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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

  [X] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
             Act of 1934 for the fiscal year ended December 31, 2002

                                       or

     [ ] Transition report pursuant to section 13 or 15(d) of the Securities
                              Exchange Act of 1934

                         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: None

           Securities registered pursuant to Section 12(g) of the Act:
           -----------------------------------------------------------
             Common Stock, par value $.01 per share (Title of class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the

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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]

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

As of June 30, 2002, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $25,472,947. 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 24, 2003, there were 20,748,865 shares of the registrant's Common
Stock outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE:

Portions of Orthovita, Inc.'s Proxy Statement relating to the 2003 Annual
Meeting of Shareholders (to be filed within 120 days after the end of the fiscal
year covered by this annual report on Form 10-K) are incorporated into Part III
of this annual report on Form 10-K by reference.

Portions of Orthovita, Inc.'s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002 filed with the Commission on November 19, 2002 are
incorporated into Part I of this annual report on Form 10-K by reference.

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                                TABLE OF CONTENTS

<TABLE>
<S>                                                                                                  <C>
PART I

ITEM 1.        Business.........................................................................      1-18
ITEM 2.        Properties.......................................................................        19
ITEM 3.        Legal Proceedings................................................................        20
ITEM 4.        Submission of Matters to a Vote of Security Holders..............................        20

PART II

ITEM 5.        Market for Registrant's Common Equity And Related Shareholder Matters............     20-21
ITEM 6.        Selected Consolidated Financial Data.............................................     21-22
ITEM 7.        Management's Discussion and Analysis of Financial Condition and Results of
                Operations......................................................................     23-51
ITEM 7A.       Quantitative and Qualitative Disclosure About Market Risk........................        51
ITEM 8.        Financial Statements and Supplemental Data.......................................        51
ITEM 9.        Changes In and Disagreements with Accountants on Accounting and Financial
                Disclosure......................................................................        51

PART III

ITEM 10.       Directors and Executive Officers of the Registrant...............................        52
ITEM 11.       Executive Compensation...........................................................        52
ITEM 12.       Security Ownership of Certain Beneficial Owners and Management and
                Related Stockholder Matters.....................................................        52
ITEM 13.       Certain Relationships and Related Transactions...................................        52
ITEM 14.       Controls and Procedures..........................................................     52-53

PART IV

ITEM 15.       Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................     53-57

SIGNATURES                                                                                              58
</TABLE>

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                                     PART I

ITEM 1.      BUSINESS

FORWARD LOOKING INFORMATION

In addition to historical facts or statements of current conditions, our
disclosure and analysis in this Annual Report on Form 10-K contains some
forward-looking statements. Forward-looking statements give our current
expectations or forecasts of future events. You can identify these statements by
the fact that they do not relate strictly to historical or current facts. Such
statements may include words such as "may," "will," "anticipate," "estimate,"
"expect," "project," "intend," "plan," "believe," "seek" and other words and
terms of similar meaning in connection with any discussion of future operating
or financial performance. In particular, these include statements relating to
present or anticipated products and markets, future revenues, capital
expenditures, future financing and liquidity, and other statements regarding
matters that are not historical facts or statements of current condition.

Any or all of our forward-looking statements in this Annual Report on Form 10-K
may turn out to be wrong. They can be affected by inaccurate assumptions we
might make, or by known or unknown risks and uncertainties. Many factors
mentioned in ITEM 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Risks Related to Our Business"
below will be important in determining future results. Consequently, no
forward-looking statement can be guaranteed. Actual future results may vary
materially.

We undertake no obligation to publicly update any forward-looking statements,
whether as a result of new information, future events or otherwise. You are
advised, however, to consult any further disclosures we make on related subjects
in our filings with the U.S. Securities and Exchange Commission ("SEC"). This
discussion is provided as permitted by the Private Securities Litigation Reform
Act of 1995.

Unless the context indicates otherwise, the terms "Orthovita," "Company," "we,"
"us" or "our" herein refers to Orthovita, Inc. and, where appropriate, one or
more of its subsidiaries.

GENERAL DEVELOPMENT OF OUR BUSINESS

Orthovita 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 incorporated in 1992 and have developed several
products to date:

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

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

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     .    CORTOSS(R) Synthetic Cortical Bone Void Filler; and

     .    ALIQUOT(TM) Microdelivery System used with CORTOSS.

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

VITOSS has characteristics resembling those of cancellous bone with a
lattice-like or spongy, porous structure that is subject to compressive forces.
CORTOSS has characteristics resembling those of cortical bone, which is dense,
structural and subject to bending, load bearing and twisting forces. Both
cortical and cancellous bones can be damaged from traumatic injury and
degenerative disease, such as osteoporosis, creating a need for both cortical
and cancellous synthetic bone substitutes. In surgical procedures, IMBIBE is
used to deliver VITOSS to the bone graft site, and ALIQUOT is used to deliver
CORTOSS to the surgical site.

Information regarding our product sales by geographic market for each of the
fiscal years ended December 31, 2002, 2001 and 2000 is included in Note 10
(Product Sales) to the consolidated financial statements which is elsewhere in
this Annual Report.

We have assembled a network of commissioned sales agencies in the U.S. in order
to market VITOSS and IMBIBE. Outside of the U.S., we utilize a network of
independent stocking distributors to market VITOSS, CORTOSS, and ALIQUOT. If
Japan Medical Dynamic Marketing, Inc. is successful in obtaining clearance to
market VITOSS it will distribute, market and sell VITOSS in Japan.

We market and sell our products for only the indication(s) or use(s) that have
received regulatory approval as further discussed below under the caption
"Government Regulations."

In August 2002, we entered into a supply agreement with BioMimetic
Pharmaceutical Inc. ("BioMimetic") that allows BioMimetic to use its recombinant
human platelet derived growth factor ("rhPDGF") in combination with our
proprietary VITOMATRIX(TM) particulate synthetic scaffold biomaterial. Under the
agreement, we will supply our proprietary calcium phosphate biomaterial to
BioMimetic for its clinical and commercial use in conjunction with rhPDGF. The
agreement provides that, upon obtaining the requisite regulatory approvals,
BioMimetic will market and sell the combined product, which is currently
distributed for investigational use, in the dental, periodontal, oral and
cranio-maxillofacial bone grafting markets.

In March 2003, we entered into an agreement with Kensey Nash Corporation to
jointly develop and commercialize new biomaterials-based spine products. The new
products to be developed under this agreement will be based on our proprietary
VITOSS bone void filler material in combination with proprietary Kensey Nash
biomaterials. The intent of the agreement is to develop new products that can be
brought to market through the 510(k) regulatory process. Kensey Nash will
manufacture the products and we will market and sell the products worldwide.

We maintain a web site at www.orthovita.com and make available free of charge on
this web site our annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on

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Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as
reasonably practicable after we electronically file these materials with, or
furnish them to, the SEC.

OUR PRODUCT PIPELINE AND RELATED CLINICAL APPLICATIONS

As further discussed below under the caption "Government Regulation," our
products and product candidates are subject to extensive regulation as medical
devices by the U.S. Food and Drug Administration ("FDA"), regulatory authorities
in Europe such as TNO, or the Netherlands Organization for Applied Scientific
Research, who we have selected as our notified body (our "Notified Body") and
regulatory authorities in other jurisdictions. Product approval applications for
our products must be supported by valid scientific evidence, typically including
clinical trial data, to demonstrate the safety and effectiveness of the
products.

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 three 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 CE Certification in the European Union from our Notified Body in July
2000 (see GOVERNMENT REGULATION-Europe below). The CE Certification 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 U.S. in March 2001. Pursuant to an
agreement we reached in April 2001, Japan Medical Dynamic Marketing, Inc., an
orthopaedic company, will initiate clinical studies necessary to apply for
regulatory approval to market VITOSS in Japan. These clinical studies in Japan
have not yet been initiated and there can be no assurance that such studies will
support clearance or approval from the Japanese Ministry of Health, Labor and
Welfare ("MHW") to market this product for any use.

Through 2002, VITOSS was available in two product configurations - VITOSS Block
and VITOSS Morsel. In February 2003, we launched two additional VITOSS
configurations - VITOSS Scaffold Micro Morsels and VITOSS Scaffold Macro Morsels
(see "PRODUCT LINE EXTENSIONS" below). These product iterations are designed to
provide a broader choice for our surgeon customers when utilizing VITOSS in
various applications.

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

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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 $300,000,000. Bone grafting
material is either (i) autograft material, which is often obtained or harvested
from the iliac crest region of the patient's own hip, or (ii) allograft
material, which is obtained from a cadaver, or (iii) synthetically derived
materials such as VITOSS. VITOSS has been used in bone grafting procedures as a
bone void filler in a variety of applications, including those of the long bone,
extremity, spine and pelvic areas.

An 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 instead of autograft material avoids these potential
complications of autograft harvest procedures. In addition, using VITOSS avoids
any patient and surgeon quality concerns regarding the use of cadaver derived
allograft material.

Spinal Repair. 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. In cases where
the patient has advanced disc degeneration or spinal instability, spinal fusion
involves the fusing together of adjoining vertebrae. This procedure involves a
surgical incision in the patient's back or abdomen and frequently requires 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. As discussed above, bone
grafting material is either (i) autograft material, (ii) allograft material, or
(iii) synthetically derived materials such as VITOSS. We believe the use of
VITOSS, rather than allograft or autograft materials, in spinal repair
procedures is preferable to both the patient and the surgeon.

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

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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 pelvis. In addition, VITOSS has
been used to fill bone void defects due to trauma in cancelleous fractures of
the wrist, ankle, tibia and femur.

Dental, Periodontal, Oral and Cranio-Maxillofacial. In August 2002, we entered
into a supply agreement with BioMimetic that allows BioMimetic to use its rhPDGF
in combination with our proprietary VITOMATRIX(TM) particulate synthetic
scaffold biomaterial. Under the agreement, we will supply our proprietary
calcium phosphate biomaterial to BioMimetic for its clinical and commercial use
in conjunction with rhPDGF. The agreement provides that, upon obtaining the
requisite regulatory approvals, BioMimetic will market and sell the combined
product, which is currently distributed for investigational use, in the dental,
periodontal, oral and cranio-maxillofacial bone grafting markets.

IMBIBE BONE MARROW ASPIRATE SYRINGE

In September 2001, we received regulatory clearance in the U.S. 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.
In March 2003, we received regulatory clearance in the U.S. from the FDA to
market three additional IMBIBE syringes which, we believe, will provide greater
flexibility and options for surgeons.

CORTOSS SYNTHETIC CORTICAL BONE VOID FILLER

CORTOSS is a high-strength, bone-bonding, self-setting composite engineered
specifically to mimic the characteristics of human cortical bone. Laboratory
tests demonstrate that CORTOSS exhibits compressive strength similar to human
cortical bone and is bioactive such that it promotes direct bony apposition. 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 delivery system 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 pre-filled, 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. 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

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histology (pre-clinical 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.

We received the CE Certification for CORTOSS for use in screw augmentation
procedures in October 2001 in the European Union and regulatory approval in
March 2001 in Australia, which allow us to sell CORTOSS in these territories as
well as in other countries that have adopted the European Union's regulatory
standards. 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, during January 2003
we received European regulatory approval through the CE Certification to market
CORTOSS for vertebral augmentation including compression fractures caused by
osteoporosis and invasive tumors. Vertebral augmentation is a procedure for
repairing fractured vertebrae that can be performed on an outpatient or
short-stay basis. We completed post-marketing human clinical studies in Europe
for the use of CORTOSS in hip compression screw augmentation. During 2002, we
received investigational device exemption ("IDE") approval from the FDA and
began enrolling patients in a pilot clinical study in the U.S. for the use of
CORTOSS in vertebral augmentation using the vertebroplasty surgical technique.
There can be no assurance that the data from any such clinical trials will
support clearance or approval from the FDA to market this product for any of
these uses. CORTOSS is not available for commercial distribution in the U.S.

Vertebral Augmentation. We estimate there are approximately 700,000 patients
worldwide with vertebral compression fractures ("VCFs") caused by osteoporotic
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 has been reported to provide early 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 product that has received
FDA approval or European approval for use in this procedure; however, surgeons
currently use polymethylmethacrylate ("PMMA") bone cement "off-label" which
means the use of a product for a non-approved indication. We believe that
CORTOSS is the only biomaterial in Europe approved for vertebral augmentation
injections based on prospective clinical studies. In addition, CORTOSS may have
several advantages over PMMA in vertebral augmentation, such as its ability to
be seen by surgeons without adding additional materials such as barium when
using imaging equipment in performing the procedure, its lower temperature
setting time that reduces the risk of tissue necrosis associated with PMMA, its
higher compression strength and its ability to be mixed on demand. In addition,
CORTOSS does not release free unreacted monomers into the patient's body like
PMMA. Monomer release has been shown to cause a variety of complications such as
hypotension and emboli.

Clinical Study. We completed a multi-center prospective clinical study using
CORTOSS in vertebral augmentation in Europe. A total of 53 patients, including
both osteoporotic VCFs and cancerous VCFs, were enrolled and over 80 vertebral
levels were treated. Monitoring was conducted pre-operatively, and
post-operative follow-up was completed at the end of one day, four days, eight
days, one month, three months and six-months.

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The study results indicated that one month after treatment with CORTOSS, visual
analog pain scores were reduced on average by 55%. This clinical study data was
submitted and resulted in our receiving the CE Mark in Europe for CORTOSS for
vertebral augmentation.

Systematic Approach to CORTOSS in VCFs. We are pursuing a systematic four-step
approach to studying CORTOSS for use in vertebral augmentation. First, we
completed the above-mentioned multi-center prospective clinical study in Europe.
Next, we initiated a U.S. pilot clinical study under an FDA IDE for vertebral
augmentation using the vertebroplasty surgical technique and have started to
enroll patients. This U.S. pilot clinical study will utilize our ALIQUOT
microdelivery system to inject CORTOSS directly into the fractured vertebrae.
Thirdly, we have submitted to FDA an IDE application seeking approval to allow
us to begin a second pilot study using CORTOSS for vertebral augmentation using
the kyphoplasty surgical technique. With the kyphoplasty surgical technique, the
fractured vertebral body is tamped and reduced on the inside of the vertebral
body using disposable instrumentation, such as a balloon, prior to the injection
of CORTOSS into the vertebral body. The final step in our systematic approach to
CORTOSS in VCFs will be to conduct a U.S. FDA-approved pivotal clinical study,
which studies the use of CORTOSS in VCFs using both the vertebroplasty and
kyphoplasty surgical techniques. In addition, we expect the pivotal study design
will include a control group for comparison.

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.

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 Certification that would be in competition with
CORTOSS for this indication.

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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.

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 believe CORTOSS has the potential
to ensure secure fixation of the screws, allowing the instrumentation systems to
restore maximum fixation and stabilize the spine. Additionally, we believe
CORTOSS's mix-on-demand delivery system makes its use here convenient and
practical. We are not aware of any products approved for this indication that
would be in competition with CORTOSS.

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 "ball" of the hip-and-socket, or
the head 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 femur 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 "walk-out" through the femoral head.
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 was 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 and was completed
during early 2002. 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

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hip fracture. The use of CORTOSS for this indication has the potential to reduce
the need for a second corrective surgery.

ALIQUOT MICRODELIVERY SYSTEM

Our ALIQUOT Microdelivery System facilitates effective delivery of our CORTOSS
product directly to the surgical site. A two-part system of catheter and syringe
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation and vertebral augmentation procedures. During the second quarter of
2002, we received CE Certification from our Notified Body for ALIQUOT. The
ALIQUOT system was used as part of our European multi-center prospective
clinical study for CORTOSS in vertebral augmentation and will be used in the
U.S. studies for CORTOSS in vertebral augmentation.

RHAKOSS SYNTHETIC BONE SPINAL IMPLANTS

RHAKOSS is under development as a synthetic bioactive bone-bonding, load-bearing
pre-formed spinal implant product for use in spinal repair procedures including
vertebral interbody fusion and spine reconstruction. RHAKOSS is manufactured
using our proprietary ORTHOBONE(TM) bioactive composite technology. RHAKOSS can
be manufactured into any size or shape to optimize anatomic fit. RHAKOSS can be
injection molded or machined, thus generating a potentially unlimited supply and
consistent material performance. RHAKOSS is designed to address the spine repair
needs of the vertebral interbody fusion and spinal reconstruction markets. We
believe that RHAKOSS represents a potential alternative to titanium/carbon fiber
cages and allograft cadaver bone implants. 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 bonding to bone, potential concerns about disease transmission and
potential limited supply. RHAKOSS is designed to mimic the radiolucency of bone,
which means its transparency to x-ray and other radiation, as well as the
strength and flexibility characteristics of bone.

We have completed patient enrollment for the pivotal phase of our RHAKOSS
clinical study in Europe for patients undergoing cervical spinal fusion surgery.
More than 70 patients have been enrolled and we will follow each patient for 6
months. There can be no assurances that the data from any such clinical trials
will result in obtaining the CE Certification necessary to sell RHAKOSS in the
European Union. In the U.S. during 2002, we filed an IDE with the FDA seeking
approval to initiate human clinical studies for the use of RHAKOSS in cervical
spinal fusion.

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 $445,000,000. We believe RHAKOSS potentially offers the
surgeon and patient the consistency of engineered synthetics, with similar
characteristics to those of human bone implants. We have completed patient
enrollment for the pivotal phase our RHAKOSS human clinical study in Europe.

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NEAR-TERM PRODUCT DEVELOPMENT

In an effort to increase product revenue in the short term, we are developing
new products under our currently approved VITOSS and IMBIBE product platforms.
We are seeking to bring these product line extensions to market in the U.S.
through the 510(k) regulatory process. These products will be in addition to our
long-term IDE clinical programs with CORTOSS and RHAKOSS. We intend for the new
2003 product pipeline to include:

VITOSS Scaffold Micro Morsels - 1-2 mm morsels will provide surgeons the option
to pack VITOSS more tightly into voids when appropriate and the smaller size
will fit through minimally invasive tube-sets. We began to sell VITOSS Scaffold
Micro Morsels in the U.S. at the end of the first quarter of 2003.

VITOSS Scaffold Macro Morsels - 4-7 mm morsels will provide surgeons the option
to fill larger voids more efficiently and rapidly. We began to sell VITOSS
Scaffold Macro Morsels in the U.S. at the end of the first quarter of 2003.

IMBIBE Syringes - 20 cc, 30 cc and 60 cc syringes will provide surgeons with
more options for combining VITOSS with bone marrow aspirate in a variety of
sizes. We began to sell these additional IMBIBE syringe sizes in the U.S. at the
end of the first quarter of 2003.

Bone Marrow Aspiration Needles - bone marrow aspirate needles in various sizes,
diameters and lengths will allow our surgeon customers to have broader technique
options for harvesting bone marrow aspirate for combination with VITOSS.

VITOSS Scaffold Cartridges - functional packaging of VITOSS in 5 cc, 10 cc, 15
cc and 30 cc sizes. The cartridge will be pre-filled with VITOSS and will allow
surgeons to directly combine VITOSS with bone marrow aspirate in one step.

We are seeking to expand our VITOSS product portfolio further in 2004.

OUR RESEARCH & DEVELOPMENT

We employ a multidisciplinary approach to create biomaterials technology
platforms, including composite engineering, polymer science, chemistry and
nanoparticulate ceramic glass science 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
additional patent applications have been filed to protect our key biomaterial
developments. See "Patents and Proprietary Intellectual Property" below for
additional information.

Our products under development to date have been the result of our internal
research and development activities. We incurred approximately $5,971,000,
$7,203,000 and $7,500,000 in research and development expenses in 2002, 2001 and
2000, respectively.

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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 U.S. 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 we were the
first to file patent applications for such inventions for the following reasons:

     .    patent applications filed prior to December 2000 in the U.S. are
          maintained in secrecy until issued;

     .    patent applications filed after November 2000 in the U.S. 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 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 any patents issued to us will
not be challenged, invalidated or circumvented, or the rights granted thereunder
will provide commercially useful competitive advantages to us. As of the date of
this filing, we own eight issued U.S. patents, eleven pending U.S. patent
applications and numerous counterparts of certain of these patents and pending
patent applications worldwide, including Canada, Europe, Mexico and Japan.

SURGEON ADVISORY PANELS

We have two surgeon advisory panels. Our Surgeon Clinical Panel is comprised of
international surgeon experts that provide product development advice and
guidance to us. Our Scientific Advisory Board is made up of international
surgeon experts that guide us regarding design and scientific issues. Certain
members of the surgeon 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 current Good Manufacturing
Practice ("GMP") regulations, Quality System Requirements ("QSR"), International
Standards Organization ("ISO") 9000 Series standards and equivalent
requirements.

Our 16,200 square foot VITOSS and CORTOSS manufacturing facilities which produce
our commercial products, are leased through July 2012 and are certified as
meeting the requirements of ISO 9000: 2000 and European Norm ("EN") 13485 for
the period July 1, 2000 through July 1, 2003. These facilities are subject to
inspection by the FDA for compliance with FDA device manufacture requirements.
We expect to receive ISO 9000: 2000 and EN 13485 re-certification for the period
July 1, 2003 through July 1, 2006. In addition to the need for CORTOSS U.S.
regulatory approval, in order to commercialize

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CORTOSS in the U.S., the CORTOSS manufacturing facility and quality assurance
system must pass inspection by the FDA. We believe our manufacturing facility
has the capacity to meet our commercial needs for the next several years. 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 (See
GOVERNMENT REGULATION below).

Our ability to manufacture VITOSS and CORTOSS is dependent on a limited number
of specialty suppliers of certain raw materials. We do not have any long-term
supply agreements for 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 commissioned sales agencies in the U.S. in order
to market VITOSS and IMBIBE. In the U.S., we are represented by approximately 35
sales agencies. 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.

Outside of the U.S., we utilize a network of independent stocking distributors
to market VITOSS, CORTOSS and ALIQUOT. We have arrangements with independent
distributors outside the U.S. to purchase products directly from us, to
warehouse inventory of products purchased from us and to hold title to the
products purchased. Sales of VITOSS, CORTOSS and ALIQUOT in Europe may
experience seasonal slowdowns during the summer months.

If Japan Medical Dynamic Marketing, Inc. is successful in obtaining clearance to
market VITOSS, it will distribute, sell and market VITOSS in Japan. We may seek
a similar arrangement for CORTOSS in Japan.

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. The time between receipt of orders and shipment is generally
short, and as a result, backlog is not significant.

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

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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 faces
competition from products currently on the market as well as products that may
enter the market in the future.

Our share of the bone graft market is not significant due to the fact that our
two commercial products have only recently been approved. VITOSS was approved in
the U.S. in December 2000 and launched in March 2001. CORTOSS, which was
approved in Europe during the fourth quarter of 2001, has had limited European
sales to date. Moreover, we do not expect CORTOSS to receive approval in the
U.S. for at least several years, if at all. The companies against whom we
currently compete are different than those that we had, at the time of product
launch, expected to be our primary competitors. This is indicative of the
dynamic market in which we operate. During 2002, the bone graft market saw the
introduction of synthetic recombinant signaling growth factors, also known as
bone morphogenic proteins ("BMPs"), into the synthetic segment of the
marketplace. BMPs are growth factors that are believed to significantly
accelerate the healing mechanism of bone. We believe the healing mechanism of
bone is dependent upon the presence of all three of the following components:
(i) signaling molecules, either provided by the patient or commercially provided
such as with BMPs, (ii) the patient's own stem cells or osteorogenitor cells,
and (iii) bone graft material, either provided by the patient or commercially
provided such as with VITOSS.

We expect the introduction of BMPs will greatly expand the overall bone graft
market and in particular the synthetic segment of the bone graft market.
However, it is too early for us to determine whether the market will place
greater emphasis on the signaling molecule component ((i) above) over the other
two components ((ii) and (iii) above) to the healing mechanism of bone. We
believe that several factors mitigate against the broad use of BMPs, including
(i) concern over BMPs causing excess bone growth in unwanted areas, and (ii) the
current high cost of BMPs in comparison to commercial bone graft materials and
to VITOSS in particular. Moreover, due to the high cost of BMPs and the
potential to cause excessive bone growth, surgeons may prefer using only a small
volume of BMPs in relation to the anatomic site where new bone growth is sought.
VITOSS can be used in conjunction with, and complementary to, BMPs in
applications where VITOSS can provide the volume of scaffold necessary to fill
the defect site. Accordingly, we have developed a two-pronged marketing strategy
that provides the option for surgeons to choose to use VITOSS either instead of,
or concurrently with, the BMPs depending upon the surgical procedure and the
patient's physiological profile.

There are no known products that have received FDA approval or a CE
Certification 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 established
products in the market place, including those manufactured from metal carbon
fiber and cadaver bone.

                                       13

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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 U.S. from the FDA under a 510(k)
(see below) in December 2000 and the CE Certification in the European Union from
our Notified Body in July 2000. In March 2001, we also received regulatory
approval to sell VITOSS in Australia. The CE Certification 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 U.S. from the FDA under a 510(k) to market our IMBIBE product
for use as a bone marrow aspiration syringe. We received the CE Certification
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 in patients with weak bone caused by osteoporosis. In
addition, during January 2003 we received European regulatory approval to market
CORTOSS for vertebral augmentation including compression fractures caused by
osteoporosis and invasive tumors. During the second quarter of 2002, we received
CE Certification from our Notified Body for ALIQUOT.

During 2001, we received conditional IDE approval from the FDA to conduct a
pilot clinical study in the U.S. for the use of CORTOSS for vertebral
augmentation using the vertebroplasty surgical technique, and during January
2003 we initiated patient enrollment in this study. 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 (see MANUFACTURING AND PRODUCT
SUPPLY above).

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 U.S., 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 we can introduce a new device into the market, we must generally obtain
market clearance through a 510(k) notification or premarket approval through a
premarket approval

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<PAGE>

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.

We must file a PMA if our 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 extensive data, including pre-clinical 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 that 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

                                       15

<PAGE>

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 we conduct additional clinical trials and submit 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", we will be
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, we
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, we must
submit an IDE supplement to the FDA and receive approval from the FDA before we
or our 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.

Our 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

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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. We are also subject to numerous federal,
state and local laws relating to such matters as safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
disposal of hazardous or potentially hazardous substances. 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 U.S., distributing
VITOSS and IMBIBE in the U.S. and distributing VITOSS, CORTOSS and ALIQUOT
outside the U.S. We are manufacturing IMBIBE and ALIQUOT in the U.S. through
outside third-party contract manufacturers. VITOSS, as well as any other
products that we manufacture or distribute following their approval 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 PMA or a PMA
supplement, or a new 510(k) notification. We may not be successful in obtaining
the approval or clearance of any new PMA, necessary PMA 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 Certification 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. 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 and the ISO 9000: 2000 and EN 13485 standards for 2003). 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

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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 U.S. and other markets will depend on
the availability of adequate reimbursement from third-party payers. In the U.S.,
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 U.S. 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 U.S. 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 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 European Union.

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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 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 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
$10,000,000, 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, 2002, we had 62 full-time employees, with 57 employees at our
Malvern, Pennsylvania headquarters and 5 employees in Europe. We had an average
of 65, 65 and 51 employees in 2002, 2001 and 2000, respectively. The increase in
number of employees from 2000 to 2001 is attributed primarily to continued
development of manufacturing, marketing and sales capabilities. 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. In order to
streamline our operations, during March 2003, we consolidated our employees into
one facility. Our manufacturing, research and development and administrative
offices now utilize approximately 25,000 square feet and 7,000 square feet is
utilized for sales and marketing training and meetings. We believe our
manufacturing facility has the capacity to meet our commercial needs for at
least the next several years. Our manufacturing, research and development and
administrative facility is leased through July 2012, and our sales and marketing
training facility is leased through July 2007. We are currently seeking to
sublet our 7,000 square foot sales and marketing training facility. We also have
our international sales and marketing activities based in our administrative
office in Leuven, Belgium.

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ITEM 3.      LEGAL PROCEEDINGS

None

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

The information called for by Item 4 of Form 10-K is set forth under the
captions "Submission of Matters to a Vote of Security Holders" in Orthovita's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed
with the SEC on November 19, 2002, and is incorporated herein by reference.

                                     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
2002:
     First Quarter.............     $ 3.18   $  1.77      $  3.00      $  1.75
     Second Quarter............       2.60      1.41         2.30         1.60
     Third Quarter.............       2.99      1.26         2.95         1.59
     Fourth Quarter............       4.34      2.41         3.85         2.30

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

As of March 21, 2003 there were 176 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 21, 2003, the last
reported sale price of the Common Stock as reported by Nasdaq and Nasdaq Europe
was $3.10 and $3.13 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. Dividends declared in 2002 of $423,618 were paid in
Common Stock to our holders of Series A 6% Adjustable Cumulative Convertible
Voting Preferred Stock ("Series A Preferred Stock"). In accordance with the
Statement of Designations, Rights and Preferences of the Series A Preferred
Stock, no dividends shall be declared or paid for payment on the shares of
Common Stock for any

                                       20

<PAGE>

dividend period unless full cumulative dividends have been declared and paid on
the Series A Preferred Stock through that most recent dividend payment date.

ITEM 6.      SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected historical consolidated financial data
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, 2002. 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,
                                                    ----------------------------------------------------------------------------
                                                        2002            2001            2000            1999            1998
                                                    ------------    ------------    ------------    ------------    ------------
<S>                                                 <C>             <C>             <C>             <C>             <C>
Statement of Operations Data:
Product sales (1)                                   $ 10,379,205    $  3,940,395    $    740,660    $  1,054,120    $  2,780,658
Cost of sales (2)                                      1,578,765         719,373         170,041         324,590         927,792
Operating expense                                     20,176,085      17,474,630      15,191,162      10,755,317       7,897,961
Other (expense) income                                  (294,299)         88,189         214,273         529,193         344,307
Net gain on sale of product line (1)                          --        (375,000)     (3,070,921)             --              --
Accretion of preferred stock                                  --              --              --              --         391,213
Dividends paid on Series A
 Preferred Stock                                         423,618              --              --              --              --
Deemed dividends on Series A Preferred Stock (3):
 Accretion                                               218,168              --              --              --              --
 Beneficial conversion feature                         7,980,672              --              --              --              --
                                                    ------------    ------------    ------------    ------------    ------------
Net loss applicable to common
 shareholders                                       $(20,292,402)   $(13,790,419)   $(11,335,349)   $ (9,496,594)   $ (6,092,001)
                                                    ============    ============    ============    ============    ============
Net loss applicable to common
 shareholders per common share,
 basic and diluted                                  $      (1.00)   $      (0.82)   $      (0.92)   $      (0.83)   $       (.73)
                                                    ============    ============    ============    ============    ============
Shares used in computing net loss
 applicable to common shareholders
 per common share, basic and diluted                  20,223,182      16,841,970      12,281,117      11,411,896       8,314,679
                                                    ============    ============    ============    ============    ============
</TABLE>

                                       21

<PAGE>

<TABLE>
<CAPTION>
                                                                As of December 31,
                                       ---------------------------------------------------------------------
                                           2002          2001          2000          1999          1998
                                       ------------  ------------   -----------   -----------   ------------
<S>                                    <C>           <C>            <C>           <C>           <C>
Balance Sheet Data:
Cash, cash equivalents and
 short-term investments.............   $ 19,167,268  $ 12,906,557   $ 3,814,992   $ 8,873,545   $ 15,355,808
Total assets........................     28,704,107    21,212,843    10,188,367    11,321,446     18,888,632
Working capital.....................     19,917,349    12,713,603       747,835     4,118,730     14,471,102
Long-term liabilities (4)...........      7,850,891     5,634,626     1,307,425       616,726        737,427
Total shareholders' equity..........     17,057,813    12,670,441     5,129,615     5,646,669     15,528,575
</TABLE>

     (1)  For 2002 and 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 10 of Notes to Consolidated Financial
          Statements). For 1999 and 1998, product sales represent BIOGRAN sales
          only.
     (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.
     (3)  See Note 9 of Notes to the Consolidated Financial Statements for
          further discussion regarding the deemed dividends.
     (4)  Included in long-term liabilities is a revenue interest obligation of
          $7,167,000 and $5,222,107 as of December 31, 2002 and 2001,
          respectively. See Note 6 of Notes to the Consolidated Financial
          Statements.

                                       22

<PAGE>

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

FORWARD-LOOKING STATEMENTS

This discussion includes statements about future operations, potential timing of
regulatory approvals, strategies, and financial results. Although we believe our
assumptions are reasonable, they could be inaccurate. Our actual future revenues
and income could differ materially from our expected results. We have no
obligation to publicly update or revise any forward-looking statements. These
forward-looking statements are based on estimates and assumptions that involve
risks and uncertainties, many of which are beyond our control or are subject to
change and include, without limitation, the risk factors described below in
"Certain Risks Related To Our Business" that could cause actual events or
results to differ materially from those expressed or implied by forward-looking
statements.

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 of America. The preparation of financial statements requires us to
make assumptions, 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 Recognition

Revenue from product sales is recognized upon the receipt of a valid order and
shipment to our distributor customers outside the U.S. 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 and we have no post-shipment obligations to our customers. In
addition, collection of the customers' receivable balance must be deemed
probable. Both our U.S. hospital customers and our distributor customers outside
of the U.S. are generally required to pay on a net 30-day basis and sales
discounts are not offered. We maintain an accounts receivable allowance for an
estimated amount of losses that may result from a customer's inability to pay
for product purchased. If the financial condition of our customers was 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

                                       23

<PAGE>

items, its prospect for replacement or obsolescence and its remaining shelf
life. If actual market conditions were to be less favorable than those projected
by management and demand decreased, inventory write-downs could be required. As
of December 31, 2002, 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
this financing, we sold Paul Royalty a revenue interest and 2,582,645 shares of
our Common Stock. The value of these shares at the time the transaction closed
was $1.85 per share, or $4,777,893 in the aggregate. The net proceeds from 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. On March 22, 2002, we amended the
original financing, which resulted in a one-time increase to the revenue
interest obligation of $1,945,593 which made the balance of the revenue interest
obligation $7,167,700 as of December 3,1 2002. Pursuant to the March 2002
Amendment, Paul Royalty surrendered to us 860,882 shares of our Common Stock
that it had originally purchased in the October 2001 financing. In exchange, we
surrendered our right to receive credits against the revenue interest
obligation. The value of the surrendered shares of our Common Stock on March 22,
2002 was $2.26 per share, or $1,945,593 in the aggregate. The March 2002
Amendment also provided for a reduction in the amount required for us to
repurchase Paul Royalty's revenue interest, if a repurchase event was to occur.
This modification was 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. Since this represents a non-monetary transaction, we utilized
the fair market value of our Common Stock surrendered by Paul Royalty on March
22, 2002, or $1,945,593, to determine the fair value of the non-monetary
consideration. This approach is in accordance with Accounting Principles Board
Opinion No. 29 "Accounting for Nonmonetary Transactions" ("APB 29"). The
treasury stock was then retired in September 2002.

The products that are subject to the revenue interest have only recently been
approved and marketed or are still under development. For these reasons, as of
December 31, 2002 and for the foreseeable future, we cannot currently make a
reasonable estimate of future revenues and payments that may become due to Paul
Royalty under this financing. Therefore, it is premature to estimate the
expected impact of this financing on our results of operations, liquidity and
financial position. Future sales from VITOSS in the U.S. and VITOSS and CORTOSS
in Europe, our approved products, are difficult to estimate. RHAKOSS is under
development with human clinical trials initiated in Europe in April 2002. We
have initiated, or plan to initiate, human clinical trials for CORTOSS and
RHAKOSS in the U.S. There is no assurance that the data from these clinical
trials will result in obtaining the necessary approval to sell CORTOSS in the
U.S. or RHAKOSS in either the U.S. or Europe. Even if such approval is obtained,
future revenue levels, if any, are difficult to estimate. Accordingly, given
these uncertainties in 2002 and for the foreseeable future, we will charge
revenue interest expense as revenues subject to the revenue interest obligation
are recognized. We will continue to monitor our product sales levels. Once we
are able to make a reasonable estimate of our related revenue interest
obligation, interest expense will be charged based upon the interest method and
the obligation will be reduced as principal payments are made. The actual impact
has been the payment of approximately $387,000 and

                                       24

<PAGE>

$66,000 in revenue interest payments during the years ended December 31, 2002
and 2001, respectively. The revenue interest payments under this agreement are
treated as interest expense in accordance with EITF 88-18.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS
No. 109 is an asset and liability approach requiring 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 differences 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, given our history of operating losses, the
realization of the deferred tax asset is not assured.

Accounting for Stock Options Issued to Employees and Non-employees

We apply the intrinsic-value-based method of accounting prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
("APB No. 25") and related interpretations to account for our fixed-plan stock
options. Under this method, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation," ("SFAS
No. 123") established accounting and disclosure requirements using a fair-value
based method of accounting for stock-based employee compensation plans. As
allowed by SFAS No. 123, as amended in SFAS No. 148, "Accounting for Stock-Based
Compensation," ("SFAS No. 148"), we have elected to continue to apply the
intrinisic-value-based method of accounting described above, and adopted only
the disclosure requirements of SFAS No. 123.

Preferred Stock

In July 2002, we sold 1,400 shares of Series A Preferred Stock at $10,000 per
share together with five-year warrants to purchase 6,154,747 shares of Common
Stock at $1.612 per share, for net cash proceeds of $12,807,197. The 1,400
shares of Series A Preferred Stock are convertible into 8,206,331 shares of
Common Stock. In connection with this transaction, after obtaining the required
shareholder approval in October 2002, we sold on the same terms and conditions
as in the July 2002 closing, an additional 500 shares of Series A Preferred
Stock together with warrants to purchase 2,198,125 shares of Common Stock at
$1.612 per share, for net cash proceeds of $4,530,153. These 500 shares of
Series A Preferred Stock are convertible into 2,930,832 shares of our Common
Stock.

For each Series A Preferred Stock closing, the respective proceeds were
allocated to the Series A

                                       25

<PAGE>

Preferred Stock and the warrants based on the relative fair values of each
instrument. The fair value of the warrants issued, in both July and October
2002, were determined based on an independent third party valuation.
Accordingly, approximately $8,565,000 of the July 2002 proceeds was allocated to
the Series A Preferred Stock and $3,504,000 of the proceeds was allocated to the
warrants. Similarly, $2,885,000 of the October 2002 proceeds was allocated to
the Series A Preferred Stock and $1,296,000 of the proceeds was allocated to the
warrants. In addition, in accordance with EITF Issue No. 00-27, "Application of
Issue No. 98-5 to Certain Convertible Instruments," ("EITF No. 00-27") the
issuance costs were not offset against the proceeds received in the issuance in
calculating the intrinsic value of the conversion option but were considered in
the calculation of the amount shown on the consolidated balance sheets. After
considering the allocation of the proceeds based on the relative fair values, it
was determined that the Series A Preferred Stock has a beneficial conversion
feature ("BCF") in accordance with EITF Issue No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios" ("EITF No. 98-5") and EITF No. 00-27. Accordingly,
a BCF adjustment of $3,604,962 was recorded, with respect to the Series A
Preferred Stock at the July 2002 closing. The value of the BCF was recorded in a
manner similar to a deemed dividend, and since the Series A Preferred Stock has
no maturity date and is convertible at the date of issuance, the BCF was fully
amortized through retained earnings during the third quarter of 2002.
Additionally, we recorded a similar deemed dividend charge during the fourth
quarter of 2002 of $4,375,710 for the BCF with respect to the Series A Preferred
Stock sold at the October 2002 closing.

In addition for the year ended December 31, 2002, we recorded approximately
$218,118 in dividend accretion related to the higher dividend rates applicable
to the Series A Preferred Stock for periods beginning after June 30, 2004 in
accordance with Staff Accounting Bulletin No. 68, "Increasing Rate Preferred
Stock" ("SAB 68"), and we recorded a one-time, non-cash charge of approximately
$7,980,672 that represents a deemed dividend relating to the intrinsic value of
the BCF of the Series A Preferred Stock. Given the substantial value associated
with the warrants and the related BCF, the total dividend attributed to holders
of the Series A Preferred Stock during 2002 consisted of the BCF of $7,980,672
($3,604,962 in the third quarter of 2002 and $4,375,710 in the fourth quarter of
2002) and the stated preferred dividend of 6% totaling $423,618. We consider the
quarterly reporting period in which the BCF was recognized to be appropriately
excludable from the period of dividend attribution as described in SAB 68, since
the third quarter of 2002 already included a disproportionate dividend
attribution, due to the BCF on the July 2002 closing we commenced recognition of
the implied discount addressed in SAB 68 in the fourth quarter of 2002 and
recorded an additional $218,118 of dividends to reflect the SAB 68 discount.
Similarly, for the October 2002 closing, no additional dividend was recorded
pursuant to SAB 68 as the fourth quarter of 2002 included the BCF for the
October 2002 closing. The SAB 68 discount relating to the October 2002 closing
will begin to be recorded in the first quarter of 2003. Assuming that the Series
A Preferred Stock remains outstanding, we expect the SAB 68 additional dividend
to be approximately $1,200,000 in 2003, $1,100,000 in 2004 and $100,000 in 2005.

                                       26

<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 stock. Cash and cash equivalents increased $2,268,711 from December 31, 2001
to 2002 due primarily to proceeds received from the sale of Series A Preferred
Stock. As of December 31, 2002 and 2001, cash, cash equivalents and short-term
investments consisted of the following:

<TABLE>
<CAPTION>
                                            Gross          Gross
                                          Unrealized     Unrealized    Fair Market
                           Original Cost     Gains         Losses         Value
                           -------------  -----------   ------------  -------------
<S>                        <C>            <C>           <C>           <C>
December 31, 2002:
Cash and cash equivalents  $  15,175,268  $        --   $         --  $  15,175,268
Short-term investments         3,992,000           --             --      3,992,000
                           -------------  -----------   ------------  -------------
                           $  19,167,268  $        --   $         --  $  19,167,268
                           =============  ===========   ============  =============
Percentage of total
 assets                                                                        66.8%
                                                                      =============

December 31, 2001:
Cash and cash equivalents  $  12,906,557  $        --   $         --  $  12,906,557
Short-term investments                --           --             --             --
                           -------------  -----------   ------------  -------------
                           $  12,906,557  $        --   $         --  $  12,906,557
                           =============  ===========   ============  =============
Percentage of total
 assets                                                                        60.8%
                                                                      =============
</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,
                                                     ---------------------------------------------
                                                         2002            2001            2000
                                                     -------------   -------------   -------------
<S>                                                  <C>             <C>             <C>
Net cash used in operating activities                $ (11,143,286)  $ (14,785,792)  $ (13,066,702)
Net cash (used in) provided by investing activities     (4,506,031)       (895,523)      6,440,248
Net cash provided by financing activities               17,631,695      24,950,020       7,842,251
Effects of exchange rate changes on cash and
 cash equivalents                                          286,333          23,226         (88,514)
                                                     -------------   -------------   -------------
Net increase in cash and cash equivalents            $   2,268,711   $   9,291,931   $   1,127,283
                                                     =============   =============   =============
</TABLE>

NET CASH USED IN OPERATING ACTIVITIES

OPERATING CASH INFLOWS-

Operating cash inflows for 2002 have been derived primarily from VITOSS and
IMBIBE product sales in the U.S. and VITOSS, CORTOSS and ALIQUOT product sales
in Europe. We have also received cash inflows from interest income on cash
equivalents and short-term investments.

                                       27

<PAGE>

Operating cash inflows for 2001 were derived primarily from VITOSS product sales
in the U.S. and Europe and 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.

OPERATING CASH FLOW REQUIREMENTS OUTLOOK--

We do not expect to receive FDA approval for the sale of CORTOSS and RHAKOSS in
the U.S. for the next several years, if at all. Accordingly, we expect to focus
our efforts on sales growth under our VITOSS product line during that period
through the extension of product configurations under our VITOSS product line,
continued training and education of surgeons and improvements to our
distribution channels. However, our efforts to grow sales and reduce our losses
are subject to certain risks related to our business, which are described in
detail below. Accordingly, we do not expect sales to generate cash flow in
excess of operating expenses for at least the next couple of years, if at all.
We expect to continue to use cash, cash equivalents and short-term investments
to fund operating activities.

In Europe, we began selling VITOSS in the fourth quarter of 2000, CORTOSS for
screw augmentation procedures in the fourth quarter of 2001, ALIQUOT in the
third quarter of 2002 and CORTOSS for vertebral augmentation procedures in the
first quarter of 2003. In the U.S., we began selling VITOSS in the first quarter
of 2001 and IMBIBE in the third quarter of 2001. Future cash flow levels from
VITOSS, CORTOSS, IMBIBE and ALIQUOT product sales are difficult to predict, and
product sales to-date may not be indicative of future sales levels. VITOSS,
CORTOSS and ALIQUOT 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.

There may be future quarterly fluctuations in spending. We expect sales
commission expense may increase at a higher rate in 2003 than any increase in
VITOSS product sales in the U.S. In addition, we expect increases in the use of
cash to fund receivables and inventory for VITOSS product line extensions. We
also expect to continue to use cash, cash equivalents and short-term investments
at a rate comparable to that for 2002 in operating activities associated with
research and development, including product development for our VITOSS product
line extensions, clinical trials in the U.S. for CORTOSS and RHAKOSS, and
marketing activities in support of our other products under development as well
as the associated marketing and sales activities with VITOSS and IMBIBE in the
U.S. and VITOSS, CORTOSS and ALIQUOT outside the U.S.

We expect our dividends will increase in future years. The dividend rate on each
share of Series A Preferred Stock is 6% per year on the $10,000 stated value of
the Series A Preferred Stock. However, commencing after June 30, 2004, for the
Series A Preferred Stock still

                                       28

<PAGE>

outstanding and not converted into Common Stock, the dividend rate will increase
each quarter by an additional two percentage points, up to a maximum dividend
rate of 14% per year. In addition, in the event that the Series A Preferred
Stock becomes subject to mandatory conversion due to our achievement of certain
revenue targets prior to July 1, 2005, we will pay an additional dividend equal
to the difference between (x) $2,000 per share of Series A Preferred Stock to be
converted and (y) the sum of all dividends that have been paid and all accrued
but unpaid dividends with respect to each such share.

Finally, we have entered into and may enter additional financing arrangements
where we pay revenue sharing amounts on the sales of certain products. Revenue
sharing arrangements can increase expenses related to the sale of our products.
In addition, beginning in 2003, and during the term of the Paul Royalty revenue
interest agreement, we are required to make advance payments on the revenue
interest obligation at the beginning of each year. In January 2003, we paid to
Paul Royalty the required $1,000,000 advance payment in respect of net sales of
our VITOSS and CORTOSS products. The amount of the advance payment increases to
$2,000,000 in 2004, and further increases to $3,000,000 in the years 2005
through 2016. While we believe that we will have sufficient cash at the end of
2003 to make the required $2,000,000 advance payment to Paul Royalty during
2004, we cannot be certain that we will have sufficient cash to meet our advance
payment obligations for the years 2005 through 2016. While the advance payments
will impact cash flow within a given year, they will not affect earnings as the
advance payments are credited within each year against the revenue interest
actually earned by Paul Royalty during that year, with any excess advance
payments refunded to us shortly after the end of the year.

NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES

We have invested $514,031 and $1,470,389 for the year ended December 31, 2002
and 2001, respectively, primarily for the purchase of manufacturing and research
and development equipment in order to support our product development and
manufacturing capabilities.

During the twelve months ended December 31, 2002, $3,992,000 was used for the
net purchase of investment grade marketable securities. During the same period
in 2001, $199,866 was provided by the net sale of investment grade marketable
securities. During March 2001, $375,000 of restricted cash was released from
escrow that had been established in connection with the sale of the BIOGRAN
dental grafting product line to 3i in March 2000.

INVESTING CASH OUTLOOK--

We expect the rate at which we invest funds in 2003 related to the purchase of
capital equipment to be relatively stable compared to 2002.

NET CASH PROVIDED BY FINANCING ACTIVITIES

During 2002, we received $80,635 from stock option and warrant exercises and
purchases of Common Stock under our Employee Stock Purchase Plan. In addition
during 2002, $491,473 and $83,197 were used to repay capital lease obligations
and notes payable, respectively, and we received $788,380 as proceeds from notes
payable. During 2001, we received $88,772 from stock

                                       29

<PAGE>

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 and $500,000 was used for the repayment of notes payable during
2001.

During 2001, we sold 1,125,000 shares of our Common Stock 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. Additionally
during 2001, we completed a product development and equity financing in which we
sold a revenue interest and 2,582,645 shares of our Common Stock. The Common
Stock was recorded at its gross market value of $4,777,893 ($4,672,890 net of
expenses) and a revenue interest obligation related to the revenue interest of
$5,222,107 was recorded. During 2001, we entered into a development and
distribution agreement and with this arrangement, we sold 189,394 shares of
Common Stock at $5.28 per share, raising net proceeds of $1,000,000.
Additionally during 2001, we sold 2,715,000 shares of our Common Stock at $4.00
per share in two private equity financings raising net proceeds of $9,982,300.
In addition during 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 $2,412,500.

SERIES A PREFERRED STOCK

In July 2002, we sold 1,400 shares of Series A Preferred Stock at $10,000 per
share together with five-year warrants to purchase 6,154,747 shares of Common
Stock at $1.612 per share, for net cash proceeds of $12,807,197. The 1,400
shares of Series A Preferred Stock are convertible into 8,206,331 shares of our
Common Stock. Additionally, in July 2002, we issued to the designees of the
placement agent for the transaction, five-year warrants to purchase an aggregate
820,633 shares of our Common Stock at $1.706 per share which were valued at
$738,570. In connection with this transaction, after obtaining the required
shareholder approval in October 2002, we sold on the same terms and conditions
as in the July 2002 closing, an additional 500 shares of Series A Preferred
Stock together with warrants to purchase 2,198,125 shares of Common Stock at
$1.612 per share, for net cash proceeds of $4,530,153. The 500 shares of Series
A Preferred Stock are convertible into 2,930,832 shares of our Common Stock. In
connection with the October 2002 sale, we issued to the placement agent's
designees additional five-year warrants to purchase 293,083 shares of our Common
Stock at $1.706 per share which were valued at $468,933.

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 our existing cash, cash equivalents and short-term
investments of approximately $19,167,000 as of December 31, 2002 will be
sufficient to meet our currently estimated operating and investing requirements
at least through the first quarter of 2004. However, there is no assurance that
we will not seek to obtain additional funds through equity or debt financings or
strategic alliances with third parties either

                                       30

<PAGE>

alone or in combination with equity. These equity or debt financings could
result in substantial dilution to our shareholders or require debt service
and/or revenue sharing arrangements. Any such required financing may not be
available in amounts or on terms acceptable to us. In addition, if the bid price
per share of our Common Stock is below $3.00 per share, we may need to raise
additional funds by the fourth quarter of 2003 to meet the Nasdaq National
Market's continuing listing requirements.

RESULTS OF OPERATIONS

This section should be read in conjunction with the detailed discussion under
"Liquidity and Capital Resources." 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, 2002 TO THE YEAR ENDED DECEMBER 31,
2001

Product Sales. Product sales for the year ended December 31, 2002 were
approximately $10,379,000 compared to approximately $3,940,000 for the year
ended December 31, 2001. Product sales for 2002 consisted primarily of VITOSS
and IMBIBE sales in the U.S., as well as VITOSS, CORTOSS and ALIQUOT sales
outside the U.S. Product sales for 2001 consisted primarily of VITOSS sales in
the U.S., as well as VITOSS sales in Europe, Australia and Israel and CORTOSS
sales in Europe during the fourth quarter of 2001. Information regarding our
product sales by geographic market for each of the fiscal years ended December
31, 2002, 2001 and 2000 is included in Note 10 (Product Sales) to the
consolidated financial statements.

Gross Profit. Our gross profit for the year ended December 31, 2002 and 2001 was
approximately $8,800,000 and $3,221,000, respectively, or 85% and 82% of product
sales, respectively. The improved gross profit margin for 2002 in comparison to
2001 is a result of a higher proportion of sales from the U.S. during 2002 where
the average selling price is higher in comparison to outside of the U.S.

Operating Expenses. Operating expenses for the year ended December 31, 2002 were
approximately $20,176,000 compared to approximately $17,475,000 for 2001.
General & administrative expenses for the year ended December 31, 2002 were
higher than the same period in 2001 primarily due to increased costs for
property and casualty insurance and severance. Selling and marketing expenses
for the same twelve-month periods from 2001 to 2002 increased primarily as a
result of increased commission expense paid to the independent commissioned
sales agencies in the U.S. on higher VITOSS product sales, increased staffing
and other spending related to the support of product sales. Research and
development expenses decreased for the year ended December 31, 2002, as compared
to the same period in 2001 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 $294,000 of net
other expense for the year ended December 31, 2002 compared to approximately
$88,000 of net other income for the year ended December 31, 2001. The decrease
in net other income between 2002 and 2001 is primarily

                                       31

<PAGE>

attributed to revenue interest expense in 2002 as a result of the royalty
arrangement with Paul Royalty and lower interest income.

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. During 2001, we realized a
net gain on the transaction of approximately $375,000 when the balance of the
escrow was released to us. During 2002 the balance of the escrow was released to
us.

Net Loss. As a result of the foregoing factors, our net loss for the year ended
December 31, 2002 was approximately $11,670,000 compared to a net loss of
approximately $13,790,000 for the year ended December 31, 2001.

Dividends on Preferred Stock and Deemed Dividend on Preferred Stock. For the
year ended December 31, 2002, dividends declared of approximately $424,000 were
paid in Common Stock to holders of our Series A Preferred Stock.

In addition for the year ended December 31, 2002, we recorded approximately
$218,000 in dividend accretion related to the higher dividend rates applicable
to the Series A Preferred Stock for periods beginning after June 30, 2004 in
accordance with Staff Accounting Bulletin No. 68, "Increasing Rate Preferred
Stock" ("SAB 68"), and we recorded a one-time, non-cash charge of approximately
$7,981,000 that represents a deemed dividend relating to the intrinsic value of
the beneficial conversion feature of the Series A Preferred Stock.

Net Loss Applicable to Common Shareholders. The net loss applicable to common
shareholders for the year ended December 31, 2002 was approximately $20,292,000,
or $1.00 per common share, on 20,223,182 weighted average common shares
outstanding as compared to a net loss applicable to common shareholders for the
year ended December 31, 2001 of $13,790,000, or $0.82 per common share, on
16,841,970 weighted average common shares outstanding.

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.

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

                                       32

<PAGE>

and development expense prior to July 2000 rather than capitalized into
inventory as was the case for periods after CE Certification was obtained.
Accordingly, the costs of producing that material are not reflected in cost of
sales. This inventory was primarily sold in 2000 and was not a material factor
that impacted gross margins realized on VITOSS sales in 2001. 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. Variations in the gross
margins realized on VITOSS sales subsequent to 2000 were primarily due to (i)
changes in the proportion of sales in Europe to our stocking distributors, where
VITOSS gross margins are lower in comparison to sales in the U.S. to our
end-user hospitals, and (ii) changes in our average selling price.

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 the twelve months ended December 31, 2001,
were comparable to the same period in 2000. Selling and marketing expenses for
the 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.

COMMITMENTS AND CONTINGENCIES
<TABLE>
<CAPTION>
Summary of                          Capital Lease          Revenue
Commitments and                      Obligations        Interest and
Contingencies:                        and Notes           Advance
                       Leases          Payable          Payments (1)    Dividends (2)        Total
                       ------          -------          ------------    -------------        -----
<S>                  <C>            <C>                  <C>             <C>              <C>

2003                 $   363,358      $   561,349        $  1,000,000      $ 1,140,000    $  3,064,707
2004                     362,568          424,972           2,000,000        1,430,466       4,218,006
2005                     362,585          153,854           3,000,000        2,566,301       6,082,740
2006                     362,586           29,287           3,000,000        2,660,000       6,051,873
2007                     319,710            2,187           3,000,000        2,660,000       5,981,897
2008 through 2016      1,167,977                -          27,000,000       29,260,000      57,427,977
                     -----------      -----------        ------------      -----------    ------------
                     $ 2,938,784      $ 1,171,649        $ 39,000,000      $39,716,767    $ 82,827,200
                     ===========      ===========        ============      ===========    ============
</TABLE>

(1): Advance payments are credited within each year against the revenue
interest actually earned by Paul Royalty during that year, with any excess
payments refunded to us shortly after year end. For the foreseeable future, we
cannot make a reasonable estimate of future revenues and the related revenue
interest payable to Paul Royalty.

(2): Assumes shares of Series A Preferred Stock outstanding as of December 31,
2002 remain outstanding, and are not converted to Common Stock, for the periods
reported. Dividends are payable in either cash or Common Stock, at our election.
To-date, all dividends have been paid in Common Stock.

Leases. We lease office space and equipment under non-cancelable operating
leases. For the years ended December 31, 2002, 2001 and 2000, lease expense was
approximately $493,000, $422,000 and $321,000, respectively. As of December 31,
2002, future minimum rent payments through the expiration of these leases are
approximately $363,000 in 2003, $363,000 in 2004, $363,000 in 2005, $363,000 in
2006, $320,000 in 2007, and $1,168,000 in 2008 and thereafter.

Revenue Interest. 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 2,582,645 shares of our Common Stock for
gross proceeds of $10,000,000.

                                       33

<PAGE>

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
certain of our products, including VITOSS, CORTOSS and RHAKOSS in North America
and Europe. As of December 31, 2002, we were in compliance with all financial
covenants. However, if we fail to maintain the specified financial covenants,
Paul Royalty can demand that we repurchase its revenue interest. In addition to
the failure to comply with the specified financial covenants, the occurrence of
certain events triggers Paul Royalty's right to require us to repurchase its
revenue interest.

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. If a repurchase
event had been triggered and Paul Royalty exercised its right to require us to
repurchase its revenue interest as of December 31, 2002, we would have owed Paul
Royalty approximately $11,653,000. If we were unable to repurchase the revenue
interest upon a repurchase event, Paul Royalty could foreclose on certain
pledged assets, and we could be forced into bankruptcy. Paul Royalty could also
foreclose on these pledged assets if we became insolvent or involved in a
voluntary or involuntary bankruptcy proceeding. No repurchase events or
foreclosures have occurred as of December 31, 2002 or as of the date of this
filing. In the event that we were required to repurchased Paul Royalty's revenue
interest, Paul Royalty would have no obligation to surrender the shares of our
Common Stock that it had purchased as part of the revenue interest transaction.

In addition beginning in 2003, and during the term of the Paul Royalty revenue
interest agreement, we are required to make advance payments on the revenue
interest obligation at the beginning of each year. In January 2003, we paid to
Paul Royalty the required $1,000,000 advance payment in respect of net sales of
our VITOSS and CORTOSS products. The amount of the advance payment increases to
$2,000,000 in 2004, and further increases to $3,000,000 in the years 2005
through 2016.

Dividends. Dividends on Series A Preferred Stock accrue and are cumulative from
the date of original issuance of the shares of the Series A Preferred Stock,
whether or not such dividend is earned or declared by the Board of Directors,
and will be payable at our option either in cash or in kind, subject to certain
limitations, on March 31, June 30, September 30 and December 31 of each year.
The dividend rate on each share of Series A Preferred Stock will be 6% per year
on the $10,000 stated value of the Series A Preferred Stock. Commencing after
June 30, 2004, for the Series A Preferred Stock still outstanding and not
converted to Common Stock, the dividend rate will increase each quarter by an
additional two percentage points, up to a maximum dividend rate of 14% per year.
In addition, in the event that the Series A Preferred Stock becomes subject to
mandatory conversion due to our achievement of certain revenue targets prior to
July 1, 2005, we will pay an additional dividend equal to the difference between
(x) $2,000 per share of Series A Preferred Stock to be converted and (y) the sum
of all dividends that have been paid and all accrued but unpaid dividends with
respect to each such share.

                                       34

<PAGE>

CERTAIN RISKS RELATED TO OUR BUSINESS

If CORTOSS and VITOSS are not commercially successful, our operating results
will be impaired.

We are highly dependent on successfully selling our products for which we 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, CORTOSS and ALIQUOT for specified
uses in the European Union, Australia and countries adhering to the regulatory
standards of the European Union. We have also received regulatory clearance to
market VITOSS and IMBIBE in the U.S. For these reasons, we are dependent upon
VITOSS and CORTOSS and their ancillary products, IMBIBE and ALIQUOT, in their
respective approved markets to generate sufficient revenues.

If we are unable to increase sales of our approved products, our operating
results will be affected adversely.

Because our products have only been recently 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. 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;
..    the introduction of new products into the market by competing orthopaedic
     companies based upon other competing technologies;
..    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 for payors to authorize insurance reimbursement for procedures
     using 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.
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. 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 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 product sales to-date have been made to a
group of early adopting surgeons. 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

                                       35

<PAGE>

products. Any failure to gain market acceptance of our products could result in
lower sales and the ability to become profitable.

If we are unable to operate an effective sales and distribution network, our
ability to generate sales and become profitable will be impaired.

We have assembled a network of commissioned sales agencies in the U.S. in order
to market VITOSS and IMBIBE. Outside of the U.S., we utilize a network of
independent stocking distributors to market VITOSS, CORTOSS and ALIQUOT. If
Japan Medical Dynamic Marketing, Inc. is successful in obtaining clearance to
market VITOSS, it will distribute, sell and market VITOSS in Japan. We may seek
a similar arrangement for CORTOSS in Japan. 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
our interests will continue to coincide with those of our independent
distributors and agencies or that the distributors and agencies 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 VITOSS to end user hospitals, as
well as hardware manufactured by other orthopaedic companies consisting of metal
plates, 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 stop carrying VITOSS and terminate their arrangement
with us. Our sales could be adversely affected if, for any reason, one or more
of our successful agencies lost their hardware product line provided by other
orthopaedic companies. Similarly, our independent agencies may be unable or
unwilling to carry or effectively sell VITOSS should any of these other
orthopaedic companies introduce new products into the market based upon other
technologies that could compete with VITOSS. Additionally, our sales could be
adversely affected if one or more of our successful agencies eliminated VITOSS
from their product line and terminated their agency arrangement with us.

Our ability to penetrate the markets we intend to serve is highly dependent upon
the quality and breadth of the other product lines carried by our distribution
network, 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.

The "off-label" use of our products may harm the reputation of our products.

The medical devices that we manufacture and market, or intend to market, are
subject to extensive regulation by the U.S. FDA, the MDD and other worldwide
regulatory agencies. In order to market our products, we must apply for, be
granted and maintain all necessary regulatory

                                       36

<PAGE>

approvals in each applicable jurisdiction for specified uses of the products. We
market and sell our products only for their approved indication(s) or use(s);
however, we cannot control a surgeon's "off-label" use of our product.

We believe there has been an unmet medical need for an injectable material for
use in procedures done to repair vertebral compression fractures. In an attempt
to address this need, we pursued clinical studies in Europe to demonstrate the
safety of using our injectable product CORTOSS in this type of procedure.
CORTOSS subsequently received a CE Certification in January 2003 for use in
repairing vertebral compression fractures. However, surgeons may have attempted
to use CORTOSS "off-label" in procedures to repair vertebral compression
fractures performed prior to the European Union's approval of CORTOSS for this
type of procedure. Furthermore, all surgeons have not been trained in the proper
use of CORTOSS in vertebral augmentation, since the European Union only recently
approved the use of CORTOSS for that type of procedure. A surgeon who has not
been properly trained to use CORTOSS in a procedure to repair vertebral
compression fractures could pose a risk to the reputation of our CORTOSS
product. The occurrence of an adverse event while using our product "off-label"
could adversely affect the reputation of CORTOSS or any of our other products.
As of the date of this filing, we are not aware that off-label uses of our
products have had a material adverse effect on the reputation of our products.

If we do not successfully train a sufficient number of surgeons, demand for our
products could be adversely affected.

It is critical to the commercial success of our products that our independent
distributors and agencies 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 that 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 U.S. and other markets will depend on
the availability of adequate reimbursement from third-party payors. 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 reimbursement plans are central
to new product acceptance. Healthcare providers may refuse to use our products
if reimbursement is inadequate. We do not yet know how reimbursement will be
handled for all of our products because some procedures that use our products
are new and reimbursement policies regarding these procedures have not been
finalized. Inadequate reimbursement by private insurance companies and
government programs could significantly reduce usage of our products.

In addition, an increased 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

                                       37

<PAGE>

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.

We may need to raise additional capital in the future or our product development
could be limited and our long term viability threatened; however, if we raise
additional capital, your percentage ownership as a shareholder of ours will
decrease and constraints could be placed on the operation of our business.

We have experienced negative operating cash flows since our inception and have
funded our operations primarily from proceeds received from sales of our stock.
In the second half of 2002 we raised approximately $17,337,000 in net proceeds
from the sale of 1,900 shares of our Series A Preferred Stock and warrants to
purchase 8,352,872 shares of our Common Stock at $1.612 per share. We expect to
continue to use cash, cash equivalents and short-term investments to fund
operating and investing activities for at least the next couple years. We
believe that our existing cash, cash equivalents and short-term investments of
approximately $19,167,000 as of December 31, 2002 will be sufficient to meet our
currently estimated operating and investing requirements at least through the
first quarter of 2004.

While we have no immediate plans to do so, we may seek to obtain additional
funds in the future through subsequent 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 and
Preferred Stock or require debt service and/or revenue sharing 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 pre-clinical and clinical trials;
..    delays in the 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.

In addition, although we have no present commitments or understandings to do so,
we may seek to expand our operations and product line through acquisitions or
joint ventures. Any such acquisitions or joint ventures may increase our capital
requirements.

If adequate financing is not available, we may be required to delay, scale back
or eliminate certain operations. In the worst case, our long term viability
could be threatened.

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 agencies must obtain regulatory approvals and otherwise comply
with extensive regulations regarding safety, quality

                                       38

<PAGE>

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, distribution and promotion of medical devices. To date, we have
received approval from the FDA to market VITOSS and IMBIBE. During 2002, we
received approval from the FDA to conduct a pilot clinical study in the U.S. for
the use of CORTOSS in vertebral augmentation using the vertebroplasty surgical
technique and have started to enroll patients. There can be no assurance that
the data from this clinical trial will support FDA clearance or approval to
market this product for this use.

We are currently manufacturing VITOSS and CORTOSS in the U.S., distributing
VITOSS and IMBIBE in the U.S. and distributing VITOSS, CORTOSS and ALIQUOT
outside the U.S. We are manufacturing IMBIBE and ALIQUOT in the U.S. through
outside third-party contract manufacturers. VITOSS, as well as any other
products that we manufacture or distribute following their approval 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 or cleared product. Moreover,
modifications to the approved or cleared product may require the submission of a
new approval application or application supplement. We may not be successful in
obtaining approval to market the modified product 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 medical devices.
In addition, each country has its own tariff regulations, duties and tax
requirements. The approval by foreign government authorities is unpredictable,
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.

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Requirement of CE Certification in the European Union. To market a product in
the European Union, we must be entitled to affix a CE Certification, an
international symbol of adherence to quality assurance standards and compliance
with applicable European medical device directives. A CE Certification 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 Certification for
the use of VITOSS as a bone void filler and for the use of CORTOSS in screw
augmentation and vertebral augmentation procedures. Additionally, we are
conducting clinical trials with RHAKOSS as a spinal implant. There can be no
assurance that we will receive CE Certification for RHAKOSS or any of our other
products under development.

Requirement of approval in Japan. In order to market our products in Japan, we
must obtain the approval of the Japanese MHW. 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 with
Japan Medical Device Marketing, Inc. 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.

Our VITOSS and CORTOSS manufacturing facilities produce commercial products and
are certified as meeting the requirements of ISO 9009: 2000 and European Norm
("EN") 13485 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 expect to receive ISO 9001 and EN 46001 re-certification for the period July
1, 2003 through July 1, 2006. In addition to the need for CORTOSS U.S.
regulatory approval, in order to commercialize CORTOSS in the U.S., the CORTOSS
manufacturing facility and quality assurance system must pass 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.

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;

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<PAGE>

..    refusal to grant premarket approvals, CE Certification 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.

The difficulties of operating in international markets may harm sales of our
products.

The international nature of our business subjects us and our representatives,
agents and distributors to the laws and regulations of the jurisdictions in
which they operate, and in which our products are sold. The types of risks that
we face in international operations include:

..    the imposition of governmental controls;
..    logistical difficulties in managing international operations; and.
..    fluctuations in foreign currency exchange rates.

Our international sales and operations may be limited or disrupted if we cannot
successfully meet the challenges of operating internationally.

If losses continue in the long term, it could limit our growth in the
orthopaedic industry 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, 2002, had an accumulated deficit
of approximately $81,892,000. These losses have resulted principally from:

..    the development and patenting of our technologies;
..    pre-clinical and clinical studies;
..    preparation of submissions to the FDA and foreign regulatory bodies; and
..    the development of manufacturing, sales and marketing capabilities.

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

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<PAGE>

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. In this financing, we sold Paul Royalty a revenue
interest and 2,582,645 shares of our Common Stock. 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 certain of our products,
including VITOSS, CORTOSS and RHAKOSS, in North America and Europe through 2016,
subject to certain adjustments. This revenue interest percentage can increase if
we fail to meet contractually specified levels of annual net sales of products
for which Paul Royalty is entitled to receive its revenue interest. We do not
currently expect that changes in the revenue interest percentage resulting from
fluctuations in sales of products subject to the revenue interest will have a
material effect on operating results for a period when considered relative to
sales of the products for that period.

In addition beginning in 2003, and for the term of the revenue interest
agreement, we are required to make advance payments on the revenue interest
obligation at the beginning of each year. In January 2003, we paid to Paul
Royalty the required $1,000,000 advance payment in respect of net sales of our
VITOSS and CORTOSS products. The amount of the advance payment increases to
$2,000,000 in 2004, and further increases to $3,000,000 in the years 2005
through 2016. While we believe that we will have sufficient cash at the end of
2003 to make the required $2,000,000 advance payment to Paul Royalty during
2004, we cannot be certain that we will have sufficient cash to meet our advance
payment obligations for the years 2005 through 2016. While the advance payments
will impact cash flow within a given year, they will not affect earnings as the
advance payments are credited within each year against the revenue interest
actually earned by Paul Royalty during that year, with any excess advance
payments refunded to us shortly after the end of each year.

Our obligation to pay the revenue interest is secured by our licenses, patents
and trademarks relating to certain of our products, including VITOSS, CORTOSS
and RHAKOSS, in North America and Europe, and the 12% revenue 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, 2002, 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.

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In addition to the failure to comply with the financial covenants described
above, the occurrence of certain events, including those set forth below,
triggers Paul Royalty's right to require us to repurchase its revenue interest:

..    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; and
..    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. If a repurchase
event had been triggered and Paul Royalty exercised its right to require us to
repurchase its revenue interest as of December 31, 2002, we would have owed Paul
Royalty approximately $11,653,000.

The repurchase price for Paul Royalty's revenue interest as of a given date is
calculated in three steps. First, a specified annual rate of return (not to
exceed 45%) is applied to Paul Royalty's $10,000,000 original purchase price
from October 16, 2001 to the date of determination of the repurchase price.
Second, the result obtained from the first step of the calculation is added to
the original $10,000,000 purchase price. Third, the sum obtained from the second
step of the calculation is reduced by both $3,333,333 and the actual revenue
interest paid during the specified period.

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 became
insolvent or involved in a voluntary or involuntary bankruptcy proceeding. No
repurchase events or foreclosures have occurred as of December 31, 2002 or as of
the date of this filing. In the event that we repurchased Paul Royalty's revenue
interest, Paul Royalty would have no obligation to surrender the shares of our
Common Stock that it had purchased as part of the revenue interest transaction.

Our results of operations may fluctuate due to factors out of our control, which
could cause volatility in our stock price.

VITOSS, IMBIBE, CORTOSS and ALIQUOT are currently our only products for which we
have received regulatory approvals for sale. VITOSS is cleared for sale in the
U.S. and the European Union. IMBIBE is cleared for sale in the U.S. CORTOSS and
ALIQUOT are cleared for sale 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. We began sales of CORTOSS in Europe and IMBIBE in
the U.S. at the end of 2001, we began sales of ALIQUOT in Europe in the

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second quarter of 2002. Future levels of VITOSS, CORTOSS, ALIQUOT and IMBIBE
product sales are difficult to predict. VITOSS product sales are difficult to
predict, and VITOSS sales to-date may not be indicative of future sales levels.
VITOSS, CORTOSS and ALIQUOT 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 and our competitors'
     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 affecting logistics and elective surgery trends;
..    the timing of expenses related to commercialization of new products;
..    competitive disruptions to our distribution channels from business
     development arrangements; and
..    the adequate training of a sufficient number of surgeons.

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 VITOSS, CORTOSS or our other 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 the date of this filing, we own eight issued U.S.
patents, eleven pending U.S. patent applications and numerous counterparts of
certain of these patents and pending patent applications worldwide, including
Canada, Europe, Mexico and Japan. There can be no assurance that patents will
issue from any of the pending patent applications. Moreover, we cannot be
certain that we were the first creator of inventions covered by pending patent
applications or we were the first to file patent applications for the relevant
inventions for the following reasons:

..    patent applications filed prior to December 2000 in the U.S. are maintained
     in secrecy until issued;
..    patent applications filed after November 2000 in the U.S. 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.

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<PAGE>

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 or
other proceedings 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 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. 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, if 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.

If we cannot keep up with technological changes and marketing initiatives of
competitors, sales of our products may be harmed.

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

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<PAGE>

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.

By increasing the number of shares of our Common Stock that may be sold into the
market, we could cause the market price of our Common Stock to drop
significantly, even if our business is doing well.

During July and October, 2002, we completed a private placement transaction in
which we sold 1,900 shares of our Series A Preferred Stock and warrants to
purchase an aggregate 8,352,872 shares of our Common Stock. As part of this
transaction, we issued warrants to purchase an aggregate 1,113,716 shares of our
Common Stock to the persons designated by our placement agent for the private
placement. In February 2003, we registered for resale the shares issuable under
the Series A Preferred Stock and the warrants that were issued in the private
placement transaction.

The 23,076,200 shares of our Common Stock covered by our February 2003
registration are freely saleable in the public market beginning on the effective
date of that registration. The shares consist of: (i) 11,137,162 shares that may
be issued upon the conversion of outstanding shares of our Series A Preferred
Stock; (ii) 8,352,872 shares that may be issued upon the exercise of outstanding
warrants that were sold to investors; (iii) 1,113,716 shares that may be issued
upon the exercise of outstanding warrants issued by us to the persons designated
by our placement agent; and (iv) an additional 2,472,450 shares that have or may
be issued: (x) as a payment of dividends on our Series A Preferred Stock; or (y)
upon the conversion of Series A Preferred Stock or exercise of warrants if
adjustments are made to the conversion price of the Series A Preferred Stock or
to the number of shares issuable upon the exercise of the warrants, as the case
may be.

The number of shares covered by our February 2003 registration represents
approximately 53.5% of the total number of our shares of Common Stock issued and
outstanding. The number of shares

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<PAGE>

covered by our registration includes substantially more than the sum of (i) the
shares received as payment of dividends on the Series A Preferred Stock and (ii)
the number of shares to which are currently eligible to be receive upon the
conversion of the Series A Preferred Stock and the exercise of the warrants. We
registered for resale more shares than have been issued or are currently
issuable under the Series A Preferred Stock and warrants pursuant to contractual
obligations with the selling security holders and to ensure that a sufficient
number of shares is registered in the event that (i) we pay dividends on the
Series A Preferred Stock by issuing shares of Common Stock in lieu of paying
such dividends in cash, or (ii) adjustments, if any, are made to the conversion
price of the Series A Preferred Stock or to the number of shares issuable upon
the exercise of the warrants. Sales of these shares in the public market, or the
perception that future sales of these shares could occur, could have the effect
of lowering the market price of our Common Stock below current levels and make
it more difficult for us and our shareholders to sell our equity securities in
the future.

Our prior use of Arthur Andersen LLP as our independent public accountants could
impact our ability to access the capital markets.

Our consolidated financial statements as of and for each of the two years in the
period ended December 31, 2001 were audited by Arthur Andersen LLP ("Andersen").
On March 14, 2002, Andersen was indicted on federal obstruction of justice
charges arising from the government's investigation of Enron Corporation.
Following this event, our Audit Committee directed management to consider the
need to appoint new independent public accountants. On June 15, 2002, a jury
found Andersen guilty on the government's charges. On July 15, 2002, at the
direction of the Board of Directors, acting upon the recommendation of the Audit
Committee, we dismissed Andersen and appointed KPMG LLP as our new independent
public accountants for fiscal year 2002.

SEC rules require us to present our audited financial statements in various SEC
filings, along with Andersen's consent to our inclusion of its audit report in
those filings. However, Andersen is unable to provide a consent to us for
inclusion in our future SEC filings relating to its report on our consolidated
financial statements as of and for each of the two years in the period ended
December 31, 2001. Additionally, Andersen is unable to provide us with assurance
services, such as advice customarily given to underwriters of our securities
offerings and other similar market participants. The SEC has provided regulatory
relief designed to allow companies that file reports with the SEC to dispense
with the requirement to file a consent of Andersen in certain circumstances.
Notwithstanding this relief, the inability of Andersen to provide its consent or
to provide assurance services to us in the future could negatively affect our
ability to, among other things, access the public capital markets. Any delay or
inability to access the public markets as a result of this situation could have
a material adverse impact on our business. Also, an investor's ability to seek
potential recoveries from Andersen related to any claims that an investor may
assert as a result of the audit performed by Andersen may be limited
significantly both as a result of an absence of a consent and the diminished
amount of assets of Andersen that are or may in the future be available to
satisfy claims.

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
shareholder.

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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 up to
20,000,000 shares of Preferred Stock having rights, privileges and preferences
as are determined by the Board of Directors. Accordingly, our Board of Directors
is empowered, without shareholder approval, to issue Preferred Stock with
dividend, liquidation, conversion, voting or other rights superior to those of
our common shareholders. For example, an issuance of Preferred Stock could:

..    adversely affect the voting power of the common shareholders;
..    make it more difficult for a third party to gain control of us;
..    discourage bids for our Common Stock at a premium; or
..    otherwise adversely affect the market price of the Common Stock.

As of the date of this filing, our Board of Directors has designated and issued
1,900 shares of Series A Preferred Stock. We may issue additional shares of our
authorized Preferred Stock at any time.

We are required to pay quarterly dividends to our Preferred Stock shareholders.

Dividends on Series A Preferred Stock accrue and are cumulative from the date of
original issuance of the shares of the Series A Preferred Stock, whether or not
such dividend is earned or declared by the Board of Directors, and will be
payable at our option either in cash or in kind, subject to certain limitations,
on March 31, June 30, September 30 and December 31 of each year. The dividend
rate on each share of Series A Preferred Stock will be 6% per year on the
$10,000 stated value of the Series A Preferred Stock. Commencing after June 30,
2004, for the Series A Preferred Stock still outstanding and not converted to
Common Stock, the dividend rate will increase each quarter by an additional two
percentage points, up to a maximum dividend rate of 14% per year. In addition,
in the event that the Series A Preferred Stock becomes subject to mandatory
conversion due to our achievement of certain revenue targets prior to July 1,
2005, we will pay an additional dividend equal to the difference between (x)
$2,000 per share of Series A Preferred Stock to be converted and (y) the sum of
all dividends that have been paid and all accrued but unpaid dividends with
respect to each such share.

We do not intend to pay any dividends to our common shareholders.

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 to our Common Stock shareholders in the
foreseeable future.

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

Our executive officers and directors, and their respective affiliates,
beneficially own as of the date of this filing approximately 8.1% of our
outstanding Common Stock. One of our directors, Jonathan Silverstein, is
employed by an affiliate of OrbiMed Associates LLC, PW Juniper Crossover Fund,
L.L.C. and Caduceus Private Investments, LP (collectively, "OrbiMed"), which

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beneficially own approximately 32.4% of our outstanding Common Stock as of the
date of this filing. 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.

Our stock price may be volatile.

Our stock price, like that of many 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;
..    disruptions to our distribution channels as a result of competitive market
     changes;
..    product recalls;
..    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 U.S. 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:

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..    specified levels for total shareholders' equity;
..    the number of shares and the market value of the public float;
..    a minimum bid price per share; and
..    total market capitalization or total assets and total revenue.

In addition, if the per share bid price of our Common Stock is below $3.00, we
may be required to raise more capital than what is necessary to fund our
operations by the fourth quarter of 2003 in order to satisfy Nasdaq National
Market shareholders' equity threshold. The additional capital may not be
available on satisfactory terms, if at all. Any additional equity capital raised
could result in substantial dilution to our shareholders. In addition, even if
we satisfy the Nasdaq National Market shareholders' equity threshold, if the
minimum bid price of our Common Stock fell below $1.00 we could still face
delisting from the Nasdaq National Market. We believe that we currently satisfy
the requisite Nasdaq National Market listing requirements; however, should we
fail to meet the Nasdaq National Market listing requirements in the future, our
stock could then list on the Nasdaq SmallCap Market or the over-the-counter
exchange, which would further limit the trading volume and liquidity of our
stock and adversely impact the stock price.

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 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 sales agencies, we indemnify the
distributor or sales 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 $10,000,000, 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 may decide not to carry this insurance. A
merit less 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

                                       50

<PAGE>

able to prevent the unauthorized disclosure or use of our technical knowledge or
other trade secrets by those former employees.

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.

As of December 31, 2002, our investments consisted primarily of fully insured
bank certificates of deposit. The impact on our future interest income and
future changes in investment yields will depend on the gross amount of our
investments and various external economic factors. We held no investments as of
December 31, 2001.

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 report on
Form 10-K beginning on page F-1.

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

On March 14, 2002, Arthur Andersen LLP ("Andersen") was indicted on federal
obstruction of justice charges arising from the government's investigation of
Enron Corporation. Following this event, our Audit Committee directed management
to consider the need to appoint new independent public accountants. On June 15,
2002, a jury found Andersen guilty on the government's charges. On July 15,
2002, at the direction of the Board of Directors, acting upon the recommendation
of the Audit Committee, we dismissed Andersen and appointed KPMG LLP as our new
independent public accountants for fiscal year 2002.

                                       51

<PAGE>

                                    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 AND
RELATED STOCKHOLDER MATTERS

The information called for by Items 11 and 12 of Form 10-K not contained in this
annual report on Form 10-K will be set forth under the captions "Executive
Compensation: Report of the Compensation Committee," "Summary Compensation
Table," and "Equity Compensation Plan Information" 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

One of our directors, Jonathan Silverstein, is employed by an affiliate of
OrbiMed, which beneficially own approximately 18.9% of our outstanding Common
Stock as of the date of this filing.

David S. Joseph was paid $143,350 in salary and benefits as an employee of ours
for the period January 1 through May 24, 2002. Upon his resignation on May 24,
2002 as an employee, Mr. Joseph served as a consultant to us for the period May
25 through December 31, 2002 and was compensated $134,225 for those services. In
addition, Mr. Joseph was granted shares of our Common Stock and stock options in
May 2002, which have an estimated value of $10,000 and $9,250, respectively, for
serving on our Board of Directors.

ITEM 14.     CONTROLS AND PROCEDURES

An evaluation of the effectiveness of the design and operation of Orthovita's
disclosure controls and procedures within 90 days prior to the filing date of
this annual report was carried out by Orthovita under the supervision and with
the participation of Orthovita's management, including the Chief Executive
Officer and Chief Financial Officer. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that Orthovita's
disclosure controls and procedures are functioning effectively to provide
reasonable assurance that all information required to be disclosed by Orthovita
in reports filed under the Securities Exchange Act of 1934 is

                                       52

<PAGE>

recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. A controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected. Subsequent to the date of the most recent evaluation of
Orthovita's internal controls, there were no significant changes in Orthovita's
internal controls or in factors that could significantly affect the internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.

                                     PART IV

ITEM 15.     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 included by reference
into Item 8 of this part of the annual report on Form 10-K:

                                                                     Page
                                                                     ----
Independent Auditors' Report                                         F-1

Report Of Independent Public Accountants                             F-2

Consolidated Balance Sheets as of December 31, 2002 and 2001         F-3

Consolidated Statements of Operations for years ended
December 31, 2002, 2001 and 2000                                     F-4

Consolidated Statements of Shareholders' Equity and
Comprehensive Income (Loss) for the years ended
December 31, 2002, 2001 and 2000                                     F-5 to F-7

Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000                                     F-8

Notes to Consolidated Financial Statements                           F-9 to F-23

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.

                                       53

<PAGE>

On March 11, 2003, the Company filed a Form 8-K under Item 5, reporting that the
Company appointed Mary Paetzold to its Board of Directors.

On December 19, 2002, the Company filed a Form 8-K under Item 5, reporting that
the Company appointed David Fitzgerald to its Board of Directors.

On October 22, 2002, the Company filed a Form 8-K under Item 5, reporting that
the Company completed a $19 million private placement.

(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.

3.1    Amended and Restated Articles of Incorporation of the Company (3)
3.2    Amended and Restated Bylaws of the Company (3)
3.3    Bylaw Amendment (17)
4.1  Specimen of Common Stock Certificate of the Company (10)
4.2  Statement of Designation of Series A 6% Adjustable Cumulative Convertible
Voting Preferred Stock (15)
4.3  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)
4.4  Registration Rights Agreement among the Company, Emerging Growth Equities,
Ltd. and each of the investors named therein (6)
4.5  Registration Rights Agreement dated March 29, 2001 between the Company and
Japan Medical Dynamic Marketing, Inc. (6)
4.6  Registration Rights Agreement dated December 20, 2001 among the Company,
SDS Merchant Fund, L.P. and S.A.C. Capital Associates, LLC (8)
4.7  Investor Rights Agreement dated as of July 19, 2002 between the Company and
the other parties named therein. (15)
4.8  Warrant to Purchase Shares of Common Stock dated as of November 3, 1999 in
favor of Progress Capital, Inc. (10)
4.9  Warrant to Purchase 31,779 Shares of Common Stock dated August 22, 2000 in
favor of Janney Montgomery Scott LLC (4)
4.10 Warrant to Purchase 31,780 Shares of Common Stock dated August 22, 2000 in
favor of VFT Special Ventures Ltd. (4)
4.11 Warrant to Purchase 566,894 Shares of Common Stock dated January 18, 2001
in favor of Rennes Fondation (10)
4.12 Warrant to Purchase 59,250 Shares of Common Stock dated March 19, 2001 in
favor of Emerging Growth Equities, Ltd. (5)
4.13 Warrant to Purchase 22,200 Shares of Common Stock dated April 27, 2001 in
favor of Emerging Growth Equities, Ltd. (6)

                                       54

<PAGE>

4.14 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)
4.15 Warrant to Purchase 50,000 Shares of Common Stock dated October 23, 2001 in
favor of Tucker Anthony Incorporated (11)
4.16 Form of Warrant issuable to the Purchasers of Series A 6% Adjustable
Cumulative Convertible Voting Preferred Stock (16)
4.17 Form of Warrant issued to the Designees of Placement Agent SmallCaps Online
Group, LLC (15)
*10.1   Employment Letter dated as of March 12, 1999 by and between the Company
and Dr. Maartin Persenaire (1)
*10.2   Employment Agreement dated as of December 31, 1999 by and between the
Company and David Joseph (10)
*10.3   Addendum to Employment Agreement dated as of January 1, 2002 between the
Company and David S. Joseph (11)
*10.4   Employment Agreement dated as of January 1, 2002 by and between the
Company and Erik M. Erbe (11)
*10.5   Employment Agreement, dated as of May 10, 2002 by and between the
Company and Erik M. Erbe (14)
*10.6   Employment Agreement, dated as of May 10, 2002 by and between the
Company and Antony Koblish (14)
*10.7   Employment Agreement, dated as of May 10, 2002 by and between the
Company and Joseph M. Paiva (14)
*10.8   Change of Control Agreement, dated as of April 23, 2001 between the
Company and David McIlhenny (1)
*10.9   1993 Stock Option Plan (3)
*10.10  Amended and Restated 1997 Equity Compensation Plan (18)
*10.11  Amended and Restated Employee Stock Purchase Plan (3)
10.12   Master Equipment Lease Agreement dated as of July 11, 1997 between the
Company and Finova Technology Finance, Inc. (2)
10.13   Amendment to the Master Equipment Lease Agreement dated as of April 15,
1999 between the Company and Finova Technology Finance, Inc. (9)
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. (portions of this document have been omitted pursuant to
the Company's confidential treatment request under Exchange Act Rule 24b-2)(13)
10.15   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. (11)
10.16   Assignment dated as of October 16, 2001 between Vita Special Purpose
Corp. and Paul Capital Royalty Acquisition Fund, L.P. (12)
10.17   Security Agreement dated as of October 16, 2001 between Vita Special
Purpose Corp. and Paul Capital Royalty Acquisition Fund, L.P. (12)
10.18   Pledge Agreement dated as of October 16, 2001 between Vita Licensing,
Inc. and Paul Capital Royalty Acquisition Fund, L.P. (12)
10.19   Stock Purchase Agreement dated as of October 16, 2001 between the
Company and Paul Capital Royalty Acquisition Fund, L.P. (12)

                                       55

<PAGE>

10.20   Third Amendment to Line of Credit, Term Loan and Security Agreement
dated October 25, 2000 between the Company and Progress Bank (10)
10.21   Capital Expenditure Loan Note dated October 25, 2000 between the Company
and Progress Bank (10)
10.22   Asset Sale Agreement dated as of February 10, 2000 between the Company
and Implant Innovations, Inc. (9)
10.23   Development and Distribution Agreement dated March 29, 2001 between the
Company and Japan Medical Dynamic Marketing, Inc. (11)
10.24   Subscription Agreement dated July 10, 2000 between the Company and
Rennes Fondation (10)
10.25   Subscription Agreement dated August 22, 2000 between the Company and
Brown Simpson Partners I, Ltd. (4)
10.26   Subscription Agreement dated as of October 4, 2000 between the Company
and Raimund Gabriel (10)
10.27   Subscription Agreement dated as of January 18, 2001 between the Company
and Rennes Fondation (10)
10.28   Form of Subscription Agreement between the Company and each of the
purchasers named therein (6)
10.29   Subscription Agreement dated March 29, 2001 between the Company and
Japan Medical Dynamic Marketing, Inc. (6)
10.306  Subscription Agreement dated as of December 20, 2001 between the Company
and S.A.C. Capital Associates, LLC (8)
10.31   Subscription Agreement dated as of December 20, 2001 between the Company
and SDS Merchant Fund, L.P. (8)
10.32   Preferred Stock and Warrant Purchase Agreement dated as of July 19, 2002
        between the Company and the Purchasers named therein. (16)
10.33   Master Security Agreement dated as of October 4, 2001 between the
        Company and General Electric Capital Corporation (1)
10.34   Form of Promissory Note relating to Master Security Agreement dated as
        of October 4, 2001 between the Company and General Electric Capital
        Corporation (1)
21.1    Subsidiaries (1)
23.1    Consent of KPMG LLP (1)
99.1    Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2    Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.

----------
(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.

                                       56

<PAGE>

(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. 333-84632) filed on March 20, 2002 and incorporated herein by
reference.
(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 Annual Report on Form 10-K for the
year ended December 31, 2001 and incorporated herein by reference.
(12) Filed as an Exhibit to the Company's Current Report on Form 8-K filed on
November 13, 2001 and incorporated herein by reference.
(13) 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.
(14) Filed as an Exhibit to the Company's Current Report on Form 8-K filed on
June 13, 2002 and incorporated herein by reference.
(15) Filed as an Exhibit to the Company's Current Report on Form 8-K filed on
July 23, 2002 and incorporated herein by reference.
(16) Filed as an Exhibit to the Amendment to the Company's Current Report on
Form 8-K filed on July 31, 2002 and incorporated herein by reference.
(17) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002 and incorporated herein by reference.
(18) Filed as an Exhibit to the Company's Registration Statement on Form S-8
(File No. 333-100034) filed on September 24, 2002 and incorporated herein by
reference.

*    Constitutes management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form.

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.

                                       57

<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: March 28, 2003
                                          /s/  ANTONY KOBLISH
                                          By:  Antony Koblish
                                          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.

<TABLE>
<CAPTION>
Signature                                 Capacity                                  Date
----------------------------              -----------------------------------       --------------
<S>                                       <C>                                       <C>
/s/ ANTONY KOBLISH                        Chief Executive Officer, President        March 28, 2003
Antony Koblish                            and Director (principal executive
                                          officer)

/s/ DAVID S. JOSEPH                       Chairman                                  March 28, 2003
David S. Joseph

/s/ JOSEPH M. PAIVA                       Chief Financial Officer                   March 28, 2003
Joseph M. Paiva                           (principal financial and accounting
                                          officer)

/s/ MORRIS CHESTON, JR.                   Director                                  March 28, 2003
Morris Cheston, Jr.

/s/ PAUL DUCHEYNE, PH.D.                  Director                                  March 28, 2003
Paul Ducheyne, Ph.D.

/s/ DAVID FITZGERALD                      Director                                  March 28, 2003
David Fitzgerald

/s/ ROBERT M. LEVANDE                     Director                                  March 28, 2003
Robert M. Levande

/s/ MARY E. PAETZOLD                      Director                                  March 28, 2003
Mary E. Paetzold

/s/ JONATHAN SILVERSTEIN                  Director                                  March 28, 2003
Jonathan Silverstein
</TABLE>

                                       58

<PAGE>

                                 ORTHOVITA, INC.

                           CERTIFICATIONS PURSUANT TO
                                 SECTION 302 OF
                         THE SARBANES-OXLEY ACT OF 2002

I, Antony Koblish, certify that:

     1.   I have reviewed this annual report on Form 10-K of Orthovita, Inc.;

     2.   Based on my knowledge, this annual report does not contain any untrue
          statement of a material fact or omit to state a material fact
          necessary to make the statements made, in light of the circumstances
          under which such statements were made, not misleading with respect to
          the period covered by this annual report;

     3.   Based on my knowledge, the financial statements, and other financial
          information included in this annual report, fairly present in all
          material respects the financial condition, results of operations and
          cash flows of the registrant as of, and for, the periods presented in
          this annual report;

     4.   The registrant's other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as
          defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
          and we have:

          a)     designed such disclosure controls and procedures to ensure that
               material information relating to the registrant, including its
               consolidated subsidiaries, is made known to us by others within
               those entities, particularly during the period in which this
               annual report is being prepared;

          b)     evaluated the effectiveness of the registrant's disclosure
               controls and procedures as of a date within 90 days prior to the
               filing date of this annual report (the "Evaluation Date"); and

          c)     presented in this annual report our conclusions about the
               effectiveness of the disclosure controls and procedures based on
               our evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officers and I have disclosed, based
          on our most recent evaluation, to the registrant's auditors and the
          audit committee of registrant's board of directors (or persons
          performing the equivalent function):

          a)   all significant deficiencies in the design or operation of
               internal controls which could adversely affect the registrant's
               ability to record, process, summarize and report financial data
               and have identified for the registrant's auditors any material
               weaknesses in internal controls; and

          b)   any fraud, whether or not material, that involves management or
               other

<PAGE>

          c)   employees who have a significant role in the registrant's
               internal controls; and

     6.   The registrant's other certifying officers and I have indicated in
          this annual report whether or not there were significant changes in
          internal controls or in other factors that could significantly affect
          internal controls subsequent to the date of our most recent
          evaluation, including any corrective actions with regard to
          significant deficiencies and material weaknesses.

/s/ Antony Koblish

Antony Koblish
President and Chief Executive Officer
March 28, 2003

<PAGE>

                                 ORTHOVITA, INC.

                           CERTIFICATIONS PURSUANT TO
                                 SECTION 302 OF
                         THE SARBANES-OXLEY ACT OF 2002

I, Joseph M. Paiva, certify that:

     1.   I have reviewed this annual report on Form 10-K of Orthovita, Inc.;

     2.   Based on my knowledge, this annual report does not contain any untrue
          statement of a material fact or omit to state a material fact
          necessary to make the statements made, in light of the circumstances
          under which such statements were made, not misleading with respect to
          the period covered by this annual report;

     3.   Based on my knowledge, the financial statements, and other financial
          information included in this annual report, fairly present in all
          material respects the financial condition, results of operations and
          cash flows of the registrant as of, and for, the periods presented in
          this annual report;

     4.   The registrant's other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as
          defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
          and we have:

          a) designed such disclosure controls and procedures to ensure that
          material information relating to the registrant, including its
          consolidated subsidiaries, is made known to us by others within those
          entities, particularly during the period in which this annual report
          is being prepared;

          b) evaluated the effectiveness of the registrant's disclosure controls
          and procedures as of a date within 90 days prior to the filing date of
          this annual report (the "Evaluation Date"); and

          c) presented in this annual report our conclusions about the
          effectiveness of the disclosure controls and procedures based on our
          evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officers and I have disclosed, based
          on our most recent evaluation, to the registrant's auditors and the
          audit committee of registrant's board of directors (or persons
          performing the equivalent function):

          a) all significant deficiencies in the design or operation of internal
          controls which could adversely affect the registrant's ability to
          record, process, summarize and report financial data and have
          identified for the registrant's auditors any material weaknesses in
          internal controls; and

          b) any fraud, whether or not material, that involves management or
          other employees who

<PAGE>

          have a significant role in the registrant's internal controls; and

     6.   The registrant's other certifying officers and I have indicated in
          this annual report whether or not there were significant changes in
          internal controls or in other factors that could significantly affect
          internal controls subsequent to the date of our most recent
          evaluation, including any corrective actions with regard to
          significant deficiencies and material weaknesses.

/s/ Joseph M. Paiva

Joseph M. Paiva
Chief Financial Officer
March 28, 2003

<PAGE>

                          INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders

Orthovita, Inc.:

We have audited the accompanying consolidated balance sheet of Orthovita, Inc.
(a Pennsylvania corporation) and subsidiaries as of December 31, 2002, and the
related consolidated statements of operations, shareholders' equity and
comprehensive income (loss) and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit. The consolidated financial statements
of Orthovita, Inc. as of December 31, 2001 and for the two years in the period
ended December 31, 2001 were audited by other auditors who have ceased
operations. Those auditors expressed an unqualified opinion on those
consolidated financial statements in their report dated January 22, 2002.

We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 audit provides a
reasonable basis for our opinion.

In our opinion, the 2002 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Orthovita,
Inc. and subsidiaries as of December 31, 2002, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.

/s/ KPMG LLP

Philadelphia, Pennsylvania
February 11, 2003

                                      F - 1

<PAGE>

The following is a copy of a report previously issued by Arthur Andersen LLP and
included in the 2001 Form 10-K report for the year ended December 31, 2001 filed
on April 1, 2002. This report has not been reissued by Arthur Andersen LLP, and
Arthur Andersen LLP has not consented to its use in this Annual Report on Form
10-K.

                    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 6, as to which the date is March 22, 2002)

                                      F - 2

<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                           December 31
                                                                                      2002            2001
                                                                                  ------------    ------------
<S>                                                                               <C>             <C>
                                     ASSETS
CURRENT ASSETS:
    Cash and cash equivalents (Notes 3 and 6)..................................   $ 15,175,268    $ 12,906,557
   Short-term investments (Notes 3 and 6)......................................      3,992,000              --
   Accounts receivable, net of allowance for doubtful accounts of
    $60,000 and $40,000, respectively..........................................      1,621,238         983,467
   Inventories (Note 4)........................................................      2,870,342       1,606,333
   Other current assets........................................................         53,904         125,022
                                                                                  ------------    ------------
          Total current assets ................................................     23,712,752      15,621,379
                                                                                  ------------    ------------
PROPERTY AND EQUIPMENT, net (Note 5)...........................................      4,896,472       5,433,353
                                                                                  ------------    ------------
OTHER ASSETS...................................................................         94,883         158,111
                                                                                  ------------    ------------
                                                                                  $ 28,704,107    $ 21,212,843
                                                                                  ============    ============

                      LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
   Current portion of notes payable (Note 7)...................................   $    308,385    $         --
   Current portion of capital lease obligations (Note 7).......................        252,964         482,420
   Accounts payable............................................................        676,681       1,010,423
   Accrued compensation and related expenses...................................        882,713         624,168
   Other accrued expenses......................................................      1,674,660         790,765
                                                                                  ------------    ------------
          Total current liabilities............................................      3,795,403       2,907,776
                                                                                  ------------    ------------
LONG-TERM LIABILITIES:
   Other long term liabilities.................................................         72,891          62,000
   Notes payable (Note 7)......................................................        396,798              --
   Capital lease obligations (Note 7) .........................................        213,502         350,519
   Revenue interest obligation (Note 6) .......................................      7,167,700       5,222,107
                                                                                  ------------    ------------
          Total long-term liabilities .........................................      7,850,891       5,634,626
                                                                                  ------------    ------------
COMMITMENTS AND CONTINGENCIES (Note 12)
SHAREHOLDERS' EQUITY (Note 9):
   Preferred Stock, $.01 par value, 20,000,000 shares authorized designated
    as: Series A 6% Adjustable Cumulative Convertible Voting Preferred Stock,
    $.01 par value, 2,000 shares authorized, 1,900 shares
    issued and outstanding.....................................................             19              --
   Common Stock, $.01 par value, 50,000,000 shares authorized,
    20,239,374 and 20,874,536 shares issued and outstanding....................        202,394         208,745
   Additional paid-in capital..................................................     98,465,855      74,066,082
   Accumulated deficit.........................................................    (81,891,924)    (61,599,522)
   Accumulated other comprehensive income (loss)...............................        281,469          (4,864)
                                                                                  ------------    ------------
          Total shareholders' equity...........................................     17,057,813      12,670,441
                                                                                  ------------    ------------
                                                                                  $ 28,704,107    $ 21,212,843
                                                                                  ============    ============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F - 3

<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                          Year Ended December 31
                                                   2002            2001             2000
                                               -------------   -------------   -------------
<S>                                            <C>             <C>             <C>
PRODUCT SALES (Notes 6 and 10)...............  $  10,379,205   $   3,940,395   $     740,660
COST OF SALES (Note 4).......................      1,578,765         719,373         170,041
                                               -------------   -------------   -------------
      Gross profit...........................      8,800,440       3,221,022         570,619
                                               -------------   -------------   -------------
OPERATING EXPENSES:
General and administrative...................      5,334,298       4,361,183       4,333,094
Selling and marketing........................      8,870,748       5,910,505       3,357,903
Research and development.....................      5,971,039       7,202,942       7,500,165
                                               -------------   -------------   -------------
      Total operating expenses...............     20,176,085      17,474,630      15,191,162
                                               -------------   -------------   -------------
      Operating loss.........................    (11,375,645)    (14,253,608)    (14,620,543)
INTEREST EXPENSE.............................        (79,490)       (154,074)       (151,161)
REVENUE INTEREST EXPENSE (Note 6)............       (386,893)        (65,750)             --
INTEREST INCOME..............................        172,084         308,013         365,434
NET GAIN ON SALE OF PRODUCT LINE (Note 10)...             --         375,000       3,070,921
                                               -------------   -------------   -------------
NET LOSS.....................................  $ (11,669,944)  $ (13,790,419)  $ (11,335,349)

DIVIDENDS PAID ON PREFERRED STOCK (Note 9)...        423,618              --              --
DEEMED DIVIDENDS ON PREFERRED STOCK (Note 9):
   Accretion.................................        218,168              --              --
   Beneficial conversion feature.............      7,980,672              --              --
                                               -------------   -------------   -------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS...  $ (20,292,402)  $ (13,790,419)  $ (11,335,349)
                                               =============   =============   =============

NET LOSS APPLICABLE TO COMMON SHAREHOLDERS
 PER COMMON SHARE, BASIC AND DILUTED.........  $       (1.00)  $        (.82)  $        (.92)
                                               =============   =============   =============

WEIGHTED AVERAGE NUMBER OF COMMON SHARES
 OUTSTANDING, BASIC AND DILUTED..............     20,223,182      16,841,970      12,281,117
                                               =============   =============   =============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F - 4

<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)

<TABLE>
<CAPTION>
                                                   Series A
                                                   Preferred        Common        Additional         Deferred        Accumulated
                                                    Stock           Stock       Paid-in Capital    Compensation        Deficit
                                                 ------------    ------------   ---------------   --------------    -------------
<S>                                                        <C>   <C>            <C>               <C>               <C>
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)

<CAPTION>
                                                  Accumulated
                                                 Comprehensive   Comprehensive
                                                 Income (Loss)   Income (Loss)        Total
                                                 -------------   -------------    --------------
<S>                                              <C>             <C>              <C>
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)        (32,382)          (32,382)
                                                                 -------------
Comprehensive loss                                          --   $ (11,367,251)               --
                                                 -------------   =============    --------------
BALANCE, DECEMBER 31, 2000                             (27,590)                        5,129,615
</TABLE>

                                   (continued)

                                      F - 5

<PAGE>

<TABLE>
<CAPTION>
                                                   Series A
                                                   Preferred        Common        Additional         Deferred        Accumulated
                                                    Stock           Stock       Paid-in Capital    Compensation        Deficit
                                                 ------------    ------------   ---------------   --------------    -------------
<S>                                                        <C>        <C>            <C>                  <C>         <C>
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)   Income (Loss)        Total
                                                 -------------   -------------    --------------
<S>                                                     <C>      <C>                 <C>
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                                          --   $ (13,767,963)               --
                                                 -------------   =============    --------------
BALANCE, DECEMBER 31, 2001                              (4,864)                       12,670,441
</TABLE>

                                   (continued)

                                      F - 6

<PAGE>

<TABLE>
<CAPTION>
                                                   Series A
                                                   Preferred        Common        Additional         Deferred        Accumulated
                                                    Stock           Stock       Paid-in Capital    Compensation        Deficit
                                                 ------------    ------------   ---------------   --------------    -------------
<S>                                              <C>             <C>            <C>               <C>               <C>
Exercise of Common Stock options and
 warrants to purchase Common Stock and
 Common Stock purchased under the
 Employee Stock Purchase Plan                              --             578            80,057               --               --

Issuance of Common Stock for services                      --             378            69,620               --               --

Issuance of Common Stock options and
 warrants for services                                     --              --           326,093               --               --

Sale of 1,900 shares of Series A
 Preferred Stock and warrants                              19              --        17,337,331               --               --

Adjustment to issuance of Common
 Stock under restricted stock award                        --            (162)          (97,338)              --               --

Treasury shares retired                                    --          (8,608)       (1,936,985)              --               --

Comprehensive loss:

Net loss                                                   --              --                --               --      (11,669,944)

Dividends paid in Common Stock                             --           1,463           422,155               --         (423,618)

Accretion of Series A Preferred Stock                      --              --           218,168               --         (218,168)

Deemed dividends on Series A
 Preferred Stock: beneficial
 conversion feature                                        --              --         7,980,672               --       (7,980,672)

Other comprehensive loss:
Currency translation adjustment                            --              --                --               --               --

Comprehensive loss                                         --              --                --               --               --
                                                 ------------    ------------   ---------------   --------------    -------------
BALANCE, DECEMBER 31, 2002                       $         19    $    202,394   $    98,465,855   $           --    $ (81,891,924)
                                                 ============    ============   ===============   ==============    =============

<CAPTION>
                                                  Accumulated
                                                 Comprehensive   Comprehensive
                                                 Income (Loss)   Income (Loss)        Total
                                                 -------------   -------------    --------------
<S>                                              <C>             <C>              <C>
Exercise of Common Stock options and
 warrants to purchase Common Stock and
 Common Stock purchased under the
 Employee Stock Purchase Plan                               --              --            80,635

Issuance of Common Stock for services                       --              --            69,998

Issuance of Common Stock options and
 warrants for services                                      --              --           326,093

Sale of 1,900 shares of Series A
 Preferred Stock and warrants                               --              --        17,337,350

Adjustment to issuance of Common
 Stock under restricted stock award                         --              --           (97,500)

Treasury shares retired                                     --              --        (1,945,593)

Comprehensive loss:

Net loss                                                    --   $ (11,669,944)      (11,669,944)

Dividends paid in Common Stock                              --        (423,618)               --

Accretion of Series A Preferred Stock                       --        (218,168)               --

Deemed dividends on Series A
 Preferred Stock: beneficial
 conversion feature                                         --      (7,980,672)               --

Other comprehensive loss:
Currency translation adjustment                        286,333         286,333           286,333
                                                                 -------------
Comprehensive loss                                          --   $ (20,006,069)               --
                                                 -------------   =============    --------------
BALANCE, DECEMBER 31, 2002                       $     281,469                    $   17,057,813
                                                 =============                    ==============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F - 7

<PAGE>

                        ORTHOVITA, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                              Year Ended December 31
                                                                                      2002             2001            2000
                                                                                  -------------    ------------    ------------
<S>                                                                               <C>              <C>             <C>
OPERATING ACTIVITIES:
   Net loss.....................................................................  $ (11,669,944)   $(13,790,419)   $(11,335,349)
   Adjustments to reconcile net loss to net cash used in operating activities:
      Depreciation and amortization.............................................      1,171,439       1,345,572         953,683
      Amortization of deferred compensation.....................................             --          97,500         172,825
      Common stock options and warrants
       issued for services rendered.............................................        326,093         354,557         510,431
      Common Stock issued for services rendered.................................         69,998              --              --
      Net gain on sale of product line..........................................             --        (375,000)     (3,070,921)
      Loss on disposal of property and equipment................................          4,473          12,692              --
      (Increase) decrease in--
          Accounts receivable...................................................       (637,771)       (903,417)        (20,539)
          Inventories...........................................................     (1,264,009)     (1,423,934)        (35,129)
          Other current assets..................................................         71,118        (103,301)         58,948
          Other assets                                                                   63,228         209,866        (264,836)
      Increase (decrease) in--
          Accounts payable......................................................       (333,742)       (146,110)       (171,292)
          Other liabilities                                                              10,891         (48,652)       (202,043)
          Other accrued expenses................................................      1,044,940         (15,146)        337,520
                                                                                  -------------    ------------    ------------
                Net cash used in operating activities...........................    (11,143,286)    (14,785,792)    (13,066,702)
                                                                                  -------------    ------------    ------------

INVESTING ACTIVITIES:
   Purchase of investments......................................................     (3,992,000)             --        (199,886)
   Proceeds from sale of investments............................................             --         199,866       6,446,469
   Proceeds from sale of product line...........................................             --              --       3,900,000
   Decrease (increase) in restricted cash.......................................             --         375,000        (400,000)
   Purchases of property and equipment..........................................       (514,031)     (1,470,389)     (3,306,335)
                                                                                  -------------    ------------    ------------
                Net cash (used in) provided by investing activities.............     (4,506,031)       (895,523)      6,440,248
                                                                                  -------------    ------------    ------------

FINANCING ACTIVITIES:
   Repayments of short-term bank borrowings.....................................             --              --      (2,000,000)
   Proceeds from notes payable..................................................        788,380              --         500,000
   Repayment of notes payable...................................................        (83,197)       (500,000)       (141,837)
   Proceeds from revenue interest obligation....................................             --       5,222,107              --
   Repayments of capital lease obligations......................................       (491,473)       (628,549)       (682,853)
   Proceeds from exercise of common stock options and
    warrants and common stock purchased under the
    Employee  Stock Purchase Plan...............................................         80,635          88,772       1,115,492
   Proceeds from sale of Common Stock and warrants..............................             --      20,767,690       9,051,449
   Proceeds from sale of Preferred Stock and warrants...........................     17,337,350              --              --
                                                                                  -------------    ------------    ------------
                Net cash provided by financing activities.......................     17,631,695      24,950,020       7,842,251
                                                                                  -------------    ------------    ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
 CASH EQUIVALENTS...............................................................        286,333          23,226         (88,514)
                                                                                  -------------    ------------    ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS.......................................      2,268,711       9,291,931       1,127,283
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR....................................     12,906,557       3,614,626       2,487,343
                                                                                  -------------    ------------    ------------
CASH AND CASH EQUIVALENTS, END OF YEAR..........................................  $  15,175,268    $ 12,906,557    $  3,614,626
                                                                                  =============    ============    ============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      F - 8

<PAGE>

ORTHOVITA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   THE COMPANY:

Orthovita 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 incorporated in 1992 and have developed several
products to date:

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

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

          .    CORTOSS(R) Synthetic Cortical Bone Void Filler; and

          .    ALIQUOT(TM) Microdelivery System used with CORTOSS.

In addition, we are developing RHAKOSSTM Synthetic Bone Spinal Implants.

Our operations are subject to certain risks including but not limited to the
need to successfully commercialize VITOSS and IMBIBE in the U.S., and VITOSS,
CORTOSS and ALIQUOT outside the U.S. 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. Our products under development may never be
commercialized or, if commercialized, may never generate substantial revenue. We
have incurred losses each year since our inception in 1993 and we expect to
continue to incur losses for at least the next couple years. As of December 31,
2002, we had an accumulated deficit of $81,891,924. We expect to continue to use
cash, cash equivalents and short-term investments to fund operating and
investing activities for at least the next couple years. We believe that our
existing cash, cash equivalents and short-term investments of $19,167,268 as of
December 31, 2002 will be sufficient to meet our currently estimated operating
and investing requirements at least through the first quarter of 2004. In
addition, if the bid price per share of our Common Stock is below $3.00 per
share, we may need to raise more capital than what is necessary to fund our
operations by the fourth quarter of 2003 in order to satisfy Nasdaq National
Market's shareholders' equity threshold. 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 and Preferred Stock or
require debt service and/or revenue sharing 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 accounting
principles generally accepted in the United States of America. This preparation
requires that we make assumptions, estimates and judgments 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 use authoritative pronouncements,
historical experience and other assumptions as the basis for making 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. 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, 2002, 2001 and 2000 because they
were anti-dilutive due to our losses.

Revenue Recognition

Revenue from product sales is recognized upon the receipt of a valid order and
shipment to our distributor customers outside the U.S. 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 and we have no post-shipment obligations to our customers. In
addition, collection of the customers' receivable balance must be deemed
probable. Both our U.S. hospital customers and our distributor customers outside
of the U.S. are generally required to pay on a net 30-day basis and sales
discounts are not offered. We maintain an accounts receivable allowance for an
estimated amount of losses that may result from a customer's inability to pay
for product

                                      F - 9

<PAGE>

purchased. If the financial condition of our customers was 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.

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.

Income Taxes

We account for income taxes in accordance with SFAS No. 109, "Accounting for
Income Taxes" ("SFAS No. 109"). SFAS No. 109 is an asset and liability approach
requiring 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 differences 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, given our history
of operating losses, the realization of the deferred tax asset is not assured.

Accounting for Stock Options Issued to Employees and Non-employees

We apply the intrinsic-value-based method of accounting prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
("APB No. 25") and related interpretations to account for our fixed-plan stock
options. Under this method, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation," ("SFAS
No. 123") established accounting and disclosure requirements using a fair-value
based method of accounting for stock-based employee compensation plans. As
allowed by SFAS No. 123, as amended in SFAS No. 148, "Accounting for Stock-Based
Compensation," ("SFAS No. 148"), we have elected to continue to apply the
intrinsic-value-based method of accounting described above, and adopted only the
disclosure requirements of SFAS No. 123.

Research & 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 2002, 2001 and 2000, respectively, we issued options and warrants for the
purchase of 273,850, 203,000 and 117,500 shares of Common Stock with various
exercise prices to certain vendors in consideration for services valued at
$326,093, $354,557 and $510,431, respectively. In addition during 2002, we
issued an aggregate 146,311 shares of our Common Stock valued at $423,618 as
payment of dividends to our Series A 6% Adjustable Cumulative Convertible Voting
Preferred Stock ("Series A Preferred Stock") shareholders (see Note 9). In 2002,
we issued 37,835 shares of Common Stock valued at $69,998 to our non-employee
directors in consideration for their services.

                                     F - 10

<PAGE>

In 2002 and 2000, we incurred capital lease obligations of $125,000 and
$997,489, respectively. We did not incur any capital lease obligations in 2001.
In 2002, 2001 and 2000, cash paid for interest expense and revenue interest
expense was $463,571, $219,824 and $151,161, respectively. The Company paid no
income taxes in 2002, 2001 and 2000.

In 2002, pursuant to a product development and equity financing, 860,882 shares
of our Common Stock were surrendered to us. The value of the surrendered shares
of our Common Stock on March 22, 2002 was $2.26 per share, or $1,945,593 in the
aggregate (see Note 6).

Other Accrued Expenses

Other accrued expenses as of December 31, 2002 consist of: accrued distributor
commissions of $293,100, accrued professional fees of $363,934 and other
accrued expenses of $1,017,626.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No.
143 requires the recording of the fair value of an asset retirement obligation
as a liability in the period in which the Company would incur the legal
obligation associated with the retirement of tangible long-lived assets that
result from the acquisition, construction, development and/or normal use of the
assets. In addition, SFAS No. 143 requires the recording of a corresponding
asset that would be depreciated over the life of the asset. Subsequent to the
initial measurement of the asset retirement obligation, the obligation would be
adjusted at the end of each period to reflect the passage of time and changes in
the estimated future cash flows underlying the obligation. SFAS No. 143 is
required to be adopted on January 1, 2003. The adoption of SFAS No. 143 did not
have a material effect on our financial statements.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections"
("SFAS No. 145"). SFAS No. 145 amends existing guidance on reporting gains and
losses on the extinguishment of debt to prohibit the classification of the gain
or loss as extraordinary, as the use of such extinguishments have become part of
the risk management strategy of many companies. SFAS No. 145 also amends SFAS
No. 13 to require sale-leaseback accounting for certain lease modifications that
have economic effects similar to sale-leaseback transactions. The provisions of
SFAS No. 145 related to the rescission of SFAS No. 4 are applied in fiscal years
beginning after May 15, 2002.; however, earlier application of these provisions
is encouraged. The provisions of SFAS No. 145 related to SFAS No. 13 were
effective for transactions occurring after May 15, 2002, with early application
encouraged. The adoption of SFAS No. 145 did not have a material effect on our
financial statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity". SFAS No. 146 is effective for exit or disposal activities initiated
after December 31, 2002, with early application encouraged. The adoption of SFAS
No. 146 did not have a material effect on our financial statements.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107
and rescission of FASB Interpretation No. 34" ("Interpretation No. 45").
Interpretation No. 45 elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. Interpretation No. 45 also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the fair
value of the obligation undertaken. The initial recognition and measurement
provisions of Interpretation No. 45 are applicable to guarantees issued or
modified after December 31, 2002 and, the disclosure requirements are effective
for financial statements of interim or annual periods ending after December 15,
2002. We did not have any such guarantees during 2002.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123" ("SFAS No. 148"). SFAS No. 148 amends SFAS No. 123 to provide alternative
methods of transition for a voluntary change to the fair value method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements. Certain of the
disclosure modifications are required for fiscal years ended after December 15,
2002 and are included elsewhere in the notes to these consolidated financial
statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51" ("Interpretation
No. 46"). Interpretation No. 46 addresses the consolidation by business
enterprises of variable interest entities as defined in Interpretation No. 46.
Interpretation No. 46 applies immediately to variable interests in variable
interest entities created after January 31 2003, and variable interests in
variable interest entities obtained after January 31, 2003. For public
enterprises with a variable interest in a variable interest entity created
before February 1, 2003, Interpretation No. 46 is applied to the enterprise no
later than the beginning of the first annual reporting period beginning after
June 15, 2003. The application of Interpretation No. 46 is not expected to have
a material effect on our financial statements. Interpretation No. 46

                                     F - 11

<PAGE>

requires certain disclosures in financial statements issued after January 31,
2003 if it is reasonably possible to consolidate or disclose such information
about the variable interest entities when Interpretation No. 46 becomes
effective.

                                     F - 12

<PAGE>

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, 2002, 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 of December 31, 2002, short-term investments consist of
certificates of deposits.

As of December 31, 2002 and 2001, cash, cash equivalents and short-term
investments consisted of the following:

<TABLE>
<CAPTION>
                                  Original Cost   Gross Unrealized Gains   Gross Unrealized Losses   Fair Market Value
                                  -------------   ----------------------   -----------------------   -----------------
<S>                               <C>             <C>                      <C>                       <C>
December 31, 2002:
Cash and cash equivalents         $  15,175,268   $                   --   $                    --   $      15,175,268
Short-term investments                3,992,000                       --                        --           3,992,000
                                  -------------   ----------------------   -----------------------   -----------------
                                  $  19,167,268   $                   --   $                    --   $      19,167,268
                                  =============   ======================   =======================   =================

December 31, 2001:
Cash and cash equivalents         $  12,906,557   $                   --   $                    --   $      12,906,557
                                  -------------   ----------------------   -----------------------   -----------------
                                  $  12,906,557   $                   --   $                    --   $      12,906,557
                                  =============   ======================   =======================   =================
</TABLE>

4.   INVENTORIES:

As of December 31, 2002 and 2001, inventories consisted of the following:

                                            December 31
                                           2002           2001
                                  -------------   ------------
Raw materials                     $     261,500   $    108,960
Work-in-process                       1,591,894        752,079
Finished goods                        1,016,888        745,294
                                  -------------   ------------
                                  $   2,870,342   $  1,606,333
                                  =============   ============

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, 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 consisted of the following:

                                           December 31
                                           2002           2001
                                  -------------   ------------
Machinery and equipment           $   3,728,400   $  3,371,746
Furniture, computer, marketing
 and office equipment                 1,927,364      1,663,060
Leasehold improvements                4,047,515      4,037,637
                                  -------------   ------------
                                      9,703,279      9,072,443
Less - Accumulated depreciation      (4,806,807)    (3,639,090)
                                  -------------   ------------
                                  $   4,896,472   $  5,433,353
                                  =============   ============

Total assets under capital lease are $2,699,232 and $2,819,745 with related
accumulated amortization of $2,006,168 and $1,651,065 at December 31, 2002 and
2001, respectively (see Note 7).

6.   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"). The
business purpose of the transaction was to raise working capital. Our obligation
under this arrangement is to use the proceeds realized from this financing for
working capital, including the funding of clinical development and marketing
programs relating to our VITOSS, CORTOSS and RHAKOSS products. Regulatory
authorities or competing products and technologies and other factors may prevent
us from ever effectively marketing one or more of these three products.

                                     F - 13

<PAGE>

In this financing, we sold Paul Royalty a revenue interest and 2,582,645 shares
of our Common Stock. The value of these shares at the time the transaction
closed was $1.85 per share, or $4,777,893 in the aggregate. The net proceeds
from 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 in accordance with Emerging
Issues Task Force Issues No. 88-18, "Sales of Future Revenues" ("EITF 88-18").
On March 22, 2002, we amended the original financing, which resulted in a
one-time increase to the "revenue interest obligation" of $1,945,593. Pursuant
to the March 2002 Amendment, Paul Royalty surrendered to us 860,882 shares of
our Common Stock that it had originally purchased in the October 2001 financing.
In exchange, we surrendered our right to receive credits against the revenue
interest obligation. The value of the surrendered shares of our Common Stock on
March 22, 2002 was $2.26 per share, or $1,945,593 in the aggregate. The March
2002 Amendment also provided for a reduction in the amount required for us to
repurchase Paul Royalty's revenue interest, if a repurchase event was to occur
(see below for description of a repurchase event). This modification was
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. Since this
represents a non-monetary transaction, we utilized the fair market value of our
Common Stock surrendered by Paul Royalty on March 22, 2002, or $1,945,593, to
determine the fair value of the non-monetary consideration. This approach is in
accordance with Accounting Principles Board Opinion No. 29 "Accounting for
Nonmonetary Transactions" ("APB 29"). The treasury stock was then retired in
September 2002.

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 certain of our products, including VITOSS, CORTOSS and RHAKOSS,
in North America and Europe through 2016, subject to certain adjustments. This
revenue interest percentage can increase if we fail to meet contractually
specified levels of annual net sales of products for which Paul Royalty is
entitled to receive its revenue interest. We do not currently expect that
changes in the revenue interest percentage resulting from fluctuations in sales
of products subject to the revenue interest will have a material effect on
operating results for a period when considered relative to sales of the products
for that period. Accordingly, Paul Royalty bears the risk of revenue interest
paid to it being significantly less than the current revenue interest liability,
as well as the reward of revenue interest paid to it being significantly greater
than the current revenue interest liability. Therefore, we are under no
obligation to make any other payments to Paul Royalty in the scenario where no
repurchase right is triggered and no significant revenue interest payments are
made. Conversely, we will be obligated to continue to make revenue interest
payments in the scenario where sales are sufficiently high to result in amounts
due under the Revenue Interest Assignment Agreement being in excess of the
current revenue interest liability.

The products that are subject to the revenue interest have only recently been
approved and marketed or are still under development. For these reasons, as of
December 31, 2002 and for the foreseeable future, we cannot currently make a
reasonable estimate of future revenues and payments that may become due to Paul
Royalty under this financing. Therefore, it is premature to estimate the
expected impact of this financing on our results of operations, liquidity and
financial position. Future sales from VITOSS in the U.S. and VITOSS and CORTOSS
in Europe, our approved products, are difficult to estimate. RHAKOSS is under
development with human clinical trials initiated in Europe in April 2002. We
have initiated, or plan to initiate, human clinical trials for CORTOSS and
RHAKOSS in the U.S. There is no assurance that the data from these clinical
trials will result in obtaining the necessary approval to sell CORTOSS in the
U.S. or RHAKOSS in either the U.S. or Europe. Even if such approval is obtained,
future revenue levels, if any, are difficult to estimate. Accordingly, given
these uncertainties in 2002 and for the foreseeable future, we will charge
revenue interest expense as revenues subject to the revenue interest obligation
are recognized. We will continue to monitor our product sales levels. Once we
are able to make a reasonable estimate of our related revenue interest
obligation, interest expense will be charged based upon the interest method and
the obligation will be reduced as principal payments are made. The actual impact
has been the payment of approximately $387,000 and $66,000 in revenue interest
payments during the years ended December 31, 2002 and 2001, respectively. The
revenue interest payments under this agreement are treated as interest expense
in accordance with EITF 88-18.

In addition, beginning in 2003, and during the term of the revenue interest
agreement, we are required to make advance payments on the revenue interest
obligation at the beginning of each year. In January 2003, we paid to Paul
Royalty the required $1,000,000 advance payment in respect of net sales of our
VITOSS and CORTOSS products. The amount of the advance payment increases to
$2,000,000 in 2004, and further increases to $3,000,000 in the years 2005
through 2016. While we believe that we will have sufficient cash at the end of
2003 to make the required $2,000,000 advance payment to Paul Royalty during
2004, we cannot be certain that we will have sufficient cash to meet our advance
payment obligations for the years 2005 through 2016. While the advance payments
will impact cash flow within a given year, they will not affect earnings as the
advance payments are credited within each year against the revenue interest
actually earned by Paul Royalty during that year, with any excess advance
payments refunded to us shortly after the end of the year.

Our obligation to pay the revenue interest is secured by our licenses, patents
and trademarks relating to certain of our products, including VITOSS, CORTOSS
and RHAKOSS, in North America and Europe, and the 12% revenue 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:

                                     F - 14

<PAGE>

.. 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, 2002, 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 failure to comply with the financial covenants described
above, the occurrence of certain events, including those set forth below,
triggers Paul Royalty's right to require us to repurchase its revenue interest:

..    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; and
..    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. If a repurchase
event had been triggered and Paul Royalty exercised its right to require us to
repurchase its revenue interest as of December 31, 2002, we would have owed Paul
Royalty approximately $11,653,000.

The repurchase price for Paul Royalty's revenue interest as of a given date is
calculated in three steps. First, a specified annual rate of return (not to
exceed 45%) is applied to Paul Royalty's $10,000,000 original purchase price
from October 16, 2001 to the date of determination of the repurchase price.
Second, the result obtained from the first step of the calculation is added to
the original $10,000,000 purchase price. Third, the sum obtained from the second
step of the calculation is reduced by both $3,333,333 and the actual revenue
interest paid during the specified period.

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 became
insolvent or involved in a voluntary or involuntary bankruptcy proceeding. No
repurchase events or foreclosures have occurred as of December 31, 2002. In the
event that we repurchased Paul Royalty's revenue interest, Paul Royalty would
have no obligation to surrender the shares of our Common Stock that it had
purchased as part of the revenue interest transaction.

If we know that we will not be in compliance with our covenants under the Paul
Royalty agreement, we will be required to adjust the revenue interest obligation
to equal the amount required to repurchase Paul Royalty's revenue interest. As
of December 31, 2002, we do not expect to fall out of compliance in the
foreseeable future with the covenants and terms of the revenue interest
obligation.

7.   BORROWINGS AND CAPITAL LEASE OBLIGATIONS:

During July 2002, we entered into a financing arrangement with a lending
institution. The arrangement provided individual notes payable with a term of 35
months from each individual note's inception. The notes payable are secured by
certain capital assets. During 2002, we closed on three individual notes
totaling $788,380 with annual interest of approximately 11.29%.

In addition, during January 2002, we entered into a $125,000 capital lease
financing arrangement with a different lending institution. The term of this
lease is 60 months with an annual interest rate of 11.45%.

A $1,500,000 bank credit arrangement was due to expire on June 30, 2002 but was
terminated, at our request, during October 2001. The bank certificate of
deposit, which secured our credit arrangement, was released as collateral during
October 2001.

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. We have utilized all available
financing under this capital lease arrangement.

                                     F - 15

<PAGE>

The leases are secured by the underlying capital assets. Capital lease
obligations consisted of the following:

<TABLE>
<CAPTION>
                                                                       December 31
                                                                    2002                    2001
                                                           -------------           -------------
<S>                                                        <C>                     <C>
Capital lease obligations                                  $     520,430           $     881,888
Less - amount representing interest                              (53,964)                (48,949)
                                                           -------------           -------------
Present value of minimum lease payments                          466,466                832,939
Less - current portion of minimum lease payments                (252,964)               (482,420)
                                                           -------------           -------------
                                                           $     213,502           $     350,519
                                                           =============           =============
</TABLE>

Borrowing and capital lease obligation maturities as of December 31, 2002 are as
follows:

<TABLE>
<CAPTION>
                                                           Capital Leases         Notes Payable
                                                           --------------         -------------
<S>                                                        <C>                    <C>
2003                                                       $      252,964         $     308,385
2004                                                              153,380               271,592
2005                                                               28,648               125,206
2006                                                               29,287                    --
2007                                                                2,187                    --
                                                           --------------         -------------
   Total                                                   $      466,466         $     705,183
                                                           ==============         =============
</TABLE>

8.   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
$124,754, $126,331 and $106,415 for the years ended December 31, 2002, 2001 and
2000, respectively.

9.   SHAREHOLDERS' EQUITY:

Preferred Stock and Warrants

In July 2002, we sold 1,400 shares of Series A Preferred Stock at $10,000 per
share together with five-year warrants to purchase 6,154,747 shares of Common
Stock at $1.612 per share, for net cash proceeds of $12,807,197. The 1,400
shares of Series A Preferred Stock are convertible into 8,206,331 shares of our
Common Stock. Additionally, in July 2002, we issued to the designees of the
placement agent for the transaction, five-year warrants to purchase an aggregate
820,633 shares of our Common Stock at $1.706 per share which were valued at
$738,570. In connection with this transaction, after obtaining the required
shareholder approval in October 2002, we sold on the same terms and conditions
as in the July 2002 closing, an additional 500 shares of Series A Preferred
Stock together with warrants to purchase 2,198,125 shares of Common Stock at
$1.612 per share, for net cash proceeds of $4,530,153. The 500 shares of Series
A Preferred Stock are convertible into 2,930,832 shares of our Common Stock. In
connection with the October 2002 sale, we issued to the placement agent's
designees additional five-year warrants to purchase 293,083 shares of our Common
Stock at $1.706 per share which were valued at $468,933.

For each Series A Preferred Stock closing, the respective proceeds were
allocated to the Series A Preferred Stock and the warrants based on the relative
fair values of each instrument. The fair value of the warrants issued, in both
July and October 2002, were determined based on an independent third party
valuation. Accordingly, approximately $8,565,000 of the July 2002 proceeds was
allocated to the Series A Preferred Stock and $3,504,000 of the proceeds was
allocated to the warrants. Similarly, $2,885,000 of the October 2002 proceeds
was allocated to the Series A Preferred Stock and $1,296,000 of the proceeds was
allocated to the warrants. In addition, in accordance with EITF Issue No. 00-27,
"Application of Issue No. 98-5 to Certain Convertible Instruments," ("EITF No.
00-27"), the issuance costs were not offset against the proceeds received in the
issuance in calculating the intrinsic value of the conversion option but were
considered in the calculation of the amount shown on the consolidated balance
sheets. After considering the allocation of the proceeds based on the relative
fair values, it was determined that the Series A Preferred Stock has a
beneficial conversion feature ("BCF") in accordance with EITF Issue No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios" ("EITF No. 98-5") and EITF No. 00-27.
Accordingly, a BCF adjustment of $3,604,962 was recorded, with respect to the
Series A Preferred Stock at the July 2002 closing. The value of the BCF was
recorded in a manner similar to a deemed dividend, and since the Series A
Preferred Stock has no maturity date and is convertible at the date of issuance,
the BCF was fully amortized through retained earnings during the third quarter
of 2002. Additionally, we recorded similar deemed dividends during the fourth
quarter of 2002 of $4,375,710 for the BCF with respect to the Series A Preferred
Stock sold at the October 2002 closing.

                                     F - 16

<PAGE>

Upon the occurrence of each of the following events, each holder of Series A
Preferred Stock can require us to redeem each share of Series A Preferred Stock
held by such holder for cash in an amount equal to (i) $11,000 plus (ii) any
accrued and unpaid dividend payments:

..    our failure or refusal to convert any shares of the Series A Preferred
     Stock in accordance with the terms thereof, or our material breach of any
     other term or provision of the terms of the Preferred Stock;
..    any breach of any warranty or representation made by us as of the date of
     the Series A Preferred Stock Purchase Agreement that is reasonably likely
     to have a material adverse effect on Orthovita; or
..    any breach by us of any covenant or other provision of the Series A
     Preferred Stock Purchase Agreement that is reasonably likely to have a
     material adverse effect on Orthovita.

Dividends and Deemed Dividends on Series A Preferred Stock

As all of the redemption features are within our control, the Series A Preferred
Stock is classified within shareholders' equity on the consolidated balance
sheets. Dividends on the Series A Preferred Stock accrue and are cumulative from
the date of issuance of the Series A Preferred Stock, whether or not such
dividends are earned or declared by the Board of Directors, and will be payable
at our option either in cash or in kind (subject to certain share issuance
limitations as set forth in the Statement of Designations of the Series A
Preferred Stock) on March 31, June 30, September 30 and December 31 of each
year. The dividend rate (the "Dividend Rate") on each share of Series A
Preferred Stock will be 6% per year on the $10,000 stated value of the Series A
Preferred Stock. Commencing after June 30, 2004, for the Series A Preferred
Stock still outstanding and not converted to Common Stock, the Dividend Rate
will increase each quarter by an additional two percentage points per year, up
to a maximum Dividend Rate of 14% per year.

Given the substantial value associated with the warrants and the related BCF,
the total dividend attributed to holders of the Series A Preferred Stock during
2002 consisted of the BCF of $7,980,672 ($3,604,962 in the third quarter of 2002
and $4,375,710 in the fourth quarter of 2002) and the stated preferred dividend
of 6% totaling $423,618. We consider the quarterly reporting period in which the
BCF was recognized to be appropriately excludable from the period of dividend
attribution as described in Staff Accounting Bulletin No. 68, "Increasing Rate
Preferred Stock" ("SAB 68"), since the third quarter of 2002 already included a
disproportionate dividend attribution, due to the BCF on the July 2002 closing
we commenced recognition of the implied discount addressed in SAB 68 in the
fourth quarter of 2002 and recorded an additional $218,118 of dividends to
reflect the SAB 68 discount. Similarly, for the October 2002 closing, no
additional dividend was recorded pursuant to SAB 68 as the fourth quarter of
2002 included the BCF for the October 2002 closing. The SAB 68 discount relating
to the October 2002 closing will begin to be recorded in the first quarter of
2003. Assuming that the Series A Preferred Stock remains outstanding, we expect
the SAB 68 additional dividend to be approximately $1,200,000 in 2003,
$1,100,000 in 2004 and $100,000 in 2005.

In addition, in the event that the Series A Preferred Stock becomes subject to
mandatory conversion due to the achievement of certain revenue targets by us
prior to July 1, 2005 (see our Statement of Designations of the Series A
Preferred Stock filed as an Exhibit to the Amendment to our Report on Form 8-K
filed on July 31, 2002 and incorporated herein by reference), we will pay an
additional dividend equal to the difference between (x) $2,000 per share of
Series A Preferred Stock to be converted and (y) the sum of all dividends that
have been paid and all accrued but unpaid dividends with respect to each such
share.

During the year ended December 31, 2002, we declared dividends of $423,618 on
the Series A Preferred Stock. We paid these dividends in-kind by issuing an
aggregate of 1,463 shares of our Common Stock.

Common Stock

During 2002, we issued an aggregate 146,311 shares of our Common Stock as
payment of dividends to our Series A Preferred Stock shareholders (see above).
In addition during the year ended December 31, 2002, we issued 37,835 shares of
our Common Stock valued at $69,998 to our non-employee directors in
consideration for their services.

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
6).

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 - 17

<PAGE>

During April 2001, we entered into a Development and Distribution Agreement with
Japan Medical Dynamic Marketing, Inc., 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 Japan
Medical Dynamic Marketing, Inc., 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.

Treasury Stock

As previously discussed above, we sold Paul Royalty a revenue interest and
2,582,645 shares of our Common Stock. Net proceeds of the financing were first
allocated to the fair value of the Common Stock on the date of the transaction.
Pursuant to the March 2002 Amendment, Paul Royalty surrendered to us 860,882
shares of our Common Stock that it had originally purchased in the October 2001
financing. In exchange, we surrendered our right to receive credits against the
revenue interest obligation. The value of the surrendered shares of our Common
Stock on March 22, 2002 was $2.26 per share, or $1,945,593 in the aggregate. The
March 2002 Amendment also provided for a reduction in the amount required for us
to repurchase Paul Royalty's revenue interest, if a repurchase event was to
occur. This modification was 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. Since this represents a non-monetary transaction, we utilized
the fair market value of the Common Stock surrendered to us on March 22, 2002,
or $1,945,593, to determine the fair value of the non-monetary consideration.
This approach is in accordance with APB 29. The treasury stock was then retired
in September 2002.

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.

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, 2002, there were 801,331 options available for grant under the plan
and 1,832,300 exercisable options outstanding with a weighted average exercise
price of $3.50 per share.

                                     F - 18

<PAGE>

For all outstanding options, the weighted average exercise price per share is
$3.73 with a weighted average remaining contractual life of approximately eight
and three-quarter years. Summary stock option information is as follows:

                                               Exercise       Aggregate
                                    Number     Price Range    Exercise Price
                                  ---------    ------------   --------------
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
   Granted.....................   1,185,000      1.64- 4.35        3,016,109
   Exercised...................     (35,000)     1.00- 1.70          (42,000)
   Canceled....................    (518,250)     1.85- 5.31       (2,312,814)
                                  ---------    ------------   --------------
Outstanding, December 31, 2002.   3,102,550    $ 1.00-11.63   $   11,584,807
                                  =========    ============   ==============

We apply 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, 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 SFAS No. 123 to non-employee option grants by recording, on the
date of grant, the Black-Scholes model value, and we have applied the pro forma
disclosure requirement of SFAS No. 123 to employee option grants. For the year
ended December 31, 2002, we recorded $326,093 of compensation expense related to
SFAS No. 123 for our non-employee option grants. The following table illustrates
the effect on net loss if the fair value method had been applied to all
outstanding and unvested stock option grants in each period.

<TABLE>
<CAPTION>
                                                           Year ended December 31,
                                                 --------------------------------------------
                                                     2002            2001            2000
                                                 -------------   -------------  -------------
<S>                                              <C>             <C>            <C>
Net loss:
    As reported                                  $ (20,292,402)  $ (13,790,419) $ (11,335,349)
       Total stock-based employee
        compensation expense determined under
        the fair value-based method for all
        awards                                      (1,195,826)       (708,929)      (601,630)
                                                 -------------   -------------  -------------
    Pro forma                                    $ (21,488,228)  $ (14,499,348) $ (11,936,979)
                                                 =============   =============  =============
Basic and diluted net loss per share:
    As reported                                  $       (1.00)  $        (.82) $        (.92)
                                                 =============   =============  =============
    Pro forma                                    $       (1.06)  $        (.86) $        (.97)
                                                 =============   =============  =============
</TABLE>

The weighted average fair value of the options granted during 2002, 2001 and
2000 is estimated as $1.27, $.87 and $1.98 per share, respectively, on the date
of grant using the Black-Scholes option pricing model with the following
assumptions: volatility of 94%, 50% and 50%, risk-free interest rate of 3.0%,
3.3% and 5.0% during 2002, 2001 and 2000, respectively, and dividend yield of
zero and an expected life of six years for each of the measurement periods. 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.

                                     F - 19

<PAGE>

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 calendar quarter. The amount that may be offered pursuant to the
ESPP is 300,000 shares of our Common Stock. There were 22,824, 32,185 and 9,070
shares purchased under the ESPP during 2002, 2001 and 2000, respectively. As of
December 31, 2002, there were 233,189 shares of Common Stock available for
purchase under the Plan.

Common Stock Purchase Warrants

In July 2002, in connection with the Series A Preferred Stock financing we sold
five-year warrants to purchase 6,154,747 shares of Common Stock at $1.612 per
share. Additionally, in July 2002, we issued to the designees of the placement
agent for the transaction, five-year warrants to purchase an aggregate 820,633
shares of our Common Stock at $1.706 per share which were valued at $738,570. In
connection with this transaction, after obtaining the required shareholder
approval in October 2002, we sold on the same terms and conditions as in the
July 2002 closing additional warrants to purchase 2,198,125 shares of Common
Stock at $1.612 per share. In connection with the October 2002 sale, we issued
to the placement agent's designees additional five-year warrants to purchase
293,083 shares of our Common stock at $1.706 per share which were valued at
$468,933 (see Preferred Stock and Warrants above).

During 2002, warrants to purchase 547,010 shares of our Common Stock expired
unexercised at an exercise price of $4.25 per share.

During 2002, pursuant to a clinical assessment agreement, we issued warrants to
purchase an aggregate 110,000 shares of our Common Stock. These warrants have an
exercise price of $1.75 per share and an exercise period of five years and were
valued at $92,280 using the Black-Scholes model. 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. In addition, as of December 31, 2002, pursuant to
an investment banking agreement with SmallCaps Online Group LLC, as partial
payment for financial advisory services rendered, we are obligated to issue
warrants to purchase an aggregate 104,000 shares of our Common Stock. These
warrants have an exercise price of $4.625 per share and an exercise period of
four years. We have recorded the value of these warrants or $227,500 as
consulting expense. The issuance of these securities is 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.

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. 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 - 20

<PAGE>

Summary Common Stock warrant information as of December 31, 2002 is as follows:

                                   Number of Warrant
            Year of Expiration     Shares Outstanding     Exercise Price Range
            ------------------     ------------------     --------------------
            2003                              653,405            $4.00 - $4.41
            2003                               24,426            $8.60
            2004                               10,000            $6.00
            2005                              113,559            $5.26 - 5.90
            2006                              104,000            $4.625
            2007                            9,576,588            $1.612-1.75
                                   ------------------     --------------------
            Total                          10,481,978            $1.612 -$8.60
                                   ==================     ====================
10.  PRODUCT SALES:

We initiated sales of VITOSS in Europe and the United States in October 2000 and
March 2001, respectively. In addition, we initiated IMBIBE sales in the U.S.
during October 2001. CORTOSS and ALIQUOT sales were initiated in Europe during
December 2001 and May 2002, respectively. For the years ended December 31, 2002,
2001 and 2000, product sales by geographic market were as follows:

<TABLE>
<CAPTION>
                                                        Year Ended December 31
                                            -----------------------------------------------
                                                2002            2001              2000
                                            ------------    ------------      -------------
<S>                                         <C>             <C>               <C>
PRODUCT SALES (excluding BIOGRAN):
      United States                         $  9,689,798    $  3,305,873      $          --
      Outside the United States                  689,407         634,522            207,693
                                            ------------    ------------      -------------
             Total product sales            $ 10,379,205    $  3,940,395      $     207,693
                                            ============    ============      =============
</TABLE>

Sales of our dental product, BIOGRAN, were $532,967 during 2000. 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. The escrow account was released during 2001.

11.  INCOME TAXES:

We account for income taxes in accordance with 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:

<TABLE>
<CAPTION>
                                                         Year Ended December 31
                                            -----------------------------------------------
                                                2002            2001              2000
                                            ------------    ------------      -------------
            <S>                             <C>             <C>               <C>
            Current...................      $         --    $         --      $          --
            Deferred..................        (6,744,448)     (3,105,430)        (1,583,490)
                                            ------------    ------------      -------------
                                              (6,744,448)     (3,105,430)        (1,583,490)
            Valuation allowance.......         6,744,448       3,105,430          1,583,490
                                            ------------    ------------      -------------
                                            $         --    $         --      $          --
                                            ============    ============      =============
</TABLE>

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

                                     F - 21

<PAGE>

Components of our deferred tax asset as of December 31, 2002 and 2001 are as
follows:

<TABLE>
<CAPTION>
                                                                        December 31
                                                              -------------------------------
                                                                  2002              2001
                                                              -------------     -------------
<S>                                                           <C>               <C>
Deferred tax assets:
     Net operating loss carryforwards......................   $  16,047,302     $  12,949,311
     Accrued expenses not currently deductible.............       3,785,240           710,023
     Research, patent and organizational costs
      capitalized for tax purposes.........................       8,901,944         7,139,268
     Research and development credit.......................         687,801                --
                                                              -------------     -------------
                                                                 29,422,287        20,798,602
Valuation allowance........................................     (29,422,287)      (20,798,602)
                                                              -------------     -------------
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 and patent 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 10 to 17 years for federal tax
purposes.

As of December 31, 2002, we had $39,097,123 of federal net operating loss
carryforwards, which begin to expire in 2009. 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.

12.  COMMITMENTS AND CONTINGENCIES:

Operating Leases

We lease office space and equipment under noncancelable operating leases. For
the years ended December 31, 2002, 2001 and 2000, lease expense was $493,202,
$421,535, and $321,039, respectively. At December 31, 2002, future minimum
rental payments under operating leases are as follows:

            2003............                363,358
            2004............                362,568
            2005............                362,585
            2006............                362,586
            2007.........                   319,710
            2008 and thereafter....       1,167,977
                                        -----------
                                        $ 2,938,784
                                        ===========

Revenue Interest Obligation (see Note 6)

Shareholders Equity - Dividends and Deemed Dividends on Series A Preferred Stock
(see Note 9)

                                     F - 22

<PAGE>

13.  QUARTERLY FINANCIAL DATA (UNAUDITED):

<TABLE>
<CAPTION>
                                                                   For the Three Months Ended
                                      --------------------------------------------------------------------------------------
                                         March 31           June 30        September 30       December 31         Total
                                      --------------    --------------    --------------     -------------    --------------
<S>                                   <C>               <C>               <C>                <C>              <C>
2002:
Product sales                         $    1,838,389    $    2,692,513    $    2,811,727     $   3,036,576    $   10,379,205
Gross profit                               1,504,428         2,324,538         2,438,134         2,533,340         8,800,440
Total operating expenses                   4,815,086         5,193,713         5,096,508         5,070,778        20,176,085

Net loss                                  (3,343,354)       (2,961,366)       (2,758,836)       (2,606,388)      (11,669,944)
Dividends paid on Preferred Stock                 --                --           151,890           271,728           423,618
Deemed dividends on Preferred Stock               --                --         3,604,962         4,593,878         8,198,840
Net loss applicable to Common
 Shareholders                             (3,343,354)       (2,961,366)       (6,515,688)       (7,471,994)      (20,292,402)

Net loss per common share,
 basic and diluted                    $         (.16)   $         (.15)   $         (.33)    $        (.36)   $        (1.00)
</TABLE>

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

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 applicable to Common
 Shareholders                             (3,290,797)       (3,598,486)       (3,456,448)       (3,444,688)      (13,790,419)

Net loss per common share,
 basic and diluted                    $         (.23)   $         (.22)   $         (.20)    $        (.18)   $         (.82)
</TABLE>

                                     F - 23