<PAGE>
 
                                   FORM 10-K
                                        
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
                                        

  For the Fiscal Year Ended December 31, 1998 Commission file number 0-28492
                            -----------------                               

                           INNOVASIVE DEVICES, INC.
--------------------------------------------------------------------------------
            (Exact name of registrant as specified in its charter)


            Massachusetts                                04-3132641
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  (State or other jurisdiction of                     (I.R.S. Employer
  incorporation or organization)                     Identification No.)

                   734 Forest Street,  Marlborough MA  01752
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                   (Address of principal executive offices)

        Registrant's telephone number, including area code  508/460-8229
                                                            ------------

                                      N/A
--------------------------------------------------------------------------------
   Former name, former address and former fiscal year, if changed since last
                                    report.


Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK $.0001
                                                            PAR VALUE

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 definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [  ]

The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing price of the Common Stock on March 24, 1998,
on the NASDAQ Stock Market, was approximately $ 20,520,565. Shares of Common
Stock held by each officer and director and by each person who owns 5% or more
of the outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.

As of March 24, 1999 the Registrant had 9,207,249 shares of Common Stock
outstanding.
<PAGE>
 
Part I

Item 1.  Business


General

The Company designs, develops, manufactures and markets proprietary tissue
repair systems which facilitate the repair of soft tissue injuries.  The
Company's tissue repair systems are designed to be used in either open surgical
or minimally invasive arthroscopic procedures.  Performing repairs
arthroscopically offers several benefits, including reduced patient trauma and
shorter rehabilitation times, resulting in a faster return to full physical
activity.  The Company currently markets a broad-based product line within five
product platforms: suture fasteners, suturing systems, cartilage repair,
anterior cruciate ligament ("ACL") reconstruction and meniscal repair products.
These product platforms have been developed to drive the emerging growth trends
in the sports medicine segment of the orthopaedics market: the movement away
from metallic implants in and around the joints and the development of
definitive soft tissue repairs to replace existing palliative treatments.

The Company competes in the soft tissue repair segment of the sports
medicine/arthroscopic surgery market.  The Company markets its products and
related instruments principally to sports medicine orthopaedic surgeons who
treat and repair soft tissues, within and around joints, which have been damaged
by traumatic injury or degenerative disease.

The Company is focusing its efforts on this market primarily because of two
factors: the projected growth of the segment and the potential for improvement
over conventional clinical methods and products.

The Company's products are based on unique and proprietary technologies. Based
on its existing designs, the Company is developing and currently testing next
generation products using bioabsorbable composites, which degrade and absorb
into surrounding tissue, and collagen-based biomaterial composites, which
remodel into surrounding tissue.  In addition, the Company is pursuing
opportunities to apply its core technologies outside of orthopaedics.

                                       2
<PAGE>
 
Principal Products and Applications

The Company currently markets proprietary devices and instruments encompassing
five product platforms: Suture Fasteners, Suture Systems, Cartilage Repair
Systems, Anterior Cruciate Ligament ("ACL") Repair Systems and Meniscal Repair
Systems.  All of the Company's current products have received 510(K) clearance
or have been exempted by the FDA from the 510(K) clearance process.  The
following chart sets forth the product release date, current applications and
features and benefits of the Company's principal products:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                             Initial                  Current
          Product                          Release Date             Applications                Features and Benefits
-----------------------------------------------------------------------------------------------------------------------------------
                                                         Suture Fasteners
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>                 <C>                              <C> 
ROC EZ(TM) Suture Fastener Implants        June 1997            Shoulder, knee, foot, ankle,    .  primary fastener for hard bone
                                                                bladder neck suspension         .  all polymer design
                                                                                                .  revisable
                                                                                                .  available for open and 
                                                                                                   arthroscopic repair
-----------------------------------------------------------------------------------------------------------------------------------
ROC XS(TM) Suture Fastener Implants        May 1996             Shoulder, bladder neck          .  primary fastener for soft bone
                                                                suspension                      .  all polymer design
----------------------------------------------------------------------------------------------------------------------------------- 
MiniROC(TM) Suture Fastener Implants       April 1996           Shoulder, hand and wrist        .  primary fastener for small bones
                                                                                                .  all polymer design
                                                                                                .  revisable
                                                                                                .  5mm fastener length
----------------------------------------------------------------------------------------------------------------------------------- 
Bioabsorbable BioROC EZ(TM)                April 1998           Shoulder, elbow, knee,          .  L-PLA bioabsorbable polymer
    Fastener Implants                                           foot, ankle                     .  revisable
                                                                                                .  available for open and 
                                                                                                   arthroscopic repair 
-----------------------------------------------------------------------------------------------------------------------------------
                                                          Suture Systems
---------------------------------------------------------------------------------------------------------------------------------
Cuff Link(TM)  Bone Tunnel                 July 1997            Rotator Cuff                    .  prevents suture migration though
   Augmentation Device                                                                             bone following rotator 
                                                                                                   cuff repair
                                                                                                .  protects the suture/bone
                                                                                                   interface when using
                                                                                                   transosseous tunnels
-----------------------------------------------------------------------------------------------------------------------------------
Ideal (TM) Suture Grasper                  January 1995         Open and arthroscopic           .  15, 30, 45 and 60 degree angles
                                                                knot tying                      .  athroscopically sutures tissue
                                                                                                   without needles
----------------------------------------------------------------------------------------------------------------------------------- 
Y-Knot (TM) Arthroscopic Knot              April 1998           Open and arthroscopic           .  reproducible security of 
        Replacement                                             knot tying                         traditional knots eliminates
                                                                                                   complexity of tying arthroscopic
                                                                                                   knots
-----------------------------------------------------------------------------------------------------------------------------------
Cuff Guard(TM) Expanded Body  Suture       April 1998           Rotator Cuff                    .  expanded body suture matches 
                                                                                                   holding strength of multiple
                                                                                                   stitch techniques
----------------------------------------------------------------------------------------------------------------------------------- 
                                                     Cartilage Repair Systems
-----------------------------------------------------------------------------------------------------------------------------------
COR(TM) System                             September 1996       Grafting of bone plugs          .  cutter allows for precise
                                                                in the knee                        cutting of bone plugs
                                                                                                .  bone plugs are cleanly
                                                                                                   transferred to donor site
                                                                                                .  4, 6 and 8mm cutter diameters
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE> 

                                       3
<PAGE>
 
Principal Products and Applications (continued)


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                             Initial                  Current
          Product                          Release Date             Applications                Features and Benefits
-----------------------------------------------------------------------------------------------------------------------------------
                                                        ACL Repair Systems
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>                   <C>                            <C> 
Linx HT                                    November 1997        ACL soft tissue graft femoral   .  links hamstring directly to bone
                                                                fixation                        .  provides permanent biocompatible 

                                                                                                   fixation
                                                                                                .  strong fixation using 
                                                                                                   conventional technique
----------------------------------------------------------------------------------------------------------------------------------- 
Cannulated Interference Screw System       August 1997          ACL bone-tendon-bone fixation   .  design minimized tissue trauma
                                                                                                .  locking thread secures bone
                                                                                                   block fixation
----------------------------------------------------------------------------------------------------------------------------------- 
GeoFit(TM) Screw and Washer System         October 1997         ACL soft tissue graft femoral   .  low profile screws and washers
                                                                and tibial fixation                minimize tissue irritation
                                                                                                .  washers shaped to conform to
                                                                                                   bone contours
-----------------------------------------------------------------------------------------------------------------------------------
Transverse Fixation System                 January 1998         ACL bone-tendon-bone and        .  rigid graft fixation
                                                                soft tissue graft femoral       .  simplifies femoral graft
                                                                fixation                           insertion and passage  
-----------------------------------------------------------------------------------------------------------------------------------
General ACL Instruments                    March 1998           ACL bone-tendon-bone and        .  complete systematic approach
                                                                soft tissue graft femoral and      to endoscopic ACL
                                                                tibial fixation                    reconstruction
-----------------------------------------------------------------------------------------------------------------------------------
                                                      Meniscal Repair Systems
---------------------------------------------------------------------------------------------------------------------------------
Clearfix(TM) Meniscal Screw                October 1998         Repair posterior longitudinal   .  headless, to preclude abrasion
                                                                meniscus tears                  .  may be repositioned for optimal
                                                                                                   purchase
                                                                                                .  molded PLA resists splintering
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The Company also markets instrumentation used in the surgical implementation of
the products listed above.

The Company's line of suture fasteners was expanded in March 1998 with the
release of the BioROC, a bioabsorbable suture fastener which degrades and
absorbs into the surrounding bone and tissue after the repaired tissue has
sufficiently healed back to the bone.

Two new product lines were introduced within the suturing systems product line
in 1998: the Y-Knot, a device used in place of traditional knot configurations
when securing soft tissue to bone and the Cuff Guard, a suture with an expanded
surface area.

The Company introduced two new ACL reconstruction product lines in 1998: the
Transverse Fixation System, an ACL repair system which provides femoral fixation
of hamstring tendon grafts and a general ACL Repair system used in both patellar
tendon and hamstring tendon ACL reconstruction procedures.

In October 1998, the Company announced the commercial release of its Clearfix
Meniscal Screw, a bioabsorbable device used to repair traumatic tears within the
meniscus of the knee through a minimally invasive arthroscopic approach.

                                       4
<PAGE>
 
Product Development

The Company has new products in various stages of development designed to
address a variety of clinical needs. The Company has been primarily developing
products in five market platforms: Suture Fasteners, Suture Systems, Anterior
Cruciate Ligament Repair Systems, Cartilage Repair Systems and Meniscal Repair
Systems. The Company utilizes a wide variety of materials to address the
mechanical requirement of the surgical repair in its product development
process. These materials include polymer, absorbable, biologic and metallic
formulations. The Company seeks regulatory clearance to market its products
throughout the world.

The Company's objective is to continue to develop innovative products for the
sports medicine/arthroscopy market and to leverage its core proprietary
technology in other markets.  The Company's research and development team
currently consists of eight engineers with substantial design experience in the
field of orthopaedics and arthroscopy.  During the fiscal year ended December
31, 1998, 1997 and 1996 the Company incurred expenses of $4.3 million, $4.0
million and $2.7 million, respectively, in connection with its research and
development efforts.

The Company's research and development team is continually engaged in assessing
new tissue repair device technologies and techniques which are applicable to the
Company's business strategy.  The research and development engineers spend a
significant amount of time with surgeon advisors and members of the Company's
Medical Advisory Board in evaluating new product ideas.  The Company has
collaborative arrangements with university-based research centers for pre-
clinical design testing.  In the future, the Company's research and development
efforts may include the identification of new technologies developed by others
and the acquisition or licensing of new technologies and product lines.

Sales and Marketing

The Company's sales and marketing strategy is to focus its efforts on
arthroscopic/sports medicine surgeons through a combination of direct sales
calls, clinical workshops and presentations to medical arthroscopic surgeons and
sports medicine specialists.  The Company's clinical sales agents and marketing
personnel meet with surgeons to conduct product demonstrations, attend surgical
procedures and provide training.  Sales and marketing personnel also attend
numerous domestic and foreign medical conventions each year where they exhibit
and demonstrate the Company's products.

The Company markets its products to surgeons in the United States through a
network of twenty-six clinical employee sales representatives, 126 independent
sales agents and five regional sales managers.  In addition to its field sales
force, as of March 24, 1999 the Company employed a staff of eleven corporate
marketing, sales and customer service support staff employees.  This staff
manages clinical training workshops, sales management, print and video
promotion, sales data analysis, convention management and international
marketing.  The Company ships to and invoices its hospital customers directly in
the US.

The Company markets its products internationally through nineteen established
distributors of orthopaedic medical devices.  The Company's products are sold
directly to stocking distributors who sell the products to hospitals and
clinics.  For the year ended December 31, 1998, international sales accounted
for 17% of net sales.

The Company also works with a Medical Advisory Board (the "MAB") of six surgeons
and a Clinical Advisory Group (the "CAG") of nineteen surgeons located across
the United States.  The members of the MAB and CAG are opinion leaders in the
field of arthroscopy and sports medicine and are affiliated with professional
athletic teams, collegiate athletic departments and major orthopaedic hospitals.
The Company relies on the MAB and CAG to conduct workshops at which new surgeons
train on the use of the Company's products,

                                       5
<PAGE>
 
evaluate products clinically prior to their general market release, present the
Company's products at conferences, assist in creating training videos and advise
the Company on new surgical and product techniques.

Manufacturing and Quality Control

The manufacture of the Company's devices and instruments consists of inspection,
assembly, testing, packaging and sterilization of components that have been
molded, machined or manufactured by the Company or to the Company's
specifications by outside contractors. Samples of sterilized products are sent
to a certified laboratory to validate that sterilization procedures have been
adequately performed.  After this validation, the products are shipped to
customers.  The Company maintains a high level of quality control and inspects
each lot of components to ensure that they comply with the Company's exacting
specifications.  Most purchased components are available from more than one
vendor.  For certain components, there are relatively few alternative sources of
supply and establishment of additional or replacement suppliers for such
components cannot be accomplished quickly.  Many components are injection molded
using Company owned molds.  Many polymer components have only one mold and
replacement of the molds can take 12 to 16 weeks.  Bioabsorbable materials used
in products are likely to be available from only a single source.  Any supply
interruption from single source vendors could have a material adverse effect on
the Company's ability to supply products.  There is risk that certain suppliers
may terminate sales of certain materials to companies that manufacture medical
devices in an attempt to limit their potential product liability exposure.  If
the materials which are used to manufacture the Company's polymer and absorbable
based devices become unavailable, the Company would be required to identify a
new polymer and absorbable materials for the devices and certify the quality and
suitability of the new material.  In addition, a new 510(k) clearance would have
to be obtained to market products manufactured from the new materials.  This
process could take a substantial period of time and there is no assurance that
the Company would be able to identify, certify or obtain clearance for new
polymer or absorbable based fasteners. The Company operates manufacturing
facilities in Marlborough, MA and Logan UT.

The Company abides by the FDA's Good Manufacturing Practices and the
requirements of foreign regulatory agencies.  The Company's Marlborough, MA
manufacturing facility received ISO 9001 registration and EN 46001 certification
in October 1997.

Relationship with Cohesion Technologies, Inc. (formerly Collagen Corporation)

In October 1995, the Company entered into Research & Development, Distribution
and Supply agreements (the "Agreements") with Collagen Corporation ("Collagen").
In October 1997, Collagen announced that it would proceed to separate its
Aesthetic Technologies Group and its Collagen Technologies Group ("CTG") into
two independent, publicly traded companies.  Cohesion Technologies, Inc.
("Cohesion") was organized as a Delaware corporation and wholly owned subsidiary
of Collagen in June 1997.  Effective January 1, 1998, Collagen contributed
certain research and development programs of CTG to Cohesion including its
development program with Innovasive.  Collagen also contributed various equity
investments to Cohesion including all of its holdings in Innovasive Devices,
Inc.  In connection with the separation, Collagen distributed as a dividend to
its stockholders on August 18,1998, one share of Cohesion common stock for each
share of Collagen common stock outstanding.  As a result of this transaction,
Cohesion Technologies holds 843,936 shares, or approximately 9.2% of the common
stock of Innovasive Devices, Inc.  Pursuant to an agreement among the Company
and certain of its stockholders, Cohesion Technologies has the right to
designate one member of the Company's Board of Directors so long as it holds at
least five percent of the Company's outstanding Common Stock on a fully-diluted
basis.  David Foster, Chief Executive Officer of Cohesion Technologies,
currently serves as Cohesion Technologies' designee on the Company's Board of
Directors.

                                       6
<PAGE>
 
Pursuant to the agreements assigned to Cohesion Technologies, the Company and
Cohesion have cross-licensed their respective technologies relating to collagen
materials and medical devices. Under the Research and Development Agreement, the
Company and Cohesion have agreed to undertake the joint development of suture
fasteners made from collagen-based materials, to be funded by the Company up to
certain amounts as specified in an agreed project plan.  The Research and
Development Agreement contemplates subsequent development of collagen-based
tissue fixation devices if the parties can agree on a project plan and budget
for their development.  Any technology jointly developed pursuant to a project
plan is to be owned jointly by the parties.  Until October 17, 2000, the parties
have agreed to work exclusively together with respect to the development of
products covered by the agreement.  With respect to products for which a project
plan has been approved by the parties prior to October 17, 2000 and for which
there is funding through completion of development, Cohesion and the Company
have agreed not to commence the development of competing products until after
the second anniversary of the first commercial sale of such products.

The Manufacturing and Supply Agreement provides that Cohesion will be the
exclusive supplier to the Company for products manufactured from collagen and
developed under the Research and Development Agreement.  If Cohesion is unable
to supply such products, the Company is entitled to develop a second source of
supply.  The Manufacturing and Supply Agreement remains in effect with respect
to a product until either the Distribution Agreement between Cohesion and the
Company relating to such product terminates, expires or until the Manufacturing
Agreement is terminated by reason of default or as the result of the bankruptcy
or insolvency of a contracting party.

The Distribution Agreement provides that Cohesion will have exclusive
distribution rights to the Company's 3.5mm, 2.8mm and 1.9mm ROC suture fasteners
and collagen-based products developed under the Research and Development
Agreement which are labeled for facial plastic surgery or dermatology
applications.  Under the agreement, the Company will have exclusive distribution
rights to collagen-based products developed under the Research and Development
Agreement which are labeled for orthopaedic applications.  Each party must sell
a minimum number of units of products in its exclusive field to maintain
exclusivity; otherwise, the other party gains co-exclusive rights to market and
distribute products in that field.  Under the agreement, a distributing party
will purchase products from a manufacturing party at various discounts from the
actual average selling price of the products, and Cohesion is required to pay
royalties to the Company with respect to Cohesion's net sales of products for
which development was funded by the Company pursuant to the Research and
Development Agreement.

Patents and Proprietary Technology

The Company believes that a key element of its competitive advantage depends on
its ability to develop and maintain proprietary aspects of its technology.  To
this end, the Company files patent applications to protect technology,
inventions and improvements that it believes are significant to the growth of
its business.  As of March 24, 1999 the Company had 33 issued patents and more
than 22 U.S. and foreign patent applications pending.  As of March 24, 1999 the
Company had rights to license products under 26 issued patents and patents
pending.  These issued patents and pending patent applications cover its radial
osteo compression (ROC) technology, it's COR cartilage repair technology,
meniscal repair systems, suture systems, ACL repair systems and various surgical
tools, systems and methods.

On October 28, 1998, Bionx Implants, Inc., Bionx Implants, Oy. and Dr. Saul N.
Schreiber ("Bionx") filed suit against the Company in the United States District
Court for the District of Massachusetts alleging that the Company's Clearfix(TM)
Meniscal Dart product infringed a Bionx patent.  On March 24, 1999, Judge
Gertner of that Court denied Bionx's motion for a preliminary injunction which
would have precluded Innovasive from manufacturing, using or selling the
Meniscal Dart on the grounds that Bionx was unlikely to succeed on the merits of
its infringement claim.  The Company does not believe that the Meniscal Dart
infringes the Bionx patent and intends to continue to manufacture and sell the
Meniscal Dart product and to vigorously defend its 

                                       7
<PAGE>
 
position with respect to the Bionx claim. However, there can be no assurance
that current and potential competitors and other third parties have not filed or
in the future will not file applications for, or have not received or in the
future will not receive, patents and will not obtain additional proprietary
rights relating to materials or processes used or proposed to be used by the
Company. Accordingly, there can be no assurance that the Company's products have
not, do not or will not infringe any patents or other proprietary rights of
third parties.

The Company typically requires its employees, consultants and advisors to
execute confidentiality agreements in connection with their employment,
consulting or advisory relationships with the Company.  The Company also
typically requires its employees, consultants and certain advisors to agree to
disclose and assign to the Company all inventions conceived of on Company time,
using Company property or which relate to the Company's business.  There can be
no assurance, however, that the foregoing agreements will effectively prevent
disclosure of the Company's confidential information or provide meaningful
protection for the Company's confidential information if there is unauthorized
use or disclosure.  Furthermore, no assurance can be given that competitors will
not independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's proprietary technology.

Competition

The Company faces strong competition in the marketplace from soft tissue
fixation devices for knee and shoulder applications sold by large corporations
with orthopaedic divisions.  Mitek Surgical Products, Inc. ("Mitek"), a division
of Johnson & Johnson, the Zimmer division of Bristol-Meyers Squibb Company, the
Linvatec division of ConMed Inc., Smith & Nephew Endoscopy, ("Dyonics" and
"Acufex") subsidiaries of Smith & Nephew, Inc., Arthrotek Inc., a division of
Biomet, Inc. and Arthrex, Inc. all compete in the Company's market with metal
suture anchors and devices for arthroscopic soft tissue reconstruction of the
knee. These competitors have significantly greater financial, manufacturing,
marketing, distribution and technical resources than the Company.  Mitek, which
sells metal barbed anchors and bioabsorbable bone anchors, currently has the
largest share of the suture fastener market.  The Company also faces competition
from smaller companies including Bionx, Inc. and Orthopaedic Biosystems Ltd.,
Inc.

The Company believes that its suture fastener products compete favorably against
its competition based on a number of factors, including the Company's
proprietary radial osteo compression design which permits excellent holding
strength in both large and small bones and can be modeled from plastic,
bioabsorbable polymers and biomaterials; the revisability of the Company's
fasteners; the availability of a proprietary arthroscopic delivery system
without the need to tie suture knots for its products; and the small profile of
the Company's products when inserted into bone, which permits its fasteners to
be deployed in the small bones of the wrist, hand, ankle and foot.  Furthermore,
the Company believes that its products compete favorably against its competition
in soft tissue reconstruction of the knee based on a number of factors,
including the Company's proprietary ACL ligament fastener devices and meniscal
repair devices for soft tissue reconstruction which can be modeled from plastic
and bioabsorbable polymers.  However, there can be no assurance that the
Company's competitors will not succeed in developing products and technologies
that are more effective or less costly than those that have been or may be
developed by the Company.

Government Regulation

Clinical testing, manufacture and sale of the Company's products are subject to
regulation by the FDA and corresponding state and foreign regulatory agencies.
Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations
promulgated thereunder, the FDA regulates the clinical testing, design,
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 pre-market
clearance or pre-market approval for

                                       8
<PAGE>
 
devices, withdrawal of marketing approvals and criminal prosecution. The FDA
also has the authority to request repair, replacement or refund of the cost of
any device manufactured or distributed by the Company.

In the United States, medical devices are classified into one of three classes
(i.e., Class I, II, or III) on the basis of the controls deemed necessary by the
FDA to reasonably ensure their safety and effectiveness.  Class I devices are
generally exempt from the premarket notification (510(K)) and premarket approval
regulations. Class II devices are subject to general and special controls (e.g.,
performance standards, postmarket surveillance, patient registries and FDA
guidelines).  Generally, Class III devices are those which must receive
premarket approval by the FDA to ensure their safety and effectiveness (e.g.,
life-sustaining, life-supporting and implantable devices, or new devices which
have been found not to be substantially equivalent to legally marketed devices).

Before a new device can be introduced in the market, the Company must generally
obtain FDA clearance through a 510(k) notification or approval of a Premarket
Approval ("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 Class II medical device or a Class III medical
device for which the FDA has not called for PMAs.  The FDA recently has been
requiring more rigorous demonstration of substantial equivalence than in the
past, including in some cases requiring submission of clinical trial data.  The
FDA may determine that the proposed device is not substantially equivalent to a
predicate device or that additional information is needed before a substantial
equivalence determination can be made.  It generally takes from four to twelve
months from submission to obtain 510(k) premarket clearance, however the process
may take longer.  The FDA may determine that a proposed device is not
substantially equivalent to a legally marketed device or that additional
information is needed before a substantial equivalence determination can be
made.  A "not substantially equivalent" determination or a request for
additional information could prevent or delay the market introduction of new
products that fall into this category and could have a material adverse effect
on the Company's business, financial condition or results of operations.  For
any of the Company's devices that are cleared through the 510(k) process,
modifications or enhancements that could significantly affect the safety or
effectiveness of the device or that constitute a major change to the intended
use of the device will require a new 510(k) submission.

A PMA application must be filed if a proposed device is not substantially
equivalent to a legally marketed Class I or Class II device, or if it is a Class
III device for which the FDA has called for PMAs.  A PMA application must be
supported by valid scientific evidence which typically includes extensive
information (including relevant bench tests, laboratory and animal studies and
clinical trial data) to demonstrate the safety and effectiveness of the device.
The PMA application also must contain a complete description of the device and
its components; a detailed description of the methods, facilities and controls
used to manufacture the device; and the proposed labeling, advertising
literature and training materials (if any).  The PMA process can be expensive,
uncertain and lengthy.  A number of devices for which FDA approval has been
sought by other companies have never been approved for marketing.  Modifications
to a device that is the subject of an approved PMA, its labeling, or
manufacturing process may require approval by the FDA or PMA supplements or new
PMAs.

If human clinical trials of a device are required and the device presents a
"significant risk," the sponsor of the trial (usually the manufacturer or the
distributor of the device) will have to file an Investigational Device Exemption
("IDE") application prior to commencing human clinical trials. The IDE
application must be supported by data, typically including the results of animal
and laboratory testing. If the IDE application is approved by the FDA and one or
more appropriate Institutional Review Boards ("IRBs"), human clinical trials may
begin at a specific number of investigational sites with a specific number of
patients, as approved by the FDA. If the device presents a "nonsignificant risk"
to the patient, a sponsor may begin the clinical trial after obtaining approval
for the study by one or more appropriate IRBs without the need for FDA approval.
Sponsors of clinical trials are permitted to sell investigational devices
distributed in the course of the study provided that compensation does not
exceed recovery of the costs of manufacture, research, development and handling.
An IDE supplement must

                                       9
<PAGE>
 
be submitted to and approved by the FDA before a sponsor or investigator may
make a change to the investigational plan that may affect its scientific
soundness or the rights, safety or welfare of human subjects.

To date, all of the Company's products have received 510(k) clearance or have
been exempted by the FDA from the 510(k) clearance process.  The Company has
made modifications to its devices which the Company believes do not require the
submission of new 510(k) notices.  There can be no assurance, however, that the
FDA would agree with any of the Company's determinations not to submit a new
510(k) notice for any device modification, or would not require the Company to
submit a new 510(k) notice for any of the changes made to the device.  If the
FDA requires the Company to submit a new 510(k) notice for any device
modification, the Company may be prohibited from marketing the modified device
until the 510(k) notice is cleared by the FDA.  There can be no assurance that
any proposed modification will be cleared on a timely basis, if at all.

There can be no assurance the FDA will not determine that the Company's future
products must adhere to the more costly, lengthy, and uncertain PMA approval
process.  There also can be no assurance that the Company will obtain FDA
clearance or approval for such future products on a timely basis, if at all, or
that the FDA will not impose limitations on the intended use of such products as
a condition of clearance or approval.  Any delay in receipt of, failure to
obtain, or limitations on clearance or approval could have a material adverse
effect on the Company's business, financial condition or results of operation.

Any devices manufactured or distributed by the Company pursuant to FDA
clearances or approvals are subject to pervasive and continuing regulation by
the FDA and certain state agencies.  Manufacturers of medical devices for
marketing in the United States are required to adhere to applicable regulations
setting forth detailed Good Manufacturing Practices ("GMP") requirements, which
include design, testing, control and documentation requirements.  Manufacturers
must also comply with Medical Devices Reporting ("MDR") requirements that a firm
reports to the FDA any incident in which its product may have caused or
contributed to a death or serious injury, or in which its product malfunctioned
and, if the malfunction were to recur, it would be likely to cause or contribute
to a death or serious injury.  Labeling and promotional activities are subject
to scrutiny by the FDA and, in certain circumstances, by the Federal Trade
Commission.  Current FDA enforcement policy prohibits the marketing of approved
medical devices for unapproved uses.

The Company is also subject to regulation in each of the foreign countries in
which it sells its products in the areas of product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements.  Many of the regulations applicable to the
Company's products in these countries are similar to those of the FDA.  The
national health organization of some countries require the Company's products to
be qualified before they can be marketed in those countries.  The Company relies
on its international distributors to comply with these requirements.  To date,
the Company has not experienced significant difficulty in complying with these
regulations.

The Company has implemented policies and procedures which has allowed the
Company to receive ISO 9001 registration and EN 46001 certification. These
standards for quality systems in manufacturing have been developed to ensure
that companies know, on a worldwide basis, the standards of quality to which
they will be held. The European Union has promulgated rules which require that
medical products receive the CE mark before entering the European market. The CE
mark is an international symbol of quality and compliance with applicable
European medical device directives. As of March 24, 1999 the Company has
received CE Mark approval for substantially all of its principal products. There
can be no assurance that the Company will be successful in meeting the
continuing certification requirements for these products. There can also be no
assurance that the Company will be successful in meeting the certification
requirements for future product introductions.

The Company is subject to numerous federal, state and local laws relating to
such matters as safe working conditions and environmental protection.  There can
be no assurance that the Company will not be required to incur significant costs
to comply with such laws and regulations in the future or that such laws or
regulations 

                                       10
<PAGE>
 
will not have a material adverse effect on the Company's business, financial
condition or results of operations.

Product Liability and Insurance

Medical device companies are subject to an inherent risk of product liability
and other liability claims in the event that the use of their products results
in personal injury.  The Company maintains liability insurance coverage in the
amounts deemed appropriate by management based upon the nature and risks of its
business in general and its actual experience to date.  There can be no
assurance that a future claim will not exceed insurance coverage or that such
coverage will continue to be available.  In addition, any substantial increase
in the cost of such insurance could have a material adverse effect on the
Company's business, financial condition and results of operations.

Employees

As of February 28, 1999, the Company has 131 employees, 25 of whom were engaged
in research and development and regulatory, 50 in manufacturing and quality
assurance and 56 in marketing, sales and administrative positions.  The Company
also contracts with outside consultants.  None of the Company's employees is
covered by a collective bargaining agreement.  The Company believes that it
maintains good relations with its employees.

                                       11
<PAGE>
 
Item 2.  Properties

As of December 31, 1998, the Company leased the following facilities:

<TABLE>
<CAPTION>
                                                                                           Appx. Square 
               Location                                  Type of Facility                    Footage
<S>                                     <C>                                              <C>
Marlborough, MA......................    Executive Offices, Research and Development,         28,000
                                         Manufacturing, Warehousing and Distribution
Attleboro, MA........................    Research and Development                              2,500
Logan, UT............................    Research and Development , Manufacturing             12,500
 
</TABLE>

Item 3.  Legal Proceedings

On October 28, 1998, Bionx Implants, Inc., Bionx Implants, Oy. and Dr. Saul N.
Schreiber ("Bionx") filed suit against the Company in the United States District
Court for the District of Massachusetts alleging that the Company's Clearfix(TM)
Meniscal Dart product infringed a Bionx patent.  On March 24, 1999, Judge
Gertner of that Court denied Bionx's motion for a preliminary injunction which
would have precluded Innovasive from manufacturing, using or selling the
Meniscal Dart on the grounds that Bionx was unlikely to succeed on the merits of
its infringement claim.  The Bionx claim does not allege any infringement with
respect to the Company's Meniscal Screw, which was commercially launched in
October 1998.  The Company believes that the Bionx claim is without merit and
intends to continue to defend itself vigorously.

Item 4.  Submission of Matters to a Vote of Security Holders

None.

                                       12
<PAGE>
 
Part II

Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters

The Company's common stock is traded in the over-the-counter market on The
NASDAQ National Market under the symbol IDEA.  The table below lists the
quarterly range of the high and low per share closing bids of the Company's
Common Stock on the NASDAQ National Market during the periods indicated.

<TABLE>
<CAPTION>
FISCAL PERIOD                    HIGH           LOW
-------------                    ----           ---       
<S>                             <C>          <C> 
 First Quarter - 1998            $11.00        $8.00
 Second Quarter - 1998           $10.63        $8.63
 Third Quarter - 1998            $ 9.50        $5.25
 Fourth Quarter - 1998           $ 5.00        $2.38
</TABLE>

The Company has never declared or paid any cash dividends on its Common Stock.
The Company currently intends to retain all future earnings for the operation
and expansion of its business and therefore does not anticipate paying any cash
dividends in the foreseeable future.

On March 25, 1999 there were 98 stockholders of record of the Company's common
stock.

                                       13
<PAGE>
 
Item 6.  Selected Financial Data

<TABLE>
<CAPTION>
                                                                         Years Ended December 31,
                                             ------------------------------------------------------------------------------------
                                                  1998             1997             1996             1995             1994
                                             ---------------  ---------------  ---------------  ---------------  ---------------
<S>                                            <C>              <C>              <C>              <C>              <C>
                                                                   (in thousands, except per share data)
Statement of Operations Data:
Net sales                                          $ 11,911         $  7,754          $ 4,353          $ 1,234          $   244
Cost of sales                                         3,339            2,232            1,611            1,000              465
                                                   --------         --------          -------          -------          -------
 
Gross profit (loss)                                   8,572            5,522            2,742              234             (221)
 
Selling, general and administrative
     expenses                                        11,294            8,407            4,922            2,435            1,533
Purchased in-process research and
Development (1)                                           -           13,370                -                -                -
Research and development
     expenses (2)                                     4,290            3,952            2,667            1,597            1,172
                                                   --------         --------          -------          -------          -------
 
Loss from operations                                ( 7,012)         (20,207)          (4,847)          (3,798)          (2,926)
Interest income                                         513            1,053              785               64               34
                                                   --------         --------          -------          -------          -------
 
Net loss                                           $ (6,499)        $(19,154)         $(4,062)         $(3,734)         $(2,892)
                                                   ========         ========          =======          =======          =======
 
Basic and diluted net loss per share                 $(0.71)          $(2.33)          $(0.83)          $(2.06)          $(1.79)
                                                   ========         ========          =======          =======          =======
 
Shares used in computing basic and
    diluted net loss per share (3)                   9,179             8,225            4,911            1,811            1,621
                                                   ========         ========          =======          =======          =======
<CAPTION> 
                                                                                December 31,
                                                   ----------------------------------------------------------------------------
                                                     1998             1997              1996             1995             1994
                                                   --------         --------          -------          -------          -------
                                                                               (in thousands)
<S>                                              <C>              <C>             <C>                <C>             <C> 
Balance Sheet Data:
Cash and cash equivalents                          $  3,724         $  2,916          $12,825          $ 5,052          $ 2,051
Working capital                                       9,882           15,885           22,841            4,857            1,628
Total assets                                         16,059           21,520           25,363            6,399            3,099
Mandatorily redeemable convertible
     preferred stock                                      -                -                -           13,970            6,993
Stockholders' equity (deficit)                     $ 13,214         $ 19,197          $23,788          $(8,501)         $(4,759)
</TABLE>


(1)   See Note 2 of Notes to Financial Statements.
(2)   Includes research and development costs payable to a related party of $60
      in 1998, $428 in 1997 and $664 in 1996.
(3)   See Note 1 of Notes to Financial Statements.

                                       14
<PAGE>
 
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operation

               MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                      CONDITION AND RESULTS OF OPERATIONS

Overview

Since its inception in 1990, the Company has been primarily engaged in the
development, manufacture and marketing of proprietary devices and
instrumentation which facilitate the reattachment of soft tissue structures,
such as ligaments and tendons, to bones and other tissues. The Company has a
limited operating history and as of December 31, 1998 had an accumulated deficit
of $41.7 million.  These losses have resulted principally from expenses
associated to fund research and development, the establishment of its
manufacturing capabilities and the expansion of its marketing and sales
organization.  On June 27, 1997, the Company acquired substantially all of the
assets, including intellectual property related to orthopaedic medicine, and
assumed substantially all of the liabilities of MedicineLodge, Inc., a Delaware
corporation ("MLI") in exchange for 1,885,000 shares of the Company's common
stock.  MLI was a privately held designer, developer and manufacturer of
orthopaedic medical devices, particularly implantable systems and related
instrumentation used in minimally invasive arthroscopic procedures to repair
injuries to the knee.  A portion of the purchase price was allocated to in-
process research and development, resulting in a charge to the Company's
operations of $13.4 million.

Although the Company's sales were principally derived from the sale of its
family of shoulder related products, the Company now markets five product
platforms: suture anchors, suturing systems, cartilage repair products, anterior
cruciate ligament ("ACL") reconstruction products and its newly introduced
meniscal repair products.   Within these product platforms, the Company released
six new product lines in 1998.  Included in these six releases were two product
lines that represent the Company's first offerings using bioabsorbable
materials, the BioROC and the Clearfix Meniscal Screw.

The Company's line of suture anchors was expanded in March 1998 with the release
of the BioROC, a bioabsorbable suture anchor which degrades and absorbs into the
surrounding bone and tissue after the repaired tissue has sufficiently healed
back to the bone. Two new product lines were introduced within the suturing
systems product line: the Y-Knot, a device used in place of traditional knot
configurations when securing soft tissue to bone and the Cuff Guard, a suture
with an expanded surface area. The Company introduced two new ACL reconstruction
product lines in 1998: the Transverse Fixation System, an ACL repair system
which provides femoral fixation of hamstring tendon grafts and a general ACL
Repair System used in both patellar tendon and hamstring tendon ACL
reconstruction procedures. In October 1998, the Company announced the commercial
release of its Clearfix Meniscal Screw, a bioabsorbable device used to repair
traumatic tears within the meniscus of the knee through a minimally invasive
arthroscopic approach.

The following information should be read in conjunction with the Financial
Statements and notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this Annual Report.

Any statements in this report expressing the beliefs and expectations of
management regarding the Company's future results and performance are forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995.  Such forward-looking statements are based on current
expectations that involve a number of risks and uncertainties.  The Company
wishes to caution readers not to place undue reliance on any such forward-
looking statements, which speak only as of the date made.  Such forward looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical results and those presently
anticipated or projected.  These risks include the receipt of regulatory
approvals, progress of product development programs, manufacturing of higher
volume product

                                       15
<PAGE>
 
requirements, clinical efficacy of and market demand for the products and the
establishment of an effective distribution channel. Certain of such risks and
uncertainties are described in Exhibit 99 of this Annual Report.

Results of Operations

Years Ended December 31, 1998 and 1997

Net sales increased to $11.9 million for the year ended December 31, 1998 from
$7.8 million for the year ended December 31, 1997. Sales of the Company's
shoulder related products increased to $8.0 million for the year ended December
31, 1998 from $5.9 million in the prior year.   Shoulder related products
include the Company's suture anchor and suturing system product lines.  Suture
anchor products increased in 1998 over the prior year primarily as a result of
incremental sales generated from the BioROC, released in the first quarter of
1998.  The BioROC is a bioabsorbable suture anchor which degrades and absorbs
into the surrounding bone and tissue after the repaired tissue has sufficiently
healed back to the bone. The Company also experienced increased sales in its
existing suture anchor offerings including its ROC EZ and ROC XS suture anchors.
The suture systems product platform experienced sales growth in 1998 with
increased sales contributions from the Suture Grasper, Cuff Link, Y-Knot and
Cuff Guard product lines.  Sales of knee related products increased to $3.7
million for the year ended December 31, 1998 from $1.7 million in the prior
year.  Knee related products include the Company's ACL repair, cartilage repair
and meniscal repair product platforms.  The Company's ACL product offerings were
primarily introduced in the fourth quarter of 1997 and the first quarter of
1998.   Significant contributors to ACL product sales in 1998 were: the Linx HT,
a product released in the fourth quarter of 1997 which facilitates femoral
fixation in ACL repair with the use of hamstring tendon grafts, the Geofit Screw
and Washer System, used in tibial fixation of hamstring tendon grafts and the
Transverse Fixation System, released in the first quarter of 1998 and also used
in femoral fixation of hamstring tendon grafts.   Sales of the Company's COR
system, used to repair osteochondral defects in the knee, also experienced sales
growth over the prior year.  In the fourth quarter of 1998, the Company
announced the commercial release of its Clearfix Meniscal Screw, a bioabsorbable
device used to repair traumatic tears within the meniscus of the knee through a
minimally invasive arthroscopic approach.   Sales of the meniscal product
commenced in the fourth quarter of 1998 and also contributed to the overall knee
related product growth as compared to the prior year.

Domestic sales increased to $9.9 million for the year ended December 31, 1998
from $6.6 million in the prior year.  This sales growth was attributable to an
increase in the unit sales and expansion of the Company's line of shoulder and
knee related product offerings and the expansion of the Company's direct sales
force and domestic distribution network.

International sales, which are denominated in US dollars, increased to $2.0
million for the year ended December 31, 1998 from $1.1 million in the prior
year.  This increase was primarily attributable to the expansion of the
Company's international distribution network as well as an increase in the unit
sales and expansion of the Company's line of shoulder and knee related product
offerings.  In the second quarter of 1998, the Company announced the appointment
of Protek GmbH, a division of Sulzer Orthopaedics, and Stryker Canada, Inc. as
distributors for the Company's products in Germany and Canada, respectively.

Gross profit increased to $8.6 million for the year ended December 31, 1998 from
$5.5 million in the prior year.  As a percentage of net sales, gross profit
increased to 72% for the year ended December 31, 1998 from 71% in the prior
year.  The increase in gross profit was primarily due to the increased improved
manufacturing efficiencies resulting from increased production volumes.

Selling, general and administrative expenses increased to $11.3 million for the
year ended December 31, 1998 from $8.4 million for the year ended December 31,
1997.  The increase resulted partially from higher commission expense on the
increased sales volume and the expansion of the domestic direct sales force and
external distribution network.  The Company also experienced increases in
clinical training costs of its direct

                                       16
<PAGE>
 
sales force and external distributors due to the volume of new products
introduced in 1998. Legal fees also increased over the prior year primarily as a
result of costs related to the Company's response to a patent infringement suit
filed against the Company by Bionx, Inc. Increased costs were also incurred in
the following areas: salary and travel, product sample expenses, product
advertising, depreciation and incremental administrative costs resulting from
the acquisition of MLI on June 27, 1997.

Research and development expenses increased to $4.3 million for the year ended
December 31, 1998 from $4.0 million for the year ended December 31, 1997.  The
increase was a result of incremental costs resulting from the acquisition of MLI
on June 27, 1997 as well as an increase in the non-cash compensation charge
related to the grant of stock options to the Company's Scientific Advisory
Board.  Offsetting this increase was a reduction in costs relating to a joint
product development project undertaken with Cohesion Technologies (as assigned
from Collagen Corporation).

As a result of the Company's transaction with MLI in the second quarter of 1997,
the Company incurred a non-recurring charge to operations of $13,370,000
representing the portion of the purchase price allocated to in-process research
and development.

Net interest income decreased to $513,000 for the year ended December 31, 1998
from $1.1 million for the year ended December 31, 1997 primarily as a result of
investment returns earned on lower average cash balances maintained during the
year.

As a result of the foregoing, the net loss decreased $6.5 million for the year
ended December 31, 1998 from $19.2 million for the year ended December 31, 1997.

Years Ended December 31, 1997 and 1996

Net sales increased to $7.8 million for the year ended December 31, 1997 from
$4.4 million for the year ended December 31, 1996.  Sales of shoulder related
products, including the Company's family of ROC suture fasteners, suture systems
and related surgical instrumentation increased to $5.9 million for the year
ended December 31, 1997 from $4.1 million in the prior year.  In June 1997, the
Company introduced the ROC EZ, an improved version of the original ROC fastener
used in hardbone applications, and the CuffLink, used to augment tunnels made in
the bone for rotator cuff repair procedures. Sales of the Company's knee related
products increased to $1.7 million for the year ended December 31, 1997 from
$0.3 million in the prior year.  The COR system, introduced in October 1996,
used to repair osteochondral defects in the knee, and the Linx HT, introduced in
December 1997, used to facilitate repair of the ACL, both contributed to the
increase in knee related products for the year ended December 31, 1997 over the
prior year.

Domestic sales increased to $6.6 million for the year ended December 31, 1997
from $3.2 million in the prior year.  The increase was attributable to an
increase in the unit sales and expansion of the Company's line of shoulder and
knee related product offerings and the expansion of the Company's direct sales
force and domestic distribution network.

International sales, which are denominated in US dollars, decreased to $1.1
million for the year ended December 31, 1997 from $1.2 million in the prior
year.  The decrease was primarily a result of a delay in the regulatory process
for the release of the ROC EZ in certain international markets and a transition
of an international distributor.

Gross profit increased to $5.5 million for the year ended December 31, 1997 from
$2.7 million in the prior year.  As a percentage of net sales, gross profit
increased to 71% for the year ended December 31, 1997 from 63% for the year
ended December 31, 1996.  The increase in gross profit was primarily due to the
increased sales of higher margin implants and the efficiencies resulting from
increased production volumes.

                                       17
<PAGE>
 
Selling, general and administrative expenses increased to $8.4 million for the
year ended December 31, 1997 from $4.9 million for the year ended December 31,
1996.  The increase resulted primarily from higher commission expense on the
increased sales volume and the expansion of the domestic direct sales force and
external distribution network.  The Company also experienced cost increases in
the following areas: salary and travel, product sample expenses, product
advertising, depreciation and incremental administrative costs resulting from
the acquisition of MLI on June 27, 1997.

Research and development expenses increased to $4.0 million for the year ended
December 31, 1997 from $2.7 million for the year ended December 31, 1996.  The
increase was primarily attributable to the following: research and development
costs incurred by MLI to support research projects in process at the time of the
acquisition, product development costs in support of the Company's meniscal
repair and bioabsorbable programs,  compensation related to the grant of stock
options and patent preparation and filing costs.

As a result of the Company's transaction with MLI, the Company incurred a charge
to operations of $13,370,000 representing the portion of the purchase price
allocated to in-process research and development.

Net interest income increased to $1.1 million for the year ended December 31,
1997 from $785,000 for the year ended December 31, 1996.  The primary reason for
the increase was due to investment returns earned on higher average cash
balances resulting from the proceeds of the initial public offering closed
during the second quarter of 1996.

As a result of the foregoing, the net loss increased to $19.2 million for the
year ended December 31, 1997 from $4.1 million for the year ended December 31,
1996.

Liquidity and Capital Resources

As of December 31, 1998, the Company had cash, cash equivalents and marketable
securities of $4.8 million as compared to a balance of $13.5 million on December
31, 1997.   Working capital decreased to $9.9 million from $15.9 million in
1997.

Cash used in the Company's operations increased to $7.8 million for the year
ended December 31, 1998 from $7.3 million in 1997.  The net loss in 1998
decreased to $6.5 million from $19.2 million in the prior year (which included a
$13.4 million non-cash charge for in-process research and development resulting
from the MLI transaction).  Accounts receivable increased to $2.2 million in
1998 from $1.6 million in 1997 as a result of increased sales volume.
Inventories increased to $5.6 million in 1998 from $2.9 million in 1997.  The
increase was primarily attributable to the expansion of the Company's product
lines and increased inventory requirements to support planned sales volumes.

Cash provided by investing activities totaled $8.4 million in 1998 resulting
from capital expenditures of $1.1 million and net redemptions of marketable
securities of $9.5 million.

Cash provided by financing activities totaled $162,000 in 1998 resulting
primarily from proceeds received from the issuance of common stock pursuant to
the Company's Employee Stock Purchase Plan.

On December 31, 1998, the Company entered into a working capital line of credit
with a bank, that provides the Company with a maximum borrowing availability of
$2.5 million, limited by certain receivable and inventory balances.  Borrowings
under this agreement bear interest at the prime rate. The line of credit expires
and all outstanding amounts thereunder are due December 31, 1999.  Under the
line of credit, the Company is obligated to comply with certain financial
covenants. There were no borrowing outstanding under the line of credit at
December 31, 1998.

                                       18
<PAGE>
 
The Company's future liquidity and capital requirements will depend upon the
progress of research and development programs, regulatory matters and the
expansion of its manufacturing capabilities to satisfy increasing volume
requirements. In addition, the Company's capital requirements will depend upon,
among other factors, the timing of the establishment of effective sales channels
in the United States and abroad and the extent to which the Company's products
gain market acceptance resulting in increased sales sufficient to generate a 
profit from operations. Therefore the Company cannot provide assurances that it
will not require additional financing in the future.  If additional financing is
necessary, the Company would seek to raise these funds through bank facilities
or debt or equity offerings. There can be no assurance that such funds would be
available on terms acceptable to the Company.

Impact of the Year 2000 Issue

The year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year.  Any computer programs
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.

The Company believes that its primary business and research and development
systems will be Y2K compliant by the second quarter of 1999 based on it's
internal evaluations and testing of these systems.  The Company does not rely
materially on non-IT related technology in its manufacturing processes and
thereby does not anticipate that Y2K issues will affect its ability to
manufacture finished goods.  The Company has begun the process of developing a
communication strategy for third party vendors and intends to issue
questionnaires that will address Y2K compliance.   The Company anticipates that
its assessment of third party vendors will be completed by the second quarter of
1999.  The Company does not anticipate incurring additional costs outside of the
scope of its current IT budget to complete future testing and compliance
activities.

The Company relies extensively on third party suppliers.  Because their systems
are not directly under the Company's control, the Company is at risk that all
required external Y2K compliance efforts will not be completed on a timely
basis.  In the event that the Company's significant suppliers do not
successfully and timely achieve Y2K compliance, and the Company is unable to
replace them with alternate suppliers, the Company's operations could be
adversely affected.

At this time, the Company believes that the Y2K problem will not pose
significant operational problems for the Company's computer systems.  Since no
significant issues have arisen, the Company does not have a contingency plan to
address any material Y2K issues.  If significant Y2K issues arise, the Company
may not be able to timely develop and implement a contingency plan and the
Company's operations could be adversely affected.

The disclosure in this Section is a Y2K Readiness Disclosure under the Year 2000
Information and Readiness Disclosure Act of 1998.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to the impact of interest rate changes and the change in
the market values of its investments. The Company's exposure to market rate risk
for changes in interest rates relates primarily to the Company's investment
portfolio. The Company has not used derivative financial instruments in its
investment portfolio. The Company invests its excess cash in money market
accounts, debt instruments of the U.S. Government and its agencies and in high-
quality corporate issuers and, by policy, limits the amount of credit exposure
to any one issuer.

The Company protects and preserves its invested funds by limiting default,
market and reinvestment risk.

Investments in both fixed rate and floating rate interest earning instruments
carries a degree of interest rate risk.  Fixed rate securities may have their
fair market value adversely impacted due to a rise in interest rates, while
floating rate securities may produce less income than expected if interest rates
fall. Due in part to these factors, the Company's future investment income may
fall short of expectations due to changes in interest rates or the Company may
suffer losses in principal if forced to sell securities which have declined in
market value due to changes in interest rates.

The amortized cost of the Company's investment approximate fair market value and
consists of $1.9 million of money market investments and $2.8 million of
corporate debt securities due in less than one year. The average interest rate
on these investments at December 31, 1998 was approximately 5.23%.

                                       19
<PAGE>
 
Item 8.  Financial Statements and Supplementary Data

                           INNOVASIVE DEVICES, INC.

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                          ---------
<S>                                                                    <C>
Report of Independent Accountants                                             21
                                                                    
Consolidated Balance Sheet at December 31, 1998 and 1997                      22
                                                                    
Consolidated Statement of Operations for the three years ended                23
    December 31, 1998                                               
                                                                    
Consolidated Statement of Stockholders' Equity (Deficit) for the              24
    three years ended December 31, 1998                             
                                                                    
Consolidated Statement of Cash Flows for the three years ended                25
     December 31, 1998                                              
                                                                    
Notes to Consolidated Financial Statements                                    26
                                                                    
                                                                    
Financial Statement Schedule:                                       
                                                                    
II.  Valuation and Qualifying Accounts and Reserves for the three             42
          years ended December 31, 1998                             
 
</TABLE>
                                                                               

All other schedules are omitted because they are not applicable.

                                       20
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and
Stockholders of Innovasive Devices, Inc.
 
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Innovasive Devices, Inc. and its subsidiary at December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.


PricewaterhouseCoopers  LLP

Boston, Massachusetts
February 18, 1999

                                       21
<PAGE>
 
                           INNOVASIVE DEVICES, INC.
 
                          CONSOLIDATED BALANCE SHEET
                       (In thousands, except share data)
<TABLE> 
<CAPTION> 
 
ASSETS                                                                        December 31,
                                                                      -------------------------
                                                                        1998            1997
                                                                     ----------      ----------
<S>                                                                 <C>             <C>      
Current assets:                                                                      
     Cash and cash equivalents                                         $  3,724        $  2,916
     Marketable securities                                                1,043          10,604
     Accounts receivable, net of allowance for                                       
        doubtful accounts of $140 and $121 at                                        
        December 31, 1998 and 1997, respectively                          2,189           1,625
     Inventories                                                          5,596           2,947
     Prepaid expenses                                                       175             116
                                                                     ----------      ----------
         Total current assets                                            12,727          18,208
     Fixed assets, net                                                    2,212           1,960
     Goodwill, net                                                        1,093           1,326
     Other assets                                                            27              26
                                                                     ----------      ----------
                                                                       $ 16,059        $ 21,520
                                                                     ==========      ==========
                                                                                     
LIABILITIES AND STOCKHOLDERS' EQUITY                                                 
                                                                                     
Current liabilities:                                                                 
     Accounts payable                                                  $    682        $    809
     Accounts payable to related party                                       60             392
     Accrued expenses                                                     2,103           1,122
                                                                     ----------      ----------
         Total current liabilities                                        2,845           2,323
                                                                     ----------      ----------
                                                                                     
Stockholders' equity:                                                                
     Common stock, $.0001 par value;                                                 
            Shares authorized: 15,000,000;                                           
            Shares issued and outstanding: 9,207,250 and                             
            9,164,848 at December 31, 1998 and 1997, respectively             1               1
     Additional paid-in capital                                          54,918          54,702
     Accumulated deficit                                                (41,655)        (35,156)
     Deferred compensation                                                  (50)           (350)
                                                                     ----------      ----------
                Total stockholders' equity                               13,214          19,197
                                                                     ----------      ----------
Commitments (Note 14)                                                         -               -
                                                                     ----------      ----------
                                                                       $ 16,059        $ 21,520
                                                                     ==========      ==========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       22
<PAGE>
 
                           INNOVASIVE DEVICES, INC.
                     CONSOLIDATED STATEMENT OF OPERATIONS
                     (In thousands, except per share data)
<TABLE> 
<CAPTION> 
 
                                                              Year Ended December 31,
                                                      -------------------------------------
                                                           1998        1997        1996
                                                      -----------   ----------   ----------
<S>                                                  <C>            <C>         <C>             
Net sales                                               $ 11,911     $  7,754     $  4,353
                                                                                 
Cost of sales                                              3,339        2,232        1,611
                                                      ----------    ---------    ---------
                                                                                 
     Gross profit                                          8,572        5,522        2,742
                                                                                 
Selling, general and administrative expenses              11,294        8,407        4,922
Research and development                                   4,230        3,524        2,003
Research and development - related party                      60          428          664
Purchased in-process research and                                                
     development                                               -       13,370            -
                                                      ----------    ---------    ---------
                                                                                 
     Loss from operations                                ( 7,012)     (20,207)      (4,847)
                                                                                 
Interest income                                              513        1,053          785
                                                      ----------    ---------    ---------
                                                                                 
     Net loss                                           $ (6,499)    $(19,154)    $ (4,062)
                                                      ==========    =========    =========
                                                                                 
                                                                                 
         Basic and diluted net loss                                              
                per share (Note 1)                       $( 0.71)     $( 2.33)     $( 0.83)
                                                      ==========    =========    =========
                                                                                 
                                                                                 
         Shares used in computing basic and                                      
                diluted net loss per share                 9,179        8,225        4,911
                                                      ==========    =========    =========
 
</TABLE>
   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       23
<PAGE>
 
                           INNOVASIVE DEVICES, INC.
           CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
                       (In thousands, except share data)
<TABLE> 
<CAPTION> 
                                      Common Stock
                                  ------------------
                                    Number               Additional                                                       Total
                                      of         Par      paid-in      Accumulated     Treasury       Deferred        stockholders'
                                    shares     value     capital        deficit         stock      compensation     equity (deficit)
                                  ---------    -----    ----------    ------------    ---------    -------------    ----------------
<S>                               <C>          <C>      <C>           <C>             <C>          <C>              <C>
Balance at December 31, 1995      1,815,922       $1       $ 3,459       $(11,936)        $(25)           $   -            $ (8,501)

Accretion of Series A and        
     Series B  mandatorily       
     redeemable preferred stock  
     to redemption value                                                       (4)                                               (4)

 Issuance of common stock        
     under stock option plan          5,111        -             9                                                                9
Conversion of Series A and       
     Series B  mandatorily       
      redeemable preferred stock 
      into common stock                            -
      (Note 9)                    3,543,819                 14,901                                                           14,901
Issuance of common stock,        
     net of issuance costs of    
     $2,305                       1,895,556        -        21,420                          25                               21,445
Net loss                                                                   (4,062)                                           (4,062)
                                 --------------------------------------------------------------------------------------------------
                                 
Balance at December 31, 1996      7,260,408        1        39,789        (16,002)           -                -              23,788
Issuance of common stock        
     under stock option plan          9,940        -            35                                                               35
Issuance of common stock -       
     acquisition of business     
    (Note 2)                      1,885,000        -        14,326                                                           14,326
Issuance of common stock         
     under employee stock        
     purchase plan (Note 11)          9,500        -            82                                                               82
Compensation related to the      
     grant of common stock       
     options                                                   470                                         (470)                  -
Amortization of deferred         
     compensation                                                                                           120                 120
Net loss                                                                  (19,154)                                          (19,154)
                                 --------------------------------------------------------------------------------------------------
Balance at December 31, 1997      9,164,848        1        54,702        (35,156)           -             (350)             19,197
                                 
Issuance of common stock        
     under stock option plan         15,539        -            48                                                               48
Issuance of common stock         
     under employee stock        
     purchase plan (Note 11)         26,863        -           114                                                              114
Compensation related to the      
     grant of common stock       
     options                                                    54                                          (54)                  -
Amortization of deferred         
     compensation                                                                                           354                 354
Net loss                                                                   (6,499)                                          ( 6,499)
                                 --------------------------------------------------------------------------------------------------
Balance at December 31, 1998      9,207,250       $1       $54,918       $(41,655)        $  -            $ (50)           $ 13,214
                                 ==================================================================================================
</TABLE>
   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       24
<PAGE>
 
                           INNOVASIVE DEVICES, INC.
                     CONSOLIDATED STATEMENT OF CASH FLOWS
                       (In thousands, except share data)
<TABLE> 
<CAPTION> 
                                                                            December 31,
                                                                 ------------------------------------
                                                                   1998          1997         1996
                                                                 ---------    ----------    ---------
<S>                                                              <C>          <C>           <C>
Cash flows from operating activities                        
     Net loss                                                     $(6,499)     $(19,154)    $ (4,062)
     Adjustments to reconcile net loss to net cash          
          provided by (used for) operating activities:      
          Depreciation and amortization                               989           571          273
          Amortization of deferred compensation                       354           120            -
          Purchased in-process research and development                 -        13,370            -
          Changes in assets and liabilities:                
               Accounts receivable                                   (564)         (854)        (476)
               Inventories                                         (2,649)       (1,853)        (454)
               Prepaid expenses                                       (59)            7          (64)
               Other assets                                           108            (1)         (13)
               Accounts payable                                      (127)           37          169
               Accounts payable to related party                     (332)          222          (95)
               Accrued expenses                                       981           254          571
                                                              -----------     ---------     --------
Net cash used for operating activities                             (7,798)       (7,281)      (4,151)
                                                            
Cash flows from investing activities                        
     Purchases of fixed assets                                     (1,117)         (856)        (596)
     Purchases of marketable securities                            (7,624)      (11,374)      (9,861)
     Redemption of marketable securities                           17,185        10,631            -
     Acquisition of business, net of cash acquired                      -          (544)           -
                                                              -----------     ---------     --------
                                                            
Net cash provided by (used for)  investing activities               8,444        (2,143)     (10,457)
                                                            
Cash flows from financing activities                        
     Proceeds from issuance of preferred stock,             
          net of issuance costs                                         -             -          927
     Proceeds from issuance of common stock,                
          net of issuance costs                                       162           117       21,454
     Principal payments on note payable                                 -          (602)           -
                                                            
                                                            
Net cash provided by (used for) financing activities                  162          (485)      22,381
                                                              -----------     ---------     --------

Net increase (decrease) in cash and cash equivalents                  808        (9,909)       7,773
                                                            
Cash and cash equivalents at beginning of year                      2,916        12,825        5,052
                                                              -----------     ---------     --------
                                                            
Cash and cash equivalents at end of year                          $ 3,724      $  2,916     $ 12,825
                                                              ===========     =========     ========
</TABLE>

Supplemental disclosure of non-cash financing activities:

In June 1997, the Company acquired substantially all of the operating assets of
MedicineLodge, Inc. in exchange for 1,885,000 shares of the Company's common
stock and the assumption of certain liabilities. (Note 2)


   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       25
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                         NOTES TO FINANCIAL STATEMENTS
                       (In thousands, except share data)


1. Nature of Business and Summary of Significant Accounting Policies

   The Company designs, develops, manufactures and markets proprietary tissue
   repair systems for use in the sports medicine/arthroscopy segment of the
   orthopaedic market. The Company currently markets a broad-based product line
   within five product platforms: suture fasteners, suturing systems, cartilage
   repair products, ACL reconstruction systems and meniscal repair products.

   As a result of funding an aggressive research and development effort, the
   establishment of its manufacturing capabilities and the expansion of its
   global sales and marketing organization, the Company has incurred losses 
   since inception and as of December 31, 1998 had an accumulated deficit of
   $41.7 million. On December 31, 1998, the Company had cash and marketable
   securities of $4.8 million and borrowing availability under a $2.5 million
   working capital line of credit (Note 7).

   The Company's ability to fund ongoing operating activities with existing
   capital resources, its working capital line of credit and cashflow from
   operations will be dependent upon the strengthening of its sales channels and
   the extent to which its proucts gain market acceptance in order to increase
   sales sufficiently to generate profits from operations.

   Therefore, the Company cannot provide assurances that it will not require
   additional financing in the future and that such funds would be available on
   terms acceptable to the Company.

   Revenue Recognition, Accounts Receivable and Concentration of Credit Risk

   Revenue is recognized upon shipment of product.  Ongoing credit evaluations
   of customers' financial condition are performed and collateral is not
   required.  Concentration of credit risk with respect to accounts receivable
   is limited due to the large number of customers comprising the Company's
   customer base.  The Company maintains reserves for potential credit losses
   and such losses, in the aggregate, have not exceeded management's
   expectations.

   Principles of Consolidation

   The consolidated financial statements reflect the operations of the Company
   and its wholly-owned subsidiary.  All significant intercompany balances and
   transactions have been eliminated.

   Cash, Cash Equivalents and Marketable Securities

   The Company considers all highly liquid investments purchased with a maturity
   of three months or less to be cash equivalents and those with maturities
   greater than three months are considered to be marketable securities.
   Marketable securities are stated at amortized cost plus accrued interest,
   which approximates fair value. Cash equivalents and marketable securities
   consist primarily of corporate debt securities, U.S. government agency
   obligations and money market instruments.

   The Company has classified its investments as "available-for-sale" as defined
   under Statement of Financial Accounting Standards ("SFAS") No. 115, 
   "Accounting for Certain Investments in Debt and Equity Securities." and any
   associated unrealized gains or losses, if material, are recorded as a
   separate component of equity until realized. At December 31, 1998 and 1997,
   any unrealized gains or losses were immaterial.

   Inventories

   Inventories are stated at the lower of cost or market, with cost being
   determined using the first-in, first-out method.

   Fixed Assets

   Fixed assets are recorded at cost and depreciated using the straight-line
   method over their estimated useful lives.  Repair and maintenance costs are
   expensed as incurred.

                                       26
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   the carrying amount of such assets, an impairment loss is recognized for the
   difference between estimated fair value and the carrying amount of the asset.

   Goodwill

   Goodwill represents the excess of cost over the fair value of net assets
   acquired, and is being amortized on a straight-line basis over the estimated
   useful life of ten years.   Accumulated amortization totaled $193 and $77 at
   December 31, 1998 and December 31, 1997, respectively.

   Basic and diluted net loss per share

   Net loss per share has been calculated in accordance with SFAS No. 128,
   "Earnings per Share". SFAS No. 128 requires the presentation of basic
   earnings per share and diluted earnings per share.

   Basic earnings per share is computed by dividing the income available to
   common stockholders by the weighted average number of common shares
   outstanding for the period.  For purposes of calculating diluted earnings per
   share, the denominator includes both the weighted average number of common
   shares outstanding and potential dilutive common shares outstanding for the
   period.

   For each of the years presented, basic and diluted earnings per share are
   the same due to the antidilutive effect of potential common shares
   outstanding.  Antidilutive potential common shares excluded from the 1998,
   1997 and 1996 computation include 1,656,299, 1,505,608 and 732,536 common
   shares, respectively, issuable upon the exercise of stock options.

   Stock-Based Compensation

   Stock-based compensation awards to employees under the Company's stock plans
   are accounted for using the intrinsic value method prescribed in Accounting
   Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
   and related interpretations. The Company has adopted the disclosure
   requirements of SFAS No. 123, "Accounting for Stock-Based Compensation."

   Accounting for the impairment of long-lived assets

   The Company periodically evaluates its long-lived assets whenever events or
   changes in circumstances indicate that the carrying amount of an asset may
   not be recoverable. At the occurrence of such an event or change in
   circumstances, the Company evaluates a potential impairment of an asset based
   on estimated future undiscounted cash flows. In the event that future
   undiscounted cash flows are less than

   Use of Estimates

   The preparation of financial statements in conformity with generally accepted
   accounting principles requires management to make estimates and assumptions
   that affect the reported amounts of assets and liabilities and disclosure of
   contingencies at December 31, 1998 and 1997, and the reported amounts of
   revenues and expenses during the three years in the period ended December 31,
   1998.  Actual results could differ from those estimates.

                                       27
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)



   Concentration

   Certain of the materials incorporated into the Company's products are
   obtained from a single source or a limited group of suppliers. The Company
   seeks to reduce the impact from it dependence on those sole and limited
   source suppliers by considering alternative sources of supply and maintaining
   an adequate supply of the materials. However, the loss of one or more of the
   sole or limited suppliers could cause a delay in manufacturing and a
   potential loss of sales, which could affect operating results adversely.

   New Accounting Pronouncement

   In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
   Instruments and Hedging Activities."   This statement establishes new
   standards for the recognition of gains and losses on derivative instruments
   and provides guidance as to whether a derivative may be accounted for as a
   hedging instrument. Gains or losses from hedging transactions may be wholly
   or partially recorded in earnings or comprehensive income as part of a
   cumulative translation adjustment, depending upon the classification of the
   hedge transaction. Gain or loss on a derivative instrument not classified as
   a hedging instrument is recognized in earnings in the period of change. SFAS
   No. 133 will be effective for the Company in 2000. The Company does not
   believe adoption of SFAS No. 133 will have a material impact on its financial
   position or its results of operations.

2. Acquisition

   On June 27, 1997, the Company, through a newly formed subsidiary, acquired
   substantially all of the operating assets of MedicineLodge, Inc. ("MLI"), in
   exchange for 1,885,000 shares of the Company's common stock valued at $14,326
   and the assumption of certain liabilities.  MLI designs, develops,
   manufactures and is marketing proprietary surgical implants which facilitate
   the repair of the Anterior Cruciate Ligament (ACL) of the knee. The
   acquisition has been accounted for under the purchase method and,
   accordingly, the purchase price has been allocated based on the estimated
   fair value of assets purchased and liabilities assumed upon acquisition. A
   portion of the purchase price relating to research projects which had not yet
   reached technological feasibility and had no alternative future use, was
   allocated to in-process research and development, resulting in a charge to
   the Company's operations of $13,370.  The excess of cost over the fair value
   of net assets acquired (goodwill) of $1,403 is being amortized over 10 years
   on a straight-line basis. The operating results of MLI are included in the
   Company's results from the date of acquisition.

                                       28
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   The following unaudited pro forma summary combines the results of operations
   of the Company and MLI as if the acquisition had occurred at the beginning of
   1997 and 1996, after giving effect to certain adjustments, including the
   write-off of purchased in-process research and development and amortization
   of goodwill.  The unaudited pro forma summary does not necessarily reflect
   the results of operations as they would have been if the Company and MLI had
   constituted a single entity during such periods.

<TABLE>
<CAPTION>
                                                     Year ended
                                                    December 31,
                                      ----------------------------------------
                                            1997                   1996
                                      ----------------      ------------------
<S>                                   <C>                   <C>
Net sales                                 $  8,298                $  5,659
Net loss                                   (20,080)                (18,849)
Basic and diluted net loss per share      $  (2.19)               $  (1.74)
</TABLE>

3. Marketable Securities

   The amortized cost of available-for-sale securities (including accrued
   interest), which approximates fair value, consists of the following:


<TABLE>
<CAPTION>
                                                                     December 31,
                                                         ------------------------------------
                                                               1998                 1997
                                                         ---------------      ---------------
<S>                                                     <C>                     <C>
Corporate debt securities                                  $ 2,842                 $ 6,779
U.S. government agency obligations                               -                   5,011
Money market instruments                                     1,925                   1,694
                                                           -------                 -------
    Total available for sale                                 4,767                  13,484
Less cash equivalents                                       (3,724)                 (2,880)
                                                           -------                 -------
    Total marketable securities                            $ 1,043                 $10,604
                                                           =======                 =======
</TABLE>
   The amortized cost of the Company's investment in debt securities at December
   31, 1998 was comprised of $2.8 million due in one year or less. Due to the
   short-term nature of the investments, expected maturities and contractual
   maturities are normally the same.

   The Company did not realize any gains or losses on available-for-sale
   securities during the three years ended December 31, 1998 as the securities
   have been held to maturity.

4. Inventories

   Inventories consist of the following:

<TABLE>
<CAPTION>
                                               December 31,
                                      ----------------------------------
                                           1998                 1997
                                      ---------------      -------------
<S>                                  <C>                 <C>
   Raw materials                           $1,880                $1,360
   Work-in-process                            640                   329
   Finished goods                           3,076                 1,258
                                          -------               -------
                                           $5,596                $2,947
                                          =======               =======  
</TABLE>
                                       29
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   Inventories are shown net of a reserve which has been established to provide
   for estimated losses arising from inventory obsolescence.  The Company
   estimates its reserve requirement for obsolete inventory based upon such
   factors as historical usage, projected sales and the impact of new product
   introductions.  Amounts charged to cost of sales relating to the obsolescence
   reserve were approximately $606, $309, and $293 in 1998, 1997 and 1996,
   respectively.

5. Fixed Assets

   Fixed assets consist of the following:
<TABLE>
<CAPTION>
                                       Useful life        December 31,  
                                         in years   ----------------------
                                                       1998         1997
                                                    ---------   ----------
<S>                                      <C>       <C>         <C> 
   Furniture and fixtures                   3 - 7     $1,132       $1,042
   Machinery and equipment                  2 - 5      1,774          995
   Leasehold improvements                       3        159          141
   Tooling                                  3 - 5      1,146          916
                                                    ---------   ----------
                                                               
                                                        4,211        3,094
   Less - Accumulated depreciation                             
                and amortization                        1,999        1,134
                                                    ---------   ----------
                                                       $2,212       $1,960
                                                    =========   ==========
</TABLE>

   Depreciation and amortization expense relating to fixed assets was $865, $522
   and $273 for 1998, 1997 and 1996 respectively.
 
6. Accrued Expenses

   Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                   December 31,
                                         ----------------------------------
                                             1998                 1997
                                         ---------------      -------------
<S>                                     <C>                  <C>
   Employee compensation and benefits    $   795                 $   445
   Commissions                               239                     250
   Professional fees                         269                     164
   Other                                     800                     263
                                         -------                 -------
                                         $ 2,103                 $ 1,122
                                         =======                 =======
</TABLE>

7. Debt

   In connection with the acquisition of MLI in June 1997 (Note 2), the Company
   assumed a note payable in the amount of $602.  The Company paid the note in
   full in July 1997.

   On December 31, 1998, the Company entered into a working capital line of
   credit with a bank, that

                                       30
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   provides the Company with a maximum borrowing availability of $2.5 million,
   limited by certain receivable and inventory balances. Borrowings under this
   agreement bear interest at the prime rate. The line of credit expires and all
   outstanding amounts thereunder are due December 31, 1999. Under the line of
   credit, the Company is obligated to comply with certain financial covenants.
   There were no borrowings outstanding under the line of credit at December 31,
   1998.

8. Income Taxes

   The provision (benefit) for incomes taxes was as follows:

<TABLE>
<CAPTION>
 
                                                                          December 31,
                                                         ------------------------------------------
                                                            1998             1997             1996
                                                         --------          -------          -------
<S>                                                     <C>              <C>            <C> 
   Deferred tax benefit                                                               
         Federal                                          $(2,135)         $(1,941)         $(1,337)
         State                                               (609)            (579)            (383)
                                                         --------         --------          ------- 
   Total deferred                                          (2,744)          (2,520)          (1,720)
   Tax asset valuation allowance                            2,744            2,520            1,720
                                                         --------         --------          ------- 
                                                          $     -          $     -          $     -
                                                         ========         ========          ======= 
</TABLE>


   Deferred income taxes reflect the tax impact of temporary differences between
   the amount of assets and liabilities for financial reporting purposes and
   such amounts as measured by tax laws and regulations. Under SFAS No. 109, the
   benefit associated with future deductible temporary differences is recognized
   if it is more likely than not that a benefit will be realized. Based on
   historical evidence of net losses, the Company has recorded a valuation
   allowance that offsets all net deferred tax assets. Principal components of
   the deferred tax assets and liabilities included on the balance sheet at
   December 31, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>
                                                                                   December 31,
                                                                     ---------------------------------------
                                                                             1998                 1997
                                                                     -------------------    ----------------
<S>                                                                    <C>                 <C> 
   Deferred tax assets:
         Net operating loss carryforwards                                $   8,604             $   6,217
         Inventory                                                             371                   404
         Research and development tax credit                                   621                   407
         Other items                                                           444                   268
                                                                         ---------             ---------
   Gross deferred tax assets                                                10,040                 7,296
   Deferred tax asset valuation allowance                                  (10,040)               (7,296)
                                                                         ---------             ---------
                                                                         $       -             $       -
                                                                         =========             =========  
</TABLE>

                                       31
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   A reconciliation between the amount of reported tax benefit and the amount
   computed using the U.S. Federal statutory rate of 35% for 1998, 1997 and 1996
   follows:

<TABLE>
<CAPTION>
                                                                          December 31,
                                                  -----------------------------------------------------------
                                                          1998                1997                   1996
                                                  -------------------    -------------------    -------------
<S>                                              <C>                    <C>                   <C>
      Tax benefit at statutory rate                  $  (2,275)             $  (6,704)             $  (1,422)
      State tax, net of federal benefit                   (332)                  (307)                  (196)
      In-process research and development
           charge for the purchase of MLI                    -                  4,680                      -
      Research and development credit                     (190)                  (209)                  (107)
      Other                                                 53                     20                      5
                                                     ---------              ---------              ---------
                                                        (2,744)                (2,520)                (1,720)
       Increase in valuation allowance                   2,744                  2,520                  1,720
                                                     ---------              ---------              ---------
                                                     $       -              $       -              $       -
                                                     =========              ==========             =========
</TABLE>

   The Company has U.S. Federal net operating loss carryforwards of
   approximately $21.1 million and tax credit carryforwards of approximately
   $398. The operating loss and tax credit carryforwards expire in the
   years 2009 through 2018.

   An ownership change, as defined by Section 382 of the Internal Revenue Code,
   resulting from the Company's initial public offering in June 1996, will limit
   the utilization of net operating loss and tax credit carryforwards generated
   prior to June 1996 to approximately $3.9 million per year.  Subsequent
   significant ownership changes could, however, further limit the utilization
   of these carryforwards in future years.

9. Mandatorily Redeemable Convertible Preferred Stock

   In February and March 1994, the Company issued 4,260,337 shares of Series A
   mandatorily redeemable convertible preferred stock ("Series A Preferred
   Stock") and 695,032 shares of common stock.  Upon issuance of the preferred
   stock and the common stock, the Company received net proceeds of $6 million
   and converted notes payable in the amount of $2.5 million plus accrued
   interest of $107.

   In October 1995, the Company issued 3,271,000 shares of Series B mandatorily
   redeemable convertible preferred stock ("Series B Preferred Stock").  Upon
   issuance, the Company received net proceeds of $6 million and converted notes
   payable in the amount of $1 million which was issued in August 1995 in the
   form of a bridge loan.

   In January 1996, the Company issued an additional 442,235 shares of Series B
   Preferred Stock, resulting in net proceeds to the Company of $927.

   All shares of Series A and Series B Preferred Stock converted into 3,543,819
   shares of common stock at the conversion ratio of 2.25 shares of Preferred
   Stock for each share of common stock upon the closing of the Company's
   initial public offering in June 1996.

                                       32
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)



10. Stockholders' Equity

    Reverse Common Stock Split

    A 1-for-2.25 reverse stock split of the Company's common stock became
    effective on May 7,1996. All shares of common stock, options and per share
    amounts included in the accompanying financial statements have been adjusted
    to give retroactive effect to the reverse stock split for all years
    presented.

    Initial Public Offering

    In June 1996, the Company completed an initial public offering of 1,900,000
    shares of its common stock. The net proceeds to the Company were
    approximately $21.5 million.

    Preferred Stock

    On April 3, 1996, the stockholders of the Company authorized 1,000,000
    shares of $0.01 par value preferred stock. Preferred stock may be issued at
    the discretion of the Board of Directors of the Company (without stockholder
    approval) with such designations, rights and preferences as the Board of
    Directors may determine from time to time. The preferred stock may have
    dividend, liquidation, redemption, conversion, voting or other rights which
    may be more expansive than the rights of the holders of common stock.


    On January 12, 1999, the director's of the Company voted to designate
    25,000 shares of the Company's Preferred Stock as Series A Junior Preferred
    Stock and reserved those shares for issuance on the exercise of Rights
    granted under the Company's Shareholder Rights Plan.

    Treasury Stock

    Common stock held in treasury at December 31, 1995 represents the Company's
    repurchase of common stock at cost.  These shares were reissued in
    conjunction with the Company's initial public offering in June 1996.

    Shareholder Rights Plan

    In January 1999, the Company's Board of Directors adopted a Shareholders
    Rights Plan. This Plan provides shareholders with special purchase rights
    under certain circumstances, including if any new person or group acquires
    15% percent or more of the Company's outstanding common stock.

11. Stock Plan

    The Company maintains three stock plans which provide for the granting of
    incentive stock options, non-qualified stock options and restricted stock to
    employees, directors and certain other individuals.

    The 1992 Stock Option Plan (the "1992 Plan") provides for the issuance of a
    maximum of 692,869 shares of common stock pursuant to the grant of incentive
    and non-qualified stock options.

                                       33
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   Incentive stock options may be granted to any officer or employee at an
   exercise price per share of not less than the fair market value per common
   share on the date of such grant (not less than 10% of such value in the case
   of holders of 10% or more of the total combined voting power of all classes
   of the Company's stock). Non-qualified options may be granted to any
   employee, officer, director or consultant at an exercise price per share to
   be specified by the Board of Directors on the date of grant. Options granted
   under the 1992 Plan are exercisable over periods determined by the Board of
   Directors, not to exceed ten years from the date of grant. The Company does
   not intend to issue any additional options under the 1992 Plan, however
   options that are forfeited will become available for grant under the 1996
   Omnibus Stock Plan (the "Omnibus Plan").

   Under the terms of the Omnibus Plan, employees, directors and certain other
   individuals may be awarded incentive stock options, nonqualified stock
   options or restricted stock. The Omnibus Plan provides for the issuance of a
   maximum of 800,000 shares of common stock, plus such additional number of
   shares that become available due to the forfeiture of options granted under
   the 1992 Plan.  The term of each option cannot exceed ten years (five years
   for options granted to holders of 10% or more of the total voting power of
   all classes of the Company's stock).  Incentive stock options must be granted
   at an exercise price equal to the fair market value of the stock on the date
   of grant and vest over a period not to exceed 10 years.

   The 1996 Non-Employee Director Stock Option Plan (the "Director Plan")
   provides for the grant of options for the purchase of up to 150,000 shares of
   common stock of the Company.  Under the terms of the Director Plan, each non-
   employee director will receive an option to purchase 2,500 shares of common
   stock at each annual meeting of stockholders.  In addition, each new non-
   employee director will receive upon his or her initial election an option to
   purchase 10,000 shares of common stock.  The term of each option cannot
   exceed ten years.  All options granted under the Directors plan will be at an
   exercise price equal to the fair market value of the stock on the date of
   grant and will vest evenly over a four-year period.

   Stock option activity is summarized as follows:


<TABLE>
<CAPTION>
                                                                           Weighted
                                                    Number of               Average
                                                     Shares             Exercise Price
                                              -------------------    -------------------
<S>                                          <C>                    <C>
   Outstanding at December 31, 1995                  478,878                $ 1.78
         Granted                                     262,324                  7.34
         Forfeited                                    (3,555)                 2.47
         Exercised                                    (5,111)                 1.69
                                              -------------------
   Outstanding at December 31, 1996                  732,536                  3.77
         Granted                                     807,100                 10.35
         Forfeited                                   (24,628)                 8.18
         Exercised                                    (9,940)                 3.55
                                              -------------------
   Outstanding at December 31, 1997                1,505,068                  7.23
         Granted                                     978,444                  4.87
         Forfeited                                  (811,674)                 9.41
         Exercised                                   (15,539)                 3.07
                                              -------------------
   Outstanding at December 31, 1998                1,656,299                $ 4.72
                                              ===================
</TABLE>
                                       34
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)



   The number and weighted average exercise price of options exercisable at
   December 31, 1998, 1997 and 1996 is 676,850 and $4.69; 421,738 and $2.58 and
   284,222 and $1.81, respectively.

   The following table summarizes information about stock options outstanding
   and exercisable at December 31, 1998.

<TABLE>
<CAPTION>
                                          Options Outstanding                                    Options Exercisable
                 -------------------------------------------------------------------    --------------------------------------------
                                            Weighted Average  
    Range of            Number                  Remaining        Weighted Average          Number             Weighted Average
 Exercise Price      Outstanding            Contractual Life      Exercise Price         Exercisable            Exercise Price
<S>                <C>                    <C>                  <C>                     <C>                  <C>
1.69                    438,893                   5.33                 1.69               430,824                     1.69
3.25  -  3.31           699,444                   9.89                 3.25                     -                        -
5.00  -  5.63            23,998                   7.85                 5.21                 7,998                     5.63
6.75                    158,327                   7.14                 6.75                70,766                     6.75
9.25  -  9.50           104,550                   9.39                 9.38                 1,675                     9.46
10.00 - 10.87            74,050                   7.77                10.08                39,300                    10.06
12.00                   157,037                   8.49                12.00               126,287                    12.00
                   --------------                                                     --------------
Total                 1,656,299                                                           676,850                 
                   ==============                                                     ==============
</TABLE>                                               
                                                       
   An aggregate of 50,000 shares of common stock is reserved for issuance
   pursuant to the 1996 Employee Stock Purchase Plan (the "Stock Purchase
   Plan"). Employees whose customary employment is in excess of 20 hours per
   week and five months per year and who own less than 5% of stock in the
   Company are eligible to participate in the plan. Employees participating in
   the plan will have the opportunity to purchase common stock at a price equal
   to the lesser of 85% of the fair market value on the date the right was
   granted or 85% of the fair market value on the date the right was exercised.
   The Company issued 26,863 and 9,500 shares to employees participating in the
   plan in 1998 and 1997, respectively.


   Compensation cost based upon the fair value approach as prescribed under SFAS
   No. 123 has not been recognized for stock options granted to employees as the
   Company adopted the disclosure-only provisions of SFAS No. 123. Had
   compensation for the Company's stock plans been determined based on the fair
   value at the grant date for awards in 1998, 1997 and 1996 consistent with the
   provisions of SFAS No. 123, the Company's net loss and net loss per share
   would have been as follows:

<TABLE>
<CAPTION>
 
                                                                     Year ended December 31,
                                                  ------------------------------------------------------------
                                                          1998                  1997                1996
                                                  -------------------    -------------------   ---------------
  <S>                                             <C>                   <C>                    <C>    
   Net Loss:  
       As reported                                     $ (6,499)              $(19,154)             $(4,062)
       Pro forma                                         (7,211)               (19,682)              (4,168)

   Basic and diluted net loss per share
       As reported                                     $  (0.71)              $  (2.33)             $ (0.83)
       Pro forma                                          (0.79)                 (2.39)               (0.85)
</TABLE>

                                       35
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


    The fair value of each option grant was estimated on the grant date using
    the Black-Scholes option-pricing model with the following weighted average
    assumptions for 1998, 1997 and 1996: expected option term of five years;
    dividend yield of 0%; risk free interest rate of 4.5 to 5.3%, 5.7% and 6.2%
    in 1998, 1997 and 1996, respectively; and expected volatility of 0% for
    options granted prior to the initial filing of the Company's registration
    statement in April 1996, 55% for options granted from April 1996 to December
    1996 and 44%-55% for options granted from January 1997 through December
    1998. The weighted average fair value per option for options granted in
    1998, 1997 and 1996 was $2.25, $4.86 and $2.46, respectively.

    Because options vest over several years and additional option grants are
    expected to be made in subsequent years, the pro forma impact on 1998, 1997
    and 1996 is not representative of the pro forma effects of reported net
    income (loss) and net income (loss) per share for future years.

    During 1997, the Company granted options in the amount of 154,000 shares to
    nonemployees under the Omnibus Plan. The estimated fair value of these
    options totaled $470, was recorded as deferred compensation and is being
    amortized over the vesting period of the options. In November 1997, the
    Emerging Issues Task Force of the Financial Accounting Standards Board
    finalized Issue No. 96-18 "Accounting for Equity Instruments That Are Issued
    to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods
    or Services" ("EITF 96-18"). Under EITF 96-18, the compensation expense that
    will ultimately be recognized for certain of the options issued to
    nonemployees in 1997 will be measured at the vesting date of the underlying
    options. The Company has recorded deferred compensation at a preliminary
    value of $341 for 131,500 of these options which have not vested as of
    December 31, 1997. As these options vest over periods of one to four years,
    the Company will be required to remeasure the fair value of these options at
    each reporting period prior to vesting and then finally at the vesting date
    of the options. Changes in the estimated fair value of these options will be
    recognized as compensation expense in the period of the change. During 1998,
    the Company accelerated vesting on 115,000 of these options resulting in a
    final compensation charge of $214.

    Repricing

    The Company elected to grant employees with outstanding stock options the
    opportunity to cancel their existing options and receive new options on a
    one for one basis with a new four-year vesting schedule commencing on the
    new date of grant. On December 14, 1998, 684,444 outstanding common stock
    options were canceled and 684,444 new options were granted with an exercise
    price of $3.25 per share, the fair market value of the Company's common
    stock on December 14, 1998. The cancellation and issuance of new options is
    included in the option activity above.

12. Retirement Savings Plan

    The Company provides an employee retirement savings plan under Section
    401(k) of the Internal Revenue Code (the "Plan") which covers substantially
    all employees. Under the terms of the Plan, employees may contribute a
    percentage of their salary, up to a maximum of 15%, which is then invested
    in one or more of several mutual funds selected by the employee. The Company
    may make contributions to the Plan at its discretion; no contributions have
    been made since inception of the Plan.

                                       36
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


13. Segment Reporting

    Effective January 1, 1998, the Company adopted SFAS No. 131, Disclosures
    about Segments of an Enterprise and Related Information. SFAS No. 131
    superseded SFAS No. 14, Financial Reporting for Segments of a Business
    Enterprise. SFAS No. 131 establishes standards for reporting information
    about operating segments, products and services, geographic areas, and major
    customers. The adoption of SFAS No. 131 did not affect the Company's results
    of operations or financial position. The Company operates in one reportable
    segment under SFAS No. 131.

    For 1996, sales approximating 13% of total sales were attributable to one
    customer.  No customer accounted for greater than 10% of net sales for 1998
    or 1997.

    Export sales were 17% (10% to Europe, 3% to Japan and 4% to other regions),
    15% (7% to Japan, 7% to Europe and 1% to other regions), and 27% (13% to
    Japan, 10% to Europe and 4% to other regions) of total sales for 1998, 1997
    and 1996, respectively.

14. Commitments

    Related Party Transaction

    In October 1995, the Company entered into Research & Development,
    Distribution and Supply agreements (the "Agreements") with Collagen
    Corporation. In October 1997, Collagen announced that it would proceed to
    separate its Aesthetic Technologies Group and its Collagen Technologies
    Group ("CTG") into two independent, publicly-traded companies. Cohesion
    Technologies, Inc. ("Cohesion") was organized as a Delaware corporation and
    wholly owned subsidiary of Collagen in June 1997. Effective January 1, 1998,
    Collagen contributed certain research and development programs of CTG to
    Cohesion including its development program with Innovasive Devices, Inc.
    Collagen also contributed various equity investments to Cohesion including
    all of its holdings in Innovasive Devices, Inc. In connection with the
    separation, Collagen distributed as a dividend to its stockholders on August
    18,1998, one share of Cohesion Common Stock for each share of Collagen
    common stock outstanding. As a result of this transaction, Cohesion
    Technologies beneficially owned 843,936 shares, or approximately 9.2% of the
    Company's Common Stock. Cohesion also assumed Collagen's relationship and
    obligations with the Company.

    Pursuant to the Agreements, the Company will fund up to $1.7 million of
    research and development efforts performed by Cohesion Technologies to
    develop certain products. In consideration for the funding provided, the
    Company will receive certain rights to market, sell and distribute certain
    products, subject to satisfying certain minimum sales requirements,
    resulting from such research and development efforts. Total research and
    development expense incurred under the Agreements was $60, $428, and $664
    for 1998, 1997 and 1996, respectively.

                                       37
<PAGE>
 
                           INNOVASIVE DEVICES, INC.

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                       (In thousands, except share data)


   Facility Lease

   The Company leases office and manufacturing facilities under various non-
   cancelable operating leases ranging from one to five years.  Future minimum
   lease commitments are approximately as follows:
<TABLE> 
<S>                                        <C> 
                   1999                     $271
                   2000                      250
                   2001                      221
                   2002                       92
                   2003                        -
                                           -----     
                                            $834
                                           =====
</TABLE> 
   Total rent expense under non-cancelable facility leases was approximately
   $264, $181 and $172 for 1998, 1997 and 1996, respectively.

                                       38
<PAGE>
 
Item 9.   Changes in and Disagreements with  Accountants
          on Accounting and Financial Disclosure

          Not Applicable

                                       39
<PAGE>
 
Part III

Item 10.  Directors and Executive Officers of the Registrant

          Information with respect to Directors may be found under the caption
          "Election of Directors" appearing in the Company's definitive Proxy
          Statement for the 1999 Annual Meeting of Stockholders. Such
          information is incorporated herein by reference.

Item 11.  Executive Compensation

          The information set forth under the captions "Executive Officer
          Compensation" and "Director Compensation" appearing in the Company's
          definitive Proxy Statement for the 1999 Annual Meeting of Stockholders
          is incorporated herein by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

          The information set forth under the captions "Principal Stockholders"
          and "Stock Ownership of Directors and Executive Officers" appearing in
          the Company's definitive Proxy Statement for the 1999 Annual Meeting
          of Stockholders is incorporated herein by reference.

Item 13.  Certain Relationships and Related Transactions

          Related Party Transaction

          In October 1995, the Company entered into Research & Development,
          Distribution and Supply agreements (the "Agreements") with Collagen
          Corporation. In October 1997, Collagen announced that it would proceed
          to separate its Aesthetic Technologies Group and its Collagen
          Technologies Group ("CTG") into two independent, publicly traded
          companies. Cohesion Technologies, Inc. ("Cohesion") was organized as a
          Delaware corporation and wholly owned subsidiary of Collagen in June
          1997. Effective January 1, 1998, Collagen contributed certain research
          and development programs of CTG to Cohesion including its development
          program with Innovasive Devices, Inc. Collagen also contributed
          various equity investments to Cohesion including all of its holdings
          in Innovasive Devices, Inc. In connection with the separation,
          Collagen distributed as a dividend to its stockholders on August
          18,1998, one share of Cohesion common stock for each share of Collagen
          common stock outstanding. As a result of this transaction, Cohesion
          Technologies beneficially owned 843,936 shares, or approximately 9.2%
          of the common stock of Innovasive Devices, Inc. at December 31, 1998.
          At December 31, 1998, the Company had expended approximately
          $1,416,000 pursuant to the Agreements. Cohesion Technologies has the
          right to designate one member of the Company's Board of Directors so
          long as it holds at least five percent of the Company's outstanding
          Common Stock on a fully-diluted basis. Mr. David Foster, Chief
          Executive Officer of Cohesion Technologies, currently serves as
          Cohesion Technologies Corporation's designee on the Company's Board of
          Directors.

                                       40
<PAGE>
 
Part IV

ITEM 14.   Exhibits, Financial Statements, Schedules, and Reports on Form 8-K

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

               (1)  Financial Statements - See Index to Financial Statements at
                    Item 8 of this report.

               (2)  Financial Statement Schedules

               (3)  Exhibits

                                       41
<PAGE>
 
ITEM 14. (a) (2) Financial Statement Schedules

                                  Schedule II

Valuation and Qualifying Accounts and Reserves for the Three Years Ended
December 31, 1998

<TABLE>
<CAPTION>
                                                  Balance at      Charged to       Charged        Deductions        Balance
(In thousands)                                    beginning       Costs and       to other           and           at end of
                                                  of period        expenses       accounts        write-offs         period
<S>                                        <C>                  <C>             <C>            <C>               <C>
Allowance for doubtful accounts
-----------------------------------------
December 31, 1996                                      50              52              -              (13)              89
December 31, 1997                                      89              36              -               (4)             121
December 31, 1998                                     121              36              -              (17)             140
 
Inventory obsolescence reserve
-----------------------------------------
December 31, 1996                                     389             293              -              (60)             622
December 31, 1997                                     622             309              -             (330)             601
December 31, 1998                                     601             606              -             (157)           1,050
 
Deferred tax assets valuation
     allowance
-----------------------------------------
December 31, 1996                                   3,056               -          1,720                -            4,776
December 31, 1997                                   4,776               -          2,520                -            7,296
December 31, 1998                                   7,296               -          2,744                -           10,040
</TABLE>

                                       42
<PAGE>
 
ITEM 14. (a) (3)  Exhibits

                            INNOVASIVE DEVICES, INC.
                                 EXHIBIT INDEX
                                        
Exhibit

10.1      Employment Agreement, dated June 27, 1997, between Registrant and 
          Alan Chervitz Incorporated by reference to the Company's Form 10-Q for
          the Quarter ended June 30, 1997.
 
10.2      Employment Agreement, dated June 27, 1997, between Registrant
          and T. Wade Fallin Incorporated by reference to the Company's Form
          10-Q for the Quarter ended June 30, 1997.
 
10.3      Consulting Agreement dated June 27, 1997, between Registrant
          and Richard B. Caspari, M.D. Incorporated by reference to the
          Company's Form 10-Q for the Quarter ended June 30, 1997.
 
23        Consent of PricewaterhouseCoopers LLP, Independent Accountants
 
23.1      Consent of PricewaterhouseCoopers LLP, Independent Accountants
 
27        Financial Data Schedule

99        Cautionary statement for purposes of the "Safe Harbor" provisions of
          the Private Securites Litigation Reform Act of 1995.

                                       43