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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
 
      [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
            EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED JUNE 30, 1998, OR
 
      [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
            EXCHANGE ACT OF 1934
 
         FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
 
                        COMMISSION FILE NUMBER: 0-10640
 
                           COLLAGEN AESTHETICS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      94-2300486
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
 
     1850 EMBARCADERO ROAD, PALO ALTO, CA                          94303
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>
 
       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (650) 856-0200
 
        SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
          COMMON STOCK, $.01 PAR VALUE PREFERRED SHARE PURCHASE RIGHTS
                                (TITLE OF CLASS)
 
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 month (or 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.  [X]
 
     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 September 4,
1998, on the Nasdaq Stock Market, was approximately $38,855,586. 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 September 4, 1998, the Registrant had 8,847,588 shares of Common
Stock outstanding.
 
     Parts of the Proxy Statement for Registrant's 1998 Annual Meeting of
Stockholders are incorporated by reference to Parts III and IV of this Form 10-K
Report.
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                                     PART I
 
     IN ITEMS 1, 2 AND 3 BELOW THE DISCUSSION DESCRIBES THE COMPANY'S AESTHETICS
BUSINESS, UNLESS OTHERWISE NOTED, AS PERFORMED BY THE AESTHETICS GROUP IN FISCAL
1998. FURTHER, THE DISCUSSION INCLUDES THE BUSINESS AS PROPOSED TO BE CONDUCTED,
PROPERTIES AND LEGAL PROCEEDINGS AFTER GIVING EFFECT TO THE SPINOFF OF COHESION
TECHNOLOGIES, INC, ("COHESION") ON AUGUST 18, 1998 AND AFTER THE COMPANY'S NAME
CHANGE FROM COLLAGEN CORPORATION TO COLLAGEN AESTHETICS, INC.
 
     In October 1997, the Company announced that it would proceed to separate
its Aesthetic Technologies Group and its Collagen Technologies Group into two,
independent, publicly-traded companies. In December 1997, the Company purchased
substantially all of the remaining outstanding shares of Cohesion Corporation
and integrated Cohesion Corporation into the Company's Collagen Technologies
Group. The Collagen Technologies Group was spun off as a separate company on
August 18, 1998, named Cohesion Technologies, Inc., to Collagen Corporation
stockholders via a tax-free distribution. On August 12, 1998, the stockholders
of the Company approved a corporate name change from Collagen Corporation to
Collagen Aesthetics, Inc. which better reflects the Company's focus on serving
the facial aesthetic medical marketplace. The Spinoff was designed to separate
two distinct businesses with significant differences in their markets, products,
research needs, investment needs, employee retention and compensation plans and
plans for growth. The Company's Board believed the separation into two
independent companies would enhance the ability of each to focus on strategic
initiatives and new business opportunities, improve cost structures and
operating efficiencies and create incentives that are more attractive and
appropriate for the recruitment and retention of key employees. As a
consequence, the Company believes that investors will be able to evaluate better
the merits of the two groups of businesses and their future prospects.
 
ITEM 1. BUSINESS
 
     In fiscal 1998, the Company's business consisted of its Aesthetic
Technologies Group and Cohesion Technologies Group. For a discussion of the
Cohesion Technologies Group, please refer to the Annual Report on Form 10-K of
Cohesion Technologies, Inc. ("Cohesion").
 
     The Company designs, develops, manufactures and markets on a worldwide
basis biocompatible products for the treatment of defective, diseased,
traumatized or aging human tissues. The Company has grown by identifying medical
applications for its technology, developing innovative products and building
markets with healthcare professionals, either directly or with marketing and
technology partners. The Company's core products are principally used in facial
aesthetic applications.
 
INDUSTRY BACKGROUND
 
     The market for facial aesthetic products and treatments includes surgical
and non-surgical therapies to remedy aging and defective soft tissues of the
face. These products are used by healthcare professionals, including plastic
surgeons and dermatologists, in an office environment and by consumers in the
home. Most of these treatments are elective and are pursued by patients for
cosmetic effects rather than due to medical necessity.
 
     The worldwide market for facial aesthetic products has experienced
significant growth over the past several years. The Company believes this growth
is primarily attributable to the following factors:
 
     - In the U.S. alone, a Baby Boomer turns 50 every eight seconds, and most
       developed countries around the world are experiencing similar demographic
       shifts.
 
     - The Company's products are elective procedures paid directly by the
       patient. As a result, increasing discretionary incomes, especially among
       aging Baby Boomers, helps to increase the size of the Company's market.
 
     - There is a significant opportunity for additional penetration among those
       patients already seeing plastic surgeons, facial plastic surgeons,
       dermatologists and other aesthetic physicians. Market research suggests
       that only 5% of such patients know of our 17-year-old line of injectable
       Zyderm(R) and Zyplast(R)
 
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       collagen implants ("Zyderm implants" and "Zyplast implant") on an
       "unaided" basis -- that is, with no prompting. With expanded customer
       awareness, demand for this product line and other products could
       increase.
 
     - Aesthetic medicine is gaining in acceptance and visibility. Physicians
       are showing greater interest in aesthetic medicine and patients are
       becoming increasingly open to discussing elective cosmetic procedures. In
       addition, the media provides a near-constant flow of information on the
       newest technologies and treatments to look one's best.
 
     - As the field of aesthetic medicine grows, more and more consumers have
       direct and easy access to trained physicians. Aesthetic medicine has
       expanded from its traditional constituency of females in select urban
       centers around the world to take its place among both men and women
       across a broader range of geographies.
 
     The Company believes that growth of the market, both within the U.S. and
internationally, can be attributed to changing social conventions, which
encourage consumers to explore products and treatments to make them look and
feel younger. As demand has grown for facial aesthetic products and treatments,
cost containment pressures imposed by managed care have induced many healthcare
providers to offer additional services that are less dependent on reimbursement
and are paid for by the consumer. The Company believes that the needs of
physicians and patients have created a demand for more innovative aesthetic
products, a wider selection of alternatives, and products that are safe, more
affordable and longer lasting than existing products and treatments.
 
  Facial Enhancement
 
     There is a wide range of products available in the facial aesthetic product
market that are designed to resurface skin, repair fine lines, deep folds and
scars, enhance the vermilion (lip) border and surgically contour the face.
Demand for products that address facial enhancement has increased significantly
over the past several years, and the Company believes there is a significant
market opportunity for products that are safe, more cost-effective, and that
cause less discomfort and trauma as compared to traditional products.
 
  Urinary Incontinence
 
     Urinary incontinence, the involuntary loss of urine from the bladder,
affects a large population of individuals. The Company believes that the
incidence of incontinence is significantly underreported, due to patient
embarrassment and the social stigma attached to incontinence, as well as the
shortage of effective treatments for the condition. Effective, emerging
therapies that treat incontinence in a less invasive manner may increase the
number of patients seeking treatment, expanding the potential market size. The
incidence of incontinence generally increases with age, and the Company believes
that as the population grows older, the market for incontinence treatments will
increase.
 
STRATEGY
 
     The Company's strategy consists of the following principal elements:
 
  Continued Innovation and Expansion of Existing Product Lines
 
     - Develop and market novel facial aesthetic products which will meet the
       changing needs and desires of current customers and offer an even broader
       range of products which will appeal to a diverse population of new
       patients and users.
 
     - Acquire and in-license products, new technologies and product
       distribution rights, allowing the Company to market additional
       complementary products and technologies that can provide effective, safe
       and innovative solutions to meet the needs of patients.
 
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  Strengthened Business Relationships
 
     - Connect with physician customers by introducing new means of using
       aesthetic products to meet the needs of patients.
 
     - Utilize physician feedback to develop new products, enhance existing
       products and design training programs to improve physician's practice
       economics and increase patient satisfaction.
 
  Scientific Leadership
 
     - Establish collaborations with leading experts in aesthetic and cosmetic
       therapies who will advise the Company about scientific development and
       clinical needs for new products, provide counsel for the design of
       clinical trials and evaluate potential new products.
 
     - Continue to market and distribute facial aesthetic products supported by
       scientific research and cutting edge clinical data.
 
  Improved Operating Margins
 
     - Leverage existing worldwide distribution network to market and sell
       through multiple channels allowing the effective launch of new products
       and creating increased operating efficiencies.
 
     - Utilize infrastructure that has the additional capacity to effectively
       increase operating profits.
 
PRODUCTS
 
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<S>                       <C>
Zyderm/Zyplast..........  Soft tissue augmentation with visible results
                          in one treatment session
Hylaform................  Same-day treatment of wrinkles and scars
SoftForm................  Long-lasting but removable material which
                          provides a solution to pronounced facial
                          wrinkles and lip border definition
Refinity................  In-office AHA peel and home-use maintenance
                          products to improve the surface and texture of
                          the skin and reduce the appearance of fine
                          lines
Contigen................  Minimally invasive outpatient procedure
                          designed to treat stress urinary incontinence
</TABLE>
 
     The Company offers products for soft tissue reconstruction and
augmentation, skin care and stress urinary incontinence. In the U.S., the
Company markets a line of collagen-based injectable products, Zyderm implants
and Zyplast implant, for soft tissue augmentation of the face. The Company has
launched, in the U.S., a new product for subdermal soft tissue reconstruction
and augmentation, the SoftForm(R) ("SoftForm implant"), made of ePTFE, expanded
polytetrafluoroethylene, a non-resorbable material, and is currently launching
the SoftForm implant in certain international markets. Internationally, the
Company markets its Zyderm and Zyplast injectable implants for the face and
Hylaform(R) viscoelastic gel ("Hylaform gel"), an injectable gel for facial
wrinkles and scars that does not require a skin sensitivity test. The Company
currently plans to introduce Refinity(TM) Medical Skin Solutions ("Refinity skin
solutions"), a line of alpha hydroxy acid ("AHA") based skin care products, in
the U.S. in fiscal 1999 and when regulatory approvals permit, these products are
expected to be introduced into Canada, Australia and Europe. In addition, the
Company's product for stress urinary incontinence, Contigen(R) Bard collagen
implant ("Contigen implant"), is currently marketed on a worldwide basis through
the Company's marketing partner, C.R. Bard ("Bard").
 
  Facial Enhancement Products
 
     ZYDERM AND ZYPLAST IMPLANTS. The Company's collagen-based injectable
product line for the treatment of skin contour defects includes Zyderm implants
and Zyplast implant. The Company markets its Zyderm and Zyplast implant products
worldwide to dermatologists, plastic surgeons, and other physicians. The Company
estimates that over one million patients worldwide have been treated with a
collagen-based injectable product
 
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of the Company, of which approximately 920,000 patients are in the U.S. and
Canada and approximately 575,000 are in international markets.
 
     Zyplast implant is a collagen product molecularly cross-linked with
glutaraldehyde. Zyderm and Zyplast implant treatments replenish the skin's
natural collagen support layer, smooth facial lines and many types of scars, and
can produce an immediate visible difference in the appearance of a patient's
skin. The implants are dispersed in a saline solution containing a small amount
of lidocaine, a local anesthetic, and injected with a fine gauge needle into
depressed layers of skin to elevate the area to the level of the surrounding
skin surface. As a result, Zyderm and Zyplast implants can minimize lines and
scars. Depending on the need and the product (or product combination) used, many
patients can achieve correction of wrinkles or scars in one treatment session.
The implants take on the texture and appearance of human tissue and are subject
to similar stresses and aging processes. Consequently, supplemental treatments
are necessary after initial treatment, depending on the location and original
cause of the skin deformity. On average, patients require two to four treatments
per year to maintain the desired result.
 
     Zyderm implants were formulated especially for people with small or
superficial contour defects. These implants are particularly effective in
smoothing delicate frown and smile lines and fine creases that develop at the
corners of the eyes and above and below the lips, and can also help correct
certain kinds of shallow scars. Zyplast implants, which are the most persistent
of the collagen-based implants, are cross-linked with glutaraldehyde, are
designed to treat depressions requiring a stronger material and can be used for
more pronounced contour problems (such as deeper scars, lines and furrows) and
for areas upon which more force is exerted (such as the corners of the mouth).
Zyderm and Zyplast implants may be used alone or in conjunction with one
another.
 
     HYLAFORM GEL. The Company has extended its injectable product line with
Hylaform gel, a product which can be used without a skin sensitivity test. The
Company has acquired exclusive distribution rights in certain international
markets from Biomatrix, Inc. ("Biomatrix") to sell Hylaform gel for facial
wrinkles and scars. Hylaform is a viscoelastic product made from hylan B, a
biopolymer created by cross linking hyaluronan molecules. Hyaluronan is the
elastoviscous polysaccharide present in the intercellular matrix of nearly all
human tissues. Hyaluronan plays an important role in the skin's hydration and
viscoelasticity. Over time, the hyaluronan content in skin decreases,
contributing to the aging appearance of skin. Due to its unique cross-linking to
hylan B, Hylaform gel has a higher water content and greater elastic properties
than other hyaluronan-derived products.
 
     Since hyaluronan is neither tissue-specific nor species-specific, Hylaform
gel can be used without a skin test. In addition, Hylaform gel has a chemical
structure that is completely different from bovine collagen and does not contain
any bovine protein. Hylaform gel allows for same day treatment of facial
wrinkles and scars, giving patients and doctors an additional treatment option.
 
     Biomatrix received CE Mark for Hylaform gel in December 1995, allowing this
product to be marketed throughout Europe. The Company began marketing Hylaform
gel in several European countries in fiscal 1997. The Company holds exclusive
marketing and distribution rights to Hylaform gel in certain markets outside the
U.S. and has the option to acquire the U.S. distribution rights in the future.
The exclusivity of the license will terminate if the Company fails to meet
certain sales goals. The Company plans to introduce Hylaform gel in additional
international markets following receipt of required regulatory approvals or
clearances. Hylaform gel is not currently approved for marketing in the U.S.
There can be no assurance that Hylaform gel will be marketed in the U.S. in the
near future, or at all.
 
     SOFTFORM IMPLANT. The Company has acquired exclusive worldwide distribution
rights from Tissue Technologies, Inc. ("Tissue Technologies") to market SoftForm
implant, for subdermal soft tissue reconstruction and augmentation. SoftForm
implant is a non-resorbable, long-lasting, yet removable facial implant for the
treatment of deep facial furrow and creases such as nasolabial folds (creases
between the nose and corners of the mouth), deep frown lines and definition of
the vermilion border. SoftForm implant comes preloaded in a self-contained
delivery system enabling precise placement without requiring physicians to
handle the implant prior to placement. Treatment with SoftForm implant consists
of a simple in-office procedure performed under a local anesthetic. The implant
is inserted below the surface of the skin through
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two small incisions. The procedure generally takes less than 30 minutes, but
treatment times will vary depending on the number of implants used. Microporous
material limits tissue in-growth through the surface of the implant, allowing
easy removal of SoftForm implant. The removability of SoftForm implant provides
physicians with the option of adjusting or removing the implant as desired. The
Company believes that SoftForm implant is more easily removable than other
non-resorbable facial implants.
 
     SoftForm implant is a soft, tube-shaped implant made of the biocompatible
polymer ePTFE. SoftForm implant has a hollow configuration designed to provide
stability by promoting fibrous tissue ingrowth through the inside of the tube.
The Company believes that SoftForm implant demonstrates greater stability and
less likelihood of extrusion through the skin's surface with the hollow
configuration of SoftForm implant as compared to competitive products. The ePTFE
polymer used in the SoftForm implant has been used for more than 20 years in a
variety of medical applications, including replacement of deteriorated blood
vessels, hernia repair, abdominal wall reinforcement and soft tissue
augmentation of the face.
 
     SoftForm implant received marketing clearance from the FDA in April 1996
under a 510(k) application and the Company introduced SoftForm implant to a
panel of six physician advisors in December 1996. The Company launched SoftForm
in the U.S. in 1997. The product is currently approved for usage in Canada and
has received CE Mark in the European Community ("EC"). SoftForm implant is
currently being launched in certain international markets.
 
     The Company's facial enhancement products have been designed to provide a
range of corrective products to the Company's customers. SoftForm implant is
designed to complement Zyderm and Zyplast implants as well as Hylaform gel by
offering a sub-dermal (under the skin), persistent treatment to patients with
deep furrows.
 
     REFINITY SKIN SOLUTIONS. The Company has acquired exclusive worldwide
rights from Cosmederm Technologies, Inc. ("Cosmederm") to distribute Refinity
skin solutions, a line of alpha hydroxy acid ("AHA") skin care products being
developed by the Company and Cosmederm. Refinity skin solutions products contain
a patented anti-irritant developed by Cosmederm. The Company believes that these
products diminish the appearance of fine lines and wrinkles and give the skin a
smoother texture and tone while minimizing or eliminating the itching, burning
and stinging traditionally associated with AHA products. The Company plans to
introduce Refinity skin solutions in the U.S. in fiscal 1999 and in certain
international markets in the future.
 
     The Company plans to distribute its Refinity skin care products through
physicians' offices to leverage the Company's existing distribution network. In
order to develop a high-performance AHA product which produces minimal adverse
effects, Cosmederm is developing the Refinity skin solutions product line for
the Company utilizing Cosmederm's patented anti-irritant, COSMEDERM-7. Because
Refinity skin solutions products contain significantly higher levels of active
ingredients than currently available alternative products, the Company believes
that they can achieve more effective results. The Refinity skin solutions
product line will include home use products with an AHA concentration of 15%
(compared with other physician dispensed products with concentrations generally
ranging from 8-12%), as well as a physician in-office peel product with an AHA
concentration of 70%.
 
     CONTIGEN IMPLANT. Contigen implant injections are designed to treat
incontinence due to intrinsic sphincter deficiency ("ISD"). Contigen implant is
a sterile, highly purified bovine dermal collagen that is crosslinked and
dispersed in a saline solution. Contigen implant is injected into the submucosal
tissues of the urethra and/or bladder neck, and into the tissues adjacent to the
urethra. The injection of Contigen implant creates increased tissue bulk and
subsequent joining of the urethral lumen. After injection, the suspended
collagen forms a soft cohesive network of fibers and over time, the implant
takes on the appearance of human tissue. The treatment cycle of Contigen implant
may require multiple injections at the start of treatment and may require
supplementary injections over time.
 
     The Company obtained pre-market approval from the United States Food and
Drug Administration (the "FDA") to market Contigen implant in September 1993 for
the treatment of ISD. Under the terms of a distribution agreement with Bard, the
Company sells Contigen implant to Bard and the Company receives a
 
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royalty on end market sales of Contigen implant. Bard has exclusive worldwide
marketing and distribution rights to Contigen implant which is currently
marketed in the United States. Bard has received reimbursement codes for
Contigen implant and is expected to commence marketing in several European
nations (Belgium, France, Germany, Italy, Spain and the United Kingdom), Latin
America, Japan, Australia and Canada.
 
DISCONTINUED OPERATIONS -- LIPOMATRIX
 
     On April 8, 1998, the Company announced plans to pursue a divestiture of
its LipoMatrix, Incorporated ("LipoMatrix") subsidiary, manufacturer of the
Trilucent(TM) breast implant ("Trilucent implant"), thereby allowing the Company
to dedicate further resources to its aesthetic operations. In June 1998, the
Company adopted a formal plan to complete the divestiture and has accounted for
the results of LipoMatrix as a discontinued operation in the accompanying
consolidated financial statements.
 
     The Company has recorded losses from discontinued operations before taxes
of $5.3 million, $9.1 million and $24.7 million in fiscal 1998, 1997 and 1996,
respectively. In addition, the Company recorded a provision of $11.0 million
before taxes, for the loss on disposal of the net assets of LipoMatrix including
estimated future costs. The Company expects to dispose of the assets by December
31, 1998.
 
SALES AND MARKETING
 
     The Company has developed a worldwide distribution network, comprised of a
direct sales force in the United States and certain international markets. The
Company's sales force consists of over 100 sales representatives and agents
worldwide, distributors in certain international markets and a marketing
partner, Bard, for Contigen implant. This distribution network is experienced in
selling technologically advanced products for facial aesthetic applications,
thereby enabling the Company to introduce more rapidly and effectively newly
developed, acquired and in-licensed products. The Company believes that the
increased utilization of the existing distribution network will lead to
increased operating efficiencies.
 
     The Company markets its Zyderm and Zyplast implants directly to
dermatologists, plastic surgeons and other physicians in the U.S. and several
European countries, Canada, Australia and New Zealand and through distributors
in certain other international markets. The Company has historically distributed
Zyderm and Zyplast implants in Japan through Lederle Japan, but in fiscal 1999
it will begin using its own subsidiary to market these products directly. The
Company has launched SoftForm implant and is marketing the SoftForm product
through its direct sales force in the U.S. and limited sales in several European
countries, Canada and through international distributors. The Company expects to
launch Refinity skin solutions in the U.S. in fiscal 1999. Hylaform gel is
currently sold in several European countries through the Company's direct sales
force and its international distributors, but is not approved for marketing in
the U.S. Contigen implant is marketed worldwide through Bard, the Company's
marketing partner.
 
     The Company utilizes a variety of methods to promote its facial aesthetic
products to patients and physicians. To stimulate demand at the patient level,
the Company conducts consumer marketing awareness programs, including public
relations events, health and beauty magazine advertising, direct mailing
campaigns and patient seminars. The Company's marketing efforts to physicians
consist of on-going education and promotional activities. Examples of physician
marketing activities include in-office education, presence at medical meetings,
and direct mail campaigns. The Company has emphasized physician education to
ensure proper education in the use of its products and timely communication of
clinical and product use information.
 
     The Company is committed to optimizing patient satisfaction through various
initiatives aimed at meeting the patient's aesthetic needs while making the
Company's products more affordable. Market research sponsored by the Company and
conducted during fiscal 1996 revealed that many patients were not receiving
enough collagen material per treatment to provide for full correction of soft
tissue defects and that existing prices for the product discouraged patients
from purchasing more collagen. As a result, the Company introduced syringes with
larger fill volumes, offering more collagen material with a minimal increase in
cost and injection time and an opportunity for more complete correction. The
Company benefits from this strategy due to increased patient satisfaction. In
addition to larger syringes, the Company has also introduced programs to further
encourage more complete correction at the initial treatment and on an ongoing
basis.
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     The Company has instituted a new patient program in an effort to attract
new patients and increase existing patient satisfaction. The Company's program
offers all patients special pricing options that make full and ongoing
correction more affordable. In addition, the Company has initiated the Collagen
Specialist Program to educate nurses to administer collagen proficiently, which
the Company believes may increase collagen-based injectable revenues of both the
Company and its physician customers while maintaining patient satisfaction. The
Company believes this program may improve physicians' practice economics while
providing for continued high quality patient care.
 
     For the uncertainties or risk factors that exist surrounding the marketing
and distribution of the Company's facial aesthetic products and its stress
urinary incontinence product see "Factors That May Affect Future Results of
Operations" under Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
 
COMPETITION
 
     The Company believes that the primary competitive factors in the market for
facial aesthetic medical products are safety, efficacy, reliability,
cost-effectiveness, patient recovery time, absence of significant side effects,
availability of third-party reimbursement, and physician and public awareness of
the existence and efficacy of products. The medical device industry is
characterized by rapid and significant technological change. The length of time
required for product development and regulatory approval plays an important role
in a company's competitive position. Consequently, the Company's success will
depend in part on its ability to respond quickly to medical and technological
changes through the development, acquisition or in-licensing and
commercialization of new products. The Company believes that it competes
favorably with respect to these factors, although there can be no assurance that
it will continue to do so.
 
     Several companies and institutions are engaged in the development of
collagen-based and other materials, techniques, procedures and products for use
in facial aesthetic applications anticipated to be addressed by the Company's
products. Some of these companies and institutions are developing human-based
collagen products which, when and if commercially introduced, may have perceived
advantages over the Company's bovine collagen-based products. Some of these
companies and institutions may have substantially greater capital resources,
research and development staffs and facilities, and experience in conducting
clinical trials, obtaining regulatory approvals, and manufacturing and marketing
products similar to those of the Company. These companies and institutions may
represent significant long-term competition for the Company. There can be no
assurance that the Company's competitors will not succeed in developing
technologies and products that are more effective than any which have been or
may be developed by the Company or that would render the Company's technology
and products obsolete or non-competitive or that the Company will be able to
compete effectively against such competitors based on its abilities to
manufacture, market and sell its products. There can be no assurance that such
potential competition will not have an adverse effect on the future business,
financial condition or results of operations of the Company.
 
     The market for facial aesthetic products and treatments is characterized by
rapidly evolving technology and increasing competition resulting from changes in
the health care environment. The Company faces competition in each of its target
product markets.
 
  Facial Enhancement
 
     The Company faces direct and indirect competition for its Zyderm and
Zyplast implant products. At the present time, the Company is aware of a
commercial product marketed in the U.S. and Canada that competes directly with
Zyderm and Zyplast implants. This product is a gelatin-based (denatured
collagen) product for soft tissue augmentation. The Company also competes with
products derived from human tissue. Collagenesis, Inc. produces a product
requiring a biopsy of the patient's tissue, which tissue is then used to
generate an injectable material. Fat injections require surgical removal of the
patient's fatty tissue. Implantable cadaver tissue obtained through tissue banks
is sold under the brand name Alloderm and competes directly with SoftForm
implant. Internationally, the direct competitors in the injectable product
segment are primarily derived from collagen, hyaluronic acid and silicone. The
Company is aware of one foreign company that is
 
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marketing internationally a collagen-based material for soft tissue
augmentation. The Company is aware of a hyaluronic acid-based product called
Restylane that is competitive with Hylaform gel. In addition, W.L. Gore, Inc.
markets an ePTFE product that is directly competitive with SoftForm implant. The
Company's injectable products also compete in the dermatology and plastic
surgery markets with substantially different treatments, such as laser
treatments, chemical peels, fat injections, dermabrasion, botulinum toxin
injections and face lifts. In addition, several companies are engaged in
research and development activities examining the use of collagen and other
biomaterials for the correction of soft tissue defects. Although the Company
believes it has a leadership position in the injectable product segment of the
soft tissue augmentation market, there can be no assurance that the Company will
not face increased direct and indirect competition in such a market.
 
     Refinity skin solutions, once introduced, will compete in the competitive
segment of the AHA product market which includes products distributed through
physicians' offices. Physician dispensed AHA products represent approximately 6%
to 7% of the $1.6 billion per year AHA market. Physicians dispense a significant
number of private label in-office peel and take-home AHA products to their
patients, making the in-office distribution channel increasingly profitable for
companies which offer their physician customers highly efficacious AHA products.
During the last two years, several large pharmaceutical companies with high
product profiles within the dermatology market have purchased or agreed to
distribute AHA skin care lines. Should such pharmaceutical companies begin
dispensing AHA products through physicians' offices, there can be no assurance
that the Company will be able to compete effectively in this market.
 
  Contigen Implant
 
     At the present time, autologous fat, silicone micro-implants and
polytetrafluoroethylene (Teflon paste, or PTFE) are directly competing or will
compete with the Contigen implant for the treatment of stress incontinence due
to ISD. Neither silicone micro-implants nor PTFE have been approved by the FDA
for use in the U.S. The Contigen implant also competes with other methods of
treatment or amelioration of ISD including absorbent products (diapers, pads and
other drip and collection devices), drugs and estrogen therapy, behavior
modification (kegel exercises, electrical stimulation, and biofeedback), surgery
(artificial urinary sphincter, sling procedures, bladder neck suspension and
bone anchors), and bulking agents (Urethrin, Macroplastique, inert materials and
fat).
 
MANUFACTURING
 
     The Company manufactures its collagen-based injectable products utilizing
readily available chemicals and enzymes. The source of its collagen is bovine
dermis. The Company uses a patented viral inactivation process for its
collagen-based products to promote both their safety and quality. Since 1987,
the hides have been sourced from a closed herd, in an effort to prevent diseases
such as Bovine Spongiform Encephalopathy ("BSE" or "mad cow disease"), from
contaminating its collagen-based products. Maintaining a closed herd requires
the physical separation of the herd from other herds, the tracking of the
lineage of each animal and the maintenance of each animal under a veterinary
program. The Company believes that the supply of raw materials and processing
materials for its manufacturing operations is and will continue to be adequate
for the foreseeable future and that such materials can be available from other
sources.
 
     The Company's principal collagen-based products have refrigerated shelf
lives of 36 months. The Company typically ships products to physicians as orders
are received on an express delivery basis, and has no material backlog. It is
the Company's policy to maintain levels of finished goods inventory adequate to
allow for the expeditious handling of orders received. The Company believes its
physician customers typically purchase products on an as-needed basis, while
distributor customers purchase products based on inventory stocking levels.
 
     The Company manufactures Zyderm and Zyplast implant products and Contigen
implant products, as well as Collagraft(R) bone graft matrix implant and
Collagraft(R) bone graft matrix strip ("Collagraft bone graft products") for
Cohesion, in its Fremont, California facility. This facility is used primarily
for bulk processing, aseptic filling and packaging of finished goods. While the
Company has not experienced any disruptions in its manufacturing schedule during
the last two fiscal years, there can be no assurance that the Company will not
 
                                        8
<PAGE>   10
 
experience disruptions in its manufacturing schedule in the event that it
attempts to manufacture products in larger quantities and with new process
improvements. In addition to the Company's in-house inspection teams which work
to promote the quality and consistency of the Company's products, the Company's
manufacturing facilities are subject to regulatory requirements and periodic
inspection by regulatory authorities, such as the FDA in the U.S. In June 1995,
the Company's quality system was audited by TUV Product Services, Munich ("TUV")
to ensure that the Company's products conform to the provisions of the European
Medical Devices Directive. After the completion of the audit and review of the
technical documentation, the Company was granted permission to affix CE Mark on
its Zyderm and Zyplast implant product packages and to sell these products in
the EC. An annual surveillance audit of the Company's quality system was
performed by TUV in March 1998 and the Company's quality systems were
recertified.
 
     Hylaform gel, SoftForm implant and Refinity skin solutions products,
distributed or expected to be distributed by the Company, are manufactured by
third parties. The Company is dependent on these third parties to manufacture
and supply products to the Company as required. While the Company has supply
agreements with these third parties, there can be no assurances that these third
parties will manufacture and supply high quality products on a timely basis or
in adequate quantities. Inventory shortages or quality issues could adversely
affect the Company's sales of these products and as a result, could adversely
affect the Company's business, financial condition and results of operations.
 
PRODUCT DEVELOPMENT
 
     Most of the research and development efforts previously conducted by the
Company have been assumed by Cohesion. In connection with the Spinoff, the
Company has entered into a Research and Development Agreement with Cohesion,
effective as of January 1, 1998. The Company's research and development efforts
will focus on those products that are in-licensed or acquired and require
additional development. In addition, the Company will continue independent
research and development activities, primarily focused on enhancement of its
manufacturing processes.
 
     Under the terms of the Research and Development Agreement, the Company is
collaborating with Cohesion to develop an alternative to bovine sourced
collagen. Research efforts are focused on the development of recombinant human
collagen through transgenic animals and yeast. Cohesion has made an equity
investment in and is actively collaborating with Pharming for the purpose of
developing recombinant human collagen through transgenic animals. In addition,
Cohesion has a collaborative agreement with Genotypes, Inc. of South San
Francisco, California, to develop recombinant human collagen through yeast.
 
     The Research and Development Agreement allocates the obligations and
responsibilities of Cohesion and the Company with respect to research,
development and manufacturing development of the recombinant technology and
provides for the sharing of development costs. Pursuant to the Research and
Development Agreement, the resultant recombinant technology and related
intellectual property shall be owned by Cohesion, but shall be exclusively
licensed to the Company for uses related to the Company's business, subject to
the payment of royalties by the Company to Cohesion.
 
PATENTS AND PROPRIETARY TECHNOLOGY
 
     The Company has historically depended substantially upon its proprietary
technological expertise in the extraction, purification, and formulation of
collagen-based materials and other biomaterials into biomedical products. The
Company has sought patents on inventions concerning novel manufacturing
processes, composition of matter, and applications for its proprietary
biomaterials. In connection with the Spinoff, the Company and Cohesion have
entered into an Assignment and License Agreement pursuant to which a large
portion of the Company's technology and intellectual property (including patents
and trade secrets), other than technology relating to the breast implant
technology, has been assigned to Cohesion. Cohesion has granted back to the
Company an exclusive, worldwide, perpetual, fully paid-up license to such
assigned technology and intellectual property for use in the Company's field of
business. The Assignment and License Agreement also provides for each of
Cohesion and the Company to obtain certain rights to any improvements made by
the other company prior to March 15, 2004, solely as such improvements relate to
its business. In
 
                                        9
<PAGE>   11
 
addition, under the Assignment and License Agreement, each of Cohesion and the
Company covenant to not compete in each other's business until March 15, 2004.
 
     Patent-related litigation is a risk in the medical device industry. There
can be no assurance the Company will be successful in the future in obtaining
patents or license rights, that patents will be issued for the Company's current
patent applications, that the Company will develop additional proprietary
technology that is patentable, that any issued patents will provide the Company
with any competitive advantages or will not be challenged by third parties, or
that patents of others will not have an adverse effect on the Company. No
assurance can be given that the processes or products of the Company or its
licensors, including Cohesion, will not infringe patents or proprietary rights
of others or that any licenses required under any such patents or proprietary
rights would be made available on terms acceptable to the Company. If the
Company does not obtain such licenses, it could encounter delays in product
introductions while it attempts to design around such patents, or it could find
that the manufacture, sale or use of products requiring such licenses could be
enjoined. In addition, the Company could incur substantial costs in defending
itself in suits brought against the Company on such patents or in bringing suits
to protect the Company's patents against infringement.
 
     The Company relies upon trade secret protection for certain unpatented
aspects of its proprietary technology. There can be no assurance that others
will not independently develop or otherwise acquire substantially equivalent
proprietary information or techniques, that others will not otherwise gain
access to the Company's proprietary technology or disclose such technology, or
that the Company can meaningfully protect its trade secrets.
 
     The Company requires its employees and consultants to execute appropriate
confidentiality and proprietary information agreements upon the commencement of
employment or a consulting relationship with the Company. These agreements
generally provide that all confidential information developed or made known to
the individual by the Company during the course of the individual's relationship
with the Company is to be kept confidential and not disclosed to third parties,
except in specific circumstances. The agreements generally provide that all
inventions conceived by the individual in the course of rendering services to
the Company shall be the exclusive property of the Company; however, certain of
the Company's agreements with consultants, who typically are employed on a
full-time basis by academic institutions or hospitals, do not contain assignment
of invention provisions. There can be no assurance, however, that these
agreements will provide meaningful protection or adequate remedies for the
Company in the event of unauthorized use, transfer or disclosure of such
information or inventions.
 
     The Company holds several registered trademarks in the U.S. and a number of
foreign countries and vigorously pursues the protection of its trademarks and
service marks, whether registered or not.
 
GOVERNMENT REGULATION
 
     The Company's manufacturing activities and most products sold in the U.S.
are subject to extensive and rigorous regulations by the FDA and by comparable
agencies in certain other countries where these products are manufactured and/or
distributed. The FDA regulates the manufacture, clinical research and sale of
medical devices, including labeling, advertising and recordkeeping. Before a new
device can be introduced into the market, generally the manufacturer must obtain
FDA approval of a premarket approval ("PMA") or clearance of a 510(k)
notification 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. The PMA
application must contain the results of clinical trials, the results of all
relevant bench tests, laboratory and animal studies, a complete description of
the device and its components, and a detailed description of the methods,
facilities and controls used to manufacture the device. The FDA's review of a
PMA application generally takes one to two years from the date the PMA is
accepted for filing, but it may take significantly longer. The review time is
often significantly extended by FDA requests for additional information or
clarification of information already provided in the submission. Modifications
to a device that is the subject of an approved PMA, its labeling or
manufacturing process may require approval by the FDA of PMA supplements or new
PMAs. The PMA process can be expensive, uncertain and lengthy, and
 
                                       10
<PAGE>   12
 
a number of devices for which FDA approval has been sought by other companies
have never been approved for marketing.
 
     If human clinical trials of a device are required in order to obtain
adequate safety, performance and/or efficacy data, and the device presents a
"significant risk" to the patient, 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 the study protocol is approved by 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 U.S. 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 be submitted and approved by the FDA and appropriate
IRB(s) 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.
 
     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 it is deemed substantially
equivalent to a predicate device or that additional information is needed before
a substantial equivalence determination can be made.
 
     The majority of the Company's products are classified as Class III medical
devices, which require pre-market approval from the FDA. All of the Company's
products described in "Products," other than Hylaform gel, have been approved or
cleared for sale in the U.S. Refinity skin solutions are regulated as cosmetic
products in the U.S. Products for which medical market applications have not yet
been approved by the FDA may only be exported from the U.S. with the appropriate
regulatory approval(s). There can be no assurance that the FDA will choose to
designate future products as medical devices or cosmetics rather than drugs,
biologics or combination products. Any such change in FDA designation would
potentially lengthen and increase the cost and complexity of the approval
process.
 
     The Company's clinical research program for medical devices has been and
remains subject to the IDE regulations of the FDA. These regulations govern many
important aspects of the clinical investigation of medical products, including
obtaining informed consent from clinical subjects, securing the approval of an
IRB and maintaining required documentation relating to the conduct of the
investigational study. In addition, these regulations may require that the
Company obtain approval from the FDA prior to the commencement of clinical
investigations of new products or of expanded applications of commercially
available products.
 
     Compliance with the current Quality Systems Regulations ("QSR"), formerly
Good Manufacturing Practices, is necessary to receive FDA approval to market new
products and to continue to market current products. Manufacturers of medical
devices for marketing in the U.S. are required to adhere to applicable
regulations setting forth detailed QSR requirements, which include testing,
control and documentation requirements. Manufacturers must also comply with
Medical Device Reporting ("MDR") requirements that a company report 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, would be likely to cause or contribute to death or serious
injury. Labeling and promotional activities are subject to scrutiny by the FDA
and, in certain circumstances, by the Federal Trade Commission. FDA enforcement
policy prohibits the marketing of approved medical devices for unapproved uses.
 
     The Company is registered with the FDA as a manufacturer of medical
devices. The Company is subject to routine inspection by the FDA and certain
state agencies for compliance with QSR requirements, MDR
                                       11
<PAGE>   13
 
requirements and other applicable regulations. The Company's facilities and
manufacturing processes have been inspected periodically by the State of
California and other agencies, and remain subject to audit from time to time.
The Company believes that it is in substantial compliance with all applicable
federal and state regulations. Nevertheless, there can be no assurance that the
FDA or a state agency will agree with the Company's position, or that its QSR
compliance will not be challenged at some subsequent point in time. Enforcement
of QSR has increased significantly in the last several years and the FDA has
stated publicly that compliance will be scrutinized more strictly. In the event
that the Company is determined to be in noncompliance with FDA regulations, to
the extent that the Company is unable to convince the FDA or state agency of the
adequacy of its compliance, the FDA or state agency has the power to assert
penalties or remedies, including injunction or temporary suspension of shipment
until compliance is achieved. Noncompliance may also lead to a recall of
product. Such penalties or remedies could have a materially adverse effect on
the Company's business, financial condition and results of operations.
 
     The continuing trend of more stringent FDA oversight in product clearance
and enforcement activities has caused medical device manufacturers to experience
longer approval cycles, more uncertainty, greater risk and higher expenses.
Failure to obtain, or delays in obtaining, the required regulatory approvals for
new products could adversely affect the Company, as could product recalls. In
addition, there can be no assurance that the FDA will give approval to the
Company to market its current products for broader or different applications, or
that it will grant approval with respect to separate product applications which
represent extensions of the basic collagen technology, or that existing
approvals will not be withdrawn.
 
     In the U.S., health care providers that purchase medical devices, such as
Contigen implant, generally rely on third-party payors, principally federal
Medicare, state Medicaid and private health insurance plans to reimburse all or
part of the cost of the procedure in which the device is used. Such
reimbursement is typically made at a fixed rate. Changes in reimbursement
policies could have an economic impact on the purchase and use of medical
devices. Although the Company's aesthetic products are not generally subject to
reimbursement, a material decrease in current reimbursement levels for treatment
of ISD could have a material adverse effect on sales of Contigen implant and on
the Company's business.
 
     Sales of medical devices outside the U.S. are subject to regulatory
requirements that vary widely from country to country. The time required to
obtain clearance required by countries may be longer or shorter than that
required for FDA clearance, and requirements for such clearances may differ
significantly from FDA requirements. Some countries have historically permitted
human studies earlier in the product development cycle than regulations in the
U.S. permit. Other countries, such as Japan, have requirements similar to those
of the U.S. This disparity in the regulation of medical devices may result in
more rapid product clearance in certain countries than in others.
 
     The primary regulatory environment in Europe is that of the EC which
consists of more than 15 countries encompassing most of the major countries in
Europe. Certain other countries, such as Switzerland, have voluntarily adopted
laws and regulations that mirror those of the EC with respect to medical
devices. The EC has adopted numerous directives and standards regulating the
design, manufacture, clinical trial, labeling, and adverse event reporting for
medical devices. The principal directives prescribing the laws and regulations
pertaining to medical devices in the EC are found in the European Medical
Devices Directive, 93/42/EC.
 
     Devices that comply with requirements of a relevant directive will be
entitled to bear CE conformity marking, indicating that the device conforms with
the essential requirements of the applicable directive and, accordingly, can be
commercially distributed throughout the EC. The method of assessing conformity
varies depending on the class of the product, but normally involves a
combination of self-assessment by the manufacturer and a third-party assessment
by a Notified Body. This third-party assessment may consist of an audit of the
manufacturer's quality system, review of a technical file and specific testing
of the manufacturer's products. An assessment by a Notified Body in one country
within the EC is required in order for a manufacturer to commercially distribute
the product throughout the EC. There can be no assurance that the Company will
be successful in meeting the European quality standards or other certification
requirements. The Company's Zyderm implants and Zyplast implant received CE Mark
on June 23, 1995, Contigen implant
 
                                       12
<PAGE>   14
 
received CE Mark on October 26, 1995, Hylaform gel received CE Mark on November
2, 1995 and SoftForm received CE Mark in September 22, 1997.
 
     While no additional pre-market approvals for individual EC countries are
required prior to the marketing of a device bearing CE Mark, practical
complications with respect to market introduction may occur. For example
differences among countries have arisen with regard to labeling requirements.
 
     Unapproved devices subject to the PMA requirements generally must receive
prior FDA export approval unless they are approved for use by any member country
of the EC and certain other countries, including Australia, Canada, Israel,
Japan, New Zealand, Switzerland and South Africa, in which case they can be
exported to any country without prior FDA approval upon meeting certain
requirements. Exports of products subject to the 510(k) notification
requirements, but not yet cleared to market, are permitted without FDA export
approval provided certain requirements are met. However, the Company must, among
other things, notify the FDA and meet the importing country's requirements.
There can be no assurance that the Company will receive FDA export approval when
such approval is necessary, or that countries to which the devices are to be
exported will approve the devices for import. Failure of the Company to receive
import approval from other countries, or to obtain Certificates for Products for
Export when required, or to meet FDA's export requirements or to obtain FDA
export approval when required to do so, could have a material adverse effect on
the Company's business, financial condition and results of operations.
 
EMPLOYEES
 
     As of September 1, 1998, the Company employed 280 employees, of whom 11
were engaged in medical affairs and regulatory affairs, 97 of whom were engaged
in sales and marketing, 94 of whom were involved in production and quality
control and 79 of whom were engaged in finance and administration. None of the
Company's employees is covered by a collective bargaining agreement.
 
EXECUTIVE OFFICERS
 
     The following table sets forth the names, ages and positions of the
executive officers of the Company as of September 1, 1998:
 
<TABLE>
<CAPTION>
           NAME             AGE                       POSITION(S)
           ----             ---                       -----------
<S>                         <C>    <C>
Gary S. Petersmeyer.......  51     President, Chief Executive Officer and Director
William Dimmer............  54     Vice President, Human Resources & Administrative
                                   Services
Charlene Andros             41     Vice President, General Counsel
  Friedman................
Norman L. Halleen.........  45     Vice President, Finance and Chief Financial
                                   Officer
Reinhard Koenig, M.D. ....  38     Vice President, Medical/Regulatory Affairs,
                                   Worldwide
Rebecca A. Stirn..........  45     Vice President, North American Marketing Strategy
</TABLE>
 
     Mr. Petersmeyer joined the Company as President, Chief Operating Officer
and a director of the Company in February 1995. In February 1997, Mr.
Petersmeyer became the Company's Chief Executive Officer. Prior to joining the
Company, Mr. Petersmeyer was employed by Syntex Corporation, a manufacturer of
pharmaceutical products, from 1991 to January 1995, where he served as Vice
President of Managed Health Care from March 1993 to January 1995, as well as
serving at various times as National Sales Director and Director of Corporate
Development. From 1986 to 1990, he served as President and Chief Executive
Officer of Beta Phase, Inc., a medical device manufacturer, and from 1982 to
1986, he was the Executive Vice President and General Manager, Ophthalmic
Products Division, of CooperVision, Inc., a manufacturer and distributor of
ophthalmic products.
 
     Mr. Dimmer joined the Company as Vice President, Human Resources and
Administrative Services in July 1998. Prior to joining the Company, Mr. Dimmer
was Principal/Consultant for PRAGMA International from April 1994 to June 1998.
From January 1991 to April 1994, he was Vice President of Human Resources for
JAMONT, S.A. in Brussels, Belgium. Mr. Dimmer was Director of Human Resources
for Syntex
 
                                       13
<PAGE>   15
 
Pharmaceutical Corporation from April 1982 to December 1991, located in
Maidenhead, England and Palo Alto, California.
 
     Ms. Friedman joined the Company as General Counsel and Assistant Secretary
in February 1996. Prior to joining Collagen, Ms. Friedman practiced law for
thirteen years, representing corporate and individual clients in the litigation
of product liability, commercial and general liability cases. Ms. Friedman
joined Collagen from the law firm of Lillick & Charles in San Francisco. From
1993 to 1995, she practiced with Warner & Stackpole in Boston. Ms. Friedman
practiced at Murphy, DeMarco & O'Neill, Boston from 1983 through 1993. She is a
member of the California and Massachusetts bars.
 
     Mr. Halleen joined the Company as Vice President, Finance and Chief
Financial Officer in February 1997. From July 1989 to January 1997, Mr. Halleen
ran his own business as a finance consultant in Hong Kong. In addition, from
October 1993 through June 1996, he served as Chief Financial Officer of the
Dutra Group, a privately held company in the construction/marine dredging
business. Subsequent to Mr. Halleen leaving the Dutra Group, the Dutra Group
filed an application for reorganization under Chapter 11 under the U.S.
Bankruptcy Court, Northern District of California in January 1997. Prior to July
1989, he was employed for 10 years with Syntex Corporation, serving in various
positions, including Regional Director of Finance for the Asia/Pacific region.
 
     Dr. Koenig joined the Company as Vice President, Medical Affairs, Worldwide
in October 1996. From May 1995 until October 1996, he was employed by Genentech,
Inc., a manufacturer of biotechnology products as the Director, Medical
Information and Drug Experience. From January 1989 until May 1995, Dr. Koenig
was employed by Boehringer Mannheim Therapeutics in Germany and the U.S. in
various positions in medical affairs and clinical research, including the
position of Director, Medical Affairs.
 
     Ms. Stirn joined the Company as Vice President, Global Marketing Strategy
in January 1996. In January 1998, Ms. Stirn became Vice President, North
American Marketing Strategy. Prior to joining the Company, Ms. Stirn provided
consulting services to the Company from March 1995 to December 1995. From
January 1988 to February 1995, Ms. Stirn consulted and served on the board of
directors for several non-profit institutions. From September 1986 to December
1987, Ms. Stirn served as Vice President of Marketing at CEMAX, Inc., a company
engaged in three-dimensional medical imaging and computer-aided design of custom
implants. From June 1981 to October 1985, Ms. Stirn was employed by
CooperVision, Inc. While employed by CooperVision, Inc., Ms. Stirn served as
Vice President of Marketing, Optics Division and in various other marketing
positions.
 
ITEM 2. PROPERTIES
 
     The Company's principal executive, marketing, and research activities are
located at 1850 Embarcadero Road, Palo Alto, California. The Company has
subleased this property from Cohesion under a lease that expires June 30, 1999
and contains a renewal option. The Company's international facilities, which
amount to approximately 20,000 square feet in total, are leased under various
leases which contain renewal options.
 
     In 1989, the Company completed a sale-leaseback transaction relating to its
50,000 square foot manufacturing facility in Fremont, California. The facility
lease term extends for fifteen years with four five-year renewal options. The
Company commenced commercial manufacturing in this facility in November 1990. In
addition, the Company leases approximately 11,000 square feet of warehouse space
in Fremont, California.
 
     The Company continues to be committed under various leases for the 20,000
square foot facility located in Neuchatel, Switzerland for its discontinued
breast implant business, LipoMatrix, until June 30, 2001. The Company has
included in its $11.0 million (before taxes) provision for the disposal of
LipoMatrix $900,000 for future lease commitments and estimated restoration
expense for this facility. The Company is actively seeking to sublease this
facility.
 
     The Company believes that its facilities are adequate to meet its
requirements for at least the next twelve months.
 
                                       14
<PAGE>   16
 
ITEM 3. LEGAL PROCEEDINGS
 
     The Company is involved in various legal actions arising in the ordinary
course of business, the majority of which involve product liability claims
alleging personal injuries as a result of injectable products. While the outcome
of such matters is currently not determinable, it is management's opinion that
these matters, including the matters discussed below, will not have a material
adverse effect on the Company's business, results of operations or financial
condition.
 
     The Company faces an inherent business risk of exposure to product
liability claims alleging that the use of the Company's technology or products
has resulted in adverse effects. Such risks will exist even with respect to
those products that have received or in the future may receive regulatory
approval for commercial sale. There can be no assurance that the Company will
avoid significant product liability claims and negative publicity in the future.
Furthermore, there can be no assurance that present insurance coverage will be
adequate or that adequate insurance coverage will remain available at acceptable
costs, if at all, or that a product liability claim or recall would not
adversely affect the future business or financial condition of the Company. It
is possible that adverse product liability actions could negatively affect the
Company's ability to obtain and maintain regulatory approval for its products.
 
ITEM 4. RESULTS OF VOTES BY SECURITY HOLDERS
 
     No matters were submitted to a vote of stockholders of Collagen Corporation
during its fourth fiscal quarter ended June 30, 1998.
 
                                       15
<PAGE>   17
 
                                    PART II
 
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
 
MARKET FOR COMMON STOCK
 
     The Company's Common Stock is traded on The Nasdaq Stock Market under the
symbol CGEN. The following table presents the high and low sale prices (prior to
the Spinoff of Cohesion Technologies, Inc.) for the Company's Common Stock for
each fiscal quarter for the fiscal years ended June 30, 1998 and 1997 as
reported by The Nasdaq Stock Market Summary of Activity(TM).
 
<TABLE>
<CAPTION>
                                          FISCAL YEAR ENDED JUNE 30,
                                      -----------------------------------
                                            1998               1997
                                      -----------------   ---------------
           QUARTER ENDED               HIGH       LOW      HIGH     LOW
           -------------              -------   -------   ------   ------
<S>                                   <C>       <C>       <C>      <C>
September 30........................  $19.875   $16.625   $20.25   $16.50
December 31.........................   20.875     18.00    21.50    18.00
March 31............................   22.125     16.75    26.00    18.25
June 30.............................    22.00     17.75    19.75    13.75
</TABLE>
 
HOLDERS OF RECORD
 
     At September 4, 1998 there were approximately 839 holders of record of the
Company's Common Stock.
 
DIVIDENDS
 
     The Company declared a cash dividend of $.10 per share on its common stock
payable to stockholders of record on June 30, 1998, in addition to a $.10 per
share dividend declared and paid earlier in fiscal 1998. In fiscal 1997, the
Company declared a cash dividend of $.10 per share on its common stock payable
to stockholders of record on June 30, 1997, in addition to a $.10 per share
dividend declared and paid earlier in fiscal 1997. While the Company does not
expect to pay dividends in the near future, the Board of Directors will
re-evaluate the Company's dividend policy on a semi-annual basis.
 
                                       16
<PAGE>   18
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                                     YEARS ENDED JUNE 30,
                                --------------------------------------------------------------
                                1998(1)       1997(1)       1996(1)       1995(1)      1994(1)
                                --------      --------      --------      -------      -------
                                           (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                             <C>           <C>           <C>           <C>          <C>
OPERATING RESULTS
Revenues......................  $ 82,772      $ 68,335      $ 68,285      $72,560      $65,552
Research and development
  expenses....................    22,715        14,087         9,175        9,943        9,366
Operating income (loss) (2)...   (18,564)       (1,767)        6,589       11,854        8,607
Gain from investments, net
  (1).........................    19,096        24,458        82,093        5,110           --
Net income (loss).............   (14,083)        7,371        26,652        8,760        4,920
Net income (loss) per share --
  Basic:
  Continuing operations.......  $  (0.21)     $   1.68      $   5.66      $  1.20      $  0.63
  Discontinued operations.....     (1.37)        (0.84)        (2.67)       (0.26)       (0.12)
                                --------      --------      --------      -------      -------
       Net income (loss) per
          share -- Basic......  $  (1.58)(3)  $   0.84(3)   $   2.99(3)   $  0.94(3)   $  0.51(3)
                                ========      ========      ========      =======      =======
Shares used in calculating
  income (loss) per share
  information -- Basic........     8,913         8,804         8,915        9,270        9,592
Net income (loss) per share --
  Diluted:
  Continuing operations.......  $  (0.21)     $   1.66      $   5.56      $  1.18      $  0.62
  Discontinued operations.....     (1.37)        (0.83)        (2.62)       (0.25)       (0.12)
                                --------      --------      --------      -------      -------
       Net income (loss) per
          share -- Diluted....  $  (1.58)     $   0.83      $   2.94      $  0.93      $  0.50
                                ========      ========      ========      =======      =======
Shares used in calculating
  income (loss) per share
  information -- Diluted......     8,913         8,930         9,075        9,460        9,896
FINANCIAL POSITION
Cash, cash equivalents and
  short-term investments......  $ 15,927      $ 23,498      $ 25,367      $ 9,384      $12,736
          Total assets........   166,339       184,640       163,007       76,906       74,505
Long-term obligations
  excluding minority
  interest....................    31,982        39,126        31,118        9,972        9,507
          Total stockholders'
            equity............   100,640       120,085       103,008       47,920       49,082
ADDITIONAL INFORMATION
Repurchase of common stock....  $  2,253      $  2,546      $  5,510      $11,282      $13,847
Cash dividends declared per
  share.......................      0.20          0.20          0.18         0.15         0.10
</TABLE>
 
---------------
(1) In the first five months of fiscal 1996 and in fiscal 1995 and 1994,
    financial information is presented with Target Therapeutics, Inc. ("Target")
    accounted for under the equity method. In January 1997, Boston Scientific
    and Target jointly announced the signing of a definitive agreement to merge
    in a tax-free stock-for-stock transaction. Gains from sales of portions of
    the Company's investment in Boston Scientific (formerly Target) contributed
    $20.4 million, $9.2 million, $85.8 million, and $6.0 million to fiscal years
    1998, 1997, 1996, and 1995 pre-tax earnings, respectively. In addition, in
    fiscal 1997, the Company recorded an additional $15.4 million, resulting
    from the sale of its holdings in Prograft to W.L. Gore and Associates, Inc.
 
(2) Includes in-process research and development charges of $10.6 and $3.0
    million in fiscal years 1998 and 1996, respectively.
 
(3) Includes effect of adopting Statement of Financial Accounting Standard No.
    128 ("SFAS 128"). The adoption of SFAS 128 resulted in no significant impact
    for fiscal years 1998, 1997, 1996, 1995 and 1994.
 
                                       17
<PAGE>   19
 
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
       OF OPERATIONS
 
     The following discussion describes the financial condition and results of
operations of Collagen Aesthetics, Inc. (formerly known as Collagen Corporation
for fiscal 1998) before the Spinoff of Cohesion Technologies, Inc. ("Cohesion")
on August 18, 1998.
 
THE COMPANY
 
     Except for historical information contained herein, the matters discussed
in this report are forward-looking statements, the accuracy of which is
necessarily subject to risks and uncertainties. These risks include among
others, the timing of product introductions, receipt of regulatory approvals,
clinical efficacy of and market demand for products, product development cycles,
results of clinical studies, development and rate of growth of new markets,
potential unfavorable publicity regarding the Company or their respective
products and possible reversal of sales among other matters discussed in this
report. Actual results are subject to risks and uncertainties and actual events
and results may differ significantly from the discussion of such matters in the
forward-looking statements. Such differences may be based upon factors within
the Company's control, such as strategic planning decisions by management and
reallocation of internal resources, or on factors outside of the Company's
control, such as scientific advances by third parties, introduction of
competitive products and delays by regulatory and tax authorities, and those in
the Company's 1998 Proxy Statement for Special Meeting of Stockholders and
factors set forth under the heading "Factors That May Affect Future Results of
Operations."
 
     The Company designs, develops, manufactures and markets on a worldwide
basis biomedical devices for the treatment of defective, diseased, traumatized
or aging human tissues. The Company's core products are used principally in
facial aesthetic applications, the treatment of stress urinary incontinence, and
bone repair. The Company markets its facial aesthetic products directly and
through a network of international distributors and its stress urinary
incontinence and bone repair products through marketing partners.
 
SPINOFF AND NAME CHANGE
 
     In October 1997, the Company announced that it would proceed to separate
its Aesthetic Technologies Group and its Collagen Technologies Group into two,
independent, publicly-traded companies. In December 1997, the Company purchased
substantially all of the remaining outstanding shares of Cohesion Corporation
and integrated Cohesion Corporation into the Company's Collagen Technologies
Group. The Collagen Technologies Group was spun off as a separate company on
August 18, 1998, named Cohesion Technologies, Inc., to Collagen Corporation
stockholders via a tax-free distribution. On August 12, 1998, the stockholders
of the Company approved a corporate name change from Collagen Corporation to
Collagen Aesthetics, Inc. which better reflects the Company's focus on serving
the facial aesthetic medical marketplace. The Spinoff was designed to separate
two distinct businesses with significant differences in their markets, products,
research needs, investment needs, employee retention and compensation plans and
plans for growth. The Company's Board believed the separation into two
independent companies would enhance the ability of each to focus on strategic
initiatives and new business opportunities, improve cost structures and
operating efficiencies and create incentives that are more attractive and
appropriate for the recruitment and retention of key employees. As a
consequence, the Company believes that investors will be able to evaluate better
the merits of the two groups of businesses and their future prospects.
 
     Based on the approved Spinoff, the Company anticipates that cost of sales
as a percentage of sales will increase slightly as a result of introducing new
product line extensions, with higher costs per unit, partially offset by lower
manufacturing costs per unit for collagen-based injectable products. The Company
expects lower SG&A spending, lower R&D spending, and higher interest income in
fiscal 1999. The Company does not expect to record any significant gains or
losses on investments since substantially all investments in affiliates,
including Boston Scientific Corporation ("Boston Scientific") and Innovasive
Devices, Inc. ("Innovasive Devices") were allocated to Cohesion.
 
                                       18
<PAGE>   20
 
DISCONTINUED OPERATIONS
 
     On June 30, 1998, the Board of Directors of the Company approved the
discontinuation of the operations of LipoMatrix of Neuchatel, Switzerland, and
authorized efforts to sell the wholly-owned subsidiary, thereby allowing the
Company's aesthetic operations to dedicate further resources to its core
business which includes products for soft tissue reconstruction and
augmentation, skin care and stress urinary incontinence.
 
     The Company recorded net losses from the discontinued operations of $5.3
million, $9.1 million, and $24.7 million in fiscal years 1998, 1997 and 1996,
respectively. Further, a provision of $8.6 million, net of an income tax benefit
of $2.5 million, has been recorded in fiscal 1998 for the loss on disposal of
net assets of LipoMatrix including estimated future costs. The Company expects
to dispose of the assets by December 31, 1998.
 
INVESTMENTS AND ACQUISITIONS
 
     The Company increased its ownership position in Cohesion Corporation of
Palo Alto, California from approximately 81% to 99% in December 1997 and
integrated Cohesion Corporation into the Company's Cohesion Technologies Group.
Cohesion Corporation is a privately-held company developing proprietary products
for hemostasis and tissue adhesion, biosealants and adhesion prevention barriers
for surgical applications. In connection with the Company's December 1997
investment in Cohesion Corporation, $10.5 million of the purchase price was
allocated to in-process research and development, which was expensed at the time
of the investment. The Company will provide minimal R&D support to Cohesion as
needed. The $10.5 million December 1997 purchase price includes cash
compensation amounts of approximately $3.8 million associated with the purchase
of certain vested employee stock options. Cohesion determined the amounts to be
allocated to in-process technology for Cohesion Corporation based on whether
technological feasibility had been achieved and whether there was any
alternative future use after taking into consideration the potential for both
usage of the technology in different products and for resale of the technology.
The products and programs related to the in-process technology acquired are
currently in the clinical trial and pre-clinical trial stages, respectively. The
Company acquired in-process technology related to surgical hemostasis and
sealing products under development, which utilized liquid-based biomaterials and
related delivering systems. Cohesion Technologies expects to benefit from the
in-process technology within the next three years, provided that sufficient
pre-clinical and clinical data has been generated, submitted to regulatory
authorities, and cleared for commercial sale by those regulatory authorities.
 
     Seeking to capitalize on recent technical successes in expressing
recombinant collagen in mouse milk, in February 1996, the Company made an
additional equity investment of approximately $4.5 million in Pharming, B.V. of
The Netherlands ("Pharming"), bringing the Company's ownership percentage in
Pharming to approximately 12%. At June 30, 1998 the Company's ownership position
in Pharming was approximately 6%, which included an additional $2.5 million
invested in fiscal 1998. Pharming is dedicated to the development and worldwide
commercialization of human health care products produced in transgenic animals.
The Company and Pharming will attempt to produce collagen in the milk of
transgenic cattle.
 
                                       19
<PAGE>   21
 
RESULTS OF OPERATIONS
 
     The following table shows, for the periods indicated, the percentage
relationship to product sales of certain items in the Consolidated Statements of
Operations.
 
<TABLE>
<CAPTION>
                                                          PERCENT OF PRODUCT SALES
                                                         --------------------------
                 YEARS ENDED JUNE 30,                     1998      1997      1996
                 --------------------                    ------    ------    ------
<S>                                                      <C>       <C>       <C>
Product sales..........................................    100%      100%      100%
Other revenue..........................................     --        --         3%
                                                          ----       ---       ---
Costs and expenses:
  Cost of sales........................................     29%       25%       24%
  Selling, general and administrative..................     51%       57%       51%
  Research and development.............................     27%       21%       14%
  Restructuring expense................................      2%       --        --
  Purchased in-process research and development........     13%       --         5%
                                                          ----       ---       ---
Income (loss) from operations..........................   (22)%      (3)%       10%
                                                          ----       ---       ---
</TABLE>
 
     PRODUCT SALES. Product sales of $82.8 million in fiscal 1998 increased
$14.5 million or 21% versus fiscal 1997 sales of $68.3 million, compared to a
$2.0 million or 3% increase from fiscal 1996 sales of $66.3 million. The $14.5
million increase in fiscal 1998 over fiscal 1997 was due primarily to an
increase in revenue from direct sales of Contigen(R) Bard collagen implant
("Contigen implant"), to physician customers by C.R. Bard, Inc. ("Bard"), the
introduction of SoftForm(TM) facial implant ("SoftForm implant"), an increase in
international sales of Hylaform(R) viscoelastic gel ("Hylaform gel") and an
increase in U.S. sales of injectable collagen products, partially offset by a
decrease in international sales of injectable collagen products and a decrease
in sales of Collagraft(R) bone graft matrix implant and Collagraft(R) bone graft
matrix strip ("Collagraft bone graft products") to the Company's marketing
partner, Zimmer. The $2.0 million increase in fiscal 1997 over fiscal 1996 was
due primarily to an increase in revenue from direct sales of Contigen implant to
physician customers by Bard, the Company's marketing partner for Contigen
implant, an increase in both international and U.S. sales of injectable collagen
products and the introduction of Hylaform gel, partially offset by a decrease in
sales of Collagraft bone graft products.
 
     Worldwide sales of facial aesthetic products in fiscal 1998 were $63.0
million or 9% higher than fiscal 1997 sales of $57.9 million, compared to a 3%
increase in fiscal 1997 from fiscal 1996 sales of $56.5 million. The $5.1
million increase in worldwide sales of facial aesthetic products in fiscal 1998
resulted from a corresponding 9% increase in units sold. The Company believes
the increase in facial aesthetic products sales primarily was due to the
introduction of SoftForm implant, a full year of HylaForm gel sales, and the
continuation of U.S. marketing programs designed to increase average treatment
volume per patient and to attract and retain new and existing patients, the
implementation of a new sales incentive program for its sales force, and contact
made with physicians not previously purchasing collagen injectable products as a
result of the introduction of SoftForm implant. The $1.4 million increase in
worldwide sales of facial aesthetics products in fiscal 1997 over fiscal 1996
resulted from an 8% increase in units sold, partially offset by decreases in
average sales prices. The Company believes that the improved unit performance in
fiscal 1997 over 1996 resulted from the implementation of marketing programs in
the United States designed to increase average treatment volume per patient for
injectable collagen products and to attract and retain new and existing
patients, the addition of Hylaform gel, which was launched in Europe in November
1996, and strong distributor sales. Exchange rates unfavorably impacted
international sales in United States dollars by $2.3 million and $1.1 million in
fiscal 1998 and 1997, respectively, and favorably affected international sales
by $457,000 in fiscal 1996. The Company anticipates continued growth in
worldwide sales of plastic surgery and dermatological products in United States
dollars during fiscal 1999.
 
                                       20
<PAGE>   22
 
     Revenue recorded from Contigen implant sales was $17.7 million in fiscal
1998 or 124% higher than fiscal 1997 sales of $7.9 million, compared to an
increase of $1.7 million or 27% from fiscal 1996 sales of $6.2 million. Revenue
recorded from Contigen implant sales over the three year period included:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED JUNE 30,
                                                              ---------------------
                                                              1998     1997    1996
                                                              -----    ----    ----
                                                                  (IN MILLIONS)
<S>                                                           <C>      <C>     <C>
Shipments of Contigen implant to Bard.......................  $10.4    $1.2    $0.3
Income from Bard's direct sales to physician customers......    7.3     6.7     5.9
                                                              -----    ----    ----
                                                              $17.7    $7.9    $6.2
                                                              =====    ====    ====
</TABLE>
 
     The $9.8 million increase in fiscal 1998 over fiscal 1997 was due to
increases in shipments of Contigen implant to Bard. The $1.7 million increase in
fiscal 1997 over fiscal 1996 was due to the resumption of shipments of Contigen
implant to Bard during the fourth quarter of fiscal 1997 in accordance with the
Company's sales agreement with Bard. The Company expects that revenues from
Contigen implant sales in fiscal 1999 will be similar to sales in fiscal 1998.
 
     A number of uncertainties exist surrounding the marketing and distribution
of Contigen implant. The Company's primary means of distribution for this
product is through a third party firm -- Bard. The Company's business and
financial results could be adversely affected in the event that Bard is unable
to market the product effectively, anticipate customer demand accurately, or
effectively manage industry-wide pricing and cost containment pressures in
health care.
 
     Sales of Collagraft bone graft products in fiscal 1998 were $1.5 million,
22% lower than fiscal 1997 sales of $1.9 million, compared to a $1.2 decrease in
fiscal 1997 from fiscal 1996 sales of $3.1 million. The $0.4 million decrease in
fiscal 1998 over fiscal 1997 and the $1.2 million decrease in fiscal 1997 over
1996 was due to lower sales by Zimmer and a consequent decrease in shipments
from the Company. Sales of Collagraft were transferred to Cohesion Technologies
as a result of the Spinoff in August 1998.
 
     OTHER REVENUE. Other revenue in fiscal year 1996 consisted of a milestone
payment of $2.0 million from Bard in accordance with the Company's agreement
with Bard. The final milestone payment of $2.0 million was paid to the Company
on September 30, 1995.
 
     COST OF SALES. Cost of sales as a percentage of product sales averaged 29%,
25% and 24% in fiscal years 1998, 1997 and 1996, respectively. The higher cost
of sales as a percentage of product sales in fiscal 1998 over 1997 and 1997 over
1996 primarily was due to the introduction of product line extensions from third
parties, Hylaform gel in fiscal 1997, SoftForm implant in fiscal 1998 and
increased direct sales of Contigen implant to physician customers by Bard in
fiscal 1997 also contributed to increases. Both Hylaform gel and SoftForm
implant are manufactured by third parties and Contigen implant is distributed by
a third party and as a result these products are sold at a lower margin.
 
     SG&A. Selling, general and administrative ("SG&A") expenses totaled $42.5
million in fiscal 1998, $38.8 million in fiscal 1997 and $33.7 million in fiscal
1996, representing 51%, 57%, and 51% of product sales, respectively. The $3.7
million, or 10%, increase in fiscal 1998 over fiscal 1997 was primarily due to
expenses related to the separation of the Aesthetic Technologies Group and
Cohesion Technologies, Inc., marketing costs related to SoftForm implant and
Hylaform gel and sales commissions which more than offset the expenses incurred
in fiscal 1997 to prepare for trial in the Company's trade secret lawsuit
against Matrix Pharmaceuticals. SG&A expenses increased $5.1 million, or 15%, in
fiscal 1997 over fiscal 1996, due primarily to payments made to the Company's
former Chief Executive Officer, Howard Palefsky, in accordance with Mr.
Palefsky's separation agreement and costs associated with existing loans to Mr.
Palefsky, legal expenses incurred in connection with the Matrix lawsuit, and
higher international sales and marketing costs associated with the commercial
introduction of Hylaform gel.
 
     R&D. R&D expenses, which include expenditures for regulatory compliance,
were $22.7 million in fiscal 1998, $14.1 million in fiscal 1997 and $9.2 million
in fiscal 1996. The $8.6 million increase in R&D spending in fiscal 1998 over
fiscal 1997 was primarily attributable to the ramp up of expenses to support
programs,
 
                                       21
<PAGE>   23
 
including clinical trials, for CoSeal and Costatis(TM) Hemostat Device and the
ramp-up of the recombinant program. The $4.9 million increase in R&D spending in
fiscal 1997 over fiscal 1996 was primarily attributable to the inclusion of a
full year of R&D expenses for Cohesion Corporation as a result of the Company
increasing its ownership percentage to 81% in June 1996.
 
     PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT. The charge for purchased
in-process research and development ("in-process R&D") of $10.6 million in
fiscal 1998 was due to the non-recurring charge related to the purchase of
substantially all of the remaining shares of Cohesion Corporation, including the
purchase of certain vested employee stock options.
 
     INCOME (LOSS) FROM OPERATIONS. The operating loss was $18.6 million in
fiscal 1998 and $1.8 million in fiscal 1997, compared to operating income of
$6.6 million in fiscal 1996. The loss in fiscal 1998 primarily was due to
acquired in-process R&D, representing the purchase of substantially all of the
remaining shares of Cohesion Corporation, the ramp-up of R&D expenses to support
planned development programs, including clinical trials for Costasis(TM)
hemostat and Coseal, the ramp-up of the Company's human collagen recombinant
program, and expenses related to the separation of the Aesthetic Technologies
Group and Cohesion Technologies, Inc., partially offset by higher Contigen
implant sales and sales from product line extensions. The loss in fiscal 1997
was due primarily to the inclusion of the operating results of Cohesion
Corporation, expenses in connection with the Matrix lawsuit and a charge for
officer separation costs. The income in fiscal 1996 was due primarily to other
revenue recorded (consisting of a $2.0 million milestone payment received from
Bard), higher Collagraft sales and lower R&D and SG&A expenses, partially offset
by the acquisition-related, non-recurring in-process R&D charge of $3.0 million
related to Cohesion Corporation.
 
     IMPACT OF FOREIGN EXCHANGE RATES. The impact of foreign exchange rates from
fiscal 1997 to fiscal 1998 resulted in a decrease in revenue of approximately
$2.3 million and a decrease in operating expenses of approximately $2.6 million,
resulting in a net increase in operating income of approximately $300,000 on an
equivalent local currency basis. The impact of foreign exchange rates from
fiscal 1996 to fiscal 1997 resulted in a decrease in revenue of approximately
$1.1 million and a decrease in operating expenses of approximately $1.7 million,
resulting in a net increase in operating income of approximately $600,000 on an
equivalent local currency basis.
 
     Until December 1994, the Company's policy was to hedge material foreign
currency transaction exposures. At June 30, 1998, 1997 and 1996, no foreign
currency transaction exposures were hedged. Unhedged net foreign assets were
$6.5 million, $7.6 million and $14.5 million at June 30, 1998, 1997 and 1996,
respectively. The Company plans to investigate hedging options in fiscal 1999 in
order to minimize the effect of currency fluctuations on the Company's results
of operations.
 
     NET GAIN ON INVESTMENTS, PRINCIPALLY BOSTON SCIENTIFIC (FORMERLY
TARGET). In fiscal 1998, the Company recorded a net pre-tax gain on investments
of $19.1 million, resulting primarily from the sale of 332,340 shares of Boston
Scientific common stock. In fiscal 1997, the Company recorded a net pre-tax gain
on investments of $9.1 million resulting primarily from the sale of 330,000
shares of Target common stock. In fiscal 1996, the Company sold 1,792,000 shares
of common stock of Target and recorded a net pre-tax gain on investments of
$82.1 million (after the recording of a $4.0 million reduction in the carrying
value of certain equity investments due to a decline in value determined to be
other than temporary).
 
     On January 20, 1997, Boston Scientific Corporation of Natick, Massachusetts
("Boston Scientific") and Target jointly announced the signing of a definitive
agreement to merge in a tax-free stock-for-stock transaction. On April 8, 1997,
the merger was completed and, as a result, the Company received approximately
1,365,200 shares of Boston Scientific common stock in exchange for the Company's
1,275,888 shares of Target common stock. Pursuant to the merger agreement, the
Company was restricted from selling its shares of Boston Scientific common stock
until the expiration of applicable pooling-of-interests restrictions, which
occurred during the first quarter of fiscal 1998. The investment in Boston
Scientific was allocated to Cohesion Technologies prior to the Spinoff of
Cohesion Technologies (see Note 17, "Subsequent Events"). To hedge against
fluctuations in the market value of a portion of the Boston Scientific common
stock, the Company entered into costless collar instruments (see Note 5,
"Investment in Boston Scientific Corporation (Target Therapeutics, Inc.")).
                                       22
<PAGE>   24
 
     NET GAIN ON INVESTMENT IN PROGRAFT. In fiscal 1997, the Company recorded an
additional net pre-tax gain on investments of $15.4 million, resulting from the
sale of its holdings in Prograft to W.L. Gore and Associates, Inc.
 
     EQUITY IN EARNINGS/LOSSES OF AFFILIATE COMPANIES. Equity in losses of other
affiliate companies in fiscal 1998 was $0.2 million compared to $1.0 million in
fiscal 1997 and $1.8 million in fiscal 1996. The decrease in equity in other
affiliates' losses in fiscal 1998 over fiscal 1997 primarily was due to minimal
research & development activity at one affiliate company. The decrease in equity
in other affiliates' losses in fiscal 1997 over fiscal 1996 was due primarily to
recording no Cohesion Corporation equity losses as a result of the Company
increasing its ownership percentage to 81% in June 1996.
 
     Equity in earnings of Target was $1.4 million in fiscal 1996. The decrease
in fiscal 1997 over fiscal 1996 in equity in Target's earnings was due to the
Company's ownership percentage falling from approximately 29% at June 30, 1995
to approximately 11% at June 30, 1996. In December 1995, when the Company's
ownership interest fell below 20%, the Company changed from the equity to the
cost method of accounting for its investment in Target.
 
     INTEREST INCOME AND EXPENSE. Interest income was $1.0 million in fiscal
1998, $1.1 million in fiscal 1997 and $1.1 in fiscal 1996. The decrease in
fiscal 1998 over fiscal years 1997 and 1996 was due primarily to lower average
short-term investment balances and lower average interest rates.
 
     Interest expense was $56,000 in fiscal 1998, $473,000 in fiscal 1997 and
$297,000 in fiscal 1996. Interest expense in fiscal 1997 and fiscal 1996 related
primarily to borrowings under the Company's $15 million revolving credit
facility, which was paid in full and canceled in June 1997. (see Note 7 of Notes
to Consolidated Financial Statements). Interest expense in fiscal 1998 decreased
as a result of no outstanding borrowings during the year. The increase in
interest expense in fiscal 1997 over fiscal 1996 was due primarily to a full
year of interest expense on the revolving credit line compared to six months in
fiscal 1996.
 
     INCOME TAXES. The Company recorded a $3.2 million income tax provision on
$1.3 million of pretax income for fiscal 1998. The tax provision resulted
primarily from the in-process research and development expenses related to the
purchase of substantially all of the remaining shares of Cohesion Corporation, a
substantial portion of which in not deductible for income tax purposes. The
effective tax rate was approximately 37% for fiscal 1997 and 44% for fiscal
1996. The higher effective tax rate in fiscal 1996 primarily was due to the
impact of non-deductible items such as losses from foreign subsidiaries and
equity losses in affiliates.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     At June 30, 1998, the Company's cash, cash equivalents and short-term
investments were $15.9 million compared to $23.5 million at June 30, 1997. Net
cash used in operating activities was $5.8 million for fiscal 1998 compared with
$1.3 million in fiscal 1997.
 
     For fiscal 1998, the $5.8 million of net cash used in operating activities
was mainly attributable to $16.3 million of net loss after adjusting for
depreciation and amortization expense, equity in losses (earnings) of affiliate
companies, gain on investments (net of taxes paid) and loss on disposal of fixed
assets, partially offset by the $11.4 million write-down of purchased
intangibles, inventory and property and equipment of discontinued operations.
The $0.4 million of net cash used in investing and the $4.2 million used in
financing activities in fiscal 1998 primarily was due to payments of $12.3
million to purchase short-term investments, capital and intangible asset and
expenditures of approximately $5.0 million, payments of approximately $3.1
million for additional investments in and loans to affiliates, payments of
approximately $2.3 million to repurchase 125,000 shares of the Company's common
stock at an average acquisition price of approximately $18.00 per share,
repayment of bank borrowings of $2.0 million and payment of cash dividends of
approximately $1.8 million to the Company's stockholders in both July 1997 and
January 1998, partially offset by net proceeds of $21.1 million from the sale of
332,340 shares of common stock of Boston Scientific and the Company's holdings
in other affiliate stock, $9.4 million received from the sale of short-term
investments and $1.8 million from the issuance of 180,000 shares of the
Company's common stock.
 
                                       23
<PAGE>   25
 
     The Company anticipates capital expenditures, equity investments in, and
loans to affiliate companies to be approximately $6.2 million in fiscal 1999. In
June 1996, the Board of Directors authorized the Company to repurchase an
additional 500,000 shares of the Company's common stock in the open market, of
which the Company has repurchased 272,900 shares as of June 30, 1998. Subsequent
to June 30, 1998, the Board of Directors approved a continuation of the stock
repurchase program previously approved. Under this program, the Company is
currently authorized to repurchase up to 500,000 shares of its common stock
having an aggregate purchase price not in excess of $5,000,000. In June 1998,
the Board of Directors declared a dividend of ten cents per share for
stockholders of record as of June 30, 1998.
 
     The Company's principal sources of liquidity include cash generated from
operations, and its cash, cash equivalents and short-term investments.
 
     The Company's capital requirements will depend on numerous factors,
including market acceptance and demand for the Company's products; the resources
the Company devotes to the development, manufacture and marketing of its
products; the progress of the Company's clinical research and product
development programs; the extent to which the Company enters into collaborative
relationships with third parties and the scope of the Company's obligations in
such relationships; the receipt of, and the time required to obtain, regulatory
clearances and approvals; the resources required to protect the Company's
intellectual property and other factors. The timing and amount of such capital
requirements cannot be accurately predicted. Funds may also be used for the
acquisition of businesses, products and technologies that are complementary to
those of the Company. The Company believes that its current sources of liquidity
should be adequate to fund its anticipated capital requirements through at least
December 31, 1999. However, during this period or thereafter, the Company may
require additional financing. There can be no assurance that such additional
financing will be available on terms favorable to the Company or at all.
 
     YEAR 2000. The "Year 2000" issue results from the use in computer hardware
and software of two digits rather than four digits to define the applicable
year. When computer systems must process dates both before and after January 1,
2000, two-digit year "fields" may create processing ambiguities that can cause
errors and system failures. The results of these errors may range from minor
undetected errors to complete shutdown of an affected system. These errors or
failures may have limited effects, or the effects may be widespread, depending
on the computer chip, system or software, and its location and function. The
effects of the Year 2000 problem are exacerbated because of the interdependence
of computer and telecommunications systems in the United States and throughout
the world. Because of this interdependence, the failure of one system may lead
to the failure of many other systems even though the other systems are
themselves "Year 2000 compliant."
 
     The Company has reviewed the Year 2000 issue as it may affect the Company's
business activity. The Company is implementing a Year 2000 plan (the "Plan")
which is designed to cover all of the Company's activities, which will be
codified as circumstances change. Under the Plan, the Company is using a
five-phase methodology for addressing the issue. The phases are Awareness,
Assessment, Renovation, Validation and Implementation.
 
     Awareness consists of defining the Year 2000 problem and gaining executive
level support and sponsorship. A Year 2000 program team has been established and
an overall strategy created. During Assessment, all internal systems, products
and supply chain partners are inventoried and prioritized for renovation. The
Company believes it has completed a majority of the Awareness and Assessment
phases, however, ongoing work will be required in these areas as the Company
completes its assessment of existing supply chain partners and enters into new
supply chain relationships in the ordinary course of business.
 
     Renovation consists of converting, replacing, upgrading or eliminating
systems that have Year 2000 problems. Renovation has begun on mission-critical
systems and is targeted for completion by December 1998. Validation involves
ensuring that hardware and software fixes will work properly in 1999 and beyond
and can occur both before and after implementation. Validation will start in the
second quarter of fiscal 1999 and continue through December 31, 1999 to allow
for thorough testing before the Year 2000. Implementation is the installation of
hardware and software components in a live environment. The Company is in the
early stages of the Implementation phase.
                                       24
<PAGE>   26
 
     The Impact of Year 2000 issues on the Company will depend not only on
corrective actions that the Company takes, but also on the way in which Year
2000 issues are addressed by governmental agencies, business and other third
parties that provide services or data to, or receive services or data from, the
Company, or whose financial condition or operational capability is important to
the Company. To reduce this exposure, the Company has an ongoing process of
identifying and contacting mission-critical third party vendors and other
significant third parties to determine their Year 2000 plans and target dates.
Risks associated with any such third parties located outside the United States
may be higher insofar as it is generally believed that non-U.S. businesses may
not be addressing their Year 2000 issues on as timely a basis as U.S.
businesses. Notwithstanding the Company's efforts, there can be no assurance
that the Company, mission-critical third party vendors or other significant
third parties will adequately address their Year 2000 issues.
 
     The Company is developing contingency plans for implementation in the event
that the Company, mission-critical third party vendors or other significant
third parties fail to adequately address Year 2000 issues. Such plans
principally involve identifying alternative vendors or internal remediation.
There can be no assurance that any such plans will fully mitigate any such
failures or problems. Furthermore, there may be certain mission-critical third
parties, such as utilities, telecommunication companies, or material vendors
where alternative arrangements or sources are limited or unavailable.
 
     Although it is difficult to estimate the total costs of implementing the
Plan, through June 1999 and beyond, the Company's preliminary estimate is that
such costs will total approximately $600,000. However, although management
believes its estimates are reasonable, there can be no assurance, for the
reasons stated in the next paragraph, that the actual costs of implementing the
Plan will not differ materially from the estimated costs. The Company has
incurred approximately $200,000 through June 30, 1998 on this project. A
significant portion of total Year 2000 project expenses is represented by
existing staff that has been redeployed by this project. The Company does not
believe that the redeployment of existing staff will have a material adverse
effect on it business, results of operations or financial position. Incremental
expense related to the Year 2000 project are not expected to materially impact
operating results in any one period.
 
     The extent and magnitude of the Year 2000 Problem as it will affect the
Company, both before and for some period after January 1, 2000, are difficult to
predict or quantify for a number of reasons. Among the most important are lack
of control over systems that are used by third parties who are critical to the
Company's operation, dependence on third party software vendors to deliver Year
2000 upgrades in a timely manner, complexity of testing inter-connected networks
and applications that depend on third party networks and the uncertainty
surrounding how others will deal with liability issues raised by Year 2000
related failures. There can be no assurance for example, that systems used by
third parties will be adequately remediated so that they are Year 2000 ready by
January 1, 2000, or by some earlier date, so as not to create a material
disruption to the Company's business. Moreover, the estimated costs of
implementing the Plan do not take into account the costs, if any, that might be
incurred as a result of Year 2000 related failures that occur despite the
Company's implementation of the Plan.
 
     Although the Company is not aware of any material operational issues
associated with preparing its internal systems for the Year 2000, or material
issues with respect to the adequacy of mission-critical third party systems,
there can be no assurance that the Company will not experience material
unanticipated negative consequences and/or material costs caused by undetected
errors or defects in such systems or by the Company's failure to adequately
prepare for the results of such errors or defects, including costs of related
litigation, if any. The impact of such consequences could have a material
adverse effect on the Company's business, financial condition or results of
operations.
 
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
 
     RELIANCE ON LIMITED NUMBER OF KEY PRODUCTS. Sales of the Company's
collagen-based injectable products, Zyderm(R) and Zyplast(R) collagen implants
("Zyderm implants" and "Zyplast implant"), SoftForm implant, as well as Contigen
implant, accounted for approximately 93% of consolidated product sales for the
fiscal year ended June 30, 1998. The Company's product sales may continue to
consist primarily of sales of these principal products. Factors such as adverse
rulings by regulatory authorities, product liability lawsuits,
 
                                       25
<PAGE>   27
 
introduction of competitive products by third parties, other loss of market
acceptance or other adverse publicity for these principal products may
significantly and adversely affect the Company's sales of these products and, as
a result, also adversely affect the Company's business, financial condition and
results of operations.
 
     SUBSTANTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS, FUTURE OPERATING
RESULTS UNCERTAIN. The Company's quarterly operating results may vary
significantly depending upon factors such as the timing of significant orders
and shipments, changes in pricing policies by the Company or its competitors,
increased competition, demand for the Company's products, the number, timing and
significance of new product and product enhancement announcements by the Company
and its competitors, the ability of the Company to develop, introduce and market
new and enhanced versions of the Company's products on a timely basis, the mix
of direct and indirect sales, the timing of investments in affiliate companies
and general economic factors, among others. The Company's expense levels are
based, in part, on its expectations of future revenue levels. If revenue levels
are below expectations, operating results are likely to be materially adversely
affected. In particular, because only a small portion of the Company's expenses
varies with revenue in the short term, net income may be disproportionately
affected by a reduction in revenue. Due to the foregoing factors, quarterly
revenue and operating results have been and will continue to be difficult to
forecast.
 
     Based upon all of the foregoing, the Company believes that quarterly
revenues and operating results may vary significantly in the future and that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
There can be no assurance that the Company's revenue will increase or be
sustained in future periods or that the Company will be profitable in any future
period. Any shortfall in revenue or earnings from levels expected by securities
analysts could have an immediate and significant adverse effect on the trading
price of the Company's Common Stock in any given period. Additionally, the
Company may not learn of, or be able to confirm, such shortfalls until late in
the fiscal quarter, or following the end of the quarter, which could result in
an even more immediate and adverse effect on the trading price of the Company's
Common Stock. Finally, the Company participates in a highly dynamic industry,
which may result in significant volatility in the price of the Company's Common
Stock.
 
     MANUFACTURING RISKS AND INVENTORY SHORTAGES. Certain of the Company's
products, including Hylaform gel, SoftForm implant and Refinity(TM) Medical Skin
Solutions ("Refinity skin solutions"), are manufactured for the Company by third
parties. As a result, the Company is dependent on these third parties to
manufacture and supply products to the Company as required. While the Company
has distribution agreements with these third parties, there can be no assurances
that these third parties will manufacture and supply quality products on a
timely basis or in adequate quantities. Any failure of these third parties to
manufacture sufficient quantities of these products or to deliver products that
meet the Company's specifications or quality control standards would adversely
affect the Company's sales of these products, and as a result, could also
adversely affect the Company's business, financial condition and results of
operations. The Company relies on a "closed herd" of cattle in order to produce
its bovine collagen-based products, including Zyderm implants, Zyplast implant
and Contigen implant. In the event of any material diminution in the size of the
Company's herd for any reason, including accident or disease, the Company would
have a limited ability to quickly increase supply of acceptable cattle. Any such
diminution would have a material adverse effect on the Company's ability to sell
bovine collagen-based products and, as a result, the Company's business,
financial condition and results of operations.
 
     COMPETITION. The medical device industry is characterized by rapidly
evolving technology and increasing competition under the recent changes in the
health care environment. The Company faces intense competition in each of its
target product markets. The Company faces direct and indirect competition for
its Zyderm implants and Zyplast implant products. At the present time, there is
a commercial product in the United States that is directly competitive with
Zyderm implants and Zyplast implant, the Company's collagen-based products for
plastic surgery and dermatology. This product is a gelatin-based (denatured
collagen) injectable commercial product, presently being marketed in the United
States and Canada that is directly competitive with Zyderm implants and Zyplast
implant. The Company also competes with products derived from human tissue.
Collagenesis, Inc. produces a product requiring a biopsy of the patient's
tissue, which tissue is then used
                                       26
<PAGE>   28
 
to generate an injectable material. Fat injections require surgical removal of
the patient's fatty tissue. Implantable cadaver tissue obtained through tissue
banks is sold under the brand name Alloderm and competes directly with the
Company's SoftForm implant. Internationally, direct competitors in the
injectable product segment have included both government approved and unapproved
products which are primarily derived from collagen, hyaluronic acid and
silicone. The Company is aware of one foreign company that is marketing
internationally a collagen-based material for soft tissue augmentation. The
Company is aware of one company in Europe that markets a hylauronic acid-based
product called Restylane that is competitive with Hylaform gel. In addition,
W.L. Gore, Inc. markets an ePTFE product that is directly competitive with
SoftForm implant. The Company's injectable collagen products also compete in the
dermatology and plastic surgery markets with substantially different alternative
treatments, such as laser treatments, chemical peels, fat injections,
dermabrasion, botulinum toxin injections and face lifts. The worldwide alpha
hydroxy acid market in which Refinity skin solutions compete is extremely
competitive. Worldwide sales of alpha hydroxy acid products total approximately
$1.6 billion per year, with the medical segment of this market accounting for
approximately 6% to 7% of this total. Large retailers and some door to door
companies, as well as the prestige market, such as salon and department stores,
participate in the alpha hydroxy market. During the last several years, several
large pharmaceutical companies with high product profiles within the dermatology
market have purchased or solidified distribution agreements with alpha hydroxy
skin care lines. In addition, physicians dispense a significant number of
private label in-office peel and take-home products.
 
     At the present time, autologous fat, silicone micro-implants and
polytetrafluoroethylene (Teflon paste, or PTFE) are directly competing with
Contigen implant for the treatment of stress incontinence due to intrinsic
sphincter deficiency ("ISD"). Neither silicone micro-implants nor PTFE have been
approved by the FDA for use in the United States. Other methods of treatment or
amelioration of ISD may be considered competitive with Contigen implant. These
include surgery, medication, absorbent products and behavior modification.
 
     In addition, several companies and institutions are engaged in the
development of collagen-based and other materials, techniques, procedures and
products for use in facial aesthetic applications anticipated to be addressed by
the Company's products. Some of these companies and institutions are developing
human-based collagen products which, when and if commercially introduced, would
have certain competitive advantages over the Company's bovine collagen-based
products, including increased biocompatibility. Some of these companies and
institutions may have substantially greater capital resources, research and
development staffs and facilities, experience in conducting clinical trials and
obtaining regulatory approvals, and manufacturing and marketing products than
the Company. There can be no assurance that the Company's competitors will not
succeed in developing technologies and products that are more effective than any
products that have been or may be developed by the Company or that would render
the Company's technology and products obsolete or noncompetitive, or that the
Company will be able to compete effectively against such competitors based on
its abilities to manufacture, market and sell its products. There can be no
assurance that such potential competition will not have an adverse effect on the
future business or financial condition of the Company. See
"Business -- Competition." Some of these companies and institutions may have
substantially greater capital resources, research and development staffs and
facilities, and experience in conducting clinical trials, obtaining regulatory
approvals, and manufacturing and marketing products similar to those of the
Company. These companies and institutions may represent significant long-term
competition for the Company. There can be no assurance that the Company's
competitors will not succeed in developing technologies and products that are
more effective than any which have been or may be developed by the Company or
that would render the Company's technology and products obsolete or
non-competitive or that the Company will be able to compete effectively against
such competitors based on its abilities to manufacture, market and sell its
products. There can be no assurance that such potential competition will not
have an adverse effect on the future business, financial condition or results of
operations of the Company.
 
     RAPID TECHNOLOGICAL CHANGE. The Company's industry is characterized by
ongoing technological developments, evolving industry standards and rapid
changes in customer requirements. The Company's success depends and will depend
upon its ability to continue to develop and introduce in a timely manner new
products that take advantage of technological advances, to identify and adhere
to emerging standards, and to continue to improve the functionality of its
products. There can be no assurance that the Company will be
 
                                       27
<PAGE>   29
 
successful in developing and marketing, on a timely basis or at all, competitive
products, product enhancements and new products that respond to technological
change, changes in customer requirements and emerging industry standards, or
that the Company's enhanced or new products will adequately address the changing
needs of the marketplace. The inability of the Company, due to resource
constraints, technological or other reasons, to develop and introduce new
products or product enhancements in a timely manner would have a material
adverse effect on the Company's business, financial condition or results of
operations.
 
     UNDEVELOPED AND UNCERTAIN MARKETS. Certain of the Company's products are
intended for use in new markets the size of which are difficult to independently
verify. In particular, the potential market for the Company's Contigen implant
product is difficult to estimate because Contigen implant represents a
relatively new method of treatment, and the Company believes that most sufferers
of stress urinary incontinence do not seek medical treatment. Bard markets
Contigen implant primarily to urologists, who may not be the only physicians
treating this disorder. Should the markets for such products be more limited
than the Company or its marketing partners currently estimate, or should the
Company, its distributors and/or its marketing partners fail to penetrate such
markets to the extent anticipated, the Company may experience lower than
anticipated revenues and a resulting adverse effect on its business, financial
condition and results of operations.
 
     DEPENDENCE ON MARKETING PARTNERS AND THIRD PARTY DISTRIBUTORS; EFFECT OF
INVENTORY FLUCTUATIONS. The Company has entered into exclusive arrangements with
Bard for the marketing and distribution of Contigen implant. As a result, the
Company's revenues and earnings for these products depend almost entirely upon
the continuing efforts of these marketing partners. The Company's business,
financial condition and results of operations could be adversely affected in the
event that either or both of these parties do not effectively market the
Company's products, accurately anticipate customer demand or effectively manage
industry-wide pricing and cost-containment pressures in health care. The
Company's revenues and earnings have in the past fluctuated and are expected to
continue to fluctuate based upon the levels of orders placed by these parties,
which are in turn affected by the levels of sales by these distributors and the
levels of their inventories. At June 30, 1995, Bard had a significant inventory
of Contigen implant and, as a result, took minimal shipments of such product
during fiscal 1996. While shipments to Bard resumed during the fourth quarter of
fiscal 1997, there can be no assurances that such shipments will continue. The
failure to continue shipments of Contigen implant to Bard during fiscal 1999
could have a material adverse effect on the Company's results of operations.
 
     In addition, the Company depends upon third party distributors to market
its other products in a number of international markets. There can be no
assurance that any of such distributors will not cease operations or be unable
to satisfy financial obligations to the Company. If a significant distributor
were to fail to adequately promote the Company's products or were to cease
operations, such failure or cessation could have a material adverse effect on
the Company's business, financial condition and results of operations.
 
     GOVERNMENT REGULATION AND ADVERSE PUBLICITY. The Company's manufacturing
activities and products sold in the United States (other than Refinity skin
solutions) are subject to extensive and rigorous regulation by the FDA and by
comparable agencies in certain foreign countries where these products are
manufactured or distributed. The FDA regulates the manufacture, clinical
research and sale of medical devices, including labeling, advertising and record
keeping. In order to market products in the United States which are considered
by the FDA to be medical devices, the Company will be required to receive 510(k)
marketing clearance or premarket approval from the FDA for such products among
other regulatory requirements. In order to obtain 510(k) marketing clearance,
the Company must show that the product is substantially equivalent to a legally
marketed device not requiring FDA approval. In addition, the Company must
demonstrate that it is capable of manufacturing the product to the relevant
standards. To obtain premarket approval of a product, the Company must submit
extensive data, including pre-clinical and clinical trial data to prove the
safety and efficacy of the product. Clinical trials are normally done in three
phases over two to five years, but may take longer to complete as a result of
many factors, including slower than anticipated patient enrollment, difficulty
in finding a sufficient number of patients fitting the appropriate trial
profile, difficulty in the acquisition of sufficient supply of clinical trial
materials or adverse events occurring during the trials. The Company's primary
products are currently classified as Class III medical devices, which require
premarket approval from the FDA. There can be no assurance that the FDA will not
choose to characterize future products of the Company as drugs or biologics
rather than medical devices, which have additional
                                       28
<PAGE>   30
 
requirements for approval. Any such change in FDA characterization would
potentially lengthen and increase the cost of the approval process.
 
     While the Company's other primary products have been approved for sale in
the United States, Hylaform gel has not been approved for domestic commercial
sale.
 
     Medical products whose market applications have not yet been approved by
the FDA may be exported only with the specific approval of the FDA. Failure to
comply with applicable regulatory requirements can, among other things, result
in fines, suspensions of regulatory approvals, product recalls, seizure of
products, operating restrictions, injunctions and criminal prosecution. In
addition, government regulations may be established that could prevent or delay
regulatory approval of the Company's products. Furthermore, compliance with
current Good Manufacturing Practices regulations is necessary to receive FDA
approval to market new products and to continue to market current products.
 
     The process of obtaining FDA and other required regulatory approvals and
clearances is lengthy and will require the expenditure of substantial capital
and resources. There can be no assurances that the Company or its suppliers will
be able to obtain the necessary approvals for Hylaform gel. Moreover, if and
when such approval or clearance is obtained, the marketing, distribution and
manufacture of such products would remain subject to extensive regulatory
requirements administered by the FDA and other regulatory bodies. Failures to
comply with applicable regulatory requirements can result in, among other
things, warning letters, fines, injunctions, civil penalties, recall or seizure
of products, total or partial suspension of production, refusal of the
government to grant approvals, premarket clearance or premarket approval,
withdrawal of approvals and criminal prosecution. Many of the Company's products
are marketed internationally and are therefore subject to foreign regulatory
requirements governing the conduct of clinical trials, product licensing,
pricing and reimbursement, which vary from country to country and are becoming
more restrictive throughout the EU. The process of obtaining foreign regulatory
approvals can be lengthy and require the expenditure of substantial capital and
resources. In particular, the Company's SoftForm implant is not approved for
marketing in any international market. There can be no assurance that the
Company will be successful in obtaining such approval for SoftForm implant or
for the Company's other products. In addition, there can be no assurance that
the Company's Refinity skin solutions line will not become subject to FDA
regulations or other foreign regulatory requirements. Any delay or failure by
the Company or its suppliers to obtain regulatory approvals for its products
could have a material adverse effect on the Company's business, financial
condition and results of operations.
 
     The continuing trend of more stringent FDA oversight in product clearance
and enforcement activities has caused medical device manufacturers to experience
longer approval cycles, more uncertainty, greater risk and higher expenses.
Failure to obtain, or delays in obtaining, the required regulatory approvals for
new products, particularly with respect to Hylaform gel, could adversely affect
the Company's financial condition and results of operations, as could product
recalls. In addition, there can be no assurance that the FDA will give approval
to the Company to market its current products for broader or different
applications, or that it will grant approval with respect to separate product
applications which represent extensions of the Company's basic technology, or
that existing approvals or market clearances will not be withdrawn. Further,
changes in governmental reimbursement systems, pursuant to which hospitals and
physicians are reimbursed for medical procedures at a fixed rate according to
diagnosis-related groups or other reimbursements, could have an economic impact
on the purchase and use of medical devices. In particular, a material decrease
in current reimbursement levels for Contigen implant and its application in the
treatment of intrinsic sphincter deficiency ("ISD") could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     The collagen used in the Company's products is derived from cow hides.
Bovine Spongiform Encephalopathy ("BSE" or "mad cow disease") is a disease,
initially reported in cattle in the United Kingdom, characterized by
degenerative lesions of the central nervous system. The source of infections in
animals derives from eating infected sheep-derived feed. While the disease has
been reported in European countries, the Company is not aware of any reports of
BSE in United States cattle to date. There can be no assurance that the various
foreign or domestic regulatory authorities will not raise issues regarding BSE
or other matters
 
                                       29
<PAGE>   31
 
which may adversely affect the Company's ability to manufacture, market or sell
its bovine collagen-based products, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
 
     In past years, the Company has been the subject of legislative and
regulatory investigations relating to, among other things, the safety and
efficacy of its injectable collagen products. There can be no assurance that
legislative and regulatory investigations or negative publicity from such
investigations or future investigations or from the news media will not result
in a material adverse effect on the Company's business, financial condition or
results of operations. In addition, significant negative publicity could result
in an increased number of product liability claims.
 
     RISK OF INVESTMENTS IN AFFILIATES. The Company has made equity and debt
investments in affiliated companies that are involved in the development of
complementary or related technologies or products, and the Company may make
additional investments in such companies from time to time in the future. These
affiliated companies typically are in an early stage of development and may be
expected to incur substantial losses. As a result, the Company has recorded and
expects to continue to record a share of the losses in such affiliates
attributable to the Company's ownership, which losses which may have an adverse
effect on the Company's results of operations. Furthermore, there can be no
assurance that any investments in affiliates will result in any return nor can
there be any assurance as to the timing of any such return, or that the Company
will not lose its entire investment.
 
     PRODUCT LIABILITY; INSURANCE. The manufacture and sale of medical products
entails significant risk of product liability claims due to disease transmission
and other health factors, and product recalls. The Company is involved in
various legal actions arising in the ordinary course of business, the majority
of which involve product liability claims for personal injury allegedly caused
by the Company's products. Any product liability claim could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     The Company faces an inherent business risk of exposure to product
liability claims alleging that the use of the Company's technology or products
has resulted in adverse effects, particularly with respect to claims regarding
Trilucent(TM) breast implant ("Trilucent implant"), which is sold in a medical
field (breast augmentation, reconstruction and replacement) in which there have
been sizable product liability claims. Such risks will exist even with respect
to those products that have received or in the future may receive regulatory
approval for commercial sale. There can be no assurance that the Company will
avoid significant product liability claims and attendant negative publicity.
Furthermore, there can be no assurance that present insurance coverage will be
adequate or that adequate insurance coverage will remain available at acceptable
costs, if at all, or that a product liability claim or recall would not
adversely affect the future business or financial condition of the Company. A
successful claim brought against the Company for which coverage is denied or in
excess of its insurance coverage could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
adverse product liability actions could negatively affect the Company's ability
to obtain and maintain regulatory approval for its products.
 
     PATENTS AND PROPRIETARY TECHNOLOGY. The Company depends substantially upon
its proprietary technological expertise in the extraction, purification,
formulation and manufacturing of collagen-based materials and other biomaterials
into biomedical products. The Company seeks patents on inventions concerning
novel manufacturing processes, compositions of matter, and applications for its
proprietary biomaterials.
 
     Patent-related litigation is a risk in the medical device industry. There
can be no assurance the Company will be successful in the future in obtaining
patents or license rights, that patents will be issued for the Company's current
patent applications, that the Company will develop additional proprietary
technology that is patentable, that any issued patents will provide the Company
with any competitive advantages or will not be challenged by third parties, or
that patents of others will not have an adverse effect on the Company. No
assurance can be given that the processes or products of the Company or its
licensors will not infringe patents or proprietary rights of others or that any
licenses required under any such patents or proprietary rights would be made
available on terms acceptable to the Company. If the Company does not obtain
such licenses, it could encounter delays in product introductions while it
attempts to design around such patents, or it could
                                       30
<PAGE>   32
 
find that the manufacture, sale or use of products requiring such licenses could
be enjoined. In addition, the Company could incur substantial costs in defending
itself in suits brought against the Company on such patents or in bringing suits
to protect the Company's patents against infringement. In particular, although
the Company intends to seek international coverage for all patents held by it,
the Company's rights to one currently issued patent covering technology used in
its Trilucent breast implant extends only to the United States. Therefore, the
Company is not currently able to prevent others from using such technology
disclosed in such patent outside of the United States.
 
     The Company relies upon trade secret protection for certain unpatented
aspects of its proprietary technology. There can be no assurance that others
will not independently develop or otherwise acquire substantially equivalent
proprietary information or techniques, that others will not otherwise gain
access to the Company's proprietary technology or disclose such technology, or
that the Company can meaningfully protect its trade secrets. The Company
requires its employees and consultants to execute appropriate confidentiality
and proprietary information agreements upon the commencement of employment or
consulting relationship with the Company. These agreements generally provide
that all confidential information developed or made known to the individual by
the Company during the course of the individual's relationship with the Company
is to be kept confidential and not disclosed to third parties, except in
specific circumstances. The agreements generally provide that all inventions
conceived by the individual in the course of rendering services to the Company
shall be the exclusive property of the Company; however, certain of the
Company's agreements with consultants, who typically are employed on a full-time
basis by academic institutions or hospitals, do not contain assignment of
invention provisions. There can be no assurance, however, that these agreements
will provide meaningful protection or adequate remedies for the Company in the
event of unauthorized use, transfer or disclosure of such information or
inventions.
 
     IMPACT OF CURRENCY FLUCTUATIONS; IMPORTANCE OF FOREIGN SALES. Approximately
38% (excluding sales from discontinued operations of LipoMatrix) of the
Company's revenues in fiscal 1998 from continuing operations were derived from
its international operations. Accordingly, any material decrease in foreign
sales would have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, because international sales of
the Company's products typically are denominated in local currencies, the
Company's results of operations have been and are expected to continue to be
affected by changes in exchange rates between certain foreign currencies and the
United States dollar. There can be no assurance that the Company will not
experience unfavorable currency fluctuation effects in future periods, which
could have an adverse effect on the Company's operating results. The Company's
operations and financial results also may be significantly affected by other
international factors, including the imposition of government controls, export
license requirements, political instability, trade restrictions, changes in
tariffs and difficulties in managing international operations. The Company plans
to continue to evaluate hedging options in fiscal 1999 in order to minimize the
effect of unfavorable currency fluctuations on the Company's operating results.
However, there can be no assurance that hedging options will favorably affect
the Company's results of operations.
 
     USE OF HAZARDOUS MATERIALS. The Company's operations require the controlled
use of hazardous materials. Although the Company believes that its safety
procedures for handling such materials comply with the standards prescribed by
federal, state and local regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an incident, the Company could be held liable for any damages that result,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
 
     LIMITED DIVERSITY OF FACILITIES. All of the Company's manufacturing
capacity for collagen products, the majority of its research and development
activities, its corporate headquarters, and other critical business functions
are located near major earthquake faults. In addition, the Company's
manufacturing capacity for collagen-based products is located in one primary
facility, with the Company currently maintaining only limited amounts of
finished product inventory. While the Company has some limited protection in the
form of disaster recovery programs and basic insurance coverage, the Company's
operating results and financial condition would be materially adversely affected
in the event of a major earthquake, fire or other similar calamity affecting its
manufacturing facilities.
                                       31
<PAGE>   33
 
     THIRD-PARTY REIMBURSEMENT. In the United States, hospitals, physicians and
other healthcare providers that purchase medical devices generally rely on
third-party payors, such as private health insurance plans, to reimburse all or
part of the costs associated with the treatment of patients. The Company's
success will depend upon, among other things, its ability to obtain satisfactory
reimbursement from healthcare payors for its products. Certain of the Company's
products, including Contigen implant, Collagraft bone graft products, and, in
certain circumstances, Trilucent implant, are purchased by hospitals or
physicians in the United States, which then bill various third-party payors
including Medicare, Medicaid and private insurers for the healthcare services
provided to patients. Third-party payors are increasingly challenging the prices
charged for medical products and services. There can be no assurance that the
reimbursement of treatments using the Company's products will not be subject to
such challenges in the future. Given the efforts to control and decrease health
care costs in recent years, there can be no assurance that any reimbursement
will be sufficient to permit the Company to maintain profitability.
 
     Reimbursement systems in international markets vary significantly by
country, and by region within some countries, and reimbursement approvals must
be obtained on a country-by-country basis. Many international markets have
government managed health care systems that govern reimbursement for new devices
and procedures. In most markets, there are private insurance systems as well as
government-managed systems. There can be no assurance that the Company will
obtain reimbursement in any country within a particular time, for a particular
amount, or at all. Failure to obtain such reimbursement approvals could have a
material adverse effect on the Company's business, financial condition and
results of operations.
 
     Regardless of the type of reimbursement system, the Company believes that
physician advocacy of its products will be required to obtain reimbursement.
Availability of reimbursement will depend on the clinical efficacy and cost of
the Company's products. There can be no assurance that reimbursement for the
Company's products will be available in the United States or in international
markets under either government or private reimbursement systems, or that
physicians will support and advocate reimbursement for use of the Company's
systems for all uses intended by the Company. Failure by physicians, hospitals
and other users of the Company's products to obtain sufficient reimbursement
from health care payors or adverse changes in government and private third-party
payors' policies toward reimbursement for procedures employing the Company's
products would have a material adverse effect on the Company's business,
financial condition and results of operations.
 
     DEPENDENCE ON KEY PERSONNEL. The Company is dependent upon a limited number
of key management and technical personnel, the loss of any one of which could
have a material adverse effect on the Company's business. The Company's future
success will depend in part upon its ability to attract and retain highly
qualified personnel. The Company competes for such personnel with other
companies, academic institutions, government entities and other organizations.
There can be no assurance that the Company will be successful in hiring or
retaining qualified personnel. Any inability to attract and retain key employees
could have a material adverse effect on the Company's business, financial
condition and results of operations.
 
     NEGATIVE PUBLICITY. The Company had been, and may in the future, be the
subject of negative publicity, which can arise from various sources, ranging
from the news media on cosmetic procedures in general to legislative and
regulatory investigations specific to the Company concerning, among other
things, the safety and efficacy of its products. There can be no assurance that
such investigations or negative publicity from such investigation or from the
news media will not result in a material adverse effect on the Company's future
financial position, its results of operations or the market price of its stock.
In addition, significant negative publicity could result in an increased number
of product liability claims.
 
     The foregoing factors are not meant to represent an exhaustive list of the
risks and uncertainties attendant to the Company's business. Due to the factors
noted above, as well as other factors that may affect the Company's operating
results, the Company's future earnings and stock price may be subject to
significant volatility, particularly on a quarterly basis. Any shortfall in
revenue or earnings from levels expected by securities analysts could have an
immediate and significant adverse effect on the trading price of the Company's
common stock in any given period. Additionally, the Company may not learn of, or
be able to confirm, such shortfalls until late in the fiscal quarter, or
following the end of the quarter, which could result in
 
                                       32
<PAGE>   34
 
an even more immediate and adverse effect on the trading price of the Company's
common stock. Finally, the Company participates in a highly dynamic industry,
which often results in significant volatility of the Company's common stock.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     The Company is exposed to market risk, including changes to interest rates,
foreign currency exchange rates and equity investment prices. A discussion of
the Company's accounting policies for financial instruments and further
disclosures relating to financial instruments is included in the Description of
Business and Significant Accounting Policies in the Notes to Consolidated
Financial Statements.
 
     The Company monitors the risks associated with interest rates, foreign
currency exchange rates and equity investment price changes, and its derivative
and financial instrument positions.
 
INVESTMENT PORTFOLIO
 
     The Company does not use derivative financial instruments in its debt
investment portfolio. The Company places its debt investments in instruments
that meet high credit quality standards, as specified in the Company's
investment policy guidelines; the policy also limits the amount of credit
exposure to any one issue, issuer, or type of instrument. The Company does not
expect any material loss with respect to its debt investment portfolio.
 
     There are inherent risks which may only be partially offset by the
Company's hedging programs should there be unfavorable movements in equity
investment prices, specifically Boston Scientific Corporation.
 
     The estimated exposures discussed below are intended to measure the maximum
amount the Company could lose from adverse market movements in interest rates,
foreign currency exchange rates and equity investment prices over a given period
of time. Loss is defined in the value at risk estimation as fair market value
loss.
 
     The Company's interest income is sensitive to changes in the general level
of U.S. interest rates. In this regard, changes in U.S. interest rates affect
the interest earned on the Company's cash equivalents and short-term
investments.
 
     The table below provides information about the Company's debt investment
portfolio. For debt securities, the table presents principal cash flows and
related weighted average fixed interest rates by expected maturity dates. The
Company's investment policy requires that all investments mature in 400 days or
less.
 
<TABLE>
<CAPTION>
                                                           MATURITIES
                                    ---------------------------------------------------------   FAIR VALUE
                                    FY 1999   FY 2000   FY 2001   FY 2002   FY 2003    TOTAL    AT 6/30/98
                                    -------   -------   -------   -------   -------   -------   ----------
                                                         (U.S. DOLLARS IN THOUSANDS)
<S>                                 <C>       <C>       <C>       <C>       <C>       <C>       <C>
DEBT INVESTMENTS
Cash Equivalents..................  $ 6,791      --       --        --        --      $ 6,791    $ 6,791
  Weighted Average Interest
     Rate.........................      5.6%                                              5.6%
Short Term Investments............  $ 8,011      --       --        --        --      $ 8,011    $ 8,011
  Weighted Average Interest
     Rate.........................      7.5%                                              7.5%
Total Debt Investments............  $14,802      --       --        --        --      $14,802    $14,802
  Weighted Average Interest
     Rate.........................     6.63%                                             6.63%
</TABLE>
 
     As part of its strategic alliance efforts, the Company invests in equity
instruments of biotechnology companies that are subject to fluctuations from
market value changes in stock prices. In order to manage the risk of market
fluctuations in this stock, the Company entered into certain costless collar
instruments ("collars"), to hedge a portion (725,000 shares at June 30, 1998) of
the Boston Scientific equity securities against changes in market value. A
costless collar instrument is a form of equity collar instrument consisting of a
purchased put option and a written call option on a specific equity security
such that the cost of the purchased put and the proceeds of the written call
offset each other; therefore, there is no initial cost or cash outflow for these
instruments. The Company purchased the collars with expiration dates and numbers
of
 
                                       33
<PAGE>   35
 
shares so that the potential adverse impact of movements in market price of the
stock will be at least partially offset by an associated increase in the value
of the collars.
 
<TABLE>
<CAPTION>
                                                           FAIR VALUE
                                                           AT 6/30/98
                                                          -------------
                                                          (U.S. DOLLARS
                                                          IN THOUSANDS)
<S>                                                       <C>
EQUITY INVESTMENTS
Boston Scientific.......................................     $73,979
  Ownership %...........................................        0.53%
Innovasive Devices......................................     $ 7,916
  Ownership %...........................................           9%
Medarex.................................................     $ 1,920
  Ownership %...........................................           1%
Cosmederm...............................................     $ 1,000
  Ownership %...........................................           8%
Pharming................................................     $ 7,010
  Ownership %...........................................           6%
Cosmetic Therapeutic....................................     $   364
  Ownership %...........................................          29%
                                                             -------
Total Portfolio.........................................     $92,189
                                                             =======
</TABLE>
 
     To hedge against fluctuations in the market value of a portion of the
Boston Scientific common stock, the Company entered into costless collar
instruments that expire quarterly from August 1998 through May 2001 and will
require settlement in cash. At June 30, 1998, 725,000 shares, out of 1,032,860
held by Collagen, were hedged using these collars. The call options are
collateralized by shares of Boston Scientific common stock held by the Company.
At June 30, 1998 the notional amount of the put and call options were $46
million and $70.7 million, respectively. The fair value of the equity collars at
June 30, 1998 was $96,000.
 
IMPACT OF FOREIGN CURRENCY RATE CHANGES
 
     Approximately 38% (excluding sales discontinued operations of LipoMatrix)
of the Company's revenues from continuing operations in fiscal 1998 were derived
from its international operations. Accordingly, any material decrease in foreign
sales would have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, because international sales of
the Company's products typically are denominated in local currencies, the
Company's results of operations have been and are expected to continue to be
affected by changes in exchange rates between certain foreign currencies and the
United States dollar. There can be no assurance that the Company will not
experience unfavorable currency fluctuation effects in future periods, which
could have an adverse effect on the Company's operating results.
 
     The Company is exposed to changes in exchange rates in Europe, Pacific Rim
countries, Canada, South America and the Middle East. The Company's exposure to
foreign exchange rates primarily exists with the Japanese Yen, German Mark,
Italian Lira, French Franc and the British Pound. When the U.S. dollar
strengthens against the currencies in these countries, the U.S. dollar value of
non-U.S. dollar based revenue decreases; when the U.S. dollar weakens, the U.S.
dollar value of the non-U.S. dollar-based revenue increases.
 
     The impact of foreign exchange rates from fiscal 1997 to fiscal 1998
resulted in a decrease in revenue of approximately $2.3 million and a decrease
in operating expenses of approximately $2.6 million, resulting in a net increase
in operating income of approximately $300,000 on an equivalent local currency
basis. The impact of foreign exchange rates from fiscal 1996 to fiscal 1997
resulted in a decrease in revenue of approximately $1.1 million and a decrease
in operating expenses of approximately $1.7 million, resulting in a net increase
in operating income of approximately $600,000 on an equivalent local currency
basis.
 
     Until December 1994, the Company's policy was to hedge material foreign
currency transaction exposures. At June 30, 1998, 1997 and 1996, no foreign
currency transaction exposures were hedged.
 
                                       34
<PAGE>   36
 
Unhedged net foreign assets were $6.5 million, $7.6 million and $14.5 million at
June 30, 1998, 1997 and 1996, respectively. The Company plans to investigate
hedging options in fiscal 1999 in order to minimize the effect of unfavorable
currency fluctuations on the Company's operating results. However, there can be
no assurance that hedging options will favorably affect the Company's results of
operations.
 
     The Company's operations and financial results also may be significantly
affected by other international factors, including the imposition of government
controls, export license requirements, political instability, trade
restrictions, changes in tariffs and difficulties in managing international
operations.
 
                                       35
<PAGE>   37
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Financial Statements:
  Consolidated Balance Sheets at June 30, 1998 and 1997.....   37
  Consolidated Statements of Operations for the fiscal years
     ended June 30, 1998, 1997 and 1996.....................   38
  Consolidated Statements of Stockholders' Equity for the
     fiscal years ended June 30, 1998, 1997 and 1996........   39
  Consolidated Statements of Cash Flows for the fiscal years
     ended June 30, 1998, 1997 and 1996.....................   40
  Notes to Consolidated Financial Statements................   41
  Report of Ernst & Young LLP, Independent Auditors.........   59
  Supplementary Quarterly Consolidated Financial Data
     (Unaudited)............................................   60
Financial Statement Schedule:
For the years ended June 30, 1998, 1997 and 1996:
  Schedule II -- Valuation and Qualifying Accounts..........   61
</TABLE>
 
     Schedules not listed above have been omitted because they are not required
or the information required to be set forth therein is included in the
Consolidated Financial Statements or notes thereto.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
     Not applicable
 
                                       36
<PAGE>   38
 
                          CONSOLIDATED BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                        JUNE 30,
                                                              ----------------------------
                                                                 1998              1997
                                                              ----------        ----------
                                                              (IN THOUSANDS, EXCEPT SHARE
                                                                 AND PER SHARE AMOUNTS)
<S>                                                           <C>               <C>
Current assets:
  Cash and cash equivalents.................................   $  7,916          $ 18,381
  Short-term investments....................................      8,011             5,117
  Accounts receivable, less allowance for doubtful accounts
     ($505 in 1998 and $418 in 1997)........................     13,764            10,722
  Inventories, net..........................................     12,101            10,173
  Inventories of discontinued operations, net...............        417             4,121
  Other current assets, net.................................     11,016             9,226
                                                               --------          --------
          Total current assets..............................     53,225            57,740
Property and equipment, net.................................     14,448            13,945
Property and equipment of discontinued operations, net......         --             1,315
Intangible assets, net......................................      6,861             8,687
Purchased intangibles and goodwill of discontinued
  operations, net...........................................         --             6,078
Investment in Boston Scientific Corporation.................     73,979            83,874
Investment in Innovasive Devices, Inc.......................      7,027             5,670
Investment in Pharming, B.V.................................      7,010             4,510
Loans to officers and employees, net........................        259               172
Other investments and assets, net...........................      3,530             2,649
                                                               --------          --------
                                                               $166,339          $184,640
                                                               ========          ========
                           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................   $  3,561          $  2,363
  Accrued compensation......................................      4,749             3,886
  Accrued liabilities.......................................     14,020             8,735
  Income taxes payable......................................     10,606             9,376
  Liabilities of discontinued operations, net...............        781             1,020
                                                               --------          --------
          Total current liabilities.........................     33,717            25,380
Long-term liabilities:
  Deferred income taxes.....................................     30,589            35,449
  Other long-term liabilities...............................      1,393             3,677
                                                               --------          --------
          Total long-term liabilities.......................     31,982            39,126
Commitments and contingencies
Minority interest...........................................         --                49
Stockholders' equity:
  Preferred stock, $.01 par value, authorized: 5,000,000
     shares; none issued or outstanding.....................         --                --
  Common shares, $.01 par value, authorized: 28,950,000
     shares, issued: 10,937,830 shares (10,756,935 shares in
     1997), outstanding: 8,864,930 shares (8,809,035 shares
     in 1997)...............................................        109               108
  Additional paid-in capital................................     69,619            67,204
  Retained earnings.........................................     32,128            47,999
  Cumulative translation adjustment.........................     (2,030)           (1,529)
  Unrealized gain on available-for-sale investments.........     43,833            47,069
  Treasury stock, 2,072,900 shares in 1998 (1,947,900 shares
     in 1997)...............................................    (43,019)          (40,766)
                                                               --------          --------
          Total stockholders' equity........................    100,640           120,085
                                                               --------          --------
                                                               $166,339          $184,640
                                                               ========          ========
</TABLE>
 
The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.
                                       37
<PAGE>   39
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                        YEARS ENDED JUNE 30,
                                                              ----------------------------------------
                                                                 1998           1997          1996
                                                              -----------    ----------    -----------
                                                              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                           <C>            <C>           <C>
Revenues:
  Product sales.............................................   $ 82,772       $68,335       $ 66,285
  Other.....................................................         --            --          2,000
                                                               --------       -------       --------
                                                                 82,772        68,335         68,285
Costs and expenses:
  Cost of sales.............................................     23,958        17,223         15,793
  Selling, general and administrative.......................     42,535        38,792         33,728
  Research and development..................................     22,715        14,087          9,175
  Restructuring expense.....................................      1,541            --             --
  Purchased in-process research and development.............     10,587            --          3,000
                                                               --------       -------       --------
                                                                101,336        70,102         61,696
                                                               --------       -------       --------
Income (loss) from operations...............................    (18,564)       (1,767)         6,589
Other income (expense):
  Net gain on investments, principally Boston Scientific
     Corporation (Target Therapeutics, Inc. in 1996)........     19,096         9,063         82,093
  Net gain on investment in Prograft Medical, Inc...........         --        15,395             --
  Equity in earnings of Boston Scientific Corporation
     (Target Therapeutics, Inc. in 1996)....................         --            --          1,430
  Equity in losses of other affiliates......................       (151)         (970)        (1,823)
  Interest income...........................................        988         1,110          1,145
  Interest expense..........................................        (56)         (473)          (297)
                                                               --------       -------       --------
Income before income taxes, minority interest and
  discontinued operations...................................      1,313        22,358         89,137
Provision for income taxes..................................      3,207         8,325         38,902
Minority interest...........................................        (16)         (765)          (182)
                                                               --------       -------       --------
Income (loss) from continuing operations....................     (1,878)       14,798         50,417
Discontinued operations:
  Loss from operations......................................     (5,279)       (9,145)       (24,682)
  Benefit for income taxes..................................      1,630         1,718            917
                                                               --------       -------       --------
     Loss from discontinued operations, net of taxes........     (3,649)       (7,427)       (23,765)
  Provision for disposal....................................    (11,045)           --             --
  Benefit for income taxes..................................      2,489            --             --
                                                               --------       -------       --------
     Provision for disposal, net of taxes...................     (8,556)           --             --
                                                               --------       -------       --------
     Total loss from discontinued operations, net of
       taxes................................................    (12,205)       (7,427)       (23,765)
                                                               --------       -------       --------
Net income (loss)...........................................   $(14,083)      $ 7,371       $ 26,652
                                                               ========       =======       ========
Net income (loss) per share -- Basic:
  Continuing operations.....................................   $  (0.21)      $  1.68       $   5.66
  Discontinued operations...................................      (1.37)        (0.84)         (2.67)
                                                               --------       -------       --------
     Net income (loss) per share -- Basic...................   $  (1.58)      $  0.84       $   2.99
                                                               ========       =======       ========
Net income (loss) per share -- Diluted:
  Continuing operations.....................................   $  (0.21)      $  1.66       $   5.56
  Discontinued operations...................................      (1.37)        (0.83)         (2.62)
                                                               --------       -------       --------
     Net income (loss) per share -- Diluted.................   $  (1.58)      $  0.83       $   2.94
                                                               ========       =======       ========
Shares used in calculating per share information -- Basic...      8,913         8,804          8,915
                                                               ========       =======       ========
Shares used in calculating per share
  information -- Diluted....................................      8,913         8,930          9,075
                                                               ========       =======       ========
</TABLE>
 
The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.
                                       38
<PAGE>   40
 
                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                    YEARS ENDED JUNE 30, 1998, 1997 AND 1996
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                            UNREALIZED
                                                                              GAIN ON                 TOTAL
                                      ADDITIONAL              CUMULATIVE    AVAILABLE-                STOCK-
                             COMMON    PAID-IN     RETAINED   TRANSLATION    FOR-SALE     TREASURY   HOLDERS'
                             STOCK     CAPITAL     EARNINGS   ADJUSTMENT    INVESTMENTS    STOCK      EQUITY
                             ------   ----------   --------   -----------   -----------   --------   --------
<S>                          <C>      <C>          <C>        <C>           <C>           <C>        <C>
BALANCE AT JUNE 30, 1995...   $106     $63,855     $ 17,273     $  (604)      $    --     $(32,710)  $ 47,920
Sale of common stock under
  options and employee
  stock purchase plan......     --         963           --          --            --           --        963
Tax benefit relating to
  stock options............     --          26           --          --            --           --         26
Foreign currency
  translation adjustment...     --          --           --         (45)           --           --        (45)
Dividends declared ($.175
  per share)...............     --          --       (1,547)         --            --           --     (1,547)
Treasury stock purchased...     --          --           --          --            --       (5,510)    (5,510)
Unrealized gain on
  available-for-sale
  investments..............     --          --           --          --        34,549           --     34,549
Net income.................     --          --       26,652          --            --           --     26,652
                              ----     -------     --------     -------       -------     --------   --------
BALANCE AT JUNE 30, 1996...    106      64,844       42,378        (649)       34,549      (38,220)   103,008
Sale of common stock under
  options and employee
  stock purchase plan......      2       1,871           --          --            --           --      1,873
Tax benefit relating to
  stock options............     --         489           --          --            --           --        489
Foreign currency
  translation adjustment...     --          --           --        (880)           --           --       (880)
Dividends declared ($.20
  per share)...............     --          --       (1,750)         --            --           --     (1,750)
Treasury stock purchased...     --          --           --          --            --       (2,546)    (2,546)
Unrealized gain on
  available-for-sale
  investments..............     --          --           --          --        12,520           --     12,520
Net income.................     --          --        7,371          --            --           --      7,371
                              ----     -------     --------     -------       -------     --------   --------
BALANCE AT JUNE 30, 1997...    108      67,204       47,999      (1,529)       47,069      (40,766)   120,085
Sale of common stock under
  options and employee
  stock purchase plan......      1       1,843           --          --            --           --      1,844
Tax benefit relating to
  stock options............     --         572           --          --            --           --        572
Foreign currency
  translation adjustment...     --          --           --        (501)           --           --       (501)
Dividends declared ($.20
  per share)...............     --          --       (1,788)         --            --           --     (1,788)
Treasury stock purchased...     --          --           --          --            --       (2,253)    (2,253)
Unrealized loss on
  available-for-sale
  investments..............     --          --           --          --        (3,236)          --     (3,236)
Net income (loss)..........     --          --      (14,083)         --            --           --    (14,083)
                              ----     -------     --------     -------       -------     --------   --------
BALANCE AT JUNE 30, 1998...   $109     $69,619     $ 32,128     $(2,030)      $43,833     $(43,019)  $100,640
                              ====     =======     ========     =======       =======     ========   ========
</TABLE>
 
The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.
                                       39
<PAGE>   41
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
 
<TABLE>
<CAPTION>
                                                                   YEARS ENDED JUNE 30,
                                                             --------------------------------
                                                               1998        1997        1996
                                                             --------    --------    --------
                                                                      (IN THOUSANDS)
<S>                                                          <C>         <C>         <C>
Cash flows from operating activities:
  Net income (loss)......................................    $(14,083)   $  7,371    $ 26,652
  Adjustments to reconcile net income (loss) to net cash
     provided by (used in) operating activities:
     Purchased in-process research and development.......      10,587          --       3,000
     Purchased in-process research & development of
       discontinued operations...........................          --          --      14,800
     Depreciation and amortization.......................       4,899       4,419       4,895
     Equity in losses of affiliates......................         151         969         392
     Gain on investments, net of taxes paid of $0
       million, $10.8 million and $39.5 million in 1998,
       1997 and 1996, respectively.......................     (19,096)    (13,625)    (42,547)
     Deferred income taxes...............................      (2,979)     (1,463)     (6,659)
     Tax benefit relating to stock options...............         572         489          26
     Write-down of purchased intangibles of discontinued
       operations........................................       6,078          --          --
     Write-down of inventory and plant and equipment of
       discontinued operations...........................       5,261          --          --
     Decrease (increase) in assets:
       Accounts receivable...............................      (3,042)     (1,225)      4,044
       Inventories.......................................      (1,928)     (2,245)     (2,513)
       Other.............................................        (105)      2,820      (1,371)
     Increase (decrease) in liabilities:
       Accounts payable, accrued liabilities and other...       9,361         271        (185)
       Income taxes payable..............................       1,230       1,788       1,686
       Other long-term liabilities.......................      (2,473)      1,529      (1,181)
       Net changes in assets and liabilities of
          discontinued operations........................        (239)     (2,387)      1,251
                                                             --------    --------    --------
     Total adjustments...................................       8,277      (8,660)    (24,362)
                                                             --------    --------    --------
     Net cash provided by (used in) operating
       activities........................................      (5,806)     (1,289)      2,290
                                                             --------    --------    --------
Cash flows from investing activities:
  Net proceeds from sales of Boston Scientific Corp.
     stock, net of taxes paid............................      20,442       5,578      57,950
  Net proceeds from sale of other affiliate stock, net of
     taxes paid..........................................         704       9,771       1,447
  Proceeds from sales and maturities of short-term
     investments.........................................       9,413       6,634       4,043
  Purchases of short-term investments....................     (12,308)     (7,968)     (4,505)
  Expenditures for property and equipment................      (5,029)     (3,360)     (1,677)
  Increase in intangible and other assets................          (5)     (2,726)     (6,807)
  Equity investments and loans to affiliates.............      (3,075)     (1,928)    (14,337)
  Acquisition of discontinued operations, net of cash
     balances............................................          --          --     (21,324)
  Acquisition of interest in Cohesion Corporation, net of
     cash balances.......................................     (10,587)         --      (1,256)
                                                             --------    --------    --------
     Net cash provided by investing activities...........        (445)      6,001      13,534
                                                             --------    --------    --------
Cash flows from financing activities:
  Repurchase of common stock.............................      (2,253)     (2,546)     (5,510)
  Net proceeds from issuance of common stock.............       1,844       1,873         963
  Cash dividends paid....................................      (1,774)     (1,750)     (1,340)
  Proceeds from (repayments of) bank borrowings..........      (2,031)     (5,000)      5,000
                                                             --------    --------    --------
     Net cash used in financing activities...............      (4,214)     (7,423)       (887)
                                                             --------    --------    --------
Net increase (decrease) in cash and cash equivalents.....     (10,465)     (2,711)     14,937
Cash and cash equivalents at beginning of period.........      18,381      21,092       6,155
                                                             --------    --------    --------
Cash and cash equivalents at end of period...............    $  7,916    $ 18,381    $ 21,092
                                                             ========    ========    ========
</TABLE>
 
The accompanying Notes to Consolidated Financial Statements are an integral part
                              of these statements.
 
                                       40
<PAGE>   42
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
  1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Presentation
 
     The consolidated financial statements include the accounts of Collagen
Aesthetics, Inc. (formerly Collagen Corporation, see Note 17, "Subsequent
Events") ("Collagen" or the "Company"), a Delaware corporation, and its
wholly-owned and majority-owned subsidiaries including Cohesion Technologies,
Inc. ("Cohesion"). All significant intercompany accounts and transactions have
been eliminated. The Company operates in one industry segment focusing on the
development, manufacturing and sale of medical devices. Investments in
unconsolidated subsidiaries, and other investments in which the Company has a
20% to 50% interest or otherwise has the ability to exercise significant
influence, are accounted for under the equity method. Investments in companies
in which the Company has less than a 20% interest with either no readily
determinable fair value or with transfer restrictions are carried at cost or
estimated realizable value, if less, and those unrestricted investments with a
readily determinable fair value are carried at market value with the unrealized
gains or losses, net of tax, recorded as a component of stockholders' equity.
 
     On August 18, 1998, the Company spun off, in a one-for-one distribution of
common stock to the Company's stockholders, Cohesion, which previous to the
Spinoff was a wholly-owned subsidiary of the Company. (See Note 17, "Subsequent
Events".)
 
     In March 1998, the Board of Directors of the Company approved certain
agreements between Cohesion and the Company which (i) provided for the transfer,
effective January 1, 1998, of certain assets and liabilities relating to the
businesses previously conducted by the Cohesion division to Cohesion, and (ii)
established contractual arrangements between the Company and Cohesion described
below under "Intercompany Agreements with Cohesion Technologies, Inc." The
business activities of the Cohesion division focused on the design, development,
manufacture and commercialization of innovative resorbable biomaterials,
adhesive technologies, and delivery systems in the fields of tissue repair and
regeneration.
 
     Under the agreements, substantially all investments in affiliates,
including Boston Scientific Corporation, and Innovasive Devices, Inc. were
allocated to Cohesion. Trade receivables, notes receivable, loans to officers
and employees, fixed assets and employee related liabilities were allocated
based on specific identification. For assets and liabilities where it was not
practical to use the specific identification method, Cohesion was allocated 30%
of these assets and liabilities. The 30% allocation was based on a review of the
characteristics and activity of these assets and liabilities and business
objectives. The officer separation agreement with the Company's former CEO, as
described in Note 10, and the costs associated with the agreement have been
allocated to Cohesion.
 
  Intercompany Agreements with Cohesion Technologies, Inc.
 
     The Company has entered into supply, services, research and development,
benefits, tax allocation, and distribution agreements with Cohesion effective
January 1, 1998. Under the Collagraft Supply Agreement, the Company will supply
Cohesion's requirements of Collagraft necessary for Cohesion to fulfill its
obligations under its agreement with Zimmer, Inc. at a price that is the greater
of a percentage of the sales price or a defined multiplier of the Company's
cost. In accordance with the Collagen Supply Agreement, the Company will supply
Cohesion products, intermediates and finished materials at a price equal to a
multiplier of Collagen's cost. Under the Services Agreement, which is effective
through June 30, 1999, Cohesion shall provide the Company with services in the
following areas: facilities, telephone, library, investor relations, research
and development services (to the extent not provided for by the research and
development agreement), and clinical and regulatory. The Company shall provide
Cohesion with certain services in the following areas: financial and tax
services, health and welfare benefits administration and administration of the
401(k) Savings Plan, administrative, legal, regulatory, quality assurance,
medical affairs, and manufacturing services. In accordance with the Recombinant
Technology and Development License Agreement, the Company and Cohesion will
collaborate to develop recombinant human collagen and provide for cost sharing
for the project until certain milestones are met. The Benefits Agreement
provides for the continuation or replacement of benefits for the employees
transferred to Cohesion and employees remaining with the
 
                                       41
<PAGE>   43
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Company. The Tax Allocation Agreement provides that the Company will be
responsible for all taxes prior to the Distribution Date and Cohesion will be
responsible for all of its tax liabilities subsequent to that date. Under the
Vitrogen International Distribution Agreement, Collagen International, Inc., a
subsidiary of the Company, shall act as Cohesion's distributor in Germany for
Vitrogen.
 
  Use of Estimates in the Preparation of Financial Statements
 
     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, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
  Reclassification
 
     Certain prior year amounts in the consolidated financial statements have
been reclassified to conform with the current year presentation.
 
  Cash equivalents, short-term investments and other investments
 
     The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. Short-term
investments consist principally of bankers acceptances, commercial paper and
master notes and have maturities greater than 90 days, but not exceeding one
year.
 
     The Company invests its excess cash in deposits with major banks and in
money market securities of companies with strong credit ratings and from a
variety of industries. These securities are typically short-term in nature and,
therefore, bear minimal risk. The Company has not experienced any losses on its
money market investments.
 
     The Company determines the appropriate classification of marketable
securities at the time of purchase and re-evaluates such designation as of each
balance sheet date. All of the Company's debt and equity securities are
classified as available-for-sale. The carrying value of available-for-sale debt
securities approximates fair value because of the short-term maturity of these
investments. Both realized and unrealized gains and losses on debt securities
were immaterial as of June 30, 1998, 1997 and 1996 and for the years ended June
30, 1998, 1997 and 1996. Unrestricted available-for-sale equity securities with
a readily determinable fair value in which the Company has a less than 20%
interest, which includes holdings in Boston Scientific Corporation (holdings in
Target Therapeutics prior to April 1997), Innovasive Devices, Inc., and Medarex,
Inc., are carried at fair value with the unrealized gains and losses, net of
tax, reported as a separate component of stockholders' equity. Restricted equity
securities in which the Company has less than a 20% interest are carried at cost
or estimated realizable value, if less, and are included in "other investments
and assets" in the accompanying balance sheets. In fiscal 1996, the carrying
value of certain investments were reduced by $4.0 million to estimated net
realizable value. (See Notes 5, "Investment in Boston Scientific Corporation
(Target Therapeutics, Inc.)", 6, "Investment in Innovasive Devices, Inc." and 7,
"Acquisitions".) The cost of securities sold is based on the specific
identification method.
 
     The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale debt securities are included in
interest income. Interest and dividends on securities classified as
available-for-sale are included in interest income.
 
  Equity Collar Instruments
 
     At June 30, 1998, the Company held approximately 1.0 million shares of
Boston Scientific common stock. In order to manage the risk of market
fluctuations in this stock, the Company entered into certain costless collar
instruments ("collars"), to hedge a portion (725,000 shares at June 30, 1998) of
the Boston Scientific equity securities against changes in market value. A
costless collar instrument is a form of equity collar instrument consisting of a
purchased put option and a written call option on a specific equity security
                                       42
<PAGE>   44
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
such that the cost of the purchased put and the proceeds of the written call
offset each other; therefore, there is no initial cost or cash outflow for these
instruments. The Company purchased the collars with expiration dates and numbers
of shares so that the potential adverse impact of movements in market price of
the stock will be at least partially offset by an associated increase in the
value of the collars.
 
     Realized gains and losses on the collars are recorded in other income
(expense) with the related gains from the sale of stock. Unrealized gains and
losses on these instruments, net of tax, are recorded as an adjustment to
unrealized gains and losses on available-for-sale investments, a component of
stockholder's equity, with a corresponding receivable or payable recorded.
Equity collar instruments that do not qualify for hedge accounting and early
termination of these instruments with the sale of the underlying stock, would be
recognized in other income (expense). For early termination with the sale of the
underlying stock, the intrinsic value will adjust the cost basis of the
underlying security.
 
  Inventories
 
     Inventories are valued at the lower of cost, determined on a standard cost
basis which approximates average cost, or market.
 
  Property and equipment
 
     Depreciation and amortization of property and equipment, which is stated at
cost, are provided on the straight-line method over estimated useful lives as
follows:
 
<TABLE>
<S>                                             <C>
Machinery and equipment.......................  3-7 years
Leasehold improvements........................  Term of lease
</TABLE>
 
  Intangible assets
 
     Intangible assets are amortized using the straight-line method. Patents
acquired prior to October 1996 are amortized over a seventeen-year period
beginning with the effective date or over the remainder of such period from the
date acquired and patents purchased thereafter are expensed when acquired.
Trademarks acquired prior to fiscal 1996 are amortized over a twenty-year period
beginning with the trademark filing dates and trademarks purchased thereafter
are expensed when acquired. The effect of changes in accounting for patents and
trademarks were not material to the accompanying financial statements. Purchased
product distribution rights and a non-compete covenant are amortized over the
lesser of the estimated useful life (generally five years) or the contract
period.
 
  Purchased intangibles and goodwill
 
     The excess cost over the fair value of net assets acquired (goodwill) is
generally amortized on a straight-line basis over a period not exceeding seven
years. The cost of identified intangibles is generally amortized on a
straight-line basis over a period of seven years. The carrying value of goodwill
and intangible assets is reviewed on a regular basis for the existence of facts
or circumstances both internally and externally that may suggest impairment.
During fiscal 1998, the Company wrote-off all intangible assets and goodwill
associated with the acquisition of LipoMatrix, Inc. due to impairment (See Note
8). No other impairment has been indicated. Should there be indication of an
impairment in the future, the Company will confirm this by comparing the
undiscounted expected future cash flows from the impaired assets to the carrying
amount of the assets. If the sum of the estimated cash flows is lower, an
impairment loss, measured by comparing the fair value of the assets to their
carrying amounts, will be recorded if significant. The cash flow estimates that
will be used in such calculations will be based on management's best estimates,
using appropriate and customary assumptions and projections at the time.
 
                                       43
<PAGE>   45
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  Loans to officers and employees
 
     Principal plus accrued interest due from current and former employees
totaled approximately $1.5 million and $1.9 million at June 30, 1998 and 1997,
respectively, and principal plus accrued interest due from officers totaled
approximately $167,000 and $9,000 at June 30, 1998 and 1997, respectively.
 
     Included within the amounts due from current and former employees at June
30, 1998 and 1997 are promissory notes totaling, prior to reserves, $1.2 million
and $1.6 million, respectively, due from the Company's former Chairman and Chief
Executive Officer, Howard Palefsky. All such notes are subject to interest at
the lower of 10% per annum or the prime rate. Two loans totaling $425,000 were
forgiven on March 15, 1998 and two loans totaling $1.1 million are to be
forgiven on March 15, 1999, however the outstanding note is payable immediately
if Mr. Palefsky discontinues serving as a consultant to the Company prior to the
loan forgiveness date. Due to uncertainties regarding collection, loans to Mr.
Palefsky were fully reserved as of June 30, 1997, and the associated expenses
were recognized in fiscal 1997.
 
  Summary of Fair Value of Financial Instruments
 
     The table below summarizes the carrying value and fair value of the
Company's financial instruments which are all held for purposes other than
trading.
 
<TABLE>
<CAPTION>
                                                                           JUNE 30,
                                                            ---------------------------------------
                                                                   1998                 1997
                                                            ------------------   ------------------
                                                            CARRYING    FAIR     CARRYING    FAIR
                                                             VALUE      VALUE     VALUE      VALUE
                                                            --------   -------   --------   -------
<S>                                                         <C>        <C>       <C>        <C>
Assets:
Cash equivalents and short-term investments (See Note
  3)......................................................  $14,802    $14,802   $19,285    $19,285
Boston Scientific stock (See Note 5)......................   73,979     73,979    83,874     83,874
Innovasive Devices stock (See Note 6).....................    7,027      7,916     5,670      9,917
Medarex stock.............................................    1,920      1,920       500        500
Pharming B.V. stock.......................................    7,010      7,010     4,510      4,510
Other non-public equity securities........................    1,364      1,364     1,083      1,083
Loans to officers and employees...........................      259        259       172        172
Equity Collar Instruments.................................       --         96        --         --
</TABLE>
 
  Revenue Recognition
 
     Revenue from product sales is recognized at time of shipment, net of
allowances for estimated future returns.
 
  Concentration of Credit and Other Risk
 
     The Company sells its facial aesthetics products primarily to physicians
and pharmacies in North America, Europe and the Pacific Rim. The Company sells
Contigen(R) Bard collagen implant ("Contigen implant") to C.R. Bard, Inc.
("Bard"), its marketing partner for Contigen implant, and Collagraft(R) bone
graft matrix implant and Collagraft(R) bone graft matrix strip ("Collagraft bone
graft products") to Zimmer, Inc. ("Zimmer"), the Company's marketing partner for
Collagraft bone graft products. The Company performs ongoing credit evaluations
of its customers and generally does not require collateral. The Company
maintains reserves for potential credit losses and such losses have been within
management's expectations.
 
     The Company allows, on occasion, its customers to return product for
credit, and also allows customers to return defective or damaged product for
credit or replacement. Written authorization from the Company is required to
return merchandise. Some domestic and foreign customers are subject to extended
payment terms. These practices have not had a material effect on the Company's
working capital.
 
     As of June 30, 1998, the Company owned approximately 1.0 million shares of
Boston Scientific common stock, valued at approximately $74.0 million (based on
a market price of $71.63 per share on such date).
 
                                       44
<PAGE>   46
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     All of the Company's manufacturing capacity for collagen products, the
majority of its research and development activities, its corporate headquarters,
and other critical business functions are located near major earthquake faults.
In addition, all of the manufacturing capacity for collagen-based products is
located in one primary facility with the Company currently maintaining only
limited amounts of finished product inventory. While the Company has some
limited protection in the form of disaster recovery programs and basic insurance
coverage, the Company's operating results and financial condition would be
materially adversely affected in the event of a major earthquake, fire or other
similar calamity affecting its manufacturing facilities.
 
  Advertising costs
 
     The Company expenses advertising costs as incurred. Total advertising
expense was $975,000, $900,000 and $1.0 million for 1998, 1997 and 1996,
respectively.
 
  Stock based compensation
 
     The Company accounts for stock based compensation using the intrinsic value
method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, compensation cost for stock options is measured as the
excess, if any, of the quoted market price of the Company's stock at the date of
grant over the amount an employee must pay to acquire the stock. The Company has
adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation."
 
  Earnings per share
 
     Beginning with fiscal year 1998, basic earnings per share (EPS) and diluted
EPS are computed using the methods required by Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128"). Under SFAS 128, basic EPS is
calculated using the weighted average number of common shares outstanding for
the period. The computation of diluted EPS includes the effects of stock
options, warrants and convertible preferred stock, if such effect is dilutive.
Prior period amounts have been restated to conform with the presentation
requirements of SFAS 128. Below is a reconciliation between the basic and
diluted weighted average common and common-equivalent shares for 1997 and 1996
(there are no reconciling items for 1998):
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED JUNE 30,
                                                              --------------------
                                                               1997         1996
                                                              -------      -------
                                                                 (IN THOUSANDS)
<S>                                                           <C>          <C>
Basic (weighted average common shares outstanding)..........   8,804        8,915
Weighted average common stock options outstanding...........     126          160
                                                               -----        -----
Diluted weighted average shares outstanding.................   8,930        9,075
                                                               =====        =====
</TABLE>
 
  Foreign currency translation
 
     The functional currency for each foreign subsidiary is its respective
foreign currency. Accordingly, all assets and liabilities related to these
operations are translated at the current exchange rates at the end of each
period. The resulting cumulative translation adjustments are recorded directly
to the accumulated foreign currency translation adjustment account included in
stockholders' equity. Revenues and expenses are translated at average exchange
rates in effect during the period. Foreign currency transaction gains and losses
are included in results of operations.
 
     At June 30, 1998 and June 30, 1997, no foreign currency transaction
exposures were hedged. Unhedged net foreign assets were $6.5 million and $7.6
million at June 30, 1998 and June 30, 1997, respectively.
 
  New Accounting Standards
 
     In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income," and
Standard No. 131, "Disclosures About Segments of an Enterprise and Related
Information," which will be required to be adopted by the Company in
 
                                       45
<PAGE>   47
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
fiscal 1999. Adoption of these statements is not expected to have a significant
impact on the Company's consolidated financial position, results of operations
or cash flows.
 
     In June 1998, the Financial Accounting Standards Board issued Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133")
which provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. SFAS 133 is effective for
years beginning June 15, 1999 and is not anticipated to have an impact on the
Company's results of operations or financial condition when adopted.
 
 2. BALANCE SHEET INFORMATION
 
<TABLE>
<CAPTION>
                                                                   JUNE 30,
                                                              -------------------
                                                               1998        1997
                                                              -------    --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Other current assets:
  Deferred taxes............................................  $ 6,925    $  5,344
  Other.....................................................    4,091       3,882
                                                              -------    --------
                                                              $11,016    $  9,226
                                                              =======    ========
Property and equipment:
  Machinery and equipment...................................  $37,286    $ 33,956
  Leasehold improvements....................................    6,404       6,109
                                                              -------    --------
                                                               43,690      40,065
  Less accumulated depreciation and amortization............  (29,242)    (26,120)
                                                              -------    --------
                                                              $14,448    $ 13,945
                                                              =======    ========
Intangible assets:
  Patents, trademarks, distribution rights and non-compete
     covenant...............................................  $ 9,387    $ 10,793
  Organization costs*.......................................    1,865       1,865
                                                              -------    --------
                                                               11,252      12,658
  Less amortization.........................................   (4,391)     (3,971)
                                                              -------    --------
                                                              $ 6,861    $  8,687
                                                              =======    ========
Accrued liabilities:
  Dividends payable.........................................  $   896    $    881
  Accruals for discontinued operations......................    2,107          --
  Accrued restructuring charges.............................    1,541          --
  Other accrued liabilities.................................    9,476       8,530
                                                              -------    --------
                                                              $14,020    $  8,735
                                                              =======    ========
</TABLE>
 
---------------
 
* Organization costs are primarily related to the formation of Collagen
  International, Inc. and are fully amortized as of June 30, 1996.
 
                                       46
<PAGE>   48
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 3. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
 
     The following is a summary of available-for-sale debt securities:
 
<TABLE>
<CAPTION>
                                                                  JUNE 30,
                                                              -----------------
                                                               1998      1997
                                                              ------    -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Amortized cost which approximates estimated fair value
Cash Equivalents:
  Money market funds........................................  $3,121    $ 2,159
  Corporate obligations.....................................   3,670     12,009
                                                              $6,791    $14,168
                                                              ======    =======
Short-term investments:
  Corporate obligations.....................................  $8,011    $ 5,117
                                                              ======    =======
</TABLE>
 
     During the years ended June 30, 1998 and 1997, the Company sold
available-for-sale debt securities with a fair value at the dates of sale of
$9.4 million and $6.6 million, respectively. Both gross realized and unrealized
gains and losses on these securities were insignificant. The Company uses
amortized cost as the basis for recording gains and losses from securities
transactions. Contractual maturities of the debt securities do not exceed one
year at June 30, 1998.
 
 4. INVENTORIES
 
     Inventories consist of the following:
 
<TABLE>
<CAPTION>
                                                                JUNE 30,
                                                           ------------------
                                                            1998       1997
                                                           -------    -------
                                                             (IN THOUSANDS)
<S>                                                        <C>        <C>
Raw materials............................................  $ 1,765    $   856
Work-in-process..........................................    3,948      5,122
Finished goods...........................................    6,388      4,195
                                                           -------    -------
                                                           $12,101    $10,173
                                                           =======    =======
</TABLE>
 
 5. INVESTMENT IN BOSTON SCIENTIFIC CORPORATION (TARGET THERAPEUTICS, INC.)
 
     The Company's investment in Target Therapeutics, Inc. of Fremont,
California ("Target") was accounted for under the equity method through November
1995. During December 1995, the Company's ownership interest in Target fell
below 20%. Given that the Company did not have the ability to exercise
significant influence, the Company began accounting for its investment in Target
under the cost method beginning in December 1995.
 
     On January 20, 1997, Boston Scientific Corporation ("Boston Scientific")
and Target jointly announced the signing of a definitive agreement to merge in a
tax-free stock-for-stock transaction. On April 8, 1997, the merger was completed
and, as a result, the Company received 1,365,200 shares of Boston Scientific
common stock in exchange for the Company's 1,275,888 shares of Target common
stock. Pursuant to the merger agreement, the Company was restricted from selling
its shares of Boston Scientific common stock until the expiration of applicable
pooling-of-interests restrictions, which occurred during the first quarter of
fiscal 1998.
 
     Boston Scientific is a leading manufacturer of catheter-based devices that
can be inserted through small body openings and are used in heart surgery and
other operations. Boston Scientific common stock is quoted on the New York Stock
Exchange under the symbol BSX. On June 30, 1998, the closing price of Boston
Scientific common stock was $71.63 per share. In fiscal 1998, the Company sold
332,340 shares of Boston Scientific common stock for a pre-tax gain of
approximately $19.0 million and in fiscal 1997, the Company sold 330,000 shares
of Target common stock for a pre-tax gain of approximately $9.2 million.
 
                                       47
<PAGE>   49
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     The Company's shares of Boston Scientific common stock are classified as
available-for-sale and have been recorded at fair value. The unrealized gains
(estimated fair value less cost) on these available-for-sale securities have
been reported as a separate component of stockholders' equity, net of tax. The
following is a summary of the aggregate estimated fair value, gross unrealized
gains and amortized cost of the Company's investment in Boston Scientific common
stock.
 
<TABLE>
<CAPTION>
                                                                JUNE 30,
                                                           ------------------
                                                            1998       1997
                                                           -------    -------
<S>                                                        <C>        <C>
Amortized cost...........................................  $ 4,468    $ 5,905
Gross unrealized gains...................................   69,511     77,969
                                                           -------    -------
Estimated fair value.....................................  $73,979    $83,874
                                                           =======    =======
</TABLE>
 
     To hedge against fluctuations in the market value of a portion of the
Boston Scientific common stock, the Company entered into costless collar
instruments that expire quarterly from August 1998 through May 2001 and will
require settlement in cash. At June 30, 1998, 725,000 shares were hedged using
these collars. No shares were hedged at June 30, 1997. The call options are
collateralized by shares of Boston Scientific common stock held by the Company.
At June 30, 1998, the notional amount of the put and call options were $46.0
million and $70.7 million, respectively. The fair value of the equity collars at
June 30, 1998 was $96,000. The fair value of the purchased puts and the written
calls were determined based on quoted market prices at year-end.
 
 6. INVESTMENT IN INNOVASIVE DEVICES, INC.
 
     In October 1995, the Company's wholly-owned subsidiary Cohesion
Technologies, Inc. ("Cohesion") purchased approximately 844,000 shares of common
stock, currently representing approximately 9% of Innovasive Devices, Inc.
("Innovasive Devices") for $4.1 million and entered into a collaborative product
development agreement (the "Development Agreement"). Innovasive Devices
develops, manufactures, and markets tissue and bone reattachment systems which
are particularly relevant to the sports medicine and arthroscopy segments of the
orthopedic surgery market. Cohesion and Innovasive Devices are collaborating to
develop certain resorbable mechanical tissue-fixation devices utilizing
collagen-based biomaterials for applications in orthopedic tissue repairs.
Pursuant to the terms of the Development Agreement, Cohesion is performing
development activities in accordance with a project plan and Innovasive Devices
is reimbursing Cohesion for such activities in accordance with the project
budget. Accordingly, over the next several years, the collaboration will require
Cohesion's expertise with collagen-based biomaterials and a small percentage of
Cohesion's research and development expenditures. In the event that marketable
products are developed as a result of this collaboration, Cohesion will have the
right to distribute such products for plastic surgery and dermatology
applications and will also have rights (but no obligation) to manufacture such
products.
 
     Prior to October 1996, Cohesion's 844,000 shares of common stock of
Innovasive Devices were valued at cost or $4.1 million due to restrictions which
prevented the sale of any of Cohesion's shares of common stock of Innovasive
Devices. At June 30, 1998, restrictions were no longer applicable to 650,000
shares of common stock which Cohesion holds in Innovasive Devices. The Company
carries the portion of its investment in Innovasive Devices, which can be sold
within one year, as an available-for-sale investment at market value, or $6.1
million at June 30, 1998, reflecting an unrealized gain of $3.0 million ($6.1
million estimated fair value less $3.1 million cost), which has been included in
a separate component of stockholders' equity, net of tax. The remaining 194,000
shares of common stock continue to be valued at cost of $934,000. The investment
in Innovasive is included in "other investments and assets" in the accompanying
balance sheets.
 
     During fiscal 1998 and 1997, the Company did not sell any of its shares of
common stock of Innovasive Devices. Innovasive Devices' common stock is quoted
on The Nasdaq Stock Market under the symbol IDEA. The closing price of
Innovasive Devices' common stock at June 30, 1998, was $9.38 per share. As of
July 31, 1998, Innovasive Device's closing stock price was $7.88 per share,
resulting in a decrease of $975,000 in the estimated fair value of the
non-restricted portion of the Company's investment in Innovasive Devices.
 
                                       48
<PAGE>   50
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 7. ACQUISITIONS
 
  Cohesion Corporation
 
     The Company increased its ownership position in Cohesion Corporation of
Palo Alto, California from approximately 40% to 81% in May 1996 and from 81% to
approximately 99% in December 1997. Cohesion Corporation is a privately-held
company developing novel biomaterials with superior performance characteristics
in the area of hemostats, biosealants, and adhesion prevention barriers for
surgical applications. In connection with the Company's May 1996, December 1997,
and April 1998 investments and purchases of Cohesion Corporation shares,
substantially all of the $3.0 million and $10.6 million purchase prices,
respectively, were allocated to in-process research and development, which was
expensed at the time of the purchases. The $10.5 million December 1997 purchase
price includes $3.8 million of cash compensation amounts associated with the
purchase of certain vested employee stock options, which amounts were expensed
in accordance with the Accounting Principles Board Opinion No. 25. After
consideration of the amounts allocated to in-process technology, there was no
excess of purchase price over the fair value of the net assets acquired and no
goodwill was recorded.
 
     The Company determined the amounts to be allocated to in-process technology
for Cohesion Corporation based on whether technological feasibility had been
achieved and whether there was any alternative future use for the technology.
The Company concluded that the in-process technology had no alternative future
use after taking into consideration the potential for both usage of the
technology in different products and for resale of the technology. At June 30,
1998, there were additional unvested options outstanding providing for the
purchase of the remaining shares of Cohesion Corporation common stock.
Subsequent to June 30, 1998, the Cohesion Technologies Board of Directors
approved a plan to buyout these remaining options, (see Note 17, "Subsequent
Events").
 
     The unaudited pro forma results of operations of the Company for fiscal
years 1998, 1997 and 1996, assuming the acquisition of Cohesion Corporation
shares occurred on July 1, 1995, on the basis described above with all material
intercompany transactions eliminated, are as follows:
 
<TABLE>
<CAPTION>
                                                                    JUNE 30,
                                                        --------------------------------
                                                          1998        1997        1996
                                                        --------    --------    --------
                                                        (IN THOUSANDS, EXCEPT PER SHARE
                                                                    AMOUNTS)
<S>                                                     <C>         <C>         <C>
Revenues..............................................  $82,772     $68,335     $68,285
Income (loss) from continuing operations..............    8,709      14,798      52,543
Net income (loss).....................................   (3,496)      7,371      29,280
Net income (loss) per share -- Basic..................     0.39        0.84        3.28
Net income (loss) per share -- Diluted................     0.39        0.83        3.23
</TABLE>
 
     The unaudited pro forma net income (loss) and per share amounts above do
not include the charges for in-process research and development aggregating
$13.6 million arising from the acquisitions of shares of Cohesion Corporation.
The unaudited pro forma information is not necessarily indicative of the actual
results of operations had the transaction occurred at the beginning of the
periods indicated, nor should it be used to project the Company's results of
operations for any future dates or periods.
 
 8. DISCONTINUED OPERATIONS OF LIPOMATRIX
 
     On June 30, 1998, the Board of Directors of the Company approved the
discontinuation of the operations of LipoMatrix, Inc. ("LipoMatrix") of
Neuchatel, Switzerland, and authorized efforts to sell the wholly-owned
subsidiary, thereby allowing the Company's aesthetic operations to dedicate
further resources to its core business which includes products for soft tissue
reconstruction and augmentation, skin care and stress urinary incontinence.
 
     In August 1995, the Company entered into a stock purchase agreement with
certain stockholders of LipoMatrix, the developer and the manufacturer of the
Trilucenta breast implant ("Trilucent implant"), to
 
                                       49
<PAGE>   51
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
purchase approximately 50% of the outstanding securities of LipoMatrix on a
fully diluted basis. The Company also entered into a stock purchase agreement
with certain of LipoMatrix's management and employees to purchase the remaining
10% of the outstanding securities on a fully diluted basis. This purchase
increased the Company's ownership interest in LipoMatrix from approximately 40%
to 100% of the outstanding securities on a fully diluted basis. The acquisition
of LipoMatrix, which was accounted for as a purchase, had an aggregate purchase
price of approximately $23.7 million, consisting of payments to LipoMatrix
stockholders, the balance of the Company's investment in LipoMatrix at the date
of purchase, direct costs and the assumption of LipoMatrix' net liabilities of
$926,000. The Company completed the closing of the aforementioned acquisition of
LipoMatrix in January 1996 at which time aggregate cash payments of
approximately $20.1 million were made by the Company to the selling LipoMatrix
stockholders, as well as certain of LipoMatrix's current and former employees.
 
     The assets and liabilities assumed by the Company were recorded based on
their independently appraised fair values at the date of the acquisition. Of the
purchase price of $23.7 million, $14.8 million was allocated to in-process
research and development, $3.8 million to intangible assets and $5.1 million to
goodwill. As of June 30, 1998 all of the assets and liabilities related to
discontinued operations are disclosed separately. The in-process research and
development represented research and development projects where technological
feasibility had not yet been established, major regulatory marketing approvals
had not yet been obtained and where there were no alternative future uses or
markets. The Company's discontinued operations for fiscal 1996 include 100% of
LipoMatrix' results from August 22, 1995, through June 30, 1996 and 40% for July
1, through August 21, 1995.
 
     A provision of $8.6 million, net of an income tax benefit of $2.5 million,
has been recorded for the loss on disposal of net assets of LipoMatrix including
estimated future costs. The Company expects to dispose of the assets by December
31, 1998.
 
     Results of operations for LipoMatrix have been presented separately as
discontinued operations. The following table summarizes the revenues, loss from
operations and loss per share of LipoMatrix for the three fiscal years ended
June 30.
 
<TABLE>
<CAPTION>
                                                                    YEARS ENDED JUNE 30,
                                                              --------------------------------
                                                                1998        1997       1996
                                                              ---------   --------   ---------
                                                              (IN THOUSANDS, EXCEPT PER SHARE
                                                                          AMOUNTS)
<S>                                                           <C>         <C>        <C>
Revenues....................................................  $  3,871    $ 3,477    $  2,445
                                                              ========    =======    ========
Discontinued operations:
  Loss from operations......................................  $ (5,279)   $(9,145)   $(24,682)
  Benefit for income taxes..................................     1,630      1,718         917
                                                              --------    -------    --------
     Loss from discontinued operations net of taxes.........    (3,649)    (7,427)    (23,765)
  Provision for disposal....................................   (11,045)        --          --
  Benefit for income taxes..................................     2,489         --          --
                                                              --------    -------    --------
     Provision for disposal, net of taxes...................    (8,556)        --          --
     Total loss from discontinued operations net of taxes...  $(12,205)   $(7,427)   $(23,765)
                                                              ========    =======    ========
Net loss per share -- Basic:
  Loss from discontinued operations of LipoMatrix, Inc......  $  (0.41)   $ (0.84)   $  (2.66)
  Loss from disposal of LipoMatrix, Inc.....................     (0.96)        --          --
                                                              --------    -------    --------
     Net loss per share -- Basic............................  $  (1.37)   $ (0.84)   $  (2.66)
                                                              ========    =======    ========
Net loss per share -- Diluted:
  Loss from discontinued operations of LipoMatrix, Inc......  $  (0.41)   $ (0.83)   $  (2.62)
  Loss from disposal of LipoMatrix, Inc.....................     (0.96)        --          --
                                                              --------    -------    --------
     Net loss per share -- Diluted..........................  $  (1.37)   $ (0.83)   $  (2.62)
                                                              ========    =======    ========
</TABLE>
 
                                       50
<PAGE>   52
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 9. RESTRUCTURING EXPENSE
 
     In June 1998, the Company decided to restructure its domestic and
international operations to reduce costs and facilitate a product refocus. The
international effort includes moving the Company's European headquarters from
Switzerland to the United Kingdom and terminating seven employees. The domestic
effort is substantially smaller and includes the reorganization of the North
American Sales force and termination of one employee. As a result of these
actions the Company incurred $1.5 million in restructuring charges, consisting
of approximately $735,000 for severance costs and approximately $806,000 for
facility commitments and moving expenses associated with fixed assets. At June
30, 1998, no employees had been terminated and the Company had approximately
$1.5 million of accrued restructuring costs, representing estimated severance
costs and facility payments to be paid in fiscal 1999.
 
10. COMMITMENTS
 
  Minimum lease payments
 
     Future minimum lease payments under noncancelable operating leases at June
30, 1998 are as follows:
 
<TABLE>
<CAPTION>
                                                 (IN THOUSANDS)
<S>                                              <C>
1999...........................................     $ 4,632
2000...........................................       3,552
2001...........................................       3,358
2002...........................................       3,102
2003...........................................       3,077
Thereafter.....................................       4,599
                                                    -------
          Total minimum lease payments.........     $22,320
                                                    =======
</TABLE>
 
     Rental expense was $5.0 million, $4.6 million and $5.3 million in fiscal
1998, 1997 and 1996, respectively.
 
Minimum purchases
 
     In 1996, the Company entered into a ten year exclusive worldwide
distribution agreement with the supplier of its SoftForm(R) ("SoftForm implant')
product. Under the agreement, the Company must meet the minimum purchase
requirements in the table below or the supplier has the right to revert the
Company's exclusive distribution right to a non-exclusive distribution right, or
terminate the agreement.
 
<TABLE>
<CAPTION>
                                                 (IN THOUSANDS)
<S>                                              <C>
1999...........................................     $ 1,250
2000...........................................       1,438
2001...........................................       1,653
2002...........................................       1,818
2003...........................................       2,000
Thereafter.....................................       6,621
                                                    -------
          Total minimum purchases..............     $14,780
                                                    =======
</TABLE>
 
     Payments made to the supplier were $2.5 million and $1.6 million in fiscal
1998 and 1997, respectively.
 
     In May 1998, the Company entered into an Import Services Agreement with its
Distributor in Japan which requires the Company to pay $1.6 million to the
Distributor upon completion of the assignment of all Product Approvals and
receipt by the Company's Japanese Subsidiary of Permits corresponding thereto.
The assignment date is June 30, 1999 and the assignment consideration due will
be successively reduced by ten to twenty percent per month if the assignment
takes place after June 30, 1999.
 
                                       51
<PAGE>   53
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  Revolving Line of Credit Agreement
 
     In November 1994, the Company entered into a $7 million revolving line of
credit with a bank, secured by shares of Target common stock held by the
Company. The terms of this facility contained certain financial covenants and
restricted the aggregate amount of cash dividends payable by the Company. In
December 1995, the $7 million revolving line of credit was increased to $15
million. During fiscal 1996, $5.0 million was borrowed under this agreement. In
June 1997, the Company repaid the outstanding balance and canceled the revolving
line of credit agreement prior to its expiration date of November 15, 1997.
Interest associated with this agreement was, at the Company's option, based on
either the prime rate plus  1/2% or the Eurodollar rate plus the lesser of
1 1/4% or the Alternate LIBOR applicable margin. Interest was payable monthly.
Additionally, the Company was required to pay, on a quarterly basis, a
commitment fee of 3/8 of 1% per annum of the unused portion.
 
  Term Loans and Line of Credit
 
     Prior to the Company's acquisition of LipoMatrix, LipoMatrix established
three term loans and a general credit line with a major bank, totaling $2.9
million (4.1 million Swiss Francs). As of June 30, 1997, $2,100,000 (2.9 million
Swiss Francs) had been borrowed against these credit facilities. Borrowings
under these credit facilities bear interest at 7% per annum, payable
semi-annually in June and December. Interest subsidies totaling 5.075% are
received on the term loans annually, resulting in a net interest rate due on the
term loans of 1.925%. Semi-annual repayment of these credit facilities began on
June 30, 1996. In October 1997, the Company repaid all outstanding amounts.
Approximately one-half of these credit facilities were guaranteed by the Swiss
Confederation.
 
  Bonus Agreement
 
     In February 1996, the Company entered into a cash bonus agreement with the
Company's Chairman and Chief Executive Officer at that time whereby cash bonuses
in the amounts of $325,000, $305,000, $285,000, $265,000 and $245,000 would be
paid to him on February 13 of each of the following five years beginning in
1997, providing that he continued to serve the Company on the applicable payment
date. On February 10, 1997, Mr. Palefsky resigned as Chief Executive Officer and
subsequently resigned as Chairman of the Board of Directors on June 20, 1997,
and as a result, the February 13, 1997 payment and future payments were not
required to be paid under this bonus agreement. The bonus agreement was replaced
by the officer separation agreement. Under the officer separation agreement, Mr.
Palefsky will serve as a consultant to the Company for fiscal 1998 and 1999 and
as a result, Mr. Palefsky received payments totaling $575,000 during fiscal 1998
and will receive payments totaling $233,000 during fiscal 1999. These payments
are expensed as the services are provided.
 
11. LEGAL MATTERS
 
     In May 1997, the Company settled its lawsuit with Matrix Pharmaceuticals,
Inc. ("Matrix"), which had been pending since December 1994. The lawsuit
involved the Company's claims of trade secret misappropriation against Matrix
and two former Collagen employees hired by Matrix in 1992, as well as
cross-complaints against the Company by Matrix and the two employees for
defamation and violation of state unfair competition law.
 
     In exchange for certain consideration, Matrix has agreed that for a period
of five years it will not manufacture or sell products that are directly
competitive with the Company's current core products. The Company has granted
Matrix a nonexclusive license to certain of the Company's intellectual property,
for certain nonmonetary consideration. The lawsuit was settled and dismissed
with prejudice. All claims by and against all parties have been released.
 
     The Company is involved in other legal actions, including product liability
claims, arising in the ordinary course of business. While the outcome of such
matters is currently not determinable, it is management's opinion that these
matters will not have a material adverse effect on the Company's consolidated
financial position or results of its operations.
                                       52
<PAGE>   54
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
12. STOCKHOLDERS' EQUITY
 
  Stock Options
 
     The Company has various stock option plans under which incentive stock
options or non-statutory stock options may be granted to officers, directors,
key employees and consultants to purchase the Company's common stock. The
options are granted at no less than the fair market value at the dates of grant
and generally expire after ten years. Incentive stock options become exercisable
at the rate of two percent each month beginning the first full month after the
date of grant unless accelerated by the Board of Directors. Non-statutory stock
options become exercisable on a monthly or yearly basis as determined by the
Board of Directors at the date of grant.
 
     At June 30, 1998, the total number of shares of common stock reserved for
issuance under the Company's current stock option plans was 1,880,155.
 
     Stock option activities under the stock option plans were as follows:
 
<TABLE>
<CAPTION>
                                                                                WEIGHTED
                                                                                 AVERAGE       NUMBER
                                           NUMBER      OPTION EXERCISE PRICE    PRICE PER     OF SHARES
                                          OF SHARES       RANGE PER SHARE         SHARE      EXERCISABLE
                                          ---------    ---------------------    ---------    -----------
<S>                                       <C>          <C>                      <C>          <C>
Outstanding at June 30, 1995............  1,217,976       $ 4.69 - 28.25         $18.03         851,702
Granted.................................    431,000        17.00 - 20.50          18.09
Exercised...............................    (22,154)       16.25 - 22.88          16.26
Forfeitures or expired..................   (145,249)        6.38 - 26.50          20.10
                                          ---------       --------------         ------       ---------
Outstanding at June 30, 1996............  1,481,673         4.69 - 28.25          17.88         976,896
Granted.................................    549,250        16.75 - 20.75          18.76
Exercised...............................   (146,552)       16.56 - 22.75           9.09
Forfeitures or expired..................   (162,468)        7.25 - 28.25          20.22
                                          ---------       --------------         ------       ---------
Outstanding at June 30, 1997............  1,721,903         4.69 - 28.25          18.69       1,016,326
Granted.................................    282,115        16.63 - 21.38          17.80
Exercised...............................   (145,955)        4.69 - 20.50           9.02
Forfeitures or expired..................   (325,810)        5.50 - 28.25          19.49
                                          ---------       --------------         ------       ---------
Outstanding at June 30, 1998............  1,532,253         6.38 - 28.25          19.27       1,010,275
                                          =========       ==============         ======       =========
Available for grant at June 30, 1998....    347,902
                                          =========
</TABLE>
 
  Stock Purchase Plan
 
     In 1985, the Company established an employee stock purchase plan (the "1985
Purchase Plan") under which 450,000 shares of the Company's common stock were
reserved for issuance to employees. Subsequently, the Company increased the
total authorization to 700,000 shares. Under the 1985 Purchase Plan, the
Company's employees, subject to certain restrictions, may purchase shares at a
price per share that is the lesser of 85 percent of the fair market value as of
the beginning or close of the yearly offering period.
 
     For fiscal 1998, 1997 and 1996, shares issued under the 1985 Purchase Plan
were 34,053, 34,769, and 34,084, respectively. The average issuance price per
share was $15.52, $15.52 and $17.83 for fiscal years 1998, 1997 and 1996,
respectively. At June 30, 1998, 99,087 shares remained available for future
sales under this plan.
 
     In April 1998, the Board of Directors of the Company authorized the
adoption of the 1998 Employee Stock Purchase Plan (the "1998 Purchase Plan")
under which 125,000 shares of the Company's common stock were reserved for
issuance to employees. Under the 1998 Purchase Plan, the Company's employees,
subject to certain restrictions, may purchase shares at a price per share that
is the lesser of 85 percent of the fair market value as of the beginning or
close of the offering period. The initial offering period under the 1998
Purchase Plan will commence in August 1998. The initial purchase date will occur
on December 31, 1998.
 
                                       53
<PAGE>   55
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Subsequent offering periods consist of four six-month purchase periods, with the
last day of each period being designated a purchase date.
 
  Stock Compensation
 
     The Company has elected to follow Accounting Principles Board Statement No.
25 ("APB No. 25") and related interpretations in accounting for its employee
stock options because, as discussed below, the alternative fair value accounting
provided for under Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation ("SFAS 123") requires the use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB No. 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of the
grant, no compensation expense is generally recognized.
 
     Pro forma information regarding net income (loss) and earnings per share is
required by SFAS 123 and determined as if the Company had accounted for its
employee stock options granted subsequent to June 30, 1995 under the fair value
method of that statement. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model for the multiple-option
approach, with the following weighted-average assumptions for 1998, 1997 and
1996: risk-free interest rate of 5.75%, 6.34% and 5.82%, respectively;
volatility factor of the expected market price of the Company's Common Stock of
41%, 43% and 49%, respectively; no dividend payments; and a weighted-average
expected life of the option of 4.6, 4.0 and 4.5 years, respectively.
 
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of the Company's employee stock options.
 
     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to pro forma net income over the options' vesting period.
The Company's pro forma information follows:
 
<TABLE>
<CAPTION>
                                                         YEARS ENDED JUNE 30,
                                                --------------------------------------
                                                   1998          1997          1996
                                                -----------    ---------    ----------
                                                (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                             <C>            <C>          <C>
Pro forma net income (loss)...................   $(15,703)      $5,545       $25,685
Pro forma net income (loss) per
  share -- Basic..............................   $  (1.76)      $ 0.63       $  2.88
Pro forma net income (loss) per
  share -- Diluted............................   $  (1.76)      $ 0.62       $  2.83
</TABLE>
 
     Because SFAS 123 is applicable only to options granted subsequent to June
30, 1995, its pro forma effect will not be fully reflected until June 30, 1999.
 
     The following table summarizes information about stock options outstanding
at June 30, 1998:
 
<TABLE>
<CAPTION>
             OPTIONS OUTSTANDING                  WEIGHTED         OPTIONS EXERCISABLE
----------------------------------------------     AVERAGE     ----------------------------
                                   WEIGHTED       REMAINING                     WEIGHTED
    RANGE OF        NUMBER         AVERAGE       CONTRACTUAL     NUMBER         AVERAGE
EXERCISE PRICES   OUTSTANDING   EXERCISE PRICE      LIFE       EXERCISABLE   EXERCISE PRICE
----------------  -----------   --------------   -----------   -----------   --------------
<S>               <C>           <C>              <C>           <C>           <C>
 $ 6.38 - $17.00     368,978        $16.06          6.98          216,009        $15.52
  17.13 -  18.00     313,227         17.73          7.87          128,282         17.60
  18.13 -   9.75     327,956         19.38          6.73          197,780         19.32
  19.88 -  22.13     379,092         21.40          5.07          337,649         21.48
  22.63 -  28.25     143,000         25.04          5.14          130,555         25.04
----------------   ---------        ------          ----        ---------        ------
 $ 6.38 - $28.25   1,532,253         19.27          6.46        1,010,275         19.75
================   =========        ======          ====        =========        ======
</TABLE>
 
                                       54
<PAGE>   56
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     The weighted-average fair values of options granted during the years ended
June 30, 1998, 1997 and 1996 were $5.87, $5.75 and $6.67 per share,
respectively.
 
  Stock Repurchase Program
 
     In February 1993, the Company's Board of Directors authorized a stock
repurchase program. In fiscal years 1998, 1997 and 1996, the Company repurchased
125,000, 147,900 and 300,000 shares at average acquisition prices of
approximately $18, $17 and $18 per share, respectively. In June 1996, the Board
of Directors authorized the repurchase of up to an additional 500,000 shares. As
of June 30, 1998, an additional 227,100 shares are authorized for repurchase.
The Company plans to retain repurchased shares as treasury stock, but may use a
portion of the stock in various company stock benefit plans. Subsequent to June
30, 1998, the Board of Directors approved a continuation of the stock repurchase
program previously approved (see Note 17, "Subsequent Events").
 
  Stockholder Rights Plan
 
     In November 1994, the Board of Directors approved a stockholder rights plan
which would entitle stockholders to purchase stock in the Company or in an
acquiror of the Company at a discounted price in the event of certain hostile
efforts to acquire control of the Company. The rights may only be exercised, if
at all, upon the occurrence of certain events unless earlier redeemed pursuant
to the plan. The rights expire on November 28, 2004.
 
13. INTERNATIONAL SALES AND DISTRIBUTION RIGHTS
 
     Export sales were $31.3 million in fiscal 1998, $31.2 million in fiscal
1997 and $30.4 million in fiscal 1996. These export sales are primarily in
Europe ($19.6 million, $21.3 million and $21.4 million in fiscal years 1998,
1997 and 1996, respectively) and the Pacific Rim ($9.1 million, $7.6 million and
$7.0 million in fiscal years 1998, 1997 and 1996, respectively). No other
geographic region accounted for ten percent or more of total sales in any fiscal
year. The Company markets its products internationally directly in Canada, nine
European countries, Australia and New Zealand and via distributors in other
countries. During fiscal 1996, the Company paid commissions based upon a
percentage of net sales to its former European distributor, whose contract
expired in December 1995.
 
14. MAJOR CUSTOMER AND PRODUCTS
 
     During fiscal years 1998, 1997 and 1996, the Company realized product sales
from its marketing partner, Bard, of $17.7 million, $7.9 million and $6.2
million, respectively, which represented 20%, 11% and 9% of product sales. Bard
has exclusive worldwide marketing and distribution rights for Contigen implant,
a product introduced in fiscal 1994. These amounts were comprised of product
sales of Contigen implant of $10.4 million, $1.2 million and $300,000 of
Contigen implant as well as $7.3 million, $6.7 million and $5.9 million of
income from Bard's direct sales to physicians in fiscal years 1998, 1997 and
1996, respectively. In fiscal year 1996, the Company also recorded other revenue
of $2.0 million, which consisted of a milestone payment from Bard in accordance
with an agreement between the Company and Bard. The final milestone payment of
$2.0 million was paid to the Company on September 30, 1995. In fiscal years
1998, 1997 and 1996, 62%, 76% and 82% of product sales, respectively, were
derived from Zyderm(R) and Zyplast(R) collagen implant ("Zyderm implants" and
"Zyplast implant") products.
 
15. INCOME TAXES
 
     The Company uses the liability method of accounting for income taxes
required by SFAS No. 109.
 
                                       55
<PAGE>   57
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of June 30, 1998 and June
30, 1997 are presented below:
 
<TABLE>
<CAPTION>
                                                                   JUNE 30,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Deferred tax liabilities:
  Unrealized gain on marketable securities..................  $30,061    $32,507
  Investments...............................................    1,888      2,507
  Intangible assets.........................................       12        378
  Foreign earnings and credits (net)........................      214         56
                                                              -------    -------
          Total deferred tax liabilities....................   32,175     35,448
                                                              -------    -------
Deferred tax assets:
  Equity in losses of affiliates............................    5,700      5,607
  Accrued liabilities relating to disposal of LipoMatrix....    2,935         --
  Non-deductible accruals...................................    3,561      2,065
  State income taxes........................................      488      1,864
  Accounts receivable.......................................      676        647
  Inventories...............................................      482        501
  Property, plant & equipment...............................      207        176
  Other.....................................................      436      1,380
  Valuation allowance.......................................   (5,974)    (5,881)
                                                              -------    -------
     Total deferred tax assets..............................    8,511      6,359
                                                              -------    -------
          Net deferred tax liabilities......................  $23,664    $29,089
                                                              =======    =======
</TABLE>
 
     The valuation allowance increased by $93,000, decreased by $59,000 and
increased by $2.3 million in fiscal years 1998, 1997 and 1996, respectively.
Significant components of the provision for income taxes are as follows:
 
<TABLE>
<CAPTION>
                                                    YEARS ENDED JUNE 30,
                                                -----------------------------
                                                 1998       1997       1996
                                                -------    -------    -------
                                                       (IN THOUSANDS)
<S>                                             <C>        <C>        <C>
Current:
  Federal.....................................  $ 1,103    $ 5,442    $36,793
  Foreign.....................................      544        553        360
  State.......................................      420      2,075      7,491
                                                -------    -------    -------
          Total current.......................    2,067      8,070     44,644
                                                -------    -------    -------
Deferred:
  Federal.....................................   (2,328)      (971)    (5,971)
  State.......................................     (651)      (492)      (688)
                                                -------    -------    -------
          Total deferred......................   (2,979)    (1,463)    (6,659)
                                                -------    -------    -------
                                                $  (912)   $ 6,607    $37,985
                                                =======    =======    =======
</TABLE>
 
                                       56
<PAGE>   58
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     For financial reporting purposes, income (loss) before income taxes
includes the following components:
 
<TABLE>
<CAPTION>
                                                           YEARS ENDED JUNE 30,
                                                      -------------------------------
                                                        1998       1997        1996
                                                      --------    -------    --------
                                                              (IN THOUSANDS)
<S>                                                   <C>         <C>        <C>
Domestic operations.................................  $(12,017)   $15,498    $ 85,816
Foreign operations..................................    (2,978)    (2,284)    (21,361)
                                                      --------    -------    --------
                                                      $(14,995)   $13,214    $ 64,455
                                                      ========    =======    ========
</TABLE>
 
     The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before taxes. The sources and
tax effects of the differences are as follows:
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED JUNE 30,
                                                       ------------------------------
                                                         1998       1997       1996
                                                       --------    -------    -------
                                                               (IN THOUSANDS)
<S>                                                    <C>         <C>        <C>
Income (loss) before income taxes (including
  discontinued operations and disposal)..............  $(14,995)   $13,214    $64,455
                                                       ========    =======    =======
Expected tax at 35% or 34%...........................  $ (5,243)   $ 4,625    $22,559
State income tax, net of federal benefit.............      (223)       741      4,422
In-process research and development..................     2,375         --      6,230
Non-deductible intangibles...........................     1,699         --         --
Net operating losses of subsidiaries for which no
  current benefit is realizable......................       164      1,176      2,166
Equity in losses of affiliates.......................        76       (222)     2,039
Goodwill/intangible amortization.....................       428        530        442
Other................................................      (188)      (243)       127
                                                       --------    -------    -------
                                                       $   (912)   $ 6,607    $37,985
                                                       ========    =======    =======
</TABLE>
 
16. STATEMENTS OF CASH FLOWS
 
     Supplemental disclosures of cash flow information:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED JUNE 30,
                                                            -------------------------
                                                            1998     1997      1996
                                                            ----    ------    -------
                                                                 (IN THOUSANDS)
<S>                                                         <C>     <C>       <C>
Cash paid during the year for:
  Interest (net of capitalized interest)..................  $ 56    $  473    $   296
  Income taxes (net of refunds)...........................   (65)    5,068     42,817
Non-cash financing activity:
  Dividends declared......................................  $896    $  881    $   883
</TABLE>
 
17. SUBSEQUENT EVENTS (UNAUDITED)
 
  Spinoff of Cohesion Technologies, Inc.
 
     On August 18, 1998 (the "Distribution Date"), the Company spun off, in a
one-for-one distribution of common stock to the Company's stockholders, Cohesion
Technologies, Inc., which previous to the spin-off was a wholly-owned subsidiary
of the Company. The transaction resulted in the distribution of 100% of the
outstanding shares of Cohesion. The distribution of shares was declared tax-free
for U.S. federal income tax purposes in an IRS ruling. Subsequent to the
distribution, Cohesion has been traded on the NASDAQ National Market under the
ticker symbol of CSON.
 
CANCELLATION AND REPRICING OF OUTSTANDING STOCK OPTIONS
 
     In August 1998, each employee (including officers and directors) and
consultant of the Company or any subsidiary of the Company who, immediately
prior to the distribution date for the spin-off of Cohesion held a vested stock
option to purchase shares of Company common stock will, in connection with the
Distribution,
                                       57
<PAGE>   59
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
receive two new options in replacement of the original option, one to acquire
shares of Company common stock and the other to acquire shares of Cohesion
common stock. Each new option gives the holder the right to purchase a number of
shares equal to the number of shares in the original option.
 
     Each employee (including officers and directors) and consultant of the
Company or any subsidiary of the Company who, immediately prior to the
distribution date for the spin-off of Cohesion held an unvested stock option to
purchase shares of Company common stock will, in connection with the
distribution, receive a new option in replacement of the original option to
acquire the same number of shares of common stock of the entity (the Company or
Cohesion) for which such optionee was employed or retained as a consultant
following the distribution.
 
     The exercise price of each new option will be determined in accordance with
Emerging Issues Task Force Issue 90-9 as agreed upon by the Company's Board and
the Cohesion Board (or any committee thereof), after consultation with legal and
accounting advisors. The exercise price, as adjusted in light of the above
considerations, is not intended to result in any compensation expense to the
Company or Cohesion. All other terms of the new options other than the exercise
price will be the same as those of the original options; provided, however, the
service as an employee or consultant of Cohesion, or its subsidiaries shall be
equivalent to providing service as an employee or consultant of the Company. At
the option of the Company's Board or Cohesion Technologies Board,
out-of-the-money options may be treated differently.
 
     In August 1998 the stockholders of the Company approved the amendment of
the Company's 1994 Stock Option Plan to increase the number of shares of common
stock reserved for issuance by 70,000 shares from 1,150,000 to 1,220,000 shares,
the adoption of the Company's 1998 Employee Stock Purchase Plan and the
reservation of 125,000 shares of Company common stock for issuance, and the
adoption of the 1998 Directors' Stock Option Plan which reserved 250,000 shares
of common stock for issuance. The Company's 1990 Directors' Stock Option Plan
was terminated in August 1998. In addition, the Board of Directors approved a
continuation of the stock repurchase program previously approved. Under this
program, the Company is currently authorized to repurchase up to 500,000 shares
of its common stock having an aggregate purchase price not in excess of
$5,000,000.
 
     In September 1998, Cohesion's Board of Directors approved a program to
cancel options to purchase shares of the common stock of Cohesion Corporation
(the "Canceled Options"). In connection with such program, Cohesion will pay
each holder of Canceled Options a per share amount equal to the excess of $16.70
over the exercise price of the Canceled Option (the "Option Payment"). Cohesion
will make this Option Payment ratably over the original vesting period of the
Canceled Option so long as the holder thereof remains an employee or consultant
of Cohesion or Cohesion Corporation.
 
  Corporate Name Change
 
     On August 12, 1998, the stockholders of the Company approved a corporate
name change from Collagen Corporation to Collagen Aesthetics, Inc. which better
reflects the Company's focus on serving the facial aesthetic medical
marketplace. The name change has been reflected in the accompanying financial
statements.
 
                                       58
<PAGE>   60
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Collagen Aesthetics, Inc.
 
     We have audited the accompanying consolidated balance sheets of Collagen
Aesthetics, Inc. (formerly Collagen Corporation) as of June 30, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended June 30, 1998. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Collagen
Aesthetics, Inc. (formerly Collagen Corporation) at June 30, 1998 and 1997, and
the consolidated results of its operations and its cash flows for each of the
three years in the period ended June 30, 1998 in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects, the
information set forth therein.
 
                                                         /s/ ERNST & YOUNG LLP
Palo Alto, California
July 31, 1998
 
                                       59
<PAGE>   61
 
              SUPPLEMENTARY QUARTERLY CONSOLIDATED FINANCIAL DATA
                                  (UNAUDITED)
 
SELECTED QUARTERLY FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                                                                QUARTERS ENDED
                                                              --------------------------------------------------
                                                              JUNE 30    MARCH 31    DECEMBER 31    SEPTEMBER 30
                                                              -------    --------    -----------    ------------
                                                                   (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                           <C>        <C>         <C>            <C>
FISCAL 1998
Product sales...............................................   22,732     19,232        21,511         19,297
Cost of sales...............................................    6,388      5,567         6,516          5,487
Selling, general and administrative expenses................   12,470     10,360         9,958          9,747
Acquired in-process research & development..................       57         --        10,530             --
Research and development expenses...........................    6,637      5,866         5,177          5,035
Operating loss..............................................   (4,361)    (2,561)      (10,670)          (972)
Net gain on investments, principally Boston Scientific
  Corporation (formerly Target Therapeutics, Inc.)..........    5,358      4,964         2,843          5,932
Net gain on investments, Prograft Medical, Inc..............       --         --            --             --
Loss from discontinued operations, net of taxes.............     (828)      (733)       (1,104)          (984)
Provision for loss on disposal of discontinued operations,
  net of taxes..............................................   (8,556)        --            --             --
Net income (loss)...........................................   (9,346)     1,670        (8,417)         2,010
Net income (loss) per share -- Basic:
  Continuing operations.....................................  $  0.00    $  0.27      $  (0.82)       $  0.34
  Discontinued operations...................................    (1.04)     (0.08)        (0.13)         (0.11)
                                                              -------    -------      --------        -------
                                                              $ (1.04)   $  0.19      $   0.95        $  0.23
Net income (loss) per share -- Diluted:
  Continuing operations.....................................  $  0.00    $  0.26      $  (0.82)       $  0.34
  Discontinued operations...................................    (1.04)     (0.08)        (0.13)         (0.11)
                                                              -------    -------      --------        -------
                                                              $ (1.04)   $  0.18      $   0.95        $  0.23
Share price*:
  High......................................................    22.00     22.125        20.875         19.875
  Low.......................................................    17.75      16.75         18.00         16.625
FISCAL 1997
Product sales...............................................  $18,240    $15,780      $ 18,351        $15,964
Cost of sales...............................................    4,267      3,778         4,890          4,288
Selling, general and administrative expenses................   10,572     12,106         9,027          7,087
Research and development expenses...........................    4,331      3,602         3,199          2,955
Operating loss..............................................     (930)    (3,706)        1,235          1,634
Net gain on investments, principally Boston Scientific
  Corporation (formerly Target Therapeutics, Inc.)..........       --         --         3,038          6,184
Net gain on investments, Prograft Medical, Inc..............    9,063         --            --             --
Loss from discontinued operations, net of taxes.............   (1,529)    (1,425)       (2,033)        (2,440)
Provision for loss on disposal of discontinued operations,
  net of taxes..............................................       --         --            --             --
Net income (loss)...........................................    7,614     (3,561)        1,011          2,307
Net income (loss) per share -- Basic:
  Continuing operations.....................................  $  1.04    $ (0.25)     $   0.35        $  0.53
  Discontinued operations...................................    (0.17)     (0.16)        (0.23)         (0.27)
                                                              -------    -------      --------        -------
                                                              $  0.87    $ (0.41)     $   0.12        $  0.26
Net income (loss) per share -- Diluted:
  Continuing operations.....................................  $  1.03    $ (0.25)     $   0.34        $  0.52
  Discontinued operations...................................    (0.17)     (0.16)        (0.23)         (0.27)
                                                              -------    -------      --------        -------
                                                              $  0.86    $ (0.41)     $   0.11        $  0.25
Share price*:
  High......................................................  $ 19.75    $ 26.00      $  21.50        $ 20.25
  Low.......................................................    13.75      18.25         18.00          16.50
</TABLE>
 
---------------
* Share price not adjusted for August 1998 Cohesion Spinoff.
 
    THE COMMON STOCK OF THE COMPANY IS TRADED OVER-THE-COUNTER ON THE NASDAQ
STOCK MARKET UNDER THE SYMBOL CGEN. THE COMPANY DECLARED A CASH DIVIDEND OF $.10
PER SHARE ON ITS COMMON STOCK PAYABLE TO STOCKHOLDERS OF RECORD ON JUNE 30,
1998, IN ADDITION TO A $.10 PER SHARE DIVIDEND DECLARED AND PAID EARLIER IN
FISCAL 1998. IN FISCAL 1997, THE COMPANY DECLARED A CASH DIVIDEND OF $.10 PER
SHARE ON ITS COMMON STOCK PAYABLE TO STOCKHOLDERS OF RECORD ON JUNE 30, 1997, IN
ADDITION TO A $.10 PER SHARE DIVIDEND DECLARED AND PAID EARLIER IN FISCAL 1997.
WHILE THE COMPANY DOES NOT EXPECT TO PAY DIVIDENDS IN THE NEAR FUTURE, THE BOARD
OF DIRECTORS WILL RE-EVALUATE THE DIVIDEND POLICY ON A SEMI-ANNUAL BASIS. SEE
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY.
 
                                       60
<PAGE>   62
 
                                                                     SCHEDULE II
 
                           COLLAGEN AESTHETICS, INC.
 
                       VALUATION AND QUALIFYING ACCOUNTS
                    YEARS ENDED JUNE 30, 1996, 1997 AND 1998
 
<TABLE>
<CAPTION>
                                                             ADDITIONS
                                              BALANCE AT     CHARGED TO
                                             BEGINNING OF    COSTS AND                       BALANCE AT
                DESCRIPTION                     PERIOD        EXPENSES     DEDUCTIONS(1)    END OF PERIOD
                -----------                  ------------    ----------    -------------    -------------
                                                                    (IN THOUSANDS)
<S>                                          <C>             <C>           <C>              <C>
1996
  Allowance for doubtful accounts..........      $383           $ 33            $41             $375
1997
  Allowance for doubtful accounts..........      $375           $ 71            $28             $418
1998
  Allowance for doubtful accounts..........      $418           $169            $82             $505
</TABLE>
 
---------------
(1) Write-off of uncollectible accounts
 
                                       61
<PAGE>   63
 
                                    PART III
 
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE
REGISTRANT
 
     The information required by this item concerning the Company's directors is
incorporated by reference from the information under the caption "Election of
Directors" in the Company's Proxy Statement for its Annual Meeting of
Stockholders filed on or about September 28, 1998 (the "Proxy Statement"). See
"Business -- Executive Officers" in Item I of this Annual Report on Form 10-K
for information concerning the Company's executive officers.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     The information required by this item is incorporated by reference from the
information under the caption "Compensation of Executive Officers" in the Proxy
Statement.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The information required by this item is incorporated by reference from the
information under the caption "Common Stock Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The information required by this item is incorporated by reference from the
information under the caption "Certain Relationships and Related Transactions"
in the Proxy Statement.
 
                                    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 AND SCHEDULES
 
           Financial Statements and Financial Statement Schedule II -- See Index
           to Consolidated Financial Statements at Item 8 of this report
 
     Schedules not listed above have been omitted because they are not required
or the information required to be set forth therein is included in the
Consolidated Financial Statements or notes thereto.
 
          2. EXHIBITS
 
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER        NOTES                            DESCRIPTION
  --------------    -----                            -----------
  <C>               <C>      <S>
      2.1**          (22)    Separation and Distribution Agreement by and between
                             Collagen Corporation and Cohesion Technologies, Inc. dated
                             January 1, 1998
      3.1             (8)    Certificate of Incorporation of Collagen Subsidiary, Inc.
      3.2                    Certificate of Merger of Collagen Corporation, a California
                             corporation, into Collagen Subsidiary, Inc., a Delaware
                             corporation
      3.3            (12)    By-Laws of Collagen Corporation, as amended
      3.4            (17)    By-Laws of Collagen Corporation, as amended on August 9,
                             1996, effective October 30, 1996
      3.5             (9)    Preferred Shares Rights Agreement between the Registrant and
                             the Bank of New York dated November 29, 1994
     10.24            (1)    Collaborative Research and Distribution Agreement with
                             Zimmer, Inc. dated as of June 26, 1985
</TABLE>
 
                                       62
<PAGE>   64
 
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER        NOTES                            DESCRIPTION
  --------------    -----                            -----------
  <C>               <C>      <S>
     10.27            (1)    Distribution Agreement between Registrant and Lederle
                             (Japan), Ltd. dated as of June 26, 1985
     10.34            (2)    Agreement for Sale and Leaseback of Manufacturing Facility
                             between Registrant and Heleasco Seven, Inc.
     10.36            (3)    Amended and Restated Development and Distribution Agreement
                             with C.R. Bard, Inc., dated as of August 4, 1989
     10.38            (4)    Agreement for Sale and Leaseback of Manufacturing Facility
                             between Registrant and Heleasco Seven, Inc. dated September
                             25, 1989
     10.39            (4)    Agreement for Sale and Leaseback of Manufacturing Facility
                             between Registrant and Heleasco Seven, Inc. dated December
                             29, 1989
     10.40            (4)    Amended and Restated Promissory Note of Dale A.
                             Stringfellow, dated September 7, 1990
     10.41            (4)    Amended and Restated Promissory Note Secured by Deed of
                             Trust by Dale A. Stringfellow, dated September 7, 1990
     10.42*           (4)    1984 Incentive Stock Option Plan, as amended
     10.43*                  1985 Employee Stock Purchase Plan, as amended
     10.44*          (12)    1990 Directors' Stock Option Plan, as amended
     10.46            (5)    Agreement between Registrant and Essex Chemie, A.G. dated
                             November 19, 1990
     10.56            (6)    Lease Agreement dated June 1, 1992 by and between Registrant
                             and Harbor Investment Partners
     10.58            (6)    License and Option Agreement dated June 30, 1992 between
                             Registrant and Research Development Foundation
     10.60            (7)    Amendments dated February 16, 1993 and February 18, 1993
                             respectively, to the Product Development and Distribution
                             Agreement dated January 18, 1985 by and between Registrant
                             and Zimmer, Inc., originally filed as Exhibit 10.24 to
                             Registrant's Form 10K for the fiscal year ended June 30,
                             1985
     10.61*           (7)    Letter Agreement, dated April 26, 1991 and May 21, 1993 by
                             and between Collagen Corporation and A. Neville Pelletier
     10.62*          (16)    1994 Stock Option Plan, as amended
     10.63            (8)    Renewed Lease for 2500 Faber Place, Palo Alto, California
                             dated December 1, 1992 between Registrant and Leonard Ely,
                             Shirley Ely, Carl Carlsen and Mary L. Carlsen
     10.65*           (8)    Promissory Note of Howard D. Palefsky dated August 3, 1994
     10.66            (8)    Revised Form of Agreement Regarding Proprietary Information
                             and Inventions between Registrant and all employees or
                             consultants
     10.67            (9)    Credit Agreement, dated November 15, 1994, by and between
                             the Bank of New York and the Registrant, as amended January
                             24, 1995
     10.67(a)        (12)    Second Amendment, Third Amendment and Fourth Amendment dated
                             June 30, 1995, September 30, 1995, and December 26, 1995,
                             respectively, to Credit Agreement dated November 15, 1994 by
                             and between the Bank of New York and the Registrant
</TABLE>
 
                                       63
<PAGE>   65
 
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER        NOTES                            DESCRIPTION
  --------------    -----                            -----------
  <C>               <C>      <S>
     10.67(b)        (13)    Fifth Amendment, dated March 29, 1996, to Credit Agreement
                             dated November 15, 1994 by and between the Bank of New York
                             and the Registrant
     10.67(c)        (15)    Sixth Amendment, dated June 28, 1996, to Credit Agreement
                             dated November 15, 1994 by and between the Bank of New York
                             and the Registrant
     10.67(d)        (16)    Seventh Amendment, dated September 30, 1996, to Credit
                             Agreement dated November 15, 1994 by and between the Bank of
                             New York and the Registrant
     10.67(e)        (17)    Eighth Amendment, dated December 31, 1996, to Credit
                             Agreement dated November 15, 1994 by and between the Bank of
                             New York and the Registrant
     10.68            (9)    Letter Agreement, dated October 7, 1994, by and between C.R.
                             Bard. Inc. and the Registrant, amending the Amended and
                             Restated Development and Distribution Agreement dated August
                             4, 1989 between the Parties originally filed as Exhibit
                             10.36 to the Registrant's Form 10K for the fiscal year ended
                             June 30, 1989
     10.70*          (11)    Letter of Acceptance of Employment by and between Gary
                             Petersmeyer and the Registrant, dated December 19, 1994
     10.71**         (11)    License, Supply and Option Agreement, dated March 24, 1995
                             by and between LipoMatrix, Incorporated and Registrant
     10.72**         (11)    Distributor Agreement dated March 24, 1995 by and between
                             LipoMatrix, Incorporated and the Registrant
     10.73**         (11)    Coordination Agreement dated March 24, 1995, by and between
                             LipoMatrix Incorporated and the Registrant's wholly-owned
                             subsidiary, Collagen International Incorporated
     10.74*          (11)    Promissory Note of Howard D. Palefsky dated June 5, 1995
     10.75**         (11)    Letter Agreement, dated July 10, 1995 by and between C.R.
                             Bard, Inc. and the Registrant , amending the Amended and
                             Restated Development and Distribution Agreement dated August
                             4, 1989 between the Parties originally filed as Exhibit
                             10.36 to the Registrant's Form 10K for the fiscal year ended
                             June 30, 1989
     10.76           (10)    Stock Purchase Agreement dated August 22, 1995 between the
                             Registrant and certain stockholders of LipoMatrix,
                             Incorporated
     10.77*          (12)    Promissory Note between Howard D. Palefsky and the
                             Registrant dated December 11, 1995
     10.78*          (14)    Bonus Agreement between Howard D. Palefsky and the
                             Registrant dated February 20, 1996
     10.79*          (14)    Promissory Note between Howard D. Palefsky and the
                             Registrant dated February 20, 1996
     10.80*          (13)    Amended and Restated Secured Loan Agreement between Ross R.
                             Erickson and the Registrant dated December 31, 1995
     10.81*          (15)    Letter of Acceptance of Employment by Pierre Comte and the
                             Registrant dated March 21, 1995
     10.82           (15)    Loan Agreement between the Registrant and Cohesion
                             Corporation dated May 24, 1996
</TABLE>
 
                                       64
<PAGE>   66
 
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER        NOTES                            DESCRIPTION
  --------------    -----                            -----------
  <C>               <C>      <S>
     10.83**         (15)    Worldwide Medical Product Distribution Agreement between
                             Registrant and Tissue Technologies, Inc. dated June 4, 1996
     10.84**         (15)    Distribution Agreement between Registrant and Biomatrix,
                             Inc. dated June 17, 1996
     10.85*          (16)    Repaid Promissory Note from Reid W. Dennis to the
                             Registrant, dated July 22, 1996
     10.86*          (17)    License, Supply and International Distribution Agreement
                             between Registrant and Cosmederm Technologies, Inc., dated
                             September 6, 1996
     10.88*          (18)    Agreement between Howard D. Palefsky and the Registrant
                             dated March 15, 1997
     10.89*          (18)    Employment Agreement between Gary Petersmeyer and the
                             Registrant dated February 7, 1997
     10.90*          (18)    Form of Management Continuity Agreement between certain
                             officers of the Company and the Registrant dated February 7,
                             1997
     10.91*          (19)    Employment Contract between Registrant and Jean-Pierre
                             Capdevielle dated January 9, 1997
     10.92**         (19)    Distribution Agreement between Registrant and Lederle
                             (Japan), LTD. dated June 30, 1997
     10.93**         (20)    License Agreement between Registrant and Tristrata
                             Technology, Inc. dated September 1, 1997
     10.94**         (21)    Manufacturing Agreement between Registrant and Laboratoire
                             Perouse Implant dated December 16, 1997
     10.95**         (22)    Chemical Peel Manufacturing and Sales License Amendment with
                             Cosmederm Technologies, Inc., dated February 27, 1998
     10.97**         (22)    Collagen Supply Agreement by and between Collagen
                             Corporation and Cohesion Technologies, Inc. dated January 1,
                             1998
     10.98**         (22)    Recombinant Technology Development and License Agreement by
                             and between Collagen Corporation and Cohesion Technologies,
                             Inc. dated January 1, 1998
     10.99           (22)    Tax Allocation and Indemnity Agreement by and between
                             Collagen Corporation and Cohesion Technologies, Inc. dated
                             January 1, 1998
     10.100          (22)    Services Agreement by and between Collagen Corporation and
                             Cohesion Technologies, Inc. dated January 1, 1998
     10.101          (22)    Benefits Agreement by and between Collagen Corporation and
                             Cohesion Technologies, Inc. dated January 1, 1998
     10.102          (22)    Vitrogen International Distribution Agreement by and between
                             Collagen Corporation and Cohesion Technologies, Inc. dated
                             January 1, 1998
     10.103          (22)    Assignment and License Agreement by and between Collagen
                             Corporation and Cohesion Technologies, Inc. dated January 1,
                             1998
     10.104**        (22)    Collagraft Supply Agreement by and between Collagen
                             Corporation and Cohesion Technologies, Inc. dated January 1,
                             1998
     10.105**                Import Services Agreement by and among Collagen Corporation
                             (Collagen KK) and Lederle (Japan), Ltd. Dated May 18, 1998
     21.1                    List of Subsidiaries
</TABLE>
 
                                       65
<PAGE>   67
 
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER        NOTES                            DESCRIPTION
  --------------    -----                            -----------
  <C>               <C>      <S>
     23.1                    Consent of Ernst & Young LLP, Independent Auditors
     24.1                    Power of Attorney (see page 42)
     27.1                    Financial Data Schedule (EDGAR version only)
</TABLE>
 
---------------
 * Constitutes a management contract or compensatory contract, plan or
   arrangement.
 
** Confidential treatment is requested for a portion of this document.
 
Notes to Exhibits:
 
 (1) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1985.
 
 (2) Incorporated by reference to the same exhibits filed with the Registrant's
     Current Report on Form 8-K dated March 31, 1989.
 
 (3) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1989.
 
 (4) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1990.
 
 (5) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1991.
 
 (6) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1992.
 
 (7) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1993.
 
 (8) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1994
 
 (9) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended December 31,
     1994.
 
(10) Incorporated by reference to exhibit 2.1 filed with the Registrant's
     Current Report on Form 8-K dated September 6, 1995.
 
(11) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1995
 
(12) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended December 31,
     1995
 
(13) Incorporated by reference to exhibit 10.76 originally filed with the
     Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended
     December 31, 1995
 
(14) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1996
 
(15) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1996
 
(16) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended September 30,
     1996
 
(17) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended December 31,
     1996
 
(18) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1997
 
(19) Incorporated by reference to the same exhibits filed with the Registrant's
     Annual Report on Form 10-K for the fiscal year ended June 30, 1997
 
                                       66
<PAGE>   68
 
(20) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended September 30,
     1997
 
(21) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended December 31,
     1997
 
(22) Incorporated by reference to the same exhibits filed with the Registrant's
     Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998
 
     b) REPORTS ON FORM 8-K.
 
     No reports on Form 8-K were filed by Registrant during the fiscal quarter
ended June 30, 1998.
 
                                       67
<PAGE>   69
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                          COLLAGEN AESTHETICS, INC.
 
                                                /s/ GARY S. PETERSMEYER
                                          --------------------------------------
                                                   Gary S. Petersmeyer
                                           President, Chief Executive Officer,
                                                       and Director
                                              (Principal Executive Officer)
 
Dated: September 22, 1998
 
                                       68
<PAGE>   70
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                SIGNATURE                                   TITLE                         DATE
                ---------                                   -----                         ----
<S>                                           <C>                                  <C>
 
/s/ GARY S. PETERSMEYER                       President, Chief Executive           September 22, 1998
------------------------------------------    Officer, and Director (Principal
Gary S. Petersmeyer                           Executive Officer)
 
/s/ NORMAN L. HALLEEN                         Vice President and Chief             September 22, 1998
------------------------------------------    Financial Officer (Principal
Norman L. Halleen                             Financial and Accounting Officer)
 
/s/ ANNE L. BAKAR                             Director                             September 22, 1998
------------------------------------------
Anne L. Bakar
 
/s/ FULTON COLLINS                            Director                             September 22, 1998
------------------------------------------
Fulton Collins
 
/s/ WILLIAM G. DAVIS                          Director                             September 22, 1998
------------------------------------------
William G. Davis
 
/s/ GERALD LAZARUS, M.D.                      Director                             September 22, 1998
------------------------------------------
Gerald Lazarus, M.D.
</TABLE>
 
                                       69
<PAGE>   71
 
                           COLLAGEN AESTHETICS, INC.
 
            FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED JUNE 30, 1998
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
                                                                         SEQUENTIALLY
EXHIBIT                                                                    NUMBERED
 NUMBER                              EXHIBIT                                 PAGE
-------                              -------                             ------------
<S>        <C>                                                           <C>
10.105**   Import Services Agreement by and among Collagen Corporation
           (Collagen KK) and Lederle (Japan), Ltd. dated May 18, 1998
21.1       List of Subsidiaries
23.1       Consent of Ernst & Young LLP, Independent Auditors
24.1       Power of Attorney (see page 42)
27.1       Financial Data Schedule (EDGAR version only)
</TABLE>
 
---------------
** Confidential treatment is requested for a portion of this document.