs.
     The repurchase price targets an internal rate of return for Paul Royalty's
     $10,000,000 investment ranging up to 45% net of revenue interest amounts
     paid by us to Paul Royalty during the term of the revenue sharing
     agreement. If we were unable to repurchase the revenue interest upon a
     repurchase event, Paul Royalty could foreclose on the Pledged Assets, and
     we could be forced into bankruptcy. Paul Royalty could also foreclose on
     the Pledged Assets if we are insolvent or involved in a voluntary or
     involuntary bankruptcy. No repurchase events or foreclosures have occurred
     as of December 31, 2001. As of December 31, 2001, if the repurchase event
     had been triggered and Paul Royalty exercised their right to require us to
     repurchase their revenue interest, we would have owed Paul Royalty
     $10,871,750.

     The March 2002 amendment reduced by $3,333,333 the amount that would be due
     to Paul Royalty should certain repurchase events occur in the future and
     which resulted in Paul Royalty requiring us to repurchase the revenue
     interest obligation. Had the amendment to the arrangement been executed
     prior to December 31, 2001 and had a repurchase event been triggered, as of
     December 31, 2001, we would have owed Paul Royalty $7,538,417 rather than
     $10,871,750.

     If we know that we will not be in compliance, we will be required to
     accrete the revenue interest obligation to the repurchase amount. As of
     December 31, 2001, we believe that we will remain in compliance for the
     foreseeable future with all covenants and terms of the revenue interest
     obligation.

                                     F-12
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

     8.   CAPITAL LEASE OBLIGATIONS:

     In 1997, we secured a $1,200,000 capital asset lease financing arrangement
     with a lending institution which was increased an additional $1,500,000 in
     December 1998. The term of each individual lease is 42 months from each
     individual lease's inception and annual interest is approximately 10.85%
     and 9.4% under the 1997 and 1998 arrangements, respectively. As of December
     31, 2000, we have utilized all available financing under the capital lease
     arrangement. The leases are secured by the underlying capital assets.
     Capital lease obligations consisted of the following:

                                                        December 31
                                                    2001            2000
                                                    ----            ----
Capital lease obligations......................  $ 881,888     $ 1,626,971
Less--amount representing interest.............    (48,949)       (165,483)
                                                 ---------     -----------
Present value of minimum lease payments........    832,939       1,461,488
Less--current portion of minimum lease payments   (482,420)       (654,063)
                                                 ---------     -----------
                                                 $ 350,519     $   807,425
                                                 =========     ===========

     Capital lease obligation maturities as of December 31, 2001 are as follows:

2002...........................    $516,842
2003...........................     319,397
2004...........................      45,649
                                   --------
                                   $881,888
                                   ========

9.   PROFIT SHARING PLAN:

The Company has a Section 401(k) plan for all qualified employees, as defined.
Company contributions are discretionary and determined annually and were
$126,331, $106,415 and $67,541 for the years ended December 31, 2001, 2000 and
1999, respectively.

10.   SHAREHOLDERS' EQUITY:

Common Stock

During December 2001, we sold 1,125,000 shares of our Common Stock to two
investors in a private equity financing. The aggregate consideration we received
for these shares consisted of $2,700,000 in cash, plus the surrender and
cancellation of outstanding warrants to purchase an aggregate of 1,125,000
shares of our Common Stock held by the two investors.

During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Royalty. In this financing, we sold Paul Royalty 2,582,645
shares of Common Stock which was recorded at its market value of $4,777,893. In
March 2002, Paul Royalty exchanged 860,882 shares of our Common Stock (See Note
7).

During June 2001, the investor in an August 2000 private placement purchased
206,830 shares of our Common Stock for $.01 per share, and 762,712 warrants
exercisable at $5.90 per share were adjusted to 1,125,000 warrants exercisable
at $4.00 per share in accordance with the anti-dilution provisions contained in
a subscription agreement dated August 22, 2000 due to the equity transactions in
January, March and April 2001. No other outstanding warrant shares have material
anti-dilution provisions.

                                     F-13
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

During April 2001, we entered into a Development and Distribution Agreement with
Japan Medical Dynamic Marketing, Inc. ("MDM"), a Japanese orthopaedic company.
In connection with this arrangement, we sold 189,394 shares of Common Stock at
$5.28 per share (the fair market value on the date of the transaction) to MDM,
raising net proceeds of $1,000,000.

Additionally, during April 2001, we sold 740,000 shares of our Common Stock at
$4.00 per share in a private equity financing raising net proceeds of
approximately $2,692,000.

During March 2001, we sold 1,975,000 shares of our Common Stock at $4.00 per
share in a private equity financing raising net proceeds of approximately
$7,290,000.

In addition, during January 2001, we sold 566,894 shares of our Common Stock and
warrants to purchase 566,894 shares of Common Stock at an exercise price of
$4.41 per share raising net proceeds of approximately $2,413,000.

In August 2000, we listed our Common Stock on the Nasdaq National Market while
retaining our listing on the European Association of Securities Dealers
Automated Quotation Market which is now under the name of Nasdaq-Europe.

In July and August 2000, we received approximately $9,100,000 in net proceeds
through private equity financings under which we sold 1,715,679 shares of our
Common Stock at $5.90 per share and warrants to purchase 762,712 shares of
Common Stock at an exercise price of $5.90 per share, subject to certain
anti-dilution adjustments.

Equity Compensation Plan

We have an Equity Compensation Plan (the "Plan") that provides for incentive and
nonqualified stock options, restricted stock awards and other equity incentives
to be granted to key employees, consultants and advisors. The Plan is the only
Plan under which stock options have been granted and the Plan has been approved
by our Shareholders.

                                     F-14
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Stock Options

Options are granted with exercise prices equal to or greater than the fair
market value of the Common Stock on the date of grant. Generally, incentive
stock options become exercisable in equal installments over a four-year period
and nonqualified stock options to non-employee consultants are issued fully
vested. The options remain exercisable for a maximum period of ten years. As of
December 31, 2001, there were 468,081 options available for grant under the plan
and 1,401,013 exercisable options outstanding with a weighted average exercise
price of $3.67 per share. In addition, we issued 373,500 options during January
2002 with a weighted average exercise price of $2.71 per share. For all
outstanding options, the weighted average exercise price per share is $4.42 with
a weighted average remaining contractual life of approximately seven and
three-quarter years. Summary stock option information is as follows:

<TABLE>
<CAPTION>
                                                                       Exercise            Aggregate
                                                    Number           Price Range        Exercise Price
                                                    ------           -----------        --------------
<S>                                                 <C>              <C>                   <C>
Outstanding, December 31, 1998............            982,794        $ 1.00-11.63          $  3,623,660
     Granted..............................            739,850           4.35-6.60             3,869,778
     Exercised............................          (101,472)           2.75-4.25             (332,830)
     Canceled.............................           (33,950)           4.25-4.75             (147,888)
                                                   ----------        ------------          ------------
Outstanding, December 31, 1999............          1,587,222          1.00-11.63             7,012,720
     Granted..............................            421,100           4.13-7.95             2,220,783
     Exercised............................          (220,547)           1.00-4.25             (763,031)
     Canceled.............................           (28,325)          4.25-11.12             (195,916)
                                                   ----------        ------------          ------------
Outstanding, December 31, 2000............          1,759,450          1.00-11.63             8,274,556
     Granted..............................            816,600           1.70-5.87             3,222,786
     Exercised............................           (13,350)           1.00-5.00              (17,925)
     Canceled.............................           (91,900)           2.85-7.95             (555,905)
                                                   ----------        ------------          ------------
Outstanding, December 31, 2001............          2,470,800        $ 1.00-11.63          $ 10,923,512
                                                   ==========        ============          ============
</TABLE>

We apply Accounting Principal Board Opinion No. 25, "Accounting for Stock Issued
to Employees," ("APB 25") and the related interpretations in accounting for our
stock option plans. Under APB 25, compensation cost related to stock options is
computed based on the intrinsic value of the stock option at the date of grant,
reflected by the difference between the exercise price and the fair value of our
Common Stock. Under SFAS No. 123, "Accounting for Stock-Based Compensation,"
compensation cost related to stock options is computed based on the value of the
stock options at the date of grant using an option valuation methodology,
typically the Black-Scholes model. SFAS No. 123 can be applied either by
recording the Black-Scholes model value of the options or by continuing to
record the APB 25 value and by disclosing SFAS No. 123. We have applied the pro
forma disclosure requirement of SFAS No. 123, "Accounting for Stock-Based
Compensation". Had compensation cost for our common stock option plans been
determined under SFAS No. 123, our net loss and net loss per common share would
have been adjusted as follows:

<TABLE>
<CAPTION>
                                                            Year Ended December 31
                                                    2001             2000            1999
                                                    ----             ----            ----
<S>                                               <C>             <C>              <C>
Net loss applicable to common shareholders:
     As reported...............................   $13,790,419     $11,335,349      $ 9,496,594
     Pro forma.................................    14,499,348      11,936,979       11,508,328

Net loss per common share, basic and diluted:
     As reported...............................   $      (.82)    $      (.92)     $      (.83)
     Pro forma.................................          (.86)           (.97)           (1.01)
</TABLE>

                                     F-15
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The weighted average fair value of the options granted during 2001, 2000 and
1999 is estimated as $.87, $1.98 and $2.87 per share, respectively, on the date
of grant using the Black-Scholes option pricing model with the following
assumptions: dividend yield of zero, volatility of 50%, risk-free interest rate
of 3.3%, 5.0% and 6.4% during 2001, 2000 and 1999, respectively, and an expected
life of six years. The resulting pro forma compensation charge presented may not
be representative of that to be expected in the future years to the extent that
additional stock options are granted and the fair value of the common stock
increases or decreases.

Restricted Stock Award

During 2000, a restricted stock award was made to an employee under which an
award for 45,000 shares, then valued at $270,325, was granted subject to
vesting. As of December 31, 2001 and 2000, 45,000 and 28,750 shares of Common
Stock, respectively, were vested under the award.

Employee Stock Purchase Plan

In November 1998, an Employee Stock Purchase Plan (the "ESPP") was established
to provide eligible employees an opportunity to purchase our Common Stock. Under
the terms of the ESPP, eligible employees may have up to 10% of eligible
compensation deducted from their pay to purchase Common Stock. The per share
purchase price is 85% of the lower closing price on the first or last trading
day of each calender quarter. The amount that may be offered pursuant to the
ESPP is 300,000 shares of our Common Stock. There were 32,185, 9,070 and 2,732
shares purchased under the ESPP during 2001, 2000 and 1999, respectively. As of
December 31, 2001, there were 256,013 shares of Common Stock available for
purchase under the Plan.

Common Stock Purchase Warrants

In December 2001 (see Common Stock above), warrants to purchase 1,125,000 shares
of our Common Stock, originally issued in a private placement transaction in
August 2000 were surrendered in exchange for the purchase of 1,125,000 shares of
our Common Stock.

In connection with the March and April 2001 equity financing (see Common Stock
above), we issued warrants to our placement agent to purchase an aggregate of
81,450 shares of our Common Stock at $4.00 per share as a placement agent fee.
These warrants were exercisable when issued and expire in March 2003 and April
2003.

In connection with the January 2001 private equity offering (see Common Stock
above), we issued warrants to purchase 566,894 shares of Common Stock at an
exercise price of $4.41 per share. These warrants were exercisable when issued
and expire in January 2003.

During August 2000, in connection with a private equity offering (see Common
Stock above), we issued warrants to purchase 762,712 shares of Common Stock at
an exercise price of $5.90 per share subject, to certain anti-dilution
adjustments. In addition, we paid placement agent fees consisting of warrants to
purchase 65,559 shares of our Common Stock at an exercise price of $5.90 per
share.

                                     F-16
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Summary Common Stock warrant information as of December 31, 2001 is as follows:

                       Number of Warrant
Year of Expiration     Shares Outstanding    Exercise Price Range
------------------     ------------------    --------------------
2002                     547,010                $4.25
2003                     653,405                $4.00 - $4.41
2003                      24,426                $8.60
2004                      10,000                $6.00
2005                     113,559                $5.26 - $5.90
                       ---------                -------------
    Total              1,348,400                $4.00 - $8.60
                       =========                =============

11.   PRODUCT SALES:

We initiated sales of VITOSS in Europe and the United States in October 2000 and
March 2001, respectively. CORTOSS sales were initiated in Europe during December
2001. For the years ended December 31, 2001 and 2000, product sales of VITOSS
and CORTOSS by geographic market were as follows:

                                             Year Ended December 31
                                             ----------------------
                                                 2001             2000
                                                 ----             ----
PRODUCT SALES (excluding BIOGRAN):
 United States                            $ 3,305,873       $      ---
 Outside the United States                    634,522          207,693
                                          -----------       ----------
     Total product sales                  $ 3,940,395       $  207,693
                                          ===========       ==========


Sales of our dental product, BIOGRAN, were $532,967 and $1,054,120 during 2000
and 1999, respectively. In March 2000, we sold our BIOGRAN dental grafting
product line for $3,900,000 and received proceeds of $3,500,000 with an
additional $400,000 held in a restricted cash escrow account until March 2001.

                                     F-17
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

12.   INCOME TAXES:

We account for income taxes in accordance with SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected tax
consequences of events that have been recognized in the financial statements or
tax returns.

The components of income taxes are as follows:
                                         Year Ended December 31
                                         ----------------------
                                      2001              2000               1999
                                      ----              ----               ----
Current...................     $        --       $        --        $        --
Deferred..................     (3,105,430)       (1,583,490)        (2,116,201)
                               -----------       -----------        -----------
                               (3,105,430)       (1,583,490)        (2,116,201)
Valuation allowance........      3,105,430         1,583,490          2,116,201
                               -----------       -----------        -----------
                               $        --       $       --         $        --
                               ===========       ===========        ===========

The difference between our federal statutory income tax rate and our effective
income tax rate is primarily due to state income taxes and the valuation
allowance.

Components of our deferred tax asset as of December 31, 2001 and 2000 are as
follows:

<TABLE>
<CAPTION>
                                                                          December 31
                                                                          -----------
                                                                          2001               2000
                                                                          ----               ----
<S>                                                               <C>                <C>
Deferred tax assets:
          Net operating loss carryforwards......................  $ 12,949,311       $  9,288,321
          Accrued expenses not currently deductible.............       710,023            981,904
          Research, patent and organizational costs capitalized
             for tax purposes...................................     7,139,268          5,614,886
                                                                  ------------       ------------
                                                                    20,798,602         15,885,111
Valuation allowance.............................................   (20,798,602)       (15,885,111)
                                                                  ------------       ------------
Net deferred tax asset..........................................  $        --        $        --
                                                                  ============       ============
</TABLE>

SFAS No. 109 requires that deferred tax assets and liabilities be recorded
without consideration as to their realizability. The portion of any deferred tax
asset for which it is more likely than not that a tax benefit will not be
realized must then be offset by recording a valuation allowance against the
asset. A valuation allowance has been established against all of our deferred
tax assets since the realization of the deferred tax asset is not assured given
our history of operating losses. The deferred tax asset includes the cumulative
temporary difference related to certain research, patent and organizational
costs, which have been charged to expense in the accompanying Statements of
Operations but have been recorded as assets for federal tax return purposes.
These tax assets are amortized over periods generally ranging from 5 to 20 years
for federal tax purposes.

                                     F-18
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

As of December 31, 2001, we had $37,645,033 of federal net operating loss
carryforwards, which begin to expire in 2008. Our annual utilization of net
operating loss carryforwards will be limited pursuant to the Tax Reform Act of
1986, since a cumulative change in ownership over a three-year period of more
than 50% occurred as a result of the cumulative issuance of our Common Stock and
Common Stock equivalents. We believe, however, that such limitation may not have
a material impact on the ultimate utilization of our carryforwards.

The federal net operating loss carryforwards are scheduled to expire
approximately as follows:

                           2008..........                    $      7,729
                           2009..........                         490,568
                           2010..........                       2,976,405
                           2011..........                       4,342,295
                           2012..........                       4,574,051
                           2013..........                       4,219,188
                           2014..........                       5,874,561
                           2015..........                       6,114,855
                           2016..........                       9,045,381
                                                             ------------
                                                             $ 37,645,033
                                                             ============

13.   COMMITMENTS AND CONTINGENCIES:

Operating Leases

We lease office space and equipment under noncancelable operating leases. For
the years ended December 31, 2001, 2000 and 1999, lease expense was $421,535,
$321,039, and $304,732, respectively. At December 31, 2001, future minimum
rental payments under operating leases are as follows:

                           2002............                    $   373,418
                           2003............                        362,372
                           2004............                        356,652
                           2005............                        356,652
                           2006............                        356,652
                           2007 and thereafter........           1,476,807
                                                               -----------
                                                               $ 3,282,553
                                                               ===========

                                     F-19
<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Revenue Interest Expense

We are obligated to pay to Paul Royalty of 3.5% on the first $100,000,000 of
annual sales plus 1.75% of annual sales in excess of $100,000,000 of our VITOSS,
CORTOSS and RHAKOSS products in North America and Europe through 2016, subject
to certain adjustments. In addition, Paul Royalty has the right to cause us to
repurchase their revenue interest upon the occurrence of certain events (see
Note 7).

14.   LITIGATION AND PROCEEDINGS:

In July 1992, we obtained a license from FBFC International, a Belgian company,
that allowed us to manufacture and sell our BIOGRAN dental grafting product. We
sold the rights to sell BIOGRAN to Implant Innovations, Inc. ("3i") in 2000. In
July 1994, U.S. Biomaterials Corporation filed with the U.S. Patent and
Trademark Office ("PTO") a Request for Reexamination of the U.S. patent held by
FBFC for BIOGRAN, of which we had been the exclusive licensee. FBFC filed a
response in this proceeding, establishing that the claims of the FBFC patent
were properly allowed. As a result, a Certification of Reexamination was issued
by the PTO confirming the patentability of all claims of the FBFC patent without
amendment. However, U.S. Biomaterials Corporation instituted a nullification
proceeding against the European counterpart to FBFC's U.S. patent. The
opposition division of the European Patent Office tentatively decided in FBFC's
favor, but the matter is still proceeding under an appeal. In connection with
the BIOGRAN sale to 3i, 3i assumed control of this matter and we have agreed to
reimburse 3i for the associated legal costs and to provide them with certain
indemnification with respect to the matter. We do not believe there are any
material liabilities with respect to the indemnification for this matter.

15.   QUARTERLY FINANCIAL DATA (UNAUDITED):

<TABLE>
<CAPTION>
                                                     For the Three Months Ended
2001:                           March 31            June 30          September 30        December 31            Total
                                --------            -------          ------------        -----------            -----

<S>                              <C>                 <C>                <C>                 <C>                <C>
Product sales                       $226,406           $ 953,603        $ 1,134,253          $1,626,133          $3,940,395
Gross profit                         207,006             699,965            963,542           1,350,509           3,221,022
Total operating expenses
                                   3,901,735           4,368,083          4,451,924           4,752,888          17,474,630
Net gain on sale of
product line                         375,000                 ---                ---                 ---             375,000
Net loss                         (3,290,797)         (3,598,486)        (3,456,448)         (3,444,688)        (13,790,419)

Net loss per common
share, basic and diluted             $ (.26)             $ (.22)             $(.20)              $(.18)              $(.82)
</TABLE>

<TABLE>
<CAPTION>
                                                       For the Three Months Ended
2000:                           March 31             June 30         September 30        December 31            Total
                                --------             -------         ------------        -----------            -----

<S>                                <C>               <C>                <C>                 <C>                <C>
Product sales                       $532,967               $ ---              $ ---            $207,693            $740,660
Gross profit                         368,926                 ---                ---             201,693             570,619
Total operating expenses           3,180,874           3,682,386          3,612,354           4,715,548          15,191,162
Net gain on sale of
product line                       3,070,921                 ---                ---                 ---           3,070,921
Net income (loss)                    305,162          (3,635,124)        (3,528,050)         (4,477,337)        (11,335,349)

Net income (loss) per
common share, basic
and diluted                            $ .03              $ (.31)             $(.28)              $(.36)              $(.92)
</TABLE>

                                     F-20