SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                 ---------------

                                    FORM 10-K

(Mark One)

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

    For the fiscal year ended          September 30, 1997
                                       ------------------ 

                                       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 0-26154


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


         Delaware                                             22-3208468
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(State or other jurisdiction of                           (I.R.S. Employer 
 incorporation or organization)                          Identification No.)

     10 Constitution Avenue
     P. O. Box 6860, Piscataway  NJ                             08855
--------------------------------------------------------------------------------
(Address of principal executive offices)                      (Zip Code)

                                 (732) 981-0990
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       (Registrant's telephone number, including area code)


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


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

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

                         Common Stock, $.0001 par value
--------------------------------------------------------------------------------
                                (Title of Class)

--------------------------------------------------------------------------------
                                (Title of Class)

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

         Indicate by check mark if disclosure of delinquent  filers  pursuant to
Item 405 of Regulation S-K is not contained  herein,  and will not be contained,
to the best of  registrant's  knowledge,  in  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  registrant  has only one class of voting  securities,  its  common
stock,  par value  $0.0001  per share (the  "Common  Stock"),  and no classes of
nonvoting securities. While it is difficult to determine the number of shares of
Common  Stock  owned  by  non-affiliates,  the  registrant  estimates  that  the
aggregate market value of outstanding  Common Stock on November 30, 1997, (based
upon the  closing  selling  price of such  Common  Stock on the Nasdaq  National
Market on November  28, 1997) held by  non-affiliates  was  approximately  $22.9
million.  For this computation,  the registrant has excluded the market value of
all shares of its Common  Stock  reported  as  beneficially  owned by  officers,
directors and certain significant stockholders of the registrant. Such exclusion
shall not be deemed to constitute an admission  that any such  stockholder is an
affiliate of the registrant.

         As of November 30, 1997,  there were outstanding  11,802,159  shares of
the registrant's Common Stock, par value $0.0001.


                       DOCUMENTS INCORPORATED BY REFERENCE

         The Proxy  Statement  of Exogen,  Inc.  in  connection  with the Annual
Meeting of Stockholders scheduled on or about February 25, 1998, is incorporated
by reference into Part III of this Form 10-K.
<PAGE>
                                  EXOGEN, INC.

                          1997 Form 10-K Annual Report

                                TABLE OF CONTENTS


                                      Page
                                     PART I

Item 1.    Business.............................................................
Item 2.    Properties...........................................................
Item 3.    Legal Proceedings....................................................
Item 4.    Submission of Matters to a Vote of Security Holders..................
Item 4a.   Executive Officers of the Registrant.................................

                                     PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters
Item 6.    Selected Financial Data..............................................
Item 7.    Management's Discussion and Analysis of Financial Condition
               and Results of Operations........................................
Item 8.    Financial Statements and Supplementary Data..........................
Item 9.    Changes in and Disagreements With Accountants on Accounting
               and Financial Disclosure.........................................

                                    PART III

Item 10.   Directors and Executive Officers of the Registrant...................
Item 11.   Executive Compensation...............................................
Item 12.   Security Ownership of Certain Beneficial Owners and Management.......
Item 13.   Certain Relationships and Related Transactions.......................

                                     PART IV

Item 14.   Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....
<PAGE>
                                     PART I


Item 1.  Business

         Exogen,   Inc.   (the   "Company"  or  "Exogen")   designs,   develops,
manufactures,  and markets  medical  devices for the  non-invasive  treatment of
musculoskeletal  injury and disease.  The Company's  proprietary  ultrasound and
mechanical-stress  technologies  are based on the principle  that bone growth is
stimulated by mechanical force. The Company's Sonic Accelerated Fracture Healing
System ("SAFHS(R)") device utilizes mechanical force, produced by ultrasound, to
accelerate fracture healing for closed, cast-immobilized, fresh fractures of the
tibia and distal  radius  within its approved  indications.  The SAFHS device is
small and  portable,  and is used by the patient once daily for 20 minutes.  The
SAFHS device is the only medical device approved by the FDA for the acceleration
of fresh-fracture healing of the tibia and the distal radius.

         The Company's  Pre-Market  Approval  ("PMA")  application for its first
model,   the  SAFHS  Model  2A,  was  approved  by  the  U.  S.  Food  and  Drug
Administration ("FDA") in October 1994. The Company designed a second-generation
SAFHS device, the SAFHS 2000(R),  which is entirely battery operated and smaller
and lighter  than the SAFHS Model 2A for  enhanced  portability.  The SAFHS 2000
utilizes  the same  ultrasound  signal as does the SAFHS  Model 2A. The  Company
filed a PMA  supplement  for the SAFHS 2000 in December 1995, and in March 1997,
the FDA approved this supplement.  In May 1997, the Company commenced commercial
distribution of the SAFHS 2000 in the United States.

         The Company  established a subsidiary in Germany  during fiscal 1995 as
part of its strategy to  introduce  the SAFHS  device in Europe,  and  commenced
commercial  distribution  of the device in  certain  European  countries  during
fiscal 1996 (see "Sales and Marketing").

Industry Overview

Background

         Bone, which forms the human skeleton,  undergoes constant change during
an individual's  lifetime through a dynamic process of cellular action.  Bone is
continually  remodeled  so  that  between  10%  and  20% of the  adult  skeleton
undergoes  resorption  (removal) and formation annually.  At the cellular level,
bone  consists  of   specialized   bone  cells   (osteoblasts,   osteocytes  and
osteoclasts) and minerals,  proteins, hormones, water, and other large molecules
such as  sugars.  Bone is formed by  osteoblasts,  which  line the  surface of a
bone's structure, and osteocytes, which are located within the bone's structure.
Osteoclasts  are cells that resorb bone through a  degradation  process.  Bone's
natural remodeling process,  which is balanced between resorption and formation,
can be affected by a number of factors.  For example,  smoking has been shown to
slow the process of bone  formation,  while exercise such as walking or running,
which  applies  mechanical  force  to the  body on  impact,  has  been  shown to
stimulate the process of bone formation.

         Bone  progresses  through  two  forms as it  develops:  woven  bone and
lamellar bone.  Woven bone is unorganized and premature,  and is found either in
growing bones or at fracture sites as newly formed bone. Lamellar bone is mature
bone that results from the further remodeling of woven bone. Two types of mature
<PAGE>
bone comprise  substantially all of the human skeleton:  cortical bone (dense or
compact  bone),  which  constitutes  approximately  80%  of  the  skeleton,  and
cancellous  bone  (spongy  bone),  which  constitutes  approximately  20% of the
skeleton.  Cortical bone is  approximately  30% porous,  and consists of a dense
bundle of vascular  channels,  containing  blood  vessels,  surrounded by mature
bone.  Cancellous bone is approximately  70% porous,  highly  vascularized,  and
consists of a loosely formed matrix of beams designed to withstand the principal
stresses and strains  applied to the bone.  The density of cortical bone is four
to six times higher than cancellous bone.  Cortical bone forms the middle 80% of
the long bones of the body, including the tibia and fibula in the lower leg, the
femur in the upper leg, the radius and ulna in the lower arm, and the humerus in
the upper arm.  Cancellous bone constitutes the remaining 20% of bone located at
the ends of the long bones. For example,  the distal radius, which is cancellous
bone, is the portion of the radius located closest to the wrist.  All cancellous
bone is surrounded by a cortical outer layer.

         When a fracture occurs in either cortical or cancellous bone, a complex
biological healing process is initiated. In cortical bone, there are five stages
of repair and remodeling that, if completed,  eventually restore the bone to its
original pre-fracture condition.  The first healing stage lasts approximately 48
hours,  and is an inflammatory  response in the tissue at the fracture site that
stimulates  the  formation  of stem (early  stage) cells  originating  from bone
marrow  and from  surface  tissue  at the  fracture  site.  As the  inflammation
subsides,  the dead  tissue at the bone ends is removed  and stem cells begin to
organize into a cellular matrix. In the second stage, which lasts several weeks,
stem cells proliferate in the bone marrow cavity and evolve into cartilage cells
and soft fracture callus (a matrix of fibrous tissue,  cartilage and woven bone)
in the outer and inner  surface of the bone.  During this  period,  dead bone is
continually  replaced with new cartilage  cells.  In the third stage of healing,
which  begins  approximately  six to eight  weeks  after  fracture,  there is an
increase in soft callus that fills the marrow cavity and forms along the outside
of the bone. In the fourth stage,  which  typically  begins 10 to 12 weeks after
fracture  and  extends  to 20 weeks  or  more,  the  fracture  callus  gradually
calcifies through osteoblastic action,  increasing the stability of the fracture
site. This calcified  callus begins to remodel toward the end of this stage, and
continues to convert into lamellar bone in the fifth stage.

         Fractures in cancellous bone heal in substantially  the same manner and
stages as cortical bone, except that cancellous bone does not have a bone marrow
cavity,  so bone healing occurs along the matrix of internal beams that comprise
its structure.  Cancellous bone heals in approximately  one-third less time than
cortical bone,  primarily  because  cancellous  bone is more  vascularized  than
cortical bone.

         The process of bone  healing in fresh  fractures  generally  takes from
four to  eight  months  for  cortical  bone and from  three  to six  months  for
cancellous bone. Many fractures take  substantially  longer to heal, and some do
not heal at all.  "Non-unions"  are  fractures  that have not healed within nine
months and have shown no sign of healing for the prior three months.  Physicians
may identify certain fractures, at the time of occurrence,  as being susceptible
to  extended  healing  times  and  associated  complications.  According  to the
orthopaedic literature,  some of the factors taken into account by physicians in
making such a determination  include  fracture  characteristics  such as the gap
size,  location,  displacement,  and fragmentation of the fracture,  and patient
characteristics such as the age, gender,  health condition,  weight, and smoking
habits of the patient.  Many of these  fractures could result in costly surgery,
rehabilitation therapy, and in some cases, permanent disability.
<PAGE>
Fracture Market

         Over 6,000,000 fractures occur each year in the United States, of which
more than 800,000 are tibia and distal radius  fractures.  The Company  believes
that  approximately  350,000 of these  tibia and  distal  radius  fractures  are
candidates for treatment with the SAFHS device. Many of these fractures could be
treated  surgically,  and in some instances,  multiple  surgical  procedures are
needed to achieve healing.  Each of these surgical  procedures may involve costs
of $7,500 or more, and can result in complications, such as infection and death.
In  addition,  these  fractures  expose the patient to the risks of  longer-term
complications,  such as severe muscular  atrophy,  joint disorders,  and loss of
function. Patients often require rehabilitative therapy for up to several months
following surgery,  at an additional cost of approximately  $1,000 to $4,000 per
fracture.  Indirect  medical  costs due to lost wages,  lost  productivity,  and
immobility may also be incurred during the healing period.

Methods of Treating Fractures

         Various  methods  exist for the treatment of bone  fractures.  The most
common therapy is to immobilize  the fracture with an external  cast,  generally
for 12 to 18 weeks for tibia fractures and five to eight weeks for distal radius
fractures.  Certain  fractures are treated  surgically  using one or more of the
following  methods to provide  stability and promote healing:  internal fixation
devices  such as  plates,  rods and  screws;  bone  grafts  using  human bone or
synthetic bone; and external  fixation  devices,  which are external frames with
metal pins placed through the skin into the bone.

         All of the  conventional  therapies for bone  fractures  supplement the
body's fracture  healing process by immobilizing  the injured bone, by providing
scaffolds for healing such as bone grafts, or by initiating healing when the
healing process has prematurely stopped. None, however, accelerates the fracture
healing process.  Different  approaches have been  investigated and developed to
augment or replace  conventional  therapies,  including  electrical  stimulation
devices and bone  growth  factors.  Electrical  stimulation  devices  were first
approved by the FDA and introduced  commercially  in 1979.  Although  electrical
stimulation   devices  demonstrate   efficacy  in  initiating   healing,   their
indications  for use have been  limited  to  non-union  fractures.  Bone  growth
factors are proteins that promote the healing  process and have been in clinical
trials for several years. However,  these clinical trials have also been limited
to non-union fractures.

         Clinical studies begun in the mid-1980s,  which supported the Company's
PMA application for its SAFHS device, demonstrated that mechanical force applied
to bone  induces the  formation  of bone and  accelerates  the  natural  healing
process in fresh fractures.  This work was based on a widely accepted scientific
principle  that bone  responds to mechanical  force by inducing  bone  formation
and/or   inhibiting  bone  loss.   These  clinical   studies   established  that
acceleration of fracture  healing is accomplished by using the mechanical  force
produced by low-intensity ultrasound waves.

         Ultrasound is mechanical  energy that can be transmitted  into the body
in pulses of acoustic  (sound)  pressure  waves at  frequencies  above the human
hearing  range.  Ultrasound is used for numerous  non-invasive  therapeutic  and
diagnostic purposes,  and millions of ultrasound procedures are performed in the
United States each year.  Therapeutic ultrasound systems transmit high levels of
acoustic energy to generate heat (thermal effect) into the tissue, and have been
found  to  be  a  relatively  safe  and  effective  non-invasive  treatment  for
soft-tissue   injuries  including  damaged  ligaments,   tendons,  and  muscles.
<PAGE>
Therapeutic  ultrasound has not,  however,  been widely  investigated for use in
bone,  because of the potential  risk of inducing  excessive  heat into the bone
tissue.  Diagnostic ultrasound,  by contrast, uses low levels of acoustic energy
(non-thermal)  as a safe,  non-invasive  method for viewing  internal organs and
fetuses. These low levels, however, were not previously thought to have biologic
therapeutic  effects.  The SAFHS clinical trials demonstrated that low-intensity
(similar  to  diagnostic  ultrasound),   non-thermal,   specifically  programmed
ultrasound  energy can safely  accelerate the healing of fresh fractures  within
the approved indications for the SAFHS device.

Osteoporosis Background and Market

         Numerous bone disorders  result from changes in the natural  remodeling
process  of bone  resorption  and  formation.  The most  widespread  of these is
osteoporosis,   a  disease   characterized  by  a  decrease  in  bone  mass  and
deterioration  of bone  structure.  This  deterioration  leads to an increase in
fracture risk due to bone fragility and reduced  strength of the  weight-bearing
skeleton,  particularly the spine and the hip. Loss of bone mass occurs when the
removal of bone by the osteoclasts exceeds the bone-formation  activities of the
osteoblasts and osteocytes.  As a person ages, the osteoclastic  action tends to
predominate and,  beginning at approximately age 40, bone mass begins to decline
at the rate of approximately  0.5% per year. Women lose a significantly  greater
percentage of bone mass  (between 10% and 20%)  following the onset of menopause
and the cessation of estrogen production.  Bone mass also deteriorates from lack
of physical activity such as extended bed rest.

         Over 28,000,000 people in the United States, primarily  post-menopausal
women and the elderly,  have osteoporosis.  In 1992, over 1,200,000 fractures in
the United States, or approximately  20% of the estimated total fractures,  were
osteoporosis-related.  Existing  drug  therapies,  such as  estrogen-replacement
therapy,  calcitonin,  and calcium  supplements,  have been useful in preventing
bone loss,  but none can form new bone. In addition,  use of existing  therapies
are limited by  complications  and certain side  effects  including an increased
incidence of endometrial,  ovarian, and breast cancers in women taking estrogen.
Strenuous exercise has been shown to reduce bone loss in the elderly but must be
performed with caution as exercise may itself cause fractures.  Several new drug
therapies are in clinical  trials for the treatment of  osteoporosis  to address
the limitations of current  therapeutic  approaches.  A new  estrogen-derivative
drug thereapy, which does not have the potential for side effects of cancer, has
recently  been  approved for the  treatment of  osteoporosis.  In addition,  the
Company  is  developing  a   mechanical-stress   device  for  the  treatment  of
osteoporosis,  although this product is not commercially available to treat this
disease  and there is no  assurance  that the  Company  will  ever  successfully
develop or commercialize such a device.

Business Strategy

         The  Company's  business  strategy  is to become a leading  provider of
devices for the non-invasive  treatment of  musculoskeletal  injury and disease.
The  Company   believes  a  significant   market   exists  for   cost-effective,
non-invasive  medical  devices  that  allow  the  patient  to  return  to normal
activities  as  rapidly as  possible.  The  following  are key  elements  of the
Company's strategy:

         Promote  Physician  Acceptance.  Exogen  is the  only  company  to have
obtained FDA approval to market a medical device for accelerating the healing of
fresh fractures of the tibia and distal radius.  The Company seeks to gain broad
physician acceptance of this new treatment modality through the dissemination of
scientific,  clinical,  and  patient-outcomes  data on the SAFHS treatment.  The
Company's  marketing  efforts are targeted to  orthopaedic  surgeons in academic
institutions, trauma centers, and community-based practices.
<PAGE>
         Establish  Reimbursement by Third-Party  Payors.  In the United States,
the Company is engaged in broad-based  efforts to obtain  reimbursement  for the
SAFHS  device as a new  treatment  device  from  third-party  payors,  including
managed  care  organizations,   workers'  compensation   insurers,   traditional
indemnity insurers, and Medicare. To substantiate the effectiveness of the SAFHS
devices, the Company has collected patient-outcomes data on over 4,000 fractures
since the  introduction  of SAFHS in October 1994. The Company uses  scientific,
clinical, and patient-outcomes data on the safety and effectiveness of the SAFHS
treatment  to  support  the   Company's   third-party   reimbursement   efforts.
Internationally,  the  Company  uses  indigenous  clinical  data as well as data
collected  in  the  United   States  to  support   reimbursement   efforts  with
governmental and major private insurers.

         Broaden  Sales and  Marketing  Efforts.  The Company  has a  nationwide
network of independent and direct sales representatives in the United States. At
September  30,  1997,   the  Company  had  17  employees  in  its  direct  sales
organization and a network of 185 independent sales  representatives  throughout
the  United  States.  A primary  focus of the  Company's  marketing  efforts  is
national and regional managed care  organizations and insurance  carriers,  with
coordinated  marketing  through  the  Company's  sales  force and  reimbursement
specialists.  During 1996, the Company  commenced  marketing the SAFHS device in
several  European  countries  through its wholly owned German  subsidiary  using
sales agents and  independent  distributors.  In addition,  in December 1995 the
Company  signed  a  development   agreement  with  Teijin  Limited,  a  Japanese
corporation, to market the SAFHS device in Japan, subject to Japanese regulatory
approvals.

         Expand  Technology  Applications.  The Company is seeking to expand the
applications  of its SAFHS  treatment to other  fractures.  In late 1997,  pilot
clinical  trials using SAFHS were completed in Europe for reamed  intramedullary
rodded fractures. Also in 1997, the Company completed preclinical studies in the
United  States for spine  fusion,  and is in  preclinical  studies for cartilage
repair.  The Company expects that  university-based  pilot clinical trials using
the SAFHS treatment in leg-lengthening procedures will be completed in 1998. The
Company has also developed a mechanical-stress device that may prevent and treat
osteoporosis,  and commenced a pilot  clinical trial for this device during 1996
on 62 post-menopausal  women in the United States, which trial will be completed
in early 1998.  The Company is seeking to  establish  strategic  alliances  with
other  health-care  companies to further  develop  certain  applications  of its
technologies.

         Establish   Manufacturing   Capability.   During   1996,   the  Company
established manufacturing capability at its facility in Piscataway,  New Jersey,
to augment its outside  manufacturing  source. The Company refurbishes the SAFHS
Model 2A, and in 1997, began  manufacturing the SAFHS 2000. The Company believes
that  this  manufacturing  capability,  together  with its  product  engineering
capability,  has and  will  continue  to (i)  advance  its  product  design  and
development  efforts,  (ii) provide  better  control  over its costs,  and (iii)
reduce its dependence on its contract  manufacturer  that also  manufactures the
SAFHS 2000.

Products and Products Under Development

         Exogen's  products  are  focused  on  the  non-invasive   treatment  of
musculoskeletal  injury and disease,  and are based on the  principle  that bone
growth  is   stimulated   by  mechanical   force.   The  Company's   proprietary
mechanical-force  technologies,  including  ultrasound  and  mechanical  stress,
deliver energy that promotes the growth, repair, and maintenance of bone.
<PAGE>
Sonic Accelerated Fracture Healing System ("SAFHS")

         SAFHS is a  non-invasive  device  that  delivers  ultrasound  energy to
accelerate  fracture  healing  through  specifically  programmed,  low-intensity
acoustic  pressure  waves.  The SAFHS treatment was designed to maximize ease of
use. Once the SAFHS device has been prescribed for a patient, the physician cuts
a window in the patient's  cast and installs a plastic  coupling  fixture in the
window.  The  transducer  is  locked  into  the  fixture  for  treatment,  and a
protective  cap is inserted  in the  fixture  when the device is not being used.
Treatment  requires  use of the  device  only  once  daily for 20  minutes.  The
treatment  period  averages  approximately  four months for treatment of a tibia
fracture and approximately eight weeks for a distal radius fracture.  The device
is  portable  and may be used by the  patient  at  home,  in the  workplace,  or
elsewhere.  The patient coats the transducer head with an  ultrasound-conducting
coupling gel to facilitate  transmission of the ultrasound signal, and locks the
transducer  into the coupling  fixture set in the cast.  The SAFHS device alerts
the  patient  about  treatment  status and also  contains  a  patient-compliance
monitoring system that automatically records all treatment sessions and provides
a detailed  record,  including date and time, of the patient's use of the device
for monitoring by the physician and the Company.

         The prescribing  physician is responsible for submitting to the Company
(i) the prescription for the SAFHS device,  (ii) a letter of medical  necessity,
and (iii) the required  paperwork for  submission of the claim to the applicable
third-party  payor.  The  device is shipped  by the  Company to the  physician's
office,  either  directly  or through the  Company's  sales  representatives.  A
Company  sales  representative  is  available  at  the  physician's  office,  if
necessary,  to assist the physician in instructing the patient in the use of the
SAFHS device. The documentation signed by the patient requires the return of the
device  at the end of the  treatment  period.  The  main  operating  unit may be
serviced and reused;  the transducer,  however,  is designed to be discarded and
ceases to operate  once the  battery  has been  expended.  Patients do not pay a
refundable  deposit for the device,  and consequently,  the Company expects that
not all SAFHS devices will be returned by patients.

         The Company provides the SAFHS device for the duration of the treatment
of the fracture,  regardless of the length of treatment. The Company maintains a
toll-free telephone number and provides 24-hour coverage to respond to inquiries
from either patients or physicians. If necessary, replacement units and supplies
are provided to the patient.

         SAFHS  Model 2A. The  original  SAFHS  device,  the SAFHS  Model 2A, is
currently  being sold  principally  outside  the United  States.  This device is
comprised of two  electronic  components.  The main  operating unit controls the
treatment  time  and  monitors  the  proper  attachment  and  operation  of  the
ultrasound  transducer,  and is plugged into a standard  electrical  outlet. The
second component, the ultrasound transducer, delivers a specific,  low-intensity
ultrasound signal to the fracture site, and is powered by a limited-life battery
designed to last for 120  treatments of 20 minutes each. To prevent  electricity
from traveling  between the  transducer  and the main  operating  unit, the main
operating unit and the  transducer  communicate  through fiber optics.  The list
price of the SAFHS Model 2A is $2,950, regardless of the length of treatment.
<PAGE>
         SAFHS 2000.  The Company's  second-generation  SAFHS device,  the SAFHS
2000, is entirely  battery operated and smaller and lighter than the SAFHS Model
2A for enhanced portability.  The SAFHS 2000 utilizes the same ultrasound signal
as the SAFHS Model 2A. The Company filed a PMA  supplement for the SAFHS 2000 in
December 1995, and in March 1997, the FDA approved this supplement. In May 1997,
the Company  commenced  commercial  distribution of the SAFHS 2000 in the United
States. The list price of the SAFHS 2000 is $3,500,  regardless of the length of
treatment.

Mechanical-Stress Device

         The  Company  has  developed  a  mechanical-stress  device  designed to
inhibit bone loss and increase bone mass. The device delivers  mechanical  force
to the bone similar to the SAFHS  technology.  The device induces  low-intensity
vibrational stress within the skeleton at frequencies similar to those generated
by the muscles of the human body. The device consists of a resonating  platform,
on  which  the  patient  stands,   that  delivers   mechanical   stress  to  the
weight-bearing skeleton.

         In preclinical  studies  conducted by the Company,  the device has been
shown to inhibit bone loss and enhance bone mass with treatments of less than 20
minutes per day. In a clinical  study  conducted  by the Company in Europe,  the
Company  has  demonstrated  that  approximately  90% of the  vibrational  stress
produced by this device reaches the hip and approximately 85% reaches the spine,
the regions of the  weight-bearing  skeleton most  susceptible  to bone loss and
resulting  fractures.  The Company commenced pilot clinical trials in the United
States  for  its  mechanical-stress   device  in  1996,  and  anticipates  their
completion in 1998.  Following  completion  of these pilot  trials,  the Company
intends to submit to the FDA an IDE for pivotal  clinical  trials,  and plans to
begin the pivotal  clinical trials if a strategic  alliance is  established.  No
assurance can be given that the  mechanical-stress  device will prove to be safe
and  efficacious,  that a strategic  alliance will be established,  that product
development  will ever be  successfully  completed,  that a PMA, if applied for,
will be granted by the FDA on a timely basis, or at all, that adequate levels of
third-party  reimbursement  will be  available,  or that  the  mechanical-stress
device will ever achieve commercial acceptance.

Results of SAFHS Clinical Trials

         The results of the SAFHS  clinical  trials,  which were acquired by the
Company from Interpore Orthopaedics, Inc. ("Interpore"), demonstrated the safety
and efficacy of the SAFHS treatment,  and the Company believes such results were
critical to  obtaining  approval for the SAFHS Model 2A from the FDA for certain
fracture  indications.  The PMA  application for the SAFHS Model 2A was filed in
July 1990 and  received  FDA  approval  in  October  1994.  The PMA  application
consisted  of  clinical  data on 182  fractures  in 179  patients at 21 clinical
sites. Of these  fractures,  97 were included in the tibia clinical trial and 85
were  included  in the distal  radius  trial.  The SAFHS  clinical  trials  were
prospective, randomized, double-blind, and placebo-controlled. All patients were
cast-immobilized,  and all received  treatment,  commencing within seven days of
fracture,  using  the SAFHS  device  or, in the case of the  placebo  group,  an
identical device with no ultrasound signal emission.

         The results of both  studies  showed that the average  time to a healed
fracture  (as  measured   clinically  and  by  x-ray)  was  accelerated  in  the
SAFHS-treated group as compared with the placebo-treated  group by approximately
38%. The SAFHS-treated tibia fractures healed in an average of 96 days, compared
<PAGE>
with an average of 154 days in the placebo-treated  fractures. The SAFHS-treated
distal radius fractures  healed in 61 days on average,  compared with 98 days on
average for the placebo-treated  fractures. In addition, healing was accelerated
in all healing stages of the SAFHS-treated  fracture in both types of bone. When
the patients were categorized by age (30 years old or under and over 30 years in
the  tibia  study,  and 49 years  old or under  and over 49 years in the  distal
radius study), there was a significantly  greater acceleration of healing in the
older-patient  populations.  The older SAFHS-treated patients in the tibia study
healed in an  average of 102 days,  compared  with an average of 187 days in the
placebo-treated  patients,  and the older  SAFHS-treated  patients in the distal
radius  study healed in an average of 62 days,  compared  with an average of 102
days in the placebo-treated patients.

         Typically the fracture site in distal radius fractures is significantly
crushed.  When the bone is restored to its normal length and anatomical position
to be set in a cast for healing,  there is often a gap in the crushed-bone area.
The presence of this gap makes it difficult to maintain this  restored  position
throughout  the healing  process,  even though the arm is immobilized in a cast.
During the healing  process,  the fractured  bone end  frequently  shifts out of
proper alignment, commonly resulting in physical deformity and compromised wrist
function. The loss of alignment in patients with the SAFHS-treated distal radius
fractures was on average  approximately  60% less than that  experienced  by the
placebo-treated fractures.

         The clinical  results  demonstrated  that the SAFHS  device  produced a
statistically  significant and clinically meaningful  acceleration of all stages
of  healing in fresh bone  fractures  of both the tibia  (which is an example of
cortical  bone) and the distal radius  (which is an example of cancellous  bone)
within the approved  indications for SAFHS. No contraindications or side effects
were identified in the clinical trials.

Sales and Marketing

         The  Company's  marketing  strategy  is to  gain  broad  physician  and
third-party  payor  acceptance of the SAFHS device worldwide within the approved
indications.  A critical  element of this  strategy is to utilize the results of
the SAFHS clinical  trials to  demonstrate  the safety and efficacy of the SAFHS
treatment to both physicians and  third-party  payors.  The Company's  marketing
efforts are currently focused on orthopaedic surgeons in academic  institutions,
trauma centers,  and community-based  practices.  Through its direct sales force
and reimbursement  specialists,  the Company is working closely with orthopaedic
surgeons and other  physicians,  including primary care physicians who represent
third-party  payors.  Once a  prescription  is received  by the  Company  from a
physician, the SAFHS device is shipped by the Company to the physician's office,
either directly or through the Company's sales representatives.

United States

         SAFHS.  The Company has a nationwide  network of independent and direct
sales  representatives  in the United States. At September 30, 1997, the Company
had  17  employees  in  its  direct  sales  organization  and a  network  of 185
independent sales  representatives  throughout the United States.  The Company's
sales  efforts are focused on educating  physicians  and  third-party  payors in
major  metropolitan  areas  on the  benefits  of the  SAFHS  technology  for its
approved  indications.  The Company  believes that these efforts will enable the
Company's sales representatives to better achieve nationwide market penetration.
A primary  focus of the  Company's  marketing  efforts is national  and regional
managed care and workers' compensation organizations, with coordinated marketing
through the Company's sales force and reimbursement specialists.
<PAGE>
         Other  Products.  In January 1997, the Company entered into a sales and
distribution  agreement with FLA Orthopedics,  Inc. ("FLA") and Clinitex Medical
Corporation  ("Clinitex"),  a wholly owned subsidiary of FLA, to market and sell
in the United States Clinitex's  nonfiberglass  synthetic casting materials used
in fracture immobilization.  The Company paid FLA $200,000 upon the execution of
the  agreement.  To date,  sales by the Company of Clinitex  products  have been
minimal.  The  Company  has  decided  not to pay FLA the  $150,000  required  to
continue  marketing  and  selling the Clintex  products in fiscal  1998,  and to
consequently terminate the agreement.

International

         The Company  established  a wholly  owned German  subsidiary  in fiscal
1995,  and in fiscal  1996  introduced  the SAFHS  device in Germany and Austria
through the subsidiary's  network of independent  sales agents.  In fiscal 1997,
the Company expanded its sales into Holland, Denmark, and the United Kingdom. In
other  European  countries,  the Company is selecting  and training  independent
distributors and agents. The Company is sponsoring  clinical trials in Europe to
augment  clinical  data  from the  United  States,  with  the goal of  achieving
acceptance by surgeons and governmental- and  private-insurance  payors in these
markets.  During  fiscal  1997,  the Company  filed  applications  for  national
reimbursement coverage for its SAFHS device in Germany and France.

         In November 1995, the Company signed development agreements with Teijin
Limited, a Japanese  corporation,  for two of the Company's products,  the SAFHS
device  and the  mechanical-stress  device.  The SAFHS  agreement  provides  for
milestone  payments to the Company for Teijin's  development  of the product for
commercial  launch in Japan.  The  Company  will  manufacture  and supply  SAFHS
devices to Teijin for clinical trials and subsequent  sales in Japan.  Teijin is
responsible for complying with the regulatory requirements and for marketing and
distributing  the SAFHS device in Japan.  In May 1997,  Teijin  received  import
approval  to market  the SAFHS  Model 2A in Japan,  and in August  1997,  Teijin
submitted an application for reimbursement from the Japanese Ministry of Health.
The development agreement with Teijin for the mechanical-stress  device provides
for milestone payments to the Company that will support,  in part, the Company's
clinical  trials in the United States in exchange for a first option in favor of
Teijin to negotiate a development and distribution agreement for this device for
the Japanese market.

         No assurance  can be given that the Company will receive  reimbursement
approvals in any country,  or that its  partners,  distributors,  and agents can
successfully  introduce the SAFHS device in Europe or Japan on terms  acceptable
to the Company,  or at all.  Future  foreign  sales,  if any, will be subject to
certain risks,  including  exchange rate  fluctuations,  international  monetary
conditions,  tariffs, import licenses, trade policies,  domestic and foreign tax
policies, foreign regulations, and reimbursement approvals.

         For further  information on international  operations,  see Footnote 5,
"Geographic  Segment  Information,"  of the  Consolidated  Financial  Statements
included herein.
<PAGE>
Third-Party Reimbursement

         Prior  to  approving  coverage  for  a  new  medical  technology,  most
third-party  payors require  evidence that the technology is safe and effective,
not experimental or investigational, and medically necessary and appropriate for
the specific patient.  Third-party  payors typically require that the technology
has received FDA approval or clearance for marketing. New technologies are often
prescribed for off-label  applications,  for which  reimbursement by third-party
payors  may not be  available.  Increasing  numbers  of  third-party  payors and
managed care plans are beginning to require evidence that the technology is cost
effective.

         In the United States,  the Company has commenced a multi-level  program
to obtain  coverage  and  reimbursement  from  third-party  payors for the SAFHS
device as a new treatment modality. (The SAFHS device is typically classified by
third-party payors as Durable Medical  Equipment.)  Although the Company has not
received  broad  approval  from any  reimbursement  authority for payment of the
SAFHS  device,  it has received  approval from various  third-party  payors on a
case-by-case  basis.  As of October 31, 1997,  the Company has been paid by over
800 third-party  payors including (i) traditional  indemnity  insurers including
Blue Shield organizations,  (ii) workers' compensation  insurers,  (iii) HMO and
managed  care  organizations,  (iv)  automobile  insurers,  and (v)  third-party
administrators.  The Company believes that case-by-case  reimbursement  approval
will continue to be the predominant  method of obtaining  pre-authorization  and
reimbursement  for the  SAFHS  device  until  payor  coverage  at the  national,
regional,  or local  level is  obtained.  The  Company is  seeking to  establish
separate  reimbursement  codes  for the  SAFHS  device  with  various  payors to
expedite reimbursement processing for the SAFHS device; however no assurance can
be given that such codes will be assigned on a timely basis, or at all.

        
         Currently,  the Health Care Financing  Administration  ("HCFA"),  which
administers the Medicare program,  has a national coverage policy for electrical
stimulation  devices  that  initiate the healing of  non-union  fractures.  Such
devices are  reimbursed  under a fee  schedule  in which the range of  allowable
reimbursement is $2,800 to $2,950 per treatment regimen.  In August 1996, HCFA's
Technology  Advisory Committee  recommended that the SAFHS device not be covered
under the Medicare program. The Company,  however,  continues to pursue coverage
for SAFHS by providing additional information to the HCFA staff. In the interim,
the  Company is not  shipping  orders to patients  covered  under  Medicare.  No
assurance can be given that the Company will be successful in obtaining coverage
for the SAFHS device under the Medicare program.

         During  1995,  the  Company  submitted  clinical   information  to  the
Technology  Evaluation  Center  ("TEC")  of  the  Blue  Cross  and  Blue  Shield
Association  ("BCBSA")  requesting that the TEC evaluate the SAFHS therapy.  The
TEC  program   distributes  the  results  of  its  evaluation  to  BCBSA  member
organizations and to third-party payors and others who purchase TEC assessments,
and such  evaluations are often used by payors in setting their own coverage and
reimbursement  policies.  In August 1995,  the TEC  completed  its review with a
favorable  assessment of the SAFHS therapy, and has disseminated this evaluation
to its subscribers.

         In addition to Medicare and Blue Cross and Blue Shield,  the  Company's
reimbursement  specialists are focused on obtaining  coverage and  reimbursement
from major  national  and  regional  managed care  organizations  and  insurance
carriers   throughout  the  United  States.   Most  of  the  third-party   payor
<PAGE>
organizations  independently  evaluate new treatment modalities by reviewing the
published  literature and/or the Medicare  coverage and reimbursement  policy on
the  specific  treatment  modality.  To assist the  third-party  payors in their
respective  evaluations of the SAFHS device, the Company provides scientific and
clinical data that support the safety and effectiveness of the device.

         When a  prescribing  physician  submits  a  prescription  for the SAFHS
device to the  Company,  he or she must also  submit to the  Company a letter of
medical necessity and the required  paperwork for submission of the claim to the
applicable  third-party  payor.  The Company ships the device to the  physician,
either directly or through the Company's sales  representatives,  generally only
after  obtaining  prior  reimbursement   approval  from  the  payor,  when  such
precertification is available. The Company charges a flat fee for the use of the
SAFHS device, regardless of the length of treatment. The Company's reimbursement
personnel work closely with third-party payors on a case-by-case basis.

         The Company's  international  reimbursement plan varies by country.  In
Germany,  Holland,  and France, the Company is using indigenous clinical data as
well as data  collected in the United States on the  effectiveness  of the SAFHS
device to support the Company's  filings for reimbursement  coverage.  In Japan,
Teijin has submitted an application for reimbursement from the Japanese National
Health Insurance Bureau.  These countries may have more stringent  reimbursement
requirements  than the United  States,  and the  Company  currently  has limited
experience in obtaining  reimbursement  for its products in countries other than
the United States.

         As of September  30, 1997,  the  international  accounts  receivable is
primarily derived from sales in Germany,  where the Company has received limited
local  reimbursement  on a  case-by-case  basis.  To assist  the  collection  of
outstanding  claims and to expedite the reimbursement  process on future claims,
the Company is seeking  nationwide  approval by the National  Krankenkasse,  the
German governing  organization that establishes medical reimbursement policy for
health-care  providers.  To this end,  in August  1997 the  Company  submitted a
formal  application  to  the  National  Krankenkasse.  The  application  process
includes a scientific assessment and a reimbursement assessment;  the Company is
currently in the  scientific-assessment  phase. In the interim,  the Company has
elected to sell SAFHS devices in Germany only when reimbursement is preapproved.

         There  can  be no  assurance  that  sufficient  reimbursement  for  the
Company's products will be available,  or that future reimbursement  policies of
payors will not adversely affect the Company's ability to sell its products on a
profitable basis, or at all. The United States Congress is currently considering
various  proposals to significantly  reduce Medicare and Medicaid  expenditures.
The Company cannot predict which, if any, of these proposals will be enacted and
if  enacted,  what  effect,  if any,  they may have on the  Company's  business.
Failure either in the United States or abroad by the Company to obtain favorable
coverage determinations or sufficient  reimbursement from Medicare or from other
third-party  payors, or adverse changes in governmental and private  third-party
payors' policies toward  reimbursement for the Company's products,  would have a
material adverse effect on the Company's business,  financial condition, results
of operations, and cash flows.

Manufacturing

         The  SAFHS  2000  is  manufactured  by the  Company  and by a  contract
manufacturer.  The Company also  refurbishes the SAFHS Model 2A at its facility.
<PAGE>
The agreement between the Company and the contract manufacturer is documented by
specific purchase orders, effective into 1999, covering a portion of anticipated
requirements.   This  contract   manufacturer   also  performs   certain  design
engineering  for the  Company.  Both the  Company's  facility  and its  contract
manufacturer's  facility have been  inspected by the FDA for Good  Manufacturing
Practices ("GMP") and have been found to be in compliance with GMP requirements.
In August 1996, the Company  received ISO 9003  (International  Organization  of
Standardization) Certification and CE Mark Certification for the Company's SAFHS
Model 2A. The CE Mark  signifies  that the Company  conforms  with the  European
Community  Medical Device  Directive.  The Company  believes that its Piscataway
facility  will  have  sufficient  capacity  to meet  the  Company's  anticipated
manufacturing  needs for at least  the next  three  years.  Any  failure  by the
Company or the contract  manufacturer  to maintain its respective  manufacturing
facility in accordance with GMP or CE requirements could result in the inability
to  manufacture  the SAFHS  device,  and could  limit the  Company's  ability to
deliver the SAFHS device to physicians and patients, which would have a material
adverse  effect on the  Company's  business,  financial  condition,  results  of
operations, and cash flows.

         The manufacture of the SAFHS device involves an assembly process with a
number of  significant  components.  Each  device is tested and  released by the
Company in accordance  with FDA  requirements.  Most  purchased  components  are
available from more than one vendor.  However,  certain components currently are
and will continue to be manufactured by  single-source  vendors.  For certain of
these components,  there are relatively few alternative  sources of supply,  and
establishing  additional or replacement  suppliers for such components cannot be
accomplished  quickly.  Although  the Company is  continually  in the process of
identifying primary and alternative  vendors, the qualification of additional or
replacement vendors for certain components or services is a lengthy process. Any
supply  interruption  from  single-source  vendors would have a material adverse
effect on the Company's business,  financial  condition,  results of operations,
and cash flows.

Research and Development

         The Company's principal research and development program relates to the
development  and  clinical  trials of the  Company's  mechanical-stress  device.
Additionally,  the Company has ongoing programs to develop new devices utilizing
its  SAFHS  technology  and to expand  SAFHS  applications  to other  fractures,
lower-back spine fusion,  and cartilage  repair.  No assurance can be given that
the SAFHS treatment will prove to be safe and  efficacious for other  fractures,
spine  fusion,  or  cartilage  repair or that any PMA, if applied  for,  will be
granted by the FDA on a timely basis, or at all.

         The  Company  is  evaluating  the use of  ultrasound  in a  variety  of
orthopaedic  applications.  The Company is providing  SAFHS devices to physician
investigators  for  preliminary  clinical  studies in the use of ultrasound  for
healing stress  fractures,  limb lengthening  using an external fixation device,
and healing  internally fixed fractures.  The Company is supporting  preclinical
studies on the treatment of lower-back spine fusion and on cartilage repair. The
Company also sponsors  research  relating to the basic science of ultrasound for
both therapeutic as well as diagnostic use.

         As of November  30,  1997,  the Company  had six  employees  engaged in
research and development and regulatory  affairs and eight employees  engaged in
engineering.  The Company's  expenditures  for research and  development  (which
includes   clinical  trials,   regulatory   affairs,   and   engineering)   were
approximately $3.1 million, $4.0 million, and $2.5 million in fiscal 1997, 1996,
and 1995, respectively.
<PAGE>
Patents, Copyrights and Proprietary Information

         The Company's  policy is to protect its proprietary  position by, among
other  things,  filing both United  States and foreign  patent  applications  to
protect its owned and licensed technology, inventions, and improvements that are
important to the  development of its business.  The Company holds title to eight
issued United States patents,  one issued foreign  (Canadian) patent, 12 pending
United States patent  applications,  and corresponding Patent Cooperation Treaty
("PCT") and foreign patent  applications  relating to its SAFHS technology.  The
original  United States  ultrasound  patent (the  "Initial  Patent") that is the
basis of the SAFHS  device  was set to expire  in 2002,  but has been  granted a
five-year  extension  to 2007 based on the  delays in  marketing  the  invention
caused by extensive  regulatory review. The other currently issued United States
patents relating to SAFHS technology are set to expire between 2008 and 2014.

         The Company is also the exclusive licensee of four issued United States
patents,  two issued foreign patents,  and four pending foreign patents relating
to the use and application of mechanical-stress technology. The currently issued
United States patents relating to mechanical-stress technology are currently set
to expire  between  2010 and 2011.  All of the patents  and patent  applications
relating  to  mechanical-stress  technology  that the  Company  does not own are
licensed  exclusively  to the  Company  worldwide  until  the  later  of (i) the
expiration of the final patent  licensed to the Company or (ii) March 2022.  The
license agreement generally provides for the payment of royalties on the sale of
products utilizing the patented technology,  and the Company's exclusive license
may  revert to a  nonexclusive  license if the  Company  fails to use good faith
efforts to commercially exploit the patented technology.

         The  Company  intends  to file  or  cause  to be  filed  on its  behalf
additional  United  States,   foreign,  and  international  patent  applications
relating to new  developments  or  improvements  in SAFHS and  mechanical-stress
technology and to specific products it develops. While no assurance can be given
that the patent applications owned by the Company will issue as patents, or that
they will provide the Company with significant  protection  against  competitive
products or otherwise be  commercially  valuable,  the Company is unaware of any
facts that could  preclude the grant of a patent from each of the pending patent
applications.  There can be no assurance  that any issued  patents  owned by the
Company will provide  competitive  advantages for the Company's products or will
not be challenged or designed around by its competitors.

         The Company  believes  it owns or has the right to use all  proprietary
technology necessary to manufacture and market its products.  Under current law,
patent applications in the United States are maintained in secrecy until patents
issue,  and patent  applications in foreign  countries are maintained in secrecy
for a period after filing.  The right to a device patent in the United States is
attributable to the first to invent the device,  rather than the first to file a
patent  application,  while in  foreign  countries,  ownership  of a  patent  is
typically determined by priority of patent filing, not invention.  Consequently,
the Company cannot be certain that it was the first to invent certain technology
covered by pending patent  applications  or that it was the first to file patent
applications for such inventions.  In addition,  the patent positions of medical
device companies, including the Company, are generally uncertain, partly because
the positions involve complex legal and factual questions.  Moreover, patent law
relating to certain of the Company's fields of interest,  particularly as to the
scope of claims in issued patents,  is still  developing,  and it is unclear how
this uncertainty will affect the Company's patent rights.
<PAGE>
         The Company has not received any notices alleging, and is not aware of,
any infringement by the Company of any other entity's patents.  However, because
of the  volume of  patents  issued and patent  applications  filed  relating  to
medical  devices,   there  can  be  no  assurance  that  current  and  potential
competitors  and other  third  parties  have not filed or in the future will not
file  applications  for, or have not received or in the future will not receive,
patents and will obtain additional  proprietary  rights relating to materials or
processes used or proposed to be used by the Company. Accordingly,  there can be
no  assurance  that the  Company's  products  do not  infringe  any  patents  or
proprietary rights of third parties.

         The Company also relies upon trade  secrets,  technical  know-how,  and
continuing  technological  innovation  to develop and maintain  its  competitive
position.  The  Company  typically  requires  its  employees,  consultants,  and
advisors to execute  appropriate  confidentiality  agreements in connection with
their employment,  consultation, or advisory relationships with the Company. The
Company also typically requires its employees, consultants, and certain advisors
to agree to disclose  and assign to the Company all  inventions  conceived of on
Company time, using Company  property or that relate to the Company's  business.
There  can  be  no  assurance,  however,  that  the  foregoing  agreements  will
effectively  prevent  disclosure of the Company's  confidential  information  or
provide  meaningful  protection  for the Company's  confidential  information if
there is unauthorized use or disclosure.  Furthermore, no assurance can be given
that  competitors  will  not  independently  develop  substantially   equivalent
proprietary information and techniques or otherwise gain access to the Company's
proprietary technology,  or that the Company can meaningfully protect its rights
in unpatented proprietary technology.

         The Company  also holds  rights to  copyrights  on text and on software
developed by or for itself for use in its SAFHS device.  The Company  intends to
file copyright  registrations for such software.  There can be no assurance that
any copyrights owned by the Company will provide competitive  advantages for the
Company's products or will not be challenged or circumvented by its competitors.

         The  Company's  owned  and  licensed  patents  and  copyrights  and its
products may, in the future, be subject to litigation regarding patent and other
intellectual  property  rights.  In  the  event  that  any  relevant  claims  of
third-party  patents are upheld as valid and  enforceable,  the Company could be
prevented from  practicing the subject matter claimed in such patents,  or would
be required to obtain licenses from the patent owners of each of such patents or
to redesign its products or  processes  to avoid  infringement.  There can be no
assurance  that such licenses  would be available or, if available,  would be on
terms  acceptable  to the Company or that the Company would be successful in any
attempt to  redesign  its  products  or  processes  to avoid  infringement.  The
Company's  failure to obtain these  licenses or to redesign  its products  would
have a material adverse effect on the Company's business,  financial  condition,
results of operations, and cash flows. In addition,  litigation may be necessary
to defend  against  claims of  infringement,  to enforce  patents and copyrights
issued or  licensed  to the  Company,  or to protect  trade  secrets,  and could
require significant  diversion of management's  attention and the expenditure of
financial resources, which could have a material adverse effect on the Company.

Government Regulation

         The Company's  existing  products are regulated in the United States as
medical devices by the FDA under the Federal Food,  Drug, and Cosmetic Act ("FDC
<PAGE>
Act") and require the  approval of a PMA by the FDA prior to  commercialization.
Noncompliance  with  applicable  requirements  can  result  in  failure  of  the
government  to grant  pre-market  approval for devices,  withdrawal  of the PMA,
total or partial suspension of production, fines, injunctions,  civil penalties,
recall or seizure of products, and criminal prosecution.

         In the United States, medical devices are classified into three classes
(I, II, or III) on the basis of the  controls  necessary  to  reasonably  assure
their safety and  effectiveness.  The Company's existing products are classified
as Class III devices,  the class  subject to the highest  level of regulation by
the  FDA.  In  addition  to the  general  control  requirements  of the  FDC Act
(including registration,  labeling,  pre-market  notification,  and adherence to
GMP), the Company's products are also subject to pre-market approval.

         Before a new Class III device can be  introduced  into the market,  the
manufacturer  must  obtain FDA  clearance  through a PMA  application.  The less
burdensome  510(k)  pre-market  notification  process  has not been,  and is not
expected to be, available for any of the Company's  products.  Accordingly,  the
Company has had to obtain,  and expects to apply for,  PMAs and PMA  supplements
for its future products.

         A PMA  application  must be  supported  by  extensive  data,  including
preclinical  and clinical trial data, to demonstrate  the safety and efficacy of
the device for the indicated  uses  specified in the PMA  application.  If human
clinical  trials of a device are required and the device presents a "significant
risk," the  manufacturer  or the  distributor of the device must file an IDE and
have an approved 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,
human clinical  trials may begin at a specific number of  investigational  sites
with a specified maximum number of patients, as approved by the FDA. Sponsors of
clinical trials are permitted to sell those devices distributed in the course of
study  as  long as  compensation  does  not  exceed  recovery  of the  costs  of
manufacturing, researching, developing, and handling.

         Upon  receipt  of the  PMA  application,  the  FDA  makes  a  threshold
determination as to whether the application is sufficiently complete to permit a
substantive   review.  If  the  FDA  determines  that  the  PMA  application  is
sufficiently  complete to permit a substantive  review,  the FDA will "file" the
application.  An FDA review of a PMA application  generally takes between two to
three  years  from  the  date  the  PMA  application  is  filed,  but  may  take
significantly  longer.  The  review  time is  often  significantly  extended  by
requests  from the FDA for more  information  or  clarification  of  information
already  provided  in the  submission.  During the review  period,  an  advisory
committee,  including clinicians, will likely be convened to review and evaluate
the application and provide  recommendations to the FDA as to whether the device
should be approved. In addition, the FDA will inspect the manufacturing facility
to ensure compliance with the FDA's GMP requirements  prior to approval of a PMA
application.

         The PMA process can be expensive,  lengthy, and uncertain. There can be
no  assurance  that the  Company  will be able to  obtain  necessary  regulatory
approvals.  The loss of previously received approvals, or failure to comply with
existing or future regulatory requirements, would have a material adverse effect
on the Company's business,  financial condition, results of operations, and cash
flows.
<PAGE>
         The PMA  application  for use of the  SAFHS  Model 2A to treat  certain
fresh  fractures of the tibia and distal radius was filed in July 1990,  and the
FDA's  approval  for  commercial  marketing by the Company was issued in October
1994. The promotion by the Company of the SAFHS Model 2A to treat  fractures not
covered by the initial PMA will require the submission of PMA supplements or new
PMA applications.  PMA supplements often require  submission of the same type of
information  as in a PMA  application,  except that the supplement is limited to
information  intended  to support any  changes  from the product  covered by the
original PMA and to support the treatment of new clinical  indications,  and may
not require the submission of as extensive clinical data or the convening of any
advisory committees.  In addition,  PMA supplements must be submitted to the FDA
before  making any change  that may  affect the safety or  effectiveness  of the
device.  These  changes  can  include  changes  in device  design,  composition,
specifications,  circuitry,  software,  or energy  source.  The Company has made
certain  nonperformance-related  changes to the SAFHS  Model 2A since the device
was  approved by the FDA.  Although  the Company  believes  such  changes do not
require the filing of a PMA  supplement and prior approval by the FDA, there can
be no  assurance  that  the FDA  will  not  require  the  Company  to file a PMA
supplement,  which would result in additional  costs and delays in marketing the
device.  A PMA  supplement  must also be submitted  when  unanticipated  adverse
effects,  increases in the incidence of anticipated  adverse effects,  or device
failures necessitate a label, manufacture,  or device modification.  The Company
filed a PMA  supplement  for its SAFHS 2000 in December 1995, and in March 1997,
the FDA approved this supplement.  In May 1997, the Company commenced commercial
distribution  of the SAFHS 2000 in the United  States.  The Company will also be
required to file a PMA application for its mechanical-stress device, if and when
development is completed. No assurance can be given that any supplements will be
filed or  approved,  or that new PMAs will be granted on a timely  basis,  or at
all.  Delays in  receipt  or failure  to  receive  such  approvals  would have a
material adverse effect on the Company's business,  financial condition, results
of operations, and cash flows.

         Any products  manufactured or distributed by the Company pursuant to an
approved  PMA are subject to  pervasive  and  continuous  regulation  by the FDA
including record-keeping requirements,  reporting of adverse experience with the
use of the device,  post-market  surveillance,  post-market registry,  and other
actions  as  deemed  necessary  by  the  FDA.  Product  labeling  and  promoting
activities are subject to scrutiny by the FDA and, in certain instances,  by the
Federal Trade Commission. Products may be promoted by the Company and any of its
agents only for the products'  approved  indications.  No assurance can be given
that the FDA will not impose  modifications to the labeling that could adversely
affect the Company's  ability to market,  sell,  or be reimbursed  for the SAFHS
device. In addition,  there can be no assurance that the Company will not become
subject to FDA actions as a result of physicians'  prescribing  the SAFHS device
for off-label uses.

         Product   approvals  may  be  withdrawn  for  failure  to  comply  with
regulatory  standards or the occurrence of unforeseen problems following initial
marketing.  The FDC Act  requires  the  Company's  products be  manufactured  in
registered establishments and in accordance with GMP regulations.  The Company's
SAFHS device is  manufactured by the Company and a contract  manufacturer.  Both
facilities have been inspected by the FDA and are the only  facilities  approved
for the  production  of the SAFHS  device.  Any  failure  by the  Company or the
contract manufacturer to maintain its respective facility in accordance with FDA
GMP  requirements  could result in the inability to manufacture the SAFHS device
and may limit the  Company's  ability to deliver the SAFHS device to  physicians
and  patients,  which  would have a  material  adverse  effect on the  Company's
business, financial condition, results of operations, and cash flows.
<PAGE>
         The Company also is subject to numerous federal,  state, and local laws
relating to such matters as safe working  conditions,  manufacturing  practices,
environmental  protection,  fire hazard  control,  and  disposal of hazardous or
potentially  hazardous  substances.  There can be no assurance  that the Company
will not be  required  to incur  significant  costs to comply with such laws and
regulations  in the  future,  or that such laws or  regulations  will not have a
material  adverse  effect  upon the  Company's  business,  financial  condition,
results of operations, or cash flows.

         Sales of  medical  devices  outside  the United  States are  subject to
foreign  regulatory  requirements that vary widely from country to country.  The
time required to obtain  approval by a foreign  country may be longer or shorter
than that required for FDA approval,  and the  requirements  may differ.  Export
sales of investigational  devices that have not received FDA marketing clearance
generally  are  subject  to FDA export  permit  requirements.  To obtain  such a
permit,  the Company  must provide the FDA with  documentation  from the medical
device  regulatory  authority of the country in which the  purchaser is located,
stating that the sale of the device is not a violation of that country's medical
device  laws,  and must  demonstrate  to the FDA that export is not  contrary to
public health. No assurance can be given that such foreign regulatory  approvals
will be granted on a timely basis, or at all.

         During  1996,  the Company  received  regulatory  approval of the SAFHS
Model 2A in Germany.  Under  German law,  medical  devices must have a "GS" mark
affixed to the product  labeling.  The GS mark,  which the  Company  received in
December 1995, denotes that the product meets certain safety standards. In 1996,
the Company also received the "CE" (Medical Device Directive) mark for the SAFHS
Model  2A.  The CE mark is  recognized  by  countries  that are  members  of the
European Union and the European Free Trade Association, and effective June 1998,
will be  required  to be affixed to all  medical  devices  sold in the  European
Union.  No  assurance  can be given that any  products  that the  Company  might
develop or commercialize  will obtain the CE mark, or will be able to obtain any
other required regulatory clearance or approval on a timely basis, or at all.

Competition

         The medical device industry is  characterized  by intense  competition.
Many of the Company's  existing and  potential  competitors  have  substantially
greater financial,  marketing, sales, distribution, and technical resources than
the Company and more experience in research and  development,  clinical  trials,
regulatory matters,  manufacturing,  and marketing.  In addition,  most of these
companies  have  established  third-party   reimbursement  for  their  products.
Furthermore,  the medical  device  industry is  characterized  by rapid  product
development and technological  change.  The Company's products could be rendered
obsolete  or  uneconomical  by  technological  advances  by one or  more  of the
Company's  competitors or by other  therapies such as drugs to treat  conditions
addressed  by  the  Company's  products.   The  Company's  business,   financial
condition, results of operations, and cash flows will depend upon its ability to
remain competitive with other developers of such medical devices and therapies.

         The SAFHS device  competes  with  non-invasive  bone growth  electrical
stimulation  devices  and  with  various  surgical  treatments.   The  Company's
mechanical-stress  device to  prevent  bone loss  related  to  osteoporosis,  if
developed and marketed,  will compete with drug therapies and exercise regimens.
Four companies currently market electrical stimulation devices for the treatment
of non-union fractures.  The Company believes at least one of these companies is
<PAGE>
conducting  clinical  trials  for  the  use of  electrical  stimulation  for the
treatment of fresh  fractures.  In addition,  other  companies are  developing a
variety of products and  technologies  to be used in the  treatment of fractures
and  osteoporosis,   including  growth  factors,  bone  graft  substitutes,  and
exercise/physical therapy equipment.  There can be no assurance that competitors
will not develop products that are superior to the Company's  products,  achieve
greater  market  acceptance,  or render the  Company's  technology  and products
obsolete or noncompetitive.  As a result, the Company's  long-term viability may
depend on  whether it can  continue  to develop  new  products.  There can be no
assurance that the Company will be able to compete  successfully against current
or future  competitors  or that  competition  will not have a  material  adverse
effect on the Company's business, financial condition, results of operations, or
cash flows.

Product Liability and Insurance

         The  Company  faces an  inherent  business  risk of exposure to product
liability  claims in the event  that the use of its  product  is alleged to have
resulted in adverse effects.  The Company maintains product liability  insurance
with coverage of $3 million per occurrence and an annual aggregate maximum of $3
million.  In  addition,  the Company  maintains  umbrella  liability  insurance,
including  product  liability  coverage,  of $10 million per  occurrence  and an
annual  aggregate  maximum  of  $10  million.  There  can be no  assurance  that
liability  claims will not exceed the coverage  limits of such  policies or that
such insurance will continue to be available on commercially  acceptable  terms,
or at all. Consequently,  product liability claims could have a material adverse
effect on the Company's business,  financial  condition,  results of operations,
and cash flows.

Employees

         As of November 30, 1997, the Company had 75 employees, consisting of 24
in sales and marketing, eight in engineering,  14 in finance and administration,
five in quality  assurance,  10 in reimbursement  and customer  service,  six in
research and development and regulatory affairs,  and eight in manufacturing and
shipping.  The Company  believes  that the success of its business  depends,  in
part,  on its ability to attract  and retain  qualified  personnel.  None of the
Company's  employees is covered by a  collective  bargaining  agreement.  Exogen
believes that it maintains good relations with its employees.

Item 2.  Properties

         The Company  leases  approximately  32,000 square feet of a facility in
Piscataway,  New Jersey.  This leased space contains  approximately 9,000 square
feet of  manufacturing  space and 23,000  square feet  devoted to  research  and
development,  marketing,  and  administration.  This facility is leased  through
October 2001, and the Company has an option for a five-year renewal term. Exogen
believes  its  facility  is  adequate  to  meet  its  anticipated   real  estate
requirements for the next three years.

Item 3.  Legal  Proceedings

         On April 4, 1995, a former  consultant to  Interpore,  the company from
which  Exogen  purchased  certain  SAFHS  ultrasound  assets,  filed a complaint
against  Interpore  and  Exogen  in the  United  States  District  Court for the
Southern  District of New York,  claiming the right,  pursuant to the terms of a
consulting  agreement  between such  consultant and the  predecessor  company to
<PAGE>
Interpore,  to  certain  royalties,  not  exceeding  1.25%  of the net  revenues
generated from the sale of SAFHS devices.  On June 5, 1995,  Exogen answered the
complaint,  denied that it has any liability to the  consultant,  and asserted a
number of specific  defenses.  On the same day, Interpore did the same, and also
asserted  cross-claims  against Exogen,  claiming that any royalties found to be
due to the consultant  should be paid by Exogen and that Exogen should be liable
for Interpore's  attorneys' fees and other costs incurred in the litigation.  On
July 7, 1995, Exogen answered Interpore's  cross-claims,  denied that it has any
liability  to the  consultant  or to  Interpore,  asserted a number of  specific
defenses to Interpore's claims, and asserted cross-claims against Interpore that
any royalties found to be due to the consultant  should be paid by Interpore and
that Interpore be liable for Exogen's  attorneys'  fees and other costs incurred
in the  litigation.  Exogen and  Interpore  since have agreed that (i)  Exogen's
counsel will assume the status of lead defense counsel in the  litigation;  (ii)
any adverse  judgment  entered in the litigation  will be entered against Exogen
and Interpore jointly and severally;  and (iii) Exogen will indemnify  Interpore
for any payments  that are required to be made to the  consultant as a result of
the  litigation,  and Exogen and Interpore  thereafter  will resolve  separately
their respective liabilities. As a result of the foregoing, in March 1996 Exogen
and  Interpore  dismissed  their claims  against each other in this  litigation,
without  prejudice to their right to resolve them,  if  necessary,  as described
above. The Company does not believe that the consultant's claims have merit, and
together with  Interpore,  is vigorously  defending  this action.  The discovery
process has been completed, and the Company anticipates making a motion that the
Court enter a judgment in favor of the  Company  and  Interpore  and against the
consultant. There can be no assurance,  however, that the motion will be granted
or that the consultant's claims will not be upheld.

         On March 15, 1995, a former sales representative of the Company filed a
complaint  against  the  Company in the  United  States  District  Court for the
District of New Jersey that alleged breach of the sales representative agreement
and  sought  damages  as a result of the  termination  of the  agreement  by the
Company.  In March  1996,  the Company  settled  this  matter,  and the case was
dismissed with prejudice and without costs.

         In March 1997, the Company received a demand from Pilla Consulting,
Inc. and Arthur A. Pilla  (collectively,  "Pilla") for  royalties  allegedly due
pursuant to a consulting  agreement between Pilla Consulting and the predecessor
company to Interpore.  Pilla claims entitlement to royalties of 1.25% of the net
revenues generated from the sale of SAFHS devices.  The Company does not believe
that Pilla's claim has any merit. For that reason, on April 2, 1997, the Company
filed a complaint  against  Pilla in the Supreme Court for the State of New York
seeking a judicial  declaration  that the Company is not liable to Pilla for any
royalties.  Pilla  asserted a  counterclaim  against the Company,  seeking to be
awarded the demanded  royalties,  that the Company asked the Court to dismiss on
the  grounds  that Pilla  failed to state a claim  against  the  Company.  Pilla
subsequently asked the Court for permission to replead the counterclaim, and the
Company has opposed this motion on the grounds that the amended claim also fails
to state a claim  against the Company.  These  motions are pending.  The Company
intends to aggressively pursue the action against Pilla and to
vigorously defend against any counterclaim(s) by Pilla seeking said royalties or
equivalent payments under any legal theory. There can be no assurance,  however,
that Pilla's claim will not be upheld.


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

         None.
<PAGE>
Item 4a.  Executive Officers of the Registrant

         The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
    Name                                               Age                             Position
    ----                                               ---                             --------
<S>                                                    <C>   <C>
John P. Ryaby.......................................   63    Chairman of the Board of Directors and Vice President of
                                                             Research and Development and Regulatory Affairs
Patrick A. McBrayer.................................   46    Chief Executive Officer, President, and Director
Richard H. Reisner..................................   54    Vice President, Chief Financial Officer, and Secretary
Roger J. Talish.....................................   55    Vice President of Operations
---------
</TABLE>

         John P.  Ryaby,  a founder of the  Company,  has been a Director of the
Company since March 1992 and Chairman of the Board of Directors  since  February
1994. Mr. Ryaby served as President and Chief  Executive  Officer of the Company
from March 1992 to February 1994, and currently  serves as the Vice President of
Research and Development and Regulatory Affairs. Mr. Ryaby served from late 1989
until 1992 as the President and Chief Operating Officer of Interpore, a division
of Interpore  International,  Inc., a physical and biological  research company.
Mr. Ryaby was a founder, and from 1975 to 1982 was President and Chief Operating
Officer,  of  Electro-Biology,  Inc. ("EBI"),  a company involved in bone-growth
electrical-stimulation  technology, and was responsible for obtaining regulatory
approval of EBI's PMA in 1979 and for establishing EBI's direct sales force.

         Patrick A. McBrayer was named Chief Executive Officer, President, and a
Director of the  Company in February  1994.  Prior to joining the  Company,  Mr.
McBrayer  served in various  executive  positions  from 1987 to February 1994 at
Osteotech,  Inc.,  including  President and Chief  Executive  Officer.  While at
Osteotech, Inc., a company that develops and markets biologic,  biomaterial, and
implant systems for musculoskeletal  surgery,  Mr. McBrayer guided the company's
transition  from its  inception to a public  entity.  From 1979 through 1986, he
served in a variety of positions  of  increasing  responsibility  with Johnson &
Johnson,  Inc., including Marketing Manager of the Patient Care Division,  where
he built a significant business in surgical products.

         Richard H.  Reisner,  a founder of the Company,  has served as its Vice
President and Chief  Financial  Officer since September 1992. From 1991 to 1992,
Mr. Reisner was Vice President and Chief Financial Officer of Cirrus Diagnostics
Inc.  ("Cirrus"),  a company  that  developed  a system  for the  automation  of
diagnostic immunoassay and chemistry testing, and was directly involved with the
acquisition of Cirrus by Diagnostic Products  Corporation in May 1992. From 1990
to 1991,  Mr.  Reisner was the  Corporate  Controller  for  Datascope  Corp.,  a
manufacturer  of  medical  instruments.  From  1988 to  1990,  Mr.  Reisner  was
President  and  Chief  Executive  Officer  of Pain  Suppression  Labs,  Inc.,  a
manufacturer  of electrical  stimulation  devices to suppress  chronic  headache
pain.  From  1979 to  1988,  Mr.  Reisner  was Vice  President  of  Finance  and
Administration  of  EBI,  and  was  responsible  for  establishing   third-party
reimbursement for EBI's bone-growth electrical-stimulation devices.

         Roger J. Talish, a founder of the Company, has served as Vice President
of Operations  for the Company since March 1992.  From 1989 to 1992,  Mr. Talish
was Vice  President of Operations  at Interpore,  and from 1985 to 1989 held the
same  position at  Meditron,  Inc.  From 1978 to 1985,  Mr.  Talish held various
engineering  management  positions  at EBI,  including  Director of Research and
Product Engineering.
<PAGE>
                                     PART II


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

         The  Company's  Common  Stock has been  quoted on the  Nasdaq  National
Market  under the  trading  symbol  "EXGN"  since the Company  commenced  public
trading on July 20, 1995. Prior to that date, there was no public market for the
Company's Common Stock.

         The  following  table sets forth the high and low selling price for the
Company's  Common Stock for fiscal 1996 and 1997,  based on transaction  data as
reported by the Nasdaq National Market.
<TABLE>
<CAPTION>

          Fiscal years ended
      September 30, 1996 and 1997           High              Low
      ---------------------------           ----              ---
<S>                                        <C>               <C>
      1996
      ----
      First quarter...................     $20.75            $12.75
      Second quarter..................     $25.75            $11.75
      Third quarter...................     $14.00            $ 7.25
      Fourth quarter..................     $ 9.50            $ 3.00

      1997
      ----
      First quarter...................     $ 6.000           $ 3.250
      Second quarter..................     $ 7.625           $ 3.500
      Third quarter...................     $ 5.750           $ 3.375
      Fourth quarter..................     $ 5.625           $ 3.000
</TABLE>

         On November 28, 1997,  the last  reported  sale price for the Company's
Common Stock as reported by the Nasdaq National Market was $3.75 per share.

         As of November 30, 1997, there were approximately 204 holders of record
of the Common Stock. This number excludes individual  stockholders holding stock
under nominee security position listings.

         The  Company  has not  declared  or paid any cash  dividends  since its
inception,  and does not  intend to pay any cash  dividends  in the  foreseeable
future.

The Stockholder Rights Plan

         Effective  December  6, 1996,  pursuant to a  Preferred  Shares  Rights
Agreement  (the  "Rights  Agreement")  between  the Company  and  Registrar  and
Transfer Company,  as Rights Agent (the "Rights Agent"),  the Company's Board of
Directors  declared  a  dividend  of one  right  (a  "Right")  to  purchase  one
one-hundredth  share of the Company's  Series A  Participating  Preferred  Stock
("Series  A  Preferred")  for  each  outstanding  share of  Common  Stock of the
Company.  The dividend is payable on December  19, 1996 (the  "Record  Date") to
stockholders  of record as of the close of  business  on that  date.  Each Right
entitles the registered holder to purchase from the Company one one-hundredth of
a share of Series A  Preferred  at an exercise  price of $30.00  (the  "Purchase
Price"),  subject to adjustment in the event the Company  declares a dividend on
<PAGE>
the Common Stock payable in Common Stock,  subdivides  the number of outstanding
shares of Common  Stock into a larger  number of such  shares,  or combines  the
number  of  outstanding  shares of Common  Stock  into a smaller  number of such
shares,  among other  circumstances.  In addition,  under certain  circumstances
described more fully in the Rights Agreement,  the Rights may become exercisable
for a number of shares of  Common  Stock  having a value  equal to two times the
Purchase Price.

         The Rights  approved by the Board of Directors  are designed to protect
and maximize the value of the outstanding equity interests in the Company in the
event of an  unsolicited  attempt by an  acquirer  to take over the Company in a
manner or on terms not  approved by the Board of  Directors.  Takeover  attempts
frequently  include coercive tactics to deprive the Company's Board of Directors
and its  stockholders  of any effective  opportunity  to determine the Company's
future.

Common Stock Warrants

         In  September  1997,  the  Company  and a  consultant  entered  into an
advisory agreement whereby the consultant acquired a warrant (at a cost of $0.20
per share) to purchase up to 100,000 shares of the Company's  Common Stock at an
exercise  price of $4.50 per  share  (the  "Cash  Purchase  Warrant").  The Cash
Purchase  Warrant is  immediately  exercisable  and  expires  five  years  after
issuance  subject,  however,  to expiration on August 1, 1998, in the event that
the  Company  does not, by April 30,  1998,  consummate  a strategic  partnering
transaction  relating  to the  commercialization  of  certain  of the  Company's
non-invasive technologies (each a "Strategic Partnering Transaction").  Further,
for each of the  Strategic  Partnering  Transactions  described  in the advisory
agreement and  subsequently  entered into by the Company,  the  consultant  will
receive a warrant (at no cost) to purchase 75,000 shares of the Company's Common
Stock at an exercise price of $4.50 per share (the "Transaction  Warrant").  For
each such Strategic Partnering Transaction  consummated prior to April 30, 1998,
the consultant will receive,  in lieu of the foregoing  Transaction  Warrant,  a
Transaction  Warrant to purchase 125,000 shares of the Company's Common Stock at
an exercise price of $4.50 per share (subject to adjustment).  Such  Transaction
Warrants, if issued, would expire five years after issuance.

         As of November 30, 1997,  the Cash Purchase  Warrant was not exercised,
and no additional Transaction Warrants have been issued to the consultant.

Private Placement of Common Stock

         On October 20, 1997,  the Company  completed a private  placement  (the
"Private  Placement")  of  1,799,019  shares of its Common  Stock for  aggregate
proceeds of approximately $7.5 million.  The Common Stock subject to the Private
Placement was sold by the Company pursuant to Regulation D of the Securities Act
of 1933,  as  amended,  on the basis  that the  Common  Stock was  issued  under
circumstances not involving a public offering. Pursuant to a Registration Rights
Agreement, dated October 20, 1997, by and among the Company and the investors in
the Private Placement,  the Company is required to file a registration statement
registering the shares of Common Stock sold in the Private  Placement  within 90
days of the consummation of the Private Placement.

         Participants  in the  Private  Placement  included  certain  investment
funds,  trusts, and individuals,  including Messrs.  Benson,  Lothrop, and Wall,
each of whom is a director of the Company. Additional information regarding this
item is  incorporated  herein by  reference  to  "Certain  Transactions"  in the
Company's  Definitive Proxy  Statement,  which is to be filed with the SEC on or
about January 8, 1998.
<PAGE>
Item 6.  Selected Financial Data

         Set forth below are the selected  consolidated  financial  data for the
Company for the five fiscal years ended  September 30, 1997.  The following data
should be read in conjunction with the Company's financial  statements,  related
notes thereto, and "Management's  Discussion and Analysis of Financial Condition
and Results of Operations."
<TABLE>
<CAPTION>
                                          SELECTED CONSOLIDATED FINANCIAL DATA
                                          (in thousands, except per share data)

                                                                     For the years ended September 30,
                                                   --------------------------------------------------------------------
                                                     1997           1996           1995           1994           1993
                                                   --------       --------       --------       --------       --------
<S>                                                <C>            <C>            <C>            <C>            <C>
Statement of Operations Data:
Revenues:
    Product sales ...........................      $  7,081       $  5,777       $  1,852       $   --         $   --
    Revenues from development agreements ....           400          1,100           --             --             --
                                                   --------       --------       --------       --------       --------
        Total revenues ......................         7,481          6,877          1,852           --             --
                                                   --------       --------       --------       --------       --------

Operating costs and expenses:
    Cost of product sales ...................         3,864          3,661          1,128           --             --
    Research and development and related
        patent acquired .....................          --             --             --             --            1,068
    Research and development ................         3,124          3,988          2,545          1,432            572
    Selling, general, and administrative ....        12,291         11,030          5,775          1,782            382
                                                   --------       --------       --------       --------       --------
        Total operating costs and expenses ..        19,279         18,679          9,448          3,214          2,022
                                                   --------       --------       --------       --------       --------

Operating loss ..............................       (11,798)       (11,802)        (7,596)        (3,214)        (2,022)

Other income (expense):
    Interest income (expense), net ..........           701          1,438            604           (185)           (24)
    Other expense, net ......................           (51)          (224)           (59)            (2)           (21)
                                                   --------       --------       --------       --------       --------
        Total other income (expense), net ...           650          1,214            545           (187)           (45)
                                                   --------       --------       --------       --------       --------

Loss before income taxes ....................       (11,148)       (10,588)        (7,051)        (3,401)        (2,067)

Provision for income taxes ..................             4            --             --             --             --
                                                   --------       --------       --------       --------       --------

Net loss ....................................      $(11,152)      $(10,588)      $ (7,051)      $ (3,401)      $ (2,067)
                                                   ========       ========       ========       ========       ========

Net loss per share ..........................      $  (1.12)      $  (1.07)           --             --             --
                                                   ========       ========
Weighted average shares outstanding .........         9,946          9,875            --             --             --
Pro forma net loss per share ................          --             --         $  (0.93)      $  (0.48)      $  (0.32)
                                                                                 ========       ========       ========
Pro forma weighted average shares outstanding          --             --            7,574          7,020          6,517
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                                                September 30,
                                                        -------------------------------------------------------------
                                                         1997          1996         1995         1994          1993
                                                         ----          ----         ----         ----          ----
<S>                                                     <C>          <C>          <C>          <C>           <C>
Balance Sheet Data:
Cash and cash equivalents and short- and long-term
    investments ..................................      $ 8,544      $19,534      $31,061      $   640       $   180
Working capital ..................................       11,042       17,235       30,054          301          (461)
Total assets .....................................       14,789       25,511       34,886        1,773           442
Redeemable Preferred Stock .......................         --           --           --          6,002         1,758
Total stockholders' equity (deficit) .............       12,091       23,077       33,342       (5,487)       (2,075)
</TABLE>



Item 7. Management's  Discussion and Analysis of Financial Condition and Results
of Operations

         This  Annual  Report  on Form 10-K  contains  certain  statements  of a
forward-looking  nature  relating  to  future  events  or the  future  financial
performance of the Company. Such statements are only predictions, and the actual
events or results  may  differ  materially  from the  results  discussed  in the
forward-looking  statements.  Factors  that could  cause or  contribute  to such
differences  include those discussed below under  "Business  Considerations"  as
well as those discussed in other filings made by the Company with the Securities
and Exchange Commission.

Results of Operations

Fiscal Year ended  September 30, 1997 compared with Fiscal Year ended  September
30, 1996

         Essentially all of the Company's  product sales were from the Company's
SAFHS devices.  For fiscal 1997, product sales were $7.1 million,  compared with
$5.8 million for fiscal 1996. The increase of $1.3 million (or 23%) was a result
of an increase in sales  volume.  International  product sales were 18% of total
product sales in fiscal 1997, compared with 14% in fiscal 1996.

         In fiscal 1997, the Company  recorded  revenues of $400,000  related to
development  agreements with Teijin Limited,  a Japanese  corporation,  compared
with $1.1 million in fiscal 1996. These development  agreements cover two of the
Company's  technologies:  (i) the SAFHS  device  and (ii) the  mechanical-stress
device under development. The SAFHS agreement provides for milestone payments to
the Company for  Teijin's  development  of the product for launch in Japan.  The
Company will  manufacture and supply SAFHS devices to Teijin for clinical trials
and  subsequent  sales in Japan.  Teijin is  responsible  for complying with the
regulatory  requirements  and for marketing and distributing the SAFHS device in
Japan. The  mechanical-stress  agreement  provides for milestone payments to the
Company that will support,  in part, the Company's clinical trials in the United
States  in  exchange  for a first  option  in favor of  Teijin  to  negotiate  a
development and distribution agreement for this device for the Japanese market.
<PAGE>
         Cost of product  sales was $3.9 million for fiscal 1997,  compared with
$3.7 million for fiscal 1996.  Included in cost of sales were  royalties and the
cost of  manufacture  of the SAFHS device by the Company and an outside  source.
Excluding  revenues related to development  agreements,  gross profit for fiscal
1997 was $3.2 million (or 45% as a percentage of product  sales),  compared with
$2.1  million (or 37%) for fiscal 1996.  This $1.1 million  increase (or 52%) in
gross  profit was  principally  due to the  increase in sales volume and reduced
per-unit  product costs,  partially offset by a decrease in the average realized
selling price of a SAFHS device, which was approximately $2,025 for fiscal 1997,
compared  with  approximately  $2,285 for fiscal  1996.  The decrease in average
realized  selling price was primarily due to an increase in the  allowances  for
returns and for price reductions by third-party payors.

         Research  and  development  expenses in fiscal 1997  decreased  to $3.1
million from $4.0 million in fiscal 1996.  The decrease of $864,000 (or 22%) was
primarily the result of (i) reduced  expenditures for designing and building the
mechanical-stress  device for  clinical  studies,  (ii) the  discontinuation  of
shipments of SAFHS devices in connection with certain clinical prescriptions for
which  reimbursement  is  currently  not  available,  and  (iii)  reduced  costs
associated  with analyses of clinical data for the SAFHS therapy.  This decrease
was partially offset by increased expenses  associated with additional  research
projects.

         Selling,  general, and administrative expenses in fiscal 1997 increased
to $12.3  million from $11.0 million in fiscal 1996.  The $1.3 million  increase
(or 11%) resulted from (i) expanded selling and marketing efforts related to the
SAFHS Model 2A, both in the United States and in Europe, and the introduction in
May  1997 of the  second-generation  SAFHS  2000,  in the  United  States,  (ii)
marketing  activities  relating  to the  Company's  line  of  synthetic  casting
materials used in fracture  immobilization,  (iii) increased activities relating
to  reimbursement  efforts,  and (iv) a  nonrecurring  charge  of  approximately
$150,000, related to a workforce reduction in the third quarter of fiscal 1997.

         Net  interest  income in fiscal 1997  decreased  to $701,000  from $1.4
million  in  fiscal  1996,  consistent  with the  level of funds  available  for
investment.  Other  expense,  net for fiscal  1997  decreased  to  $51,000  from
$224,000 for fiscal 1996, principally due to the settlement of a legal action by
the Company in the second quarter of fiscal 1996.

         The Company  incurred net losses of $11.2 million,  or $1.12 per share,
in fiscal 1997 compared with $10.6 million,  or $1.07 per share,  in fiscal 1996
(per share data based upon weighted  average shares  outstanding,  which exclude
options because they are antidilutive).  The increase of $564,000 (or 5%) in net
loss was caused principally by the factors discussed above.

Fiscal Year ended  September 30, 1996 compared with Fiscal Year ended  September
30, 1995

         For fiscal 1996,  product sales were $5.8  million,  compared with $1.9
million  for  fiscal  1995,  which was the  period in which  the  Company  first
recorded sales.  International  product sales were 14% of total product sales in
fiscal 1996; there were no international product sales in fiscal 1995. In fiscal
1996,  the Company  recorded  revenues of $1.1  million  related to  development
agreements with Teijin Limited. No such revenues were reported for fiscal 1995.
<PAGE>
         Cost of product  sales was $3.7 million for fiscal 1996,  compared with
$1.1 million for fiscal 1995. Included in cost of sales were royalties, the cost
of manufacture of the SAFHS device by outside sources,  and the in-house cost of
refurbishment and quality assurance  activities.  Excluding  revenues related to
development  agreements,  gross  profit for 1996 was $2.1  million  (or 37% as a
percentage of product  sales),  compared  with $724,000 (or 39%) for 1995.  This
$1.4  million  increase  (or 192%) in gross  profit was  principally  due to the
increase in sales volume,  while the decrease in gross profit percentage was due
primarily to higher warranty costs.

         Research  and  development  expenses in fiscal 1996  increased  to $4.0
million from $2.5 million in fiscal 1995.  The increase of $1.4 million (or 57%)
was  primarily  the result of increased  staff,  additional  research  projects,
expanded  efforts in designing and building the  mechanical-stress  device,  and
extensive analyses of clinical data associated with the SAFHS therapy.

         Selling,  general, and administrative expenses in fiscal 1996 increased
to $11.0  million from $5.8 million in fiscal 1995. Of the $5.3 million (or 91%)
increase,  $3.2  million  was due to sales and  marketing  efforts in the United
States, including expansion of the direct sales force and related commissions on
sales.  The  remaining  $2.1  million  increase  was  primarily  due to expanded
activities of the Company's subsidiary in Germany;  increased domestic expenses,
including  rent,  utilities,  and  depreciation;  and legal fees associated with
litigation and patent matters.

         Net  interest  income in fiscal 1996  increased  to $1.4  million  from
$604,000 in fiscal 1995, principally due to a full year's interest earned on the
proceeds from the Company's  Initial Public Offering ("IPO") in July 1995. Other
expense, net for fiscal 1996 increased to $224,000 from $59,000 for fiscal 1995,
principally due to the settlement of a legal action by the Company in the second
quarter of fiscal 1996.

         The Company  incurred net losses of $10.6  million,  or $1.07 per share
(per share data based upon weighted  average shares  outstanding,  which exclude
options  because  they are  antidilutive),  in fiscal  1996  compared  with $7.1
million,  or $0.93 per share  (per  share  data  based  upon pro forma  weighted
average  shares  outstanding),  in fiscal 1995. The increase of $3.5 million (or
47%) in net loss was caused principally by the factors discussed above.

Liquidity and Capital Resources

         Since inception, the Company's expenses have significantly exceeded its
revenues,  resulting in an accumulated deficit of $34.3 million at September 30,
1997.  Through  September  30,  1997,  the  Company  had funded  its  operations
primarily through the private placement of equity securities  (aggregating $17.6
million) and an IPO of Common  Stock in July 1995  (aggregating  $28.5  million,
including  proceeds from the overallotment  option).  Subsequent to the close of
fiscal 1997, on October 20, 1997, the Company  completed a $7.5 million  private
placement of 1,799,019 shares of its Common Stock.

         At September  30, 1997,  the Company had a working  capital  balance of
approximately  $11 million.  In fiscal 1997,  the Company used net cash of $10.9
million for operating activities, primarily to fund (i) selling and marketing of
the SAFHS Model 2A and, in the second  half of fiscal  1997,  the SAFHS 2000 and
(ii) an increase in the international  accounts receivable days outstanding from
240 days at September 30, 1996, to 390 days at September 30, 1997. The Company's
<PAGE>
capital  expenditures in fiscal 1997 were $165,000.  The Company  estimates that
equipment and furnishings to expand in-house  manufacturing  and  administrative
support activities will require capital  expenditures of approximately  $300,000
during each of the next two fiscal years.

         To help  conserve  its  capital  resources,  the  Company  reduced  its
workforce  during the quarter ended June 30, 1997.  Through the  reduction,  the
Company  expects to realize  approximately  $750,000 of annual  pretax  savings;
approximately $221,000 was saved in fiscal 1997.

         The Company plans to finance its capital  needs from  existing  capital
resources  and  the  proceeds  of  the  October  1997  private  placement,   the
combination  of  which  the  Company  believes  will be  sufficient  to fund its
operations  into fiscal 1999.  Additional  funding  might not be available  when
needed or on terms  acceptable  to the  Company,  which  would  have a  material
adverse  effect on the  Company's  business,  financial  condition,  results  of
operations, and cash flows.

Recent Pronouncement

         In February  1997,  the  Financial  Accounting  Standards  Board issued
Statement of Financial Accounting Standards No. 128 ("SFAS 128"),  "Earnings Per
Share." This  statement  establishes  standards  for  computing  and  presenting
earnings per share ("EPS"),  replacing the  presentation  of currently  required
primary EPS with a presentation  of Basic EPS. For entities with complex capital
structures,  SFAS 128  requires  the dual  presentation  of both  Basic  EPS and
Diluted EPS on the face of the statement of operations. Under this new standard,
Basic EPS is computed based on weighted average shares  outstanding and excludes
any  potential  dilution;  Diluted  EPS  reflects  potential  dilution  from the
exercise or conversion of securities  into common stock or from other  contracts
to issue common stock,  and is similar to the currently  required  fully diluted
EPS. SFAS 128 is effective for financial  statements  issued for periods  ending
after December 15, 1997,  including interim periods,  and earlier application is
not permitted. When adopted, the Company will be required to restate its EPS for
all prior  periods  presented.  The  Company  does not  expect the impact of the
adoption of SFAS 128 to be material to previously reported EPS.

Business Considerations

Limited Operating History

         The Company has a limited  history of  operations  that,  to date,  has
consisted primarily of research and development, product engineering,  obtaining
approval from the FDA for the Company's  SAFHS device,  developing the Company's
sales and  marketing  organization,  supervising  the  manufacture  of the SAFHS
device by a contract manufacturer, developing in-house manufacturing capability,
and selling its SAFHS device domestically and  internationally.  The Company was
formed for the purpose of acquiring the SAFHS  technology  and related  clinical
data,  as well as the  mechanical-stress  technology.  The  Company  has limited
direct  clinical  trial  experience.  The Company  received  approval of its PMA
Application  for the SAFHS  Model 2A device  and began  marketing  it in October
1994, and further received approval of the SAFHS 2000 device and began marketing
the SAFHS 2000 in May 1997,  and therefore  has limited  experience in marketing
and selling its products in commercial  quantities.  The Company had no previous
<PAGE>
direct manufacturing experience prior to commencing in-house refurbishing of its
SAFHS device in fiscal  1996.  Whether the Company can  successfully  manage the
transition to a larger-scale  commercial  enterprise will depend,  in part, upon
further  developing  its  distribution  network;   successfully  developing  its
manufacturing  capability;   and  strengthening  its  financial  and  management
systems,   procedures,   and  controls.   Failure  to  make  such  a  transition
successfully  would have a material  adverse  effect on the Company's  business,
financial condition, results of operations, and cash flows.

Uncertainty of Market Potential and Market Acceptance

         The  Company's  SAFHS  device was  approved  by the FDA for  commercial
marketing in October 1994 to treat closed, cast-immobilized,  fresh fractures of
the tibia and distal radius within  approved  indications.  Since that time, the
Company has been engaged in efforts to gain  physician  acceptance  of the SAFHS
device and  reimbursement  coverage  for its use.  The market  potential  of the
Company's SAFHS device depends on the acceptance by the medical community of the
use of ultrasound  technology as a safe and effective  method of treating  fresh
fractures and the use of the Company's  SAFHS device by physicians for treatment
of these  fractures.  The SAFHS device is based upon new technology that had not
been used  previously to treat bone  fractures.  There can be no assurance  that
physicians will prescribe treatment using the SAFHS device. In addition,  use of
the  SAFHS  device  depends  significantly  on the  availability  and  extent of
third-party  reimbursement  (which has occurred  substantially on a case-by-case
basis),  increased  awareness of the effectiveness of the SAFHS technology,  and
focused sales efforts by the Company.  Electrical  stimulation devices, the only
other  non-invasive  devices  commercially  available  for the treatment of bone
fractures, have gained only limited physician acceptance to date. Failure of the
Company's  SAFHS  device to  achieve  market  acceptance  would  have a material
adverse  effect on the  Company's  business,  financial  condition,  results  of
operations, and cash flows.

Dependence on Third-Party Reimbursement

         Successful  sales of SAFHS devices in the United  States,  Europe,  and
other  countries  depend on the  availability  of  adequate  reimbursement  from
third-party  payors such as managed care  organizations,  workers'  compensation
insurers, private insurance plans, and government entities. There is significant
uncertainty  concerning  third-party  reimbursement  for the use of any  medical
device incorporating new technology, such as the SAFHS device.  Reimbursement by
a  third-party  payor may depend on a number of factors,  including  the payor's
determination that the use of the SAFHS device is safe and effective,  medically
necessary,  appropriate  for  the  specific  patient,  cost-effective,  and  not
experimental  or  investigational.  In  addition,  devices  incorporating  a new
technology are often  prescribed by physicians for indications  other than those
approved by the FDA (off-label).  Reimbursement  for such off-label uses may not
be  available  or  permitted  by  government  regulations.  Since  reimbursement
approval is required from each payor  individually,  seeking such approvals is a
time-consuming   and  costly  process  that  requires  the  Company  to  provide
scientific  and  clinical  support for the use of the SAFHS device to each payor
separately.  In most cases,  in the United  States,  the  Company  has  received
reimbursement  approval from  third-party  payors only on a case-by-case  basis.
Currently,  third-party payors that have conducted technology assessments of the
SAFHS therapy,  and have established medical guidelines for its use, require the
Company, in most cases, to obtain preauthorization from these third-party payors
prior to providing the SAFHS devices to the patients. There can  be no assurance
<PAGE>
that  third-party  reimbursement  will be  sufficiently  available for the SAFHS
device or any of the Company's  other products that may be developed,  that such
third-party  reimbursement will be adequate,  or that other third-party  payors,
including  Medicare,  will not  recommend  that the SAFHS  device not be covered
under their programs.

         In August 1996,  the Technology  Advisory  Committee of the Health Care
Financing Administration  recommended that the SAFHS device not be covered under
the Medicare  program.  The Company,  however,  continues to pursue coverage for
SAFHS by providing additional information to the HCFA staff; in the interim, the
Company is not shipping orders to patients  covered under  Medicare.  The United
States Congress is also considering  various  proposals to significantly  reduce
Medicare and  Medicaid  expenditures,  which,  if they were enacted and if SAFHS
were covered under Medicare or Medicaid, could have a material adverse effect on
the Company's business,  financial  condition,  results of operations,  and cash
flows. In addition,  third-party payors are increasingly limiting  reimbursement
coverage for medical devices, and in many instances have put pressure on medical
suppliers to lower their prices. The Company has limited experience in obtaining
reimbursement  for its products in countries  other than the United States,  and
has obtained only limited  reimbursement in Germany.  There is no assurance that
the Company's efforts to obtain  reimbursement  approval in Germany and in other
countries  will  be  successful.   Lack  of  or  inadequate   reimbursement   by
governmental and other third-party  payors for the Company's products would have
a  material  adverse  effect on the  Company's  business,  financial  condition,
results of operations, and cash flows.

History of Losses; Profitability Uncertain; Fluctuations in Operating Results

         The Company has incurred  substantial losses since inception and, as of
September 30, 1997, had an accumulated  deficit of approximately  $34.3 million.
Such losses have resulted  principally  from expenses  associated with obtaining
FDA approval for the Company's  SAFHS device,  engineering  and  developing  the
SAFHS and  mechanical-stress  devices,  and establishing and expanding the sales
and marketing organization and reimbursement activities in the United States and
in Europe. The Company expects to generate substantial  additional losses in the
future  primarily  attributable  to development of, and clinical trials for, the
mechanical-stress  device, clinical trials for expanded indications of the SAFHS
technology,  the  continued  expansion of domestic and  international  sales and
marketing activities,  and the expansion of in-house  manufacturing  capability.
Results of operations may fluctuate  significantly from quarter to quarter based
on such factors,  and will also depend upon reimbursement by third-party payors,
new  product  introductions  by  the  Company  or  its  competitors,  timing  of
regulatory actions, expenditures incurred in the research and development of new
products, and the mix of product sales between the United States and abroad. The
Company's future revenues and profitability are critically  dependent on whether
it can successfully market and sell its SAFHS device.  There can be no assurance
that significant revenues or profitability will ever be achieved.

Dependence on Principal Product

         Essentially  all of the  Company's  product  revenues to date have been
derived from sales of its SAFHS device. The SAFHS device is expected to continue
to account for substantially  all of the Company's  revenues for the foreseeable
future.  The Company's  long-term  success will depend in part on the successful
commercialization  of  the  SAFHS  device  for  its  approved  indications,  the
development  and  regulatory  approval  of SAFHS  devices  to  treat  additional
indications,  and the acceptance of the SAFHS treatment by the medical community
and third-party  payors.  Failure to gain market acceptance for the SAFHS device
or to obtain adequate reimbursement coverage,  among other factors, would have a
material adverse effect on the Company's business,  financial condition, results
of operations, and cash flows.
<PAGE>
Limited Sales and Marketing Experience

         The Company  began  marketing  the SAFHS device in the United States in
October 1994.  Because of limited market  awareness of SAFHS therapy,  the sales
effort is a lengthy  process,  requiring the Company to educate  physicians  and
third-party payors regarding the clinical benefits and cost-effectiveness of the
SAFHS  technology,  to assist  patients  in the  reimbursement  process,  and to
provide  product  support to patients.  The Company uses a combination of direct
sales  representatives  and a network of independent  sales  representatives  to
market and distribute its products.  Independent sales representatives typically
market  orthopaedic  and other  devices  for a variety of  manufacturers.  These
representatives  do not have prior  experience  in the sale or use of devices to
accelerate  fresh-fracture  healing.  There  can  be  no  assurance  that  these
independent sales  representatives will commit the necessary resources to market
the SAFHS  device  effectively  or that the  Company's  direct  sales staff will
succeed  in its  efforts to  promote  the SAFHS  technology  to  physicians  and
third-party payors.

         The Company  markets  the SAFHS  device in several  European  countries
through  independent  distributors  and sales agents,  and has recorded sales in
Germany, Austria, the Netherlands,  Denmark,  Switzerland,  Belgium, and Israel.
The Company also will collaborate with marketing  partners in the Pacific Rim to
assist with regulatory  requirements  and to market and distribute the Company's
products.  The Company has entered into one such  agreement  covering Japan with
Teijin Limited, a Japanese corporation. Each of the foreign markets in which the
Company  sells,   or  plans  to  sell,  its  products  has  its  own  regulatory
requirements and approvals, and the distribution, price, and market structure to
be established  by the Company might vary from country to country.  No assurance
can be given that the Company can successfully market the SAFHS device in Europe
or that it can secure additional  marketing partners in the Pacific Rim on terms
acceptable to the Company, or at all.

         The  Company's  marketing  success in the United States and abroad will
depend  on  whether  it can  gain  further  regulatory  approvals,  successfully
demonstrate the cost-effectiveness of its products, further develop direct sales
capability  to  augment  its  existing   distribution   network,  and  establish
arrangements with distributors and marketing partners. Failure by the Company to
successfully market its products  domestically and internationally  would have a
material adverse effect on the Company's business,  financial condition, results
of operations, and cash flows.

Risks Associated with International Operations

         The Company  established a subsidiary in Germany  during fiscal 1995 as
part of its strategy to  introduce  the SAFHS  device in Europe,  and  commenced
commercial  distribution  of the device in  certain  European  countries  during
fiscal 1996.  International  product sales,  which were  principally in Germany,
were 14% of total product sales in fiscal 1996 and 18% in fiscal 1997,  and such
revenues are expected to continue to represent a significant percentage of total
revenues.  The Company believes that its profitability and continued growth will
require expansion of sales in foreign markets,  and so it intends to continue to
expand  its   operations   outside  the  United  States  and  enter   additional
international  markets,  which will require significant management attention and
financial resources.  There can be no assurance that the Company will be able to
achieve market  acceptance of its products in international  markets or maintain
or increase international market demand for its products.
<PAGE>
         As of  September  30,  1997,  the  balance  in  international  accounts
receivable,  net of allowances for returns and bad debt, was $1.4 million,  with
days  outstanding  of  approximately  390  days.  The   international   accounts
receivable  is primarily  derived  from sales in Germany,  where the Company has
received  limited local  reimbursement  on a case-by-case  basis.  To assist the
collection of outstanding  claims and to expedite the  reimbursement  process on
future  claims,  the  Company is seeking  nationwide  approval  by the  National
Krankenkasse,   the  German  governing  organization  that  establishes  medical
reimbursement policy for health-care providers.  To this end, in August 1997 the
Company  submitted  a  formal  application  to the  National  Krankenkasse.  The
application  process  includes  a  scientific  assessment  and  a  reimbursement
assessment; the Company is currently in the scientific-assessment  phase. In the
interim,  the  Company has  elected to sell SAFHS  devices in Germany  only when
reimbursement  is  preapproved.  There can be no assurance that the Company will
obtain a favorable  ruling on its request  for  nationwide  approval on a timely
basis,  if at  all.  Lack  of  approval  by the  National  Krankenkasse  for the
Company's  products  could  have a  material  adverse  effect  on the  Company's
business, financial condition, results of operations, and cash flows.

         The Company's  international  product sales are  denominated in foreign
currencies.  Management  can give no  assurances  that  changes in currency  and
exchange rates will not materially  affect the Company's  revenues,  costs, cash
flows,  and  business  practices  and plans.  Additional  risks  inherent in the
Company's international business activities generally include unexpected changes
in  regulatory  requirements,  tariffs  and  other  trade  barriers,  delays  in
receiving  payments on accounts  receivable  balances,  reimbursement  approvals
(both   government  and  private),   difficulties   in  managing   international
operations,  potentially adverse tax consequences,  restrictions on repatriation
of earnings,  and the burdens of complying  with a wide variety of foreign laws.
There can be no  assurances  that such factors will not have a material  adverse
effect on the Company's future international revenues and, consequently,  on the
Company's business, financial condition, results of operations, or cash flows.

Manufacturing and Related Risks

         The Company has  developed  in-house  refurbishing  capability  for the
SAFHS Model 2A device and in-house  manufacturing  capability for the SAFHS 2000
device. In addition,  the Company uses a contract  manufacturer to manufacture a
portion of the  Company's  SAFHS 2000  production.  Both the  Company's  and the
contract  manufacturer's  respective  facilities have been inspected by the FDA,
and have been approved for the production of the SAFHS 2000 under the FDA's Good
Manufacturing Practices ("GMP") requirements.  Any failure by either the Company
or the contract  manufacturer to maintain its respective  facility in accordance
with GMP  requirements  could result in the inability to  manufacture  the SAFHS
device on a commercial  scale, and could limit the Company's  ability to deliver
the SAFHS device to physicians or patients,  which would have a material adverse
effect on the Company's business,  financial  condition,  results of operations,
and cash flows.

         Several components  incorporated in the SAFHS device currently are, and
will continue to be, manufactured by single-source vendors. For certain of these
components,  there  are  relatively  few  alternative  sources  of  supply,  and
establishing  additional or replacement  suppliers for such components cannot be
accomplished  quickly. Any supply interruption from single-source  vendors would
have a material adverse effect on the Company's business,  financial  condition,
results of operations, and cash flows.
<PAGE>
Intense Competition and Risks Associated with Rapid Technological Change

         The medical device industry is  characterized  by intense  competition.
Many of the Company's  existing and  potential  competitors  have  substantially
greater financial,  marketing, sales, distribution, and technical resources than
the Company and more experience in research and  development,  clinical  trials,
regulatory matters,  manufacturing,  and marketing.  In addition,  most of these
companies  have  established  third-party   reimbursement  for  their  products.
Furthermore,  the medical  device  industry is  characterized  by rapid  product
development and technological  change.  The Company's products could be rendered
obsolete  or  uneconomical  by  technological  advances  by one or  more  of the
Company's  competitors or by other  therapies such as drugs to treat  conditions
addressed  by  the  Company's  products.   The  Company's  business,   financial
condition,  results of  operations,  and cash flows will depend upon whether the
Company can compete  effectively  with other  developers of such medical devices
and therapies.

         The   SAFHS   device    competes    with    non-invasive    bone-growth
electrical-stimulation   devices  and  with  various  surgical  treatments.  The
Company's mechanical-stress device to prevent bone loss related to osteoporosis,
if  developed  and  marketed,  will  compete  with drug  therapies  and exercise
regimens.  There can be no  assurance  that such device will ever be  developed,
approved by the FDA, or become commercially available.  Four companies currently
market  electrical-stimulation  devices for the treatment of non-union fractures
(fractures that remain unhealed after nine months). The Company believes that at
least  one of these  companies  is  conducting  clinical  trials  for the use of
electrical stimulation for the treatment of fresh fractures. In addition,  other
companies are  developing a variety of products and  technologies  to be used in
the  treatment  of  fractures  and   osteoporosis,   including  growth  factors,
bone-graft substitutes, and exercise/physical therapy equipment. There can be no
assurance that  competitors  will not develop  products that are superior to the
Company's products,  achieve greater market acceptance,  or render the Company's
technology and products obsolete or  noncompetitive.  As a result, the Company's
long-term  viability  may  depend on  whether it can  continue  to  develop  new
products.  There can be no  assurance  that the Company  will be able to compete
successfully  against current or future competitors or that competition will not
have a material adverse effect on the Company's business,  financial  condition,
results of operations, or cash flows.

Extensive Government Regulation

         The  manufacture  and sale of medical  devices are subject to extensive
government  regulation in the United States and in other countries.  The process
of obtaining FDA and other required regulatory  approvals can be time-consuming,
expensive,  and uncertain,  frequently  requiring  several years from commencing
clinical trials to receiving  regulatory  approval.  For example, the process of
conducting  clinical  trials and  obtaining  the PMA for the SAFHS Model 2A took
nine years.  The Company is required to file PMA supplements for new or expanded
indications for its SAFHS  technology.  In addition,  modifications to its SAFHS
devices may require PMA  supplements.  If a supplement  were not accepted by the
FDA,  the Company  would be required to  undertake  and  complete the entire PMA
process  in  order  to use  future  SAFHS  devices  to  treat  those  additional
indications or commercialize a modified  device.  There can be no assurance that
the Company will obtain any such  approvals on a timely basis,  or at all, which
could  have a  material  adverse  effect on the  Company's  business,  financial
condition, results of operations, and cash flows.
<PAGE>
         The Company filed a PMA Supplement for its second-generation SAFHS, the
SAFHS  2000,  in  December  1995,  and in  March  1997,  the FDA  approved  this
supplement.  In May 1997, the Company commenced  commercial  distribution of the
SAFHS 2000 in the United  States.  The Company  recently  filed a PMA Supplement
seeking approval of an expanded indication for the SAFHS 2000, but withdrew that
application  in July 1997 to revise and  resubmit it for both  expanded  and new
applications.  The Company expects to refile this  Supplement  during the second
quarter  of  fiscal  1998.  The  Company  will  also be  required  to file a PMA
application  for  its  mechanical-stress  device,  if and  when  development  is
completed.  No assurance can be given that such application will be made, and if
made,  that a PMA or a supplement to an existing PMA will be granted on a timely
basis,  or at all.  In order for the  Company to market the SAFHS  device or any
future products in foreign jurisdictions, it will be required to seek regulatory
approvals in those jurisdictions. No assurance can be given that the Company can
obtain required regulatory  approvals in foreign countries on a timely basis, or
at all.

         Regulatory approvals,  if granted, may include significant  limitations
on the  indicated  uses for which a product  may be  marketed.  FDA  enforcement
policy  strictly  prohibits  the  promotion  by  the  Company  and  any  of  its
distributors of approved  medical  devices for off-label  uses.  There can be no
assurance that the Company will not become subject to FDA actions as a result of
physicians'  prescribing  the SAFHS  device for  off-label  uses.  In  addition,
product  approvals  may be  withdrawn  for  failure  to comply  with  regulatory
standards or the occurrence of unforeseen  problems following initial marketing.
The  Company  is  required  to  adhere  to FDA  regulations  setting  forth  GMP
requirements relating to tests,  control, and documentation.  Ongoing compliance
with GMP and other  applicable  regulatory  requirements  is  monitored  through
periodic  inspections by state and federal  agencies,  including the FDA, and by
comparable agencies in other countries. Failure to comply with applicable United
States and  international  regulatory  requirements can result in failure of the
relevant government agency to grant pre-market approval for devices,  withdrawal
of approval,  total or partial  suspension of  production,  fines,  injunctions,
civil  penalties,  recall or  seizure of  products,  and  criminal  prosecution.
Furthermore,  changes in existing  regulations or adoption of new regulations or
policies  could  prevent the Company  from  obtaining,  or affect the timing of,
future regulatory approvals or clearances.

         During  1996,  the Company  received  regulatory  approval of the SAFHS
Model 2A in Germany.  Under  German law,  medical  devices must have a "GS" mark
affixed to the product  labeling.  The GS mark,  which the  Company  received in
December 1995, denotes that the product meets certain safety standards. In 1996,
the Company also received the "CE" (Medical Device Directive) mark for the SAFHS
Model  2A.  The CE mark is  recognized  by  countries  that are  members  of the
European Union and the European Free Trade Association, and effective June 1998,
will be  required  to be affixed to all  medical  devices  sold in the  European
Union.

         There  can be no  assurance  that the  Company  will be able to  obtain
necessary regulatory  approvals or clearances in the United States,  Europe, the
Pacific Rim, or elsewhere on a timely basis,  or at all. Delays in receipt of or
failure to receive such approvals or clearances, the loss of previously received
approvals or clearances, or failure to comply with existing or future regulatory
requirements  would have a material  adverse  effect on the Company's  business,
financial condition, results of operations, and cash flows.
<PAGE>
Limited Protection of Patents, Copyrights and Proprietary Rights; Risk of Patent
Infringement

         The  Company  relies  on  a  combination  of  patents,  trade  secrets,
copyrights,   and   confidentiality   agreements  to  protect  its   proprietary
technology,  rights, and know-how.  No assurance can be given that the Company's
patent  applications  will issue as patents or that any issued  patents owned by
the Company will provide  competitive  advantages for the Company's  products or
will not be  successfully  challenged  or  circumvented  by  competitors.  Under
current law, patent  applications in the United States are maintained in secrecy
until  patents are issued,  and patent  applications  in foreign  countries  are
maintained in secrecy for a period after filing. The right to a device patent in
the United  States is  attributable  to the first to invent the device,  not the
first to file a patent application. Accordingly, the Company cannot be sure that
its products or technologies do not infringe  patents that may be granted in the
future  pursuant  to pending  patent  applications  or that its  products do not
infringe any patents or proprietary  rights of third parties.  In the event that
any relevant claims of third-party  patents are upheld as valid and enforceable,
the Company could be prevented from selling its products or could be required to
obtain  licenses  from the owners of such patents or be required to redesign its
products to avoid  infringement.  There can be no assurance  that such  licenses
would be  available  or,  if  available,  would be on  terms  acceptable  to the
Company,  or that the Company would be successful in any attempt to redesign its
products or processes to avoid  infringement.  The  Company's  failure to obtain
these licenses or to redesign its products would have a material  adverse effect
on the Company's business,  financial condition, results of operations, and cash
flows. The Company also relies on trade secrets and proprietary information, and
enters into  confidentiality  agreements  with its employees,  consultants,  and
advisors.  There  can be no  assurance  that the  obligations  to  maintain  the
confidentiality   of  such  trade  secrets  and  proprietary   information  will
effectively  prevent  disclosure of the Company's  confidential  information  or
provide  meaningful  protection  for the Company's  confidential  information if
there is unauthorized use or disclosure,  or that the Company's trade secrets or
proprietary  information  will not be  independently  developed by the Company's
competitors. The Company also holds rights to copyrights on text and on software
developed  by or for  itself  for  use  in its  SAFHS  device.  There  can be no
assurance  that any  copyrights  owned by the Company will  provide  competitive
advantages for the Company's  products or will not be challenged or circumvented
by its  competitors.  Litigation  may be necessary to defend  against  claims of
infringement,  to enforce  patents  and  copyrights  issued or  licensed  to the
Company,  or to protect trade secrets,  and could result in substantial cost to,
and  diversion  of effort by, the Company.  There can be no  assurance  that the
Company would prevail in any such litigation.

Uncertainty of New Product Development

         The Company plans to seek FDA approval to commence  clinical  trials in
the near future to expand the approved  indications for the SAFHS  technology to
include other fractures,  spine fusion,  and cartilage repair. In addition,  the
Company has developed a mechanical-stress device to prevent bone loss related to
osteoporosis.  The Company has  commenced a pilot  clinical  trial in the United
States,  and  anticipates  that it  will be  required  to  undertake  additional
development  activities  and human  clinical  trials before  seeking  regulatory
approval for this device.  There can be no assurance that the  mechanical-stress
device will prove to be safe and efficacious, that product development will ever
be  successfully  completed,  that a PMA, if applied for, will be granted by the
FDA  on a  timely  basis,  or  at  all,  that  adequate  levels  of  third-party
<PAGE>
reimbursement will be available, or that the mechanical-stress  device will ever
achieve  commercial  acceptance.  The  Company's  inability to show  efficacy in
additional  applications of its SAFHS  technology,  to successfully  develop the
mechanical-stress   device,   or  to  achieve  market  acceptance  of  such  new
applications  and products would have a material adverse effect on the Company's
business, financial condition, results of operations, and cash flows.

Royalty Payment Obligations; Potential Loss of Exclusive License

         The Company is required to pay a royalty on any net revenues from sales
of the mechanical-stress  device, if such device is successfully  developed.  In
the  event  that  the  Company  does not  commercially  exploit  the  underlying
technology as required by the license agreement for such technology, the Company
will forfeit its exclusive license to the  mechanical-stress  technology.  There
can be no assurance that the Company will  commercially  exploit such technology
within the meaning of such license,  and  forfeiture of such  exclusive  license
could  have a  material  adverse  effect on the  Company's  business,  financial
condition, results of operations, and cash flows.

Product Liability and Insurance

         The  Company  faces an  inherent  business  risk of exposure to product
liability  claims in the event that the use of its  products  is alleged to have
resulted in adverse  effects.  There can be no assurance that  liability  claims
will not exceed the coverage limits of the Company's  insurance policies or that
such insurance will continue to be available on commercially  reasonable  terms,
or at all. Consequently,  product liability claims could have a material adverse
effect on the Company's business,  financial  condition,  results of operations,
and cash flows.

Reliance on Key Personnel

         The Company's success depends to a significant  extent upon a number of
key management and technical personnel.  The loss of the services of one or more
key employees  could have a material  adverse effect on the Company's  business,
financial  condition,  results of operations,  and cash flows.  The Company also
believes  that its future  success  will  depend in large part on whether it can
attract and retain highly skilled  technical,  management,  sales and marketing,
and  reimbursement  personnel.  Competition  for such personnel is intense,  and
there can be no assurance  that the Company will be successful in attracting and
retaining such  personnel.  The Company's  failure to attract,  hire, and retain
these personnel would have a material adverse effect on the Company's  business,
financial condition, results of operations, and cash flows.

Possible Volatility of Stock Price

         The trading  price of the  Company's  Common  Stock could be subject to
significant  fluctuations  in  response to  variations  in  quarterly  operating
results,  announcements  of  technological  innovations  or new  products by the
Company or its competitors,  changes in earning  estimates by analysts,  general
conditions  in the medical  device  industry,  and other  events or factors.  In
addition,  the stock market in general has experienced  extreme price and volume
fluctuations  that  have  affected  the  market  price  for  many  companies  in
industries  similar  or  related  to that of the  Company  and  that  have  been
unrelated  to  the  operating  performance  of  these  companies.  These  market
fluctuations  may  adversely  affect the market  price of the  Company's  Common
Stock.
<PAGE>
Certain Anti-Takeover Provisions

         The Company's Second Amended and Restated  Certificate of Incorporation
grants the Board of Directors the  authority to issue up to 3,000,000  shares of
preferred  stock of the  Company,  $0.0001  par value per share (the  "Preferred
Stock"), in one or more series and to fix the rights,  preferences,  privileges,
and restrictions thereof,  including dividend rights, dividend rates, conversion
rights,  voting rights,  terms of  redemption,  redemption  prices,  liquidation
preferences, and the number of shares constituting any series or the designation
of such series,  without further vote or action by the  stockholders.  Effective
December  6, 1996,  pursuant to the Rights  Agreement,  the  Company's  Board of
Directors  declared  a  dividend  of  one  Right  to  purchase,   under  certain
circumstances, one one-hundredth share of the Company's Series A Preferred Stock
for each outstanding share of Common Stock of the Company.  Although the Company
has no present plans to issue any additional  shares of Preferred  Stock, it may
do so in the future.  (See Part II,  Item 5,  "Market  for  Registrant's  Common
Equity and Related  Stockholder  Matters--The  Stockholder Rights Plan," and the
copy of the Rights Agreement attached as Exhibit 99.1 to the Company's Form 10-K
for the year ended  September  30, 1996,  for more  information  relating to the
Stockholder Rights Plan.)

         The Company's  Bylaws specify  procedures  for director  nominations by
stockholders  and  the  submission  of  other  proposals  for  consideration  at
stockholder  meetings.  Certain  provisions  of Delaware law  applicable  to the
Company could also delay or make more difficult a merger, tender offer, or proxy
contest involving the Company, including Section 203, which prohibits a Delaware
corporation  from  engaging  in any  business  combination  with any  interested
stockholder  for a period of three years unless certain  conditions are met. The
possible  issuance of Preferred Stock  (including  pursuant to the Rights Plan),
the procedures required for director nominations and stockholder proposals,  and
Delaware  law could have the effect of  delaying,  deferring,  or  preventing  a
change in control of the Company,  including without limitation,  discouraging a
proxy contest,  making more difficult the acquisition of a substantial  block of
the  Company's  Common  Stock,  or limiting  the price that  investors  might be
willing to pay in the future for shares of the Company's Common Stock.


Item 8.  Financial Statements and Supplementary Data

         The  information  in  response  to  this  item  is  set  forth  in  the
Consolidated  Financial  Statements beginning on page F-3 of this report on Form
10-K.


Item 9.  Changes in and Disagreements With Accountants on Accounting and
         Financial Disclosure

         None.
<PAGE>
                                    PART III


Item 10.  Directors and Executive Officers of the Registrant

         Information  in  response  to  this  item  is  incorporated  herein  by
reference  to  "Election  of  Directors"  in  Exogen,  Inc.'s  definitive  proxy
statement  ("Definitive Proxy Statement") to be filed pursuant to Regulation 14A
of the Securities  Exchange Act of 1934 (the "Exchange Act") with the Securities
and Exchange  Commission ("SEC") not later than 120 days after the end of fiscal
1997.  Information with respect to compliance with Section 16(a) of the Exchange
Act  is  incorporated   herein  by  reference  to  "Compliance   with  Reporting
Requirements"  in the Company's  Definitive Proxy Statement to be filed with the
SEC.


Item 11.  Executive Compensation

         Information  in  response  to  this  item  is  incorporated  herein  by
reference  to   "Executive   Officers  and   Information   Regarding   Executive
Compensation"  in the Company's  Definitive Proxy Statement to be filed with the
SEC.


Item 12.  Security Ownership of Certain Beneficial Owners and Management

         Information  in  response  to  this  item  is  incorporated  herein  by
reference to "Security Ownership of Certain Beneficial Owners and Management" in
the Company's Definitive Proxy Statement to be filed with the SEC.


Item 13.   Certain Relationships and Related Transactions

         Information  in  response  to  this  item  is  incorporated  herein  by
reference to "Certain  Transactions" in the Company's Definitive Proxy Statement
to be filed with the SEC.

<PAGE>
                                     PART IV


Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)      Documents filed as a part of this Form 10-K:
         (1)      Financial  Statements.  The following  Consolidated  Financial
                  Statements of Exogen,  Inc. and report of  independent  public
                  accountants  relating  thereto  are filed with this  report on
                  Form 10-K:  Consolidated  Balance  Sheets as of September  30,
                  1997 and 1996  Consolidated  Statements of Operations  for the
                  years ended  September 30, 1997,  1996, and 1995  Consolidated
                  Statement  of  Changes in  Stockholders'  Equity for the years
                  ended  September  30,  1997,   1996,  and  1995   Consolidated
                  Statements  of Cash Flows for the years  ended  September  30,
                  1997,   1996,  and  1995  Notes  to   Consolidated   Financial
                  Statements 
         (2)      Financial  Statement  Schedules.  Schedule  II--Valuation  and
                  Qualifying  Accounts for the years ended  September  30, 1997,
                  1996,  and 1995  Schedules  not listed above have been omitted
                  because the  information  required to be set forth  therein is
                  not  applicable  or is  shown  in the  Consolidated  Financial
                  Statements or notes thereto.
         (3)      Exhibits.
                            3.1     Second  Amended and Restated  Certificate of
                                    Incorporation  of the Company.  Incorporated
                                    by reference to Exhibit 3.1 to the Company's
                                    Form 10-Q for the third  quarter  ended June
                                    30, 1995.
                            3.2     Amended and Restated  Bylaws of the Company.
                                    Incorporated  by reference to Exhibit 3.3 to
                                    the   Company's   Form   S-1    Registration
                                    Statement (Registration No. 33-92740).
                            4.1     See Exhibits 3.1 and 3.2 for  provisions  of
                                    the Certificate of Incorporation  and Bylaws
                                    of the Company defining rights of holders of
                                    Common Stock of the Company.
                           10.1     Amended  and  Restated   Investors'   Rights
                                    Agreement  dated as of  November  14,  1994,
                                    among the Company,  the investors  listed on
                                    Schedule  A  thereto,  and  the  individuals
                                    listed on  Schedule B thereto.  Incorporated
                                    by   reference   to  Exhibit   10.1  to  the
                                    Company's  Form S-1  Registration  Statement
                                    (Registration No. 33-92740).
                           10.2     Asset Purchase  Agreement  dated as of March
                                    1, 1993,  among  Applied  Epigenetics,  Inc.
                                    ("AEI"), Interpore International,  Inc., and
                                    Interpore Orthopaedics, Inc. Incorporated by
                                    reference to Exhibit  10.2 to the  Company's
                                    Form     S-1     Registration      Statement
                                    (Registration No. 33-92740).
                           10.3     [RESERVED]
                           10.4     Employment Agreement dated February 3, 1994,
                                    between   the   Company   and  John   Bohan.
                                    Incorporated by reference to Exhibit 10.4 to
                                    the   Company's   Form   S-1    Registration
                                    Statement (Registration No. 33-92740).
<PAGE>
                           10.5     Form of  Consulting  Agreements  between the
                                    Company  and each of Drs.  McLeod and Rubin,
                                    as amended.  Incorporated  by  reference  to
                                    Exhibit  10.5  to  the  Company's  Form  S-1
                                    Registration  Statement   (Registration  No.
                                    33-92740).
                           10.6     Form of Stock Restriction  Agreement between
                                    the  Company  and  each of Drs.  McLeod  and
                                    Rubin and Messrs.  Reisner,  Ryaby,  Talish,
                                    McBrayer,   and   Bohan.   Incorporated   by
                                    reference to Exhibit  10.6 to the  Company's
                                    Form     S-1     Registration      Statement
                                    (Registration No. 33-92740).
                           10.7     Form of Stock Purchase Agreement between the
                                    Company and each of Messrs.  Reisner, Ryaby,
                                    and Talish.  Incorporated  by  reference  to
                                    Exhibit  10.7  to  the  Company's  Form  S-1
                                    Registration  Statement   (Registration  No.
                                    33-92740).
                           10.8     Manufacturing  Agreement  dated  January 20,
                                    1994,  between  the  Company and Hi- Tronics
                                    Designs,  Inc.  Incorporated by reference to
                                    Exhibit  10.8  to  the  Company's  Form  S-1
                                    Registration  Statement   (Registration  No.
                                    33-92740).
                           10.9     Form  of  1993  Stock  Option  Plan  Option
                                    Agreement.  Incorporated  by  reference  to
                                    Exhibit  10.9  to the  Company's  Form  S-1
                                    Registration  Statement  (Registration  No.
                                    33-92740).
                           10.10    1995  Stock  Option / Stock  Issuance  Plan.
                                    Incorporated  by reference to Exhibit  10.10
                                    to  the  Company's  Form  S-1   Registration
                                    Statement (Registration No. 33-92740).
                           10.11    Employee Stock  Purchase Plan.  Incorporated
                                    by  reference   to  Exhibit   10.12  to  the
                                    Company's  Form S-1  Registration  Statement
                                    (Registration No. 33-92740).
                           10.12    Lease  Agreement dated December 13, 1994, by
                                    and between the Company and Siemens  Medical
                                    Systems,  Inc.  Incorporated by reference to
                                    Exhibit  10.13  to the  Company's  Form  S-1
                                    Registration  Statement   (Registration  No.
                                    33-92740).
                           10.13    License  Agreement  dated  March  26,  1992,
                                    between  AEI  and  Drs.  McLeod  and  Rubin.
                                    Incorporated  by reference to Exhibit  10.14
                                    to  the  Company's  Form  S-1   Registration
                                    Statement (Registration No. 33-92740).
                           10.14    SAFHS  Agreement  dated  November  30, 1995,
                                    between  the  Company  and  Teijin  Limited.
                                    Incorporated  by reference to Exhibit  10.14
                                    to the  Company's  Form  10-K  for the  year
                                    ended September 30, 1995.
                           10.15+   Mechanical-Stress  Agreement  dated November
                                    30,  1995,  between  the  Company and Teijin
                                    Limited.   Incorporated   by   reference  to
                                    Exhibit 10.15 to the Company's Form 10-K for
                                    the year ended September 30, 1995.
<PAGE>
                           10.16    Employment  Agreement  dated  March 1, 1997,
                                    between the Company and Patrick A. McBrayer.
                                    Incorporated  by reference to Exhibit  10.16
                                    to the  Company's  Form 10-Q for the  second
                                    quarter ended March 31, 1997.
                           10.17*   Severance  Agreement,  dated  May 27,  1997,
                                    between the Company and John Bohan.
                           10.18*   Common  Stock  Purchase   Agreement,   dated
                                    October  20,  1997,  between the Company and
                                    certain   investors  listed  on  Schedule  1
                                    thereto.
                           10.19*   Registration Rights Agreement, dated October
                                    20,  1997,  between  the Company and certain
                                    investors listed on Schedule 1 thereto.
                           10.20*   Form of  Amendment  to 1995  Stock  Option /
                                    Stock Issuance Plan.
                           10.21*   Form of Amendment to Employee Stock Purchase
                                    Plan.
                           21.1     List   of   Subsidiary.    Incorporated   by
                                    reference to Exhibit  21.1 to the  Company's
                                    Form 10-K for the year ended  September  30,
                                    1995.
                           23.1*    Consent of Arthur Andersen LLP.
                           27*      Financial Data Schedule.
                           99.1     Preferred  Shares  Rights  Agreement,  dated
                                    December  6, 1996,  between  the Company and
                                    Registrar  and Transfer  Company,  including
                                    the Certificate of  Determination,  the Form
                                    of Rights  Certificate,  and the  summary of
                                    Rights  attached  thereto as  Exhibits A, B,
                                    and   C,   respectively.   Incorporated   by
                                    reference to Exhibit  99.1 to the  Company's
                                    Form 10-K for the year ended  September  30,
                                    1996.

                           * Filed herewith.
                           + Confidential treatment granted.

(b)      Reports on Form 8-K
                           No reports  on Form 8-K were filed  during the fourth
                           quarter of fiscal 1997.
<PAGE>
                                   SIGNATURES

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

EXOGEN, INC.


By:   /s/ Patrick A. McBrayer                                  December 17, 1997
      -----------------------
      Patrick A. McBrayer, 
      Chief Executive Officer, President, and Director




         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.

            Signature                                               Date
            ---------                                               ----
                                                     
By:   /s/ John P. Ryaby                                        December 17, 1997
      -----------------
      John P. Ryaby, 
      Chairman of the Board and
      Vice President of Research and
      Development and Regulatory Affairs


By:   /s/ Patrick A. McBrayer                                  December 17, 1997
      -----------------------
      Patrick A. McBrayer, 
      Chief Executive Officer, 
      President, and Director
      (Principal Executive Officer)

By:   /s/ Richard H. Reisner                                   December 17, 1997
      ----------------------
      Richard H. Reisner, 
      Vice President,
      Chief Financial Officer, 
      and Secretary
      (Principal Financial and 
      Accounting Officer)

By:   /s/ Buzz Benson                                          December 17, 1997
      ---------------
      Buzz Benson, 
      Director

By:   /s/ Donald J. Lothrop                                    December 17, 1997
      ---------------------
      Donald J. Lothrop, 
      Director
<PAGE>

By:   /s/ Peter C. Madeja                                      December 17, 1997
      -------------------
      Peter C. Madeja, 
      Director

By:   /s/ David J. Ottensmeyer                                 December 17, 1997
      ------------------------
      David J. Ottensmeyer, 
      Director

By:   /s/ Terence D. Wall                                      December 17, 1997
      -------------------
      Terence D. Wall, 
      Director

<PAGE>
                                  EXOGEN, INC.

                                  EXHIBIT INDEX
                                  -------------

             Number                            Description   
             ------                            -----------   
                                                      
              3.1          Second   Amended   and   Restated    Certificate   of
                           Incorporation   of  the  Company.   Incorporated   by
                           reference to Exhibit 3.1 to the  Company's  Form 10-Q
                           for the third quarter ending June 30, 1995.
              3.2          Amended   and   Restated   Bylaws  of  the   Company.
                           Incorporated  by  reference  to  Exhibit  3.3  to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
              4.1          See  Exhibits  3.1  and  3.2  for  provisions  of the
                           Certificate  of  Incorporation   and  Bylaws  of  the
                           Company defining rights of holders of Common Stock of
                           the Company.
             10.1          Amended  and  Restated  Investors'  Rights  Agreement
                           dated as of November 14, 1994, among the Company, the
                           investors  listed  on  Schedule  A  thereto,  and the
                           individuals    listed   on    Schedule   B   thereto.
                           Incorporated  by  reference  to  Exhibit  10.1 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.2          Asset Purchase  Agreement  dated as of March 1, 1993,
                           among Applied  Epigenetics,  Inc. ("AEI"),  Interpore
                           International, Inc., and Interpore Orthopaedics, Inc.
                           Incorporated  by  reference  to  Exhibit  10.2 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.3          [RESERVED]
             10.4          Employment  Agreement dated February 3, 1994, between
                           the Company and John Bohan. Incorporated by reference
                           to   Exhibit   10.4  to  the   Company's   Form   S-1
                           Registration Statement (Registration No. 33-92740).
             10.5          Form of Consulting Agreements between the Company and
                           each  of  Drs.   McLeod   and  Rubin,   as   amended.
                           Incorporated  by  reference  to  Exhibit  10.5 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.6          Form  of  Stock  Restriction  Agreement  between  the
                           Company and each of Drs. McLeod and Rubin and Messrs.
                           Reisner,   Ryaby,   Talish,   McBrayer,   and  Bohan.
                           Incorporated  by  reference  to  Exhibit  10.6 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.7          Form of Stock Purchase  Agreement between the Company
                           and  each of  Messrs.  Reisner,  Ryaby,  and  Talish.
                           Incorporated  by  reference  to  Exhibit  10.7 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
<PAGE>
                                  EXOGEN, INC.

                                  EXHIBIT INDEX
                                  -------------

             Number                            Description   
             ------                            -----------   

             10.8          Manufacturing   Agreement  dated  January  20,  1994,
                           between  the  Company and  Hi-Tronics  Designs,  Inc.
                           Incorporated  by  reference  to  Exhibit  10.8 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.9          Form of 1993  Stock  Option  Plan  Option  Agreement.
                           Incorporated  by  reference  to  Exhibit  10.9 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.10         1995 Stock Option / Stock Issuance Plan. Incorporated
                           by reference to Exhibit 10.10 to the  Company's  Form
                           S-1   Registration   Statement    (Registration   No.
                           33-92740).
             10.11         Employee  Stock  Purchase   Plan.   Incorporated   by
                           reference to Exhibit 10.12 to the Company's  Form S-1
                           Registration Statement (Registration No. 33-92740).
             10.12         Lease  Agreement  dated  December  13,  1994,  by and
                           between the Company and Siemens Medical Systems, Inc.
                           Incorporated  by  reference  to Exhibit  10.13 to the
                           Company's    Form    S-1    Registration    Statement
                           (Registration No. 33-92740).
             10.13         License  Agreement dated March 26, 1992,  between AEI
                           and Drs. McLeod and Rubin.  Incorporated by reference
                           to   Exhibit   10.14  to  the   Company's   Form  S-1
                           Registration Statement (Registration No. 33-92740).
             10.14         SAFHS Agreement dated November 30, 1995,  between the
                           Company and Teijin Limited. Incorporated by reference
                           to Exhibit 10.14 to the  Company's  Form 10-K for the
                           year ended September 30, 1995.
             10.15+        Mechanical-Stress  Agreement dated November 30, 1995,
                           between the Company and Teijin Limited.  Incorporated
                           by reference to Exhibit 10.15 to the  Company's  Form
                           10-K for the year ended September 30, 1995.
             10.16         Employment Agreement dated March 1, 1997, between the
                           Company  and  Patrick A.  McBrayer.  Incorporated  by
                           reference to Exhibit 10.16 to the Company's Form 10-Q
                           for the second quarter ended March 31, 1997.
             10.17*        Severance Agreement,  dated May 27, 1997, between the
                           Company and John Bohan. 
             10.18*        Common Stock  Purchase  Agreement,  dated October 20,
                           1997,  between  the  Company  and  certain  investors
                           listed on Schedule 1 thereto.
             10.19*        Registration  Rights  Agreement,  dated  October  20,
                           1997,  between  the  Company  and  certain  investors
                           listed on Schedule 1 thereto.
             10.20*        Form  of  Amendment  to  1995  Stock  Option  / Stock
                           Issuance Plan.
             10.21*        Form of Amendment to Employee Stock Purchase Plan.
             21.1          List of  Subsidiary.  Incorporated  by  reference  to
                           Exhibit 21.1 to the Company's  Form 10-K for the year
                           ended September 30, 1995.
             23.1*         Consent of Arthur Andersen LLP.
<PAGE>
                                  EXOGEN, INC.

                                  EXHIBIT INDEX
                                  -------------

             Number                            Description   
             ------                            -----------   

             27*           Financial Data Schedule.
             99.1          Preferred Shares Rights Agreement,  dated December 6,
                           1996,  between the Company and Registrar and Transfer
                           Company,  including the Certificate of Determination,
                           the Form of Rights  Certificate,  and the  summary of
                           Rights  attached  thereto  as  Exhibits  A, B, and C,
                           respectively.  Incorporated  by  reference to Exhibit
                           99.1 to the  Company's  Form 10-K for the year  ended
                           September 30, 1996.

                           * Filed herewith.
                           + Confidential treatment granted.


<PAGE>
                                  EXOGEN, INC.

         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES


1. FINANCIAL STATEMENTS

           Report of Independent Public Accountants.............................

           Consolidated Balance Sheets as of September 30, 1997 and 1996........

           Consolidated Statements of Operations for the years ended
                September 30, 1997, 1996, and 1995..............................

           Consolidated Statement of Changes in Stockholders' Equity
                for the years ended September 30, 1997, 1996, and 1995..........

           Consolidated Statements of Cash Flows for the years ended
                September 30, 1997, 1996, and 1995..............................

           Notes to Consolidated Financial Statements...........................


2. FINANCIAL STATEMENT SCHEDULES

           Schedule II--Valuation and Qualifying Accounts for the years ended
                September 30, 1997, 1996, and 1995..............................

<PAGE>
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Exogen, Inc.:

         We have audited the accompanying consolidated balance sheets of Exogen,
Inc. (a Delaware  corporation) and subsidiary as of September 30, 1997 and 1996,
and the related consolidated statements of operations,  changes in stockholders'
equity, and cash flows for each of the three years in the period ended September
30, 1997. These consolidated  financial  statements and the schedule referred to
below 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 financial  position of Exogen,  Inc. and
subsidiary  as of  September  30,  1997  and  1996,  and the  results  of  their
operations  and their cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted accounting principles.

         Our audits were made for the purpose of forming an opinion on the basic
financial  statements  taken as a whole.  The  schedule  listed  in the index to
financial statements and financial statement schedules is presented for purposes
of complying  with the Securities and Exchange  Commission's  rules,  and is not
part of the basic financial statements.  This schedule has been subjected to the
auditing procedures applied in the audit of the basic financial statements,  and
in our opinion,  fairly  states in all  material  respects  the  financial  data
required to be set forth therein in relation to the basic  financial  statements
taken as a whole.

                                                          /s/ARTHUR ANDERSEN LLP
                                                          ----------------------
                                                             ARTHUR ANDERSEN LLP

New York, New York
November 3, 1997(except with respect to the matter discussed in the second
                paragraph of Note 15, as to which the date is November 14, 1997)
<PAGE>  
<TABLE>
<CAPTION>
                                        EXOGEN, INC.

                                 CONSOLIDATED BALANCE SHEETS
                                 ---------------------------
                              (in thousands, except share data)


                                                                           September 30,
                                                                     ----------------------
                                                                        1997          1996
                                                                     --------      --------
                    ASSETS

<S>                                                                  <C>           <C>
Current assets:
    Cash and cash equivalents ..................................     $  4,018      $  8,115
    Short-term investments .....................................        4,526         6,824
    Accounts receivable, net of allowances of $1,786 and $346 in
         1997 and 1996, respectively ...........................        3,384         2,943
    Inventories ................................................        1,515         1,239
    Interest receivable ........................................           60           202
    Other current assets .......................................          237           344
                                                                     --------      --------
                 Total current assets ..........................       13,740        19,667
Furniture, fixtures and equipment, net .........................          758           979
Long-term investments ..........................................         --           4,595
Other assets ...................................................          291           270
                                                                     --------      --------
                 Total assets ..................................     $ 14,789      $ 25,511
                                                                     ========      ========

                    LIABILITIES AND STOCKHOLDERS' EQUITY


Current liabilities:
    Accounts payable ...........................................     $    463      $    685
    Accrued liabilities ........................................        2,178         1,625
    Capital lease obligations ..................................            2            15
    Other current liabilities ..................................           55           107
                                                                     --------      --------
                 Total current liabilities .....................        2,698         2,432
Capital lease obligations ......................................         --               2
                                                                     --------      --------
                 Total liabilities .............................        2,698         2,434

Commitments and contingencies (Note 11)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                        EXOGEN, INC.

                                 CONSOLIDATED BALANCE SHEETS
                                 ---------------------------

                              (in thousands, except share data)
                                        (continued)


                                                                           September 30,
                                                                     ----------------------
                                                                        1997          1996
                                                                     --------      --------
                     
<S>                                                                  <C>           <C>
Stockholders' equity:
    Preferred Stock, $0.0001 par value; 3,000,000 shares
         authorized in 1997 and 1996; no shares issued or
         outstanding ...........................................         --            --
    Common Stock, $0.0001 par value; 27,000,000 shares
         authorized in 1997 and 1996; 9,998,140 shares issued
         and outstanding in 1997 and 9,909,192 shares issued
         and outstanding in 1996 ...............................            1             1
    Additional paid-in capital .................................       46,691        46,272
    Cumulative translation adjustment ..........................         (275)          (22)
    Accumulated deficit ........................................      (34,326)      (23,174)
                                                                     --------      --------
                 Total stockholders' equity ....................       12,091        23,077
                                                                     --------      --------
                 Total liabilities and stockholders' equity ....     $ 14,789      $ 25,511
                                                                     ========      ========

</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
<PAGE>
<TABLE>
<CAPTION>
                                      EXOGEN, INC.

                         CONSOLIDATED STATEMENTS OF OPERATIONS
                         -------------------------------------
                         (in thousands, except per share data)


                                                    For the years ended September 30,
                                                  ------------------------------------

                                                     1997          1996          1995
                                                  --------      --------      --------
<S>                                               <C>           <C>           <C>
Revenues:
     Product sales ..........................     $  7,081      $  5,777      $  1,852
     Revenues from development agreements ...          400         1,100          --
                                                  --------      --------      --------
          Total revenues ....................        7,481         6,877         1,852
                                                  --------      --------      --------

Operating costs and expenses:
     Cost of product sales ..................        3,864         3,661         1,128
     Research and development ...............        3,124         3,988         2,545
     Selling, general, and administrative ...       12,291        11,030         5,775
                                                  --------      --------      --------
           Total operating costs and expenses       19,279        18,679         9,448
                                                  --------      --------      --------

Operating loss ..............................      (11,798)      (11,802)       (7,596)

Other income (expense):
     Interest income, net ...................          701         1,438           604
     Other expense, net .....................          (51)         (224)          (59)
                                                  --------      --------      --------
           Total other income, net ..........          650         1,214           545
                                                  --------      --------      --------

Loss before income taxes ....................      (11,148)      (10,588)       (7,051)

Provision for income taxes ..................            4          --            --
                                                  --------      --------      --------
 
Net loss ....................................     $(11,152)     $(10,588)     $ (7,051)
                                                  ========      ========      ========


Net loss per share ..........................     $  (1.12)     $  (1.07)         --
                                                  ========      ========      ========

Weighted average shares outstanding .........        9,946         9,875          --

Pro forma net loss per share ................         --            --        $  (0.93)
                                                                              ========

Pro forma weighted average shares outstanding         --            --           7,574

</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
<PAGE>
<TABLE>
<CAPTION>
                                                       EXOGEN, INC.

                                 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
                                 ---------------------------------------------------------

                                  For the Years Ended September 30, 1997, 1996, and 1995
                                                      (in thousands)

                                         Common Stock          Additional     Cumulative
                                         ------------            Paid-in       Translation      Accumulated
                                     Shares        Amount        Capital       Adjustment         Deficit         Total
                                     ------        ------        -------       ----------         -------         -----
<S>                                   <C>         <C>            <C>            <C>             <C>              <C>
Balance, October 1, 1994 ...          1,385       $   --         $     13       $   --          $ (5,500)       $ (5,487)

   Amortization of Preferred
      Stock issuance costs .           --             --             --             --               (35)            (35)
   Issuance of Common Stock           2,875           --           28,509           --              --            28,509
   Conversion of Preferred
      Stock to Common Stock           5,590              1         17,416           --              --            17,417
   Translation adjustment ..           --             --             --              (11)           --               (11)
   Net loss ................           --             --             --             --            (7,051)         (7,051)
                                      -----        -------        -------       --------         -------         -------
Balance, September 30,1995 .          9,850              1         45,938            (11)        (12,586)         33,342

   Issuance of Common Stock              39           --              245           --              --               245
   Exercise of stock options             20           --               37           --              --                37
   Amortization of
      nonemployee stock
      option compensation ..           --             --               52           --              --                52
   Translation adjustment ..           --             --             --              (11)           --               (11)
   Net loss ................           --             --             --             --           (10,588)        (10,588)
                                      -----        -------        -------       --------         -------         -------

Balance, September 30, 1996           9,909              1         46,272            (22)        (23,174)         23,077

   Issuance of Common Stock              57           --              205           --              --               205
   Exercise of stock options             32           --               12           --              --                12
   Sale of warrants ........           --             --               20           --              --                20
   Amortization of
      nonemployee stock
      option and warrant
      compensation .........           --             --              182           --              --               182
   Translation adjustment ..           --             --             --             (253)           --              (253)
   Net loss ................           --             --             --             --           (11,152)        (11,152)
                                      -----        -------        -------       --------         -------         -------

Balance, September 30, 1997           9,998       $      1       $ 46,691       $   (275)       $(34,326)       $ 12,091
                                      =====       ========       ========       ========        ========        ========

</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
<PAGE>
<TABLE>
<CAPTION>
                                                EXOGEN, INC.

                                    CONSOLIDATED STATEMENTS OF CASH FLOWS
                                    -------------------------------------
                                               (in thousands)

                                                                         For the years ended September 30,
                                                                       ------------------------------------
                                                                         1997          1996           1995
                                                                       --------      --------      --------
<S>                                                                    <C>           <C>           <C>                          
Cash flows from operating activities:
     Net loss ....................................................     $(11,152)     $(10,588)     $ (7,051)
     Adjustments to reconcile net loss to net cash used in
        operating activities:
          Depreciation and amortization ..........................          394           330           186
          Amortization of net premium (discount) on short- and
               long-term investments .............................           72          (196)          (75)
          Amortization of nonemployee stock
               option/warrant compensation .......................          182            52          --
          Provision for losses on accounts receivable ............          250          --            --
          Other adjustments ......................................            2            14            47
     Decrease (increase) in assets:
          Accounts receivable, net ...............................         (908)       (2,081)         (871)
          Interest receivable ....................................          142          (158)          (44)
          Inventories ............................................         (320)          311          (738)
          Other current assets ...................................          104          (131)         (148)
          Other assets ...........................................          (30)          (46)         (188)
     Increase (decrease) in liabilities:
          Accounts payable .......................................         (207)          162            80
          Accrued liabilities ....................................          577           637           577
          Notes payable ..........................................         --            --            (380)
          Other current liabilities ..............................          (52)          107          --
                                                                       --------      --------      --------
               Net cash used in operating activities .............      (10,946)      (11,587)       (8,605)
                                                                       --------      --------      --------

Cash flows from investing activities:
     Purchase of short- and long-term investments ................       (1,392)      (20,868)      (16,310)
     Proceeds from sale of short- and long-term
       investments ...............................................        8,212        18,532         7,500
     Purchase of furniture, fixtures and equipment ...............         (165)         (411)         (916)
     Other investing activities ..................................         --               4            (4)
                                                                       --------      --------      --------
               Net cash provided by (used in) investing activities        6,655        (2,743)       (9,730)
                                                                       --------      --------      --------

Cash flows from financing activities:
     Proceeds from Preferred Stock issuances and
       bridge financing ..........................................         --            --          11,379
     Proceeds from exercise of stock options .....................           12            37          --
     Proceeds from sale of stock warrants ........................           20          --            --
     Proceeds from sale of Common Stock ..........................          205           245        28,508
     Principal payments under capital leases .....................          (15)          (14)          (13)
                                                                       --------      --------      --------
               Net cash provided by financing activities .........          222           268        39,874
                                                                       --------      --------      --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                EXOGEN, INC.

                                    CONSOLIDATED STATEMENTS OF CASH FLOWS
                                    -------------------------------------
                                               (in thousands)
                                                (continued)

                                                                         For the years ended September 30,
                                                                       ------------------------------------
                                                                         1997          1996           1995
                                                                       --------      --------      --------
<S>                                                                    <C>           <C>           <C>                          

Effect of exchange rate changes on cash and cash
   equivalents ...................................................          (28)            1            (3)
                                                                       --------      --------      --------

Net (decrease) increase in cash and cash equivalents .............       (4,097)      (14,061)       21,536
Cash and cash equivalents, beginning of year .....................        8,115        22,176           640
                                                                       --------      --------      --------
Cash and cash equivalents, end of year ...........................     $  4,018      $  8,115      $ 22,176
                                                                       ========      ========      ========


</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
<PAGE>
                                  EXOGEN, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   Description of Business

         Exogen,  Inc. ("Exogen" or the "Company"),  incorporated in New York in
January 1992 and reincorporated in Delaware in February 1993, designs, develops,
manufactures,  and markets  medical  devices for the  non-invasive  treatment of
musculoskeletal  injury and disease.  The Company commenced  operations in March
1993.

         In  fiscal  1993  and  1994,  the  Company's  activities  consisted  of
acquiring  certain  assets  related to the Sonic  Accelerated  Fracture  Healing
System ("SAFHS")  ultrasound  technology (see Note 2), completing the Pre-Market
Approval ("PMA")  requirements of the United States Food and Drug Administration
("FDA")   relating  to  the  SAFHS   device,   and   establishing   an  internal
organizational  structure.  On October 5, 1994, the Company  received a PMA from
the FDA to commercially distribute the Company's SAFHS device.

         In fiscal 1995, the Company  commenced  commercial  distribution of the
SAFHS   device  in  the  United   States,   continued  to  expand  the  internal
organizational  structure,  increased research and development  activities,  and
established  a wholly  owned  German  subsidiary.  In fiscal 1996 and 1997,  the
Company further  strengthened  its domestic sales and marketing  infrastructure,
continued its research and development  activities of the SAFHS device and other
technologies, and began and expanded commercial distribution of the SAFHS device
in certain European  countries.  Essentially all the Company's product sales are
generated from sales of the SAFHS device, and therefore,  the Company is subject
to the risks  associated with a single  product.  The majority of primary payors
for significantly all the Company's sales are third-party insurers.


2.   Acquisition of Ultrasound Technology and Patent

         On March 1, 1993, the Company  purchased  certain assets related to the
SAFHS  ultrasound  technology from Interpore  Orthopaedics,  Inc.  ("Interpore")
under the terms of an asset purchase agreement (the "Asset Purchase Agreement").
Concurrently,  the Company acquired a license to the initial  ultrasound  United
States patent for bone healing (the "Initial  Patent") under an agreement  dated
March 1, 1993 (the "License Agreement").

         Under the terms of the Asset Purchase  Agreement,  (i) the Company paid
$600,000  for those  rights and (ii) the Company is  obligated  to make  royalty
payments to Interpore  based upon net revenues from sales of devices  covered by
the Initial Patent.

         Under the terms of the License Agreement,  the Company paid $475,000 to
the patent holder. Accordingly,  the Company was assigned the subject patent and
the  assignment  was duly  filed  with the United  States  Patent and  Trademark
Office.

         The Company  expensed the SAFHS  ultrasound  technology and the initial
patent on the date acquired in fiscal 1993.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

3.   Significant Accounting Policies

   Consolidated Financial Statements

         The consolidated  financial  statements include the accounts of Exogen,
Inc. and its wholly owned subsidiary. These statements are prepared from records
maintained in the country in which the enterprise is located.  All  intercompany
transactions and balances are eliminated in consolidation.

         The Company  established a German subsidiary,  Exogen (Europe) GmbH, in
May 1995, and the subsidiary received final incorporation status in August 1995.
The subsidiary began distributing the SAFHS device in Europe in fiscal 1996.

   Translation of Foreign Currency

         All assets and  liabilities  of the Company's  foreign  operations  are
translated  to U.S.  dollars  at  year-end  exchange  rates,  while  the  income
statement is  translated  at average  exchange  rates in effect during the year.
Translation adjustments are recorded as a component of stockholders' equity.

   Revenue Recognition and Cost of Sales

         Upon shipment of the SAFHS device,  the Company  records revenue net of
allowances  for  returns  and amounts  that the  Company  believes a  respective
third-party payor might deduct from the price of the SAFHS device.

         When revenue is recognized, the related costs are classified as cost of
sales.  The  cost  of  devices  shipped  in  connection  with  certain  clinical
prescriptions  for which  reimbursement  is currently  not available is recorded
either as sales and marketing expense or as research and development expense.

         Royalties on product revenues are included in cost of sales.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

   Cash and Cash Equivalents and Investments

         The Company considers all highly liquid  investments  purchased with an
original  maturity of three months or less to be cash  equivalents.  Cash,  cash
equivalents, and investments consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                                 September 30,
                                                           ---------------------
                                                              1997          1996 
                                                           -------       -------  
<S>                                                        <C>           <C>
Cash and cash equivalents
-------------------------
     Cash ..........................................       $   205       $   145
     Money markets .................................         1,557           917
     Commercial paper ..............................         2,256         7,053
                                                           -------       -------
                                                             4,018         8,115
Short-term investments
----------------------
     U.S. Agency notes .............................         1,000         2,171
     Corporate bonds ...............................         2,518         2,955
     Bank notes ....................................         1,008         1,502
     Other .........................................          --             196
                                                           -------       -------
                                                             4,526         6,824   
Long-term investments
---------------------
     U.S. Agency notes .............................          --           2,017
     Corporate bonds ...............................          --           2,578
                                                           -------       -------
                                                              --           4,595

Total cash, cash equivalents, and investments ......       $ 8,544       $19,534
                                                           =======       =======
</TABLE>


         As of  September  30,  1997 and  1996,  all  short-term  and  long-term
investments, if any, have been classified as held to maturity. These investments
are  stated at  amortized  cost,  which  approximates  market,  and  consist  of
certificates of deposit,  commercial  paper,  U.S.  Agency notes,  and corporate
bonds.

   Accounts Receivable

         Accounts  receivable is recorded net of accumulated  allowances for (i)
returns and amounts  that the Company  believes a respective  third-party  payor
might deduct from the price of the SAFHS device (see also  "Revenue  Recognition
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


and Cost of Sales"  discussed  above)  and (ii) bad debt.  Bad debt  expense  is
classified as a Selling,  general, and administrative  expense, and was $250,000
in fiscal 1997. No bad debt expense was recorded prior to fiscal 1997; in fiscal
1996 and 1995, accounts receivable  allowances were recorded in the aggregate as
sales reserves. Because the SAFHS device was new and marketed only since October
1994, it was not practicable in fiscal 1996 and 1995 to segregate the allowances
discussed above into three  components.  Changes in economic or other conditions
could affect the ability of third-party payors to meet their obligations.

         Of the $3.4 million in Accounts Receivable,  net at September 30, 1997,
approximately  40%  was  derived  from  the  Company's   operations  in  Europe,
principally Germany,  where the Company has received limited local reimbursement
on a case-by-case  basis. (See Note 5, "Geographic  Segment  Information," below
for a further discussion of international operations.)

   Inventories

         Inventories  are  stated at the lower of cost or market on a  first-in,
first-out basis.

   Furniture, Fixtures and Equipment

         Furniture, fixtures and equipment are recorded at cost. Depreciation is
computed  using the  straight-line  method  over the related  assets'  estimated
useful lives,  which range from two to five years.  Leasehold  improvements  are
recorded at cost,  and are  amortized  using the  straight-line  method over the
useful life of the asset or the lease  term,  whichever  is shorter.  Management
reviews these assets for impairment  whenever events or changes in circumstances
indicate that the carrying  amounts of the assets might not be recoverable.  The
Company has determined that, as of September 30, 1997, no long-lived assets have
been impaired.

   Patent Costs

         Costs incurred relating to developing patents are expensed as incurred.

   Income Taxes

         Deferred  income  taxes  are  recognized  for the tax  consequences  of
temporary  differences  by applying  enacted  statutory tax rates  applicable in
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities.

   Net Loss Per Common Share

         For the years ended  September 30, 1997 and 1996, net loss per share is
determined  using  the  weighted  average  number  of  shares  of  Common  Stock
outstanding during the period presented. The weighted average shares outstanding
is based upon Accounting  Principles Board Opinion No. 15 ("APB 15"),  "Earnings
per Share." Options have been excluded because they are antidilutive.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


         For the year ended  September 30, 1995, pro forma net loss per share is
determined  using  the  weighted  average  number  of  shares  of  Common  Stock
outstanding during the period presented. The weighted average shares outstanding
is  based  upon  (i) APB 15 for the  periods  after  March  31,  1995  and  (ii)
Securities and Exchange  Commission Staff Accounting  Bulletin No. 83 ("SAB 83")
for the period October 1994 through March 1995. Pursuant to SAB 83, the Series B
Preferred  Stock and options  issued during the 12 months  preceding the Initial
Public  Offering (see Note 4) at prices below the Initial Public  Offering price
have been included in the Company's  loss per share  computation  for the period
presented as if the shares were  converted into Common Stock at the beginning of
that period, even though they were antidilutive. The Series A Preferred Stock is
included for the period  presented as if the shares were  converted  into Common
Stock at the  beginning  of that period.  Options  issued prior to the 12 months
preceding the Initial Public Offering are excluded as they are antidilutive.

         Historical  loss per share data for fiscal 1995 have not been presented
as such information is not meaningful.

   Stock-Based Compensation

         Accounting  for stock  options  issued  to  employees  and  nonemployee
directors and stock issued  pursuant to the Company's  employee  stock  purchase
plan is  based  upon the  "intrinsic  value"  method  set  forth  in  Accounting
Principles  Board  Opinion No. 25 ("APB 25"),  "Accounting  for Stock  Issued to
Employees," with  supplemental pro forma disclosures of "fair value" as required
by Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting
for Stock-Based Compensation."

         The "fair value"  method of  accounting  is used for stock  options and
warrants  issued to  consultants.  The fair value is calculated  using an option
pricing model, and the resultant  compensation is recognized over the shorter of
the vesting period or the service period.

   Management's Use of Significant Estimates

         The  preparation of financial  statements in conformity  with generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that affect the reported  amounts of assets and  liabilities at the
date of the  financial  statements  and the  reported  amounts of  revenues  and
expenses during the reported period.  Specifically,  the accounts receivable and
revenue of the Company have been reduced by an estimated reserve for returns and
disallowed amounts; additionally, the accounts receivable has been reduced by an
estimated  reserve  for bad  debts.  Actual  results  could  differ  from  those
estimates.  Also, the Company's  inventory consists primarily of high-technology
finished goods subject to management's  estimates as to the need of obsolescence
reserves.  In the  case  of  accrued  liabilities  not  evidenced  by  invoices,
estimates are based on management's judgment.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

   Recent Pronouncement 

         In February  1997,  the  Financial  Accounting  Standards  Board issued
Statement of Financial Accounting Standards No. 128 ("SFAS 128"),  "Earnings Per
Share." This  statement  establishes  standards  for  computing  and  presenting
earnings per share ("EPS"),  replacing the  presentation  of currently  required
primary EPS with a presentation  of Basic EPS. For entities with complex capital
structures,  SFAS 128  requires  the dual  presentation  of both  Basic  EPS and
Diluted EPS on the face of the statement of operations. Under this new standard,
Basic EPS is computed based on weighted average shares  outstanding and excludes
any  potential  dilution;  Diluted  EPS  reflects  potential  dilution  from the
exercise or conversion of securities  into common stock or from other  contracts
to issue common stock,  and is similar to the currently  required  fully diluted
EPS. SFAS 128 is effective for financial  statements  issued for periods  ending
after December 15, 1997,  including interim periods,  and earlier application is
not permitted. When adopted, the Company will be required to restate its EPS for
all prior  periods  presented.  The  Company  does not  expect the impact of the
adoption of SFAS 128 to be material to previously reported EPS.

   Reclassification

         Certain prior year amounts have been  reclassified  to conform with the
current year's presentation.


4.   Initial Public Offering

         On July 25, 1995,  the Company  completed its Initial  Public  Offering
("IPO") of 2,500,000  shares of Common  Stock at a purchase  price of $11.00 per
share, for aggregate net proceeds of approximately  $24.7 million. On August 15,
1995,  the  underwriters  of the IPO purchased an additional  375,000  shares of
Common Stock, pursuant to the over-allotment  option, for aggregate net proceeds
of approximately $3.8 million.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

5.   Geographic Segment Information

         The Company began operations  outside the United States by establishing
a German  subsidiary,  Exogen  (Europe) GmbH, in May 1995.  For 1997,  1996, and
1995, net revenues,  operating loss, and identifiable  assets  pertaining to the
geographic areas in which the Company operates are as follows (in thousands):
<TABLE>
<CAPTION>

                                                      September 30,
                                          --------------------------------------
                                             1997          1996           1995
                                          --------      --------       ---------
<S>                                       <C>           <C>            <C>
Net revenues:
     United States .................      $  7,400      $  7,284       $  2,035
     Europe ........................         1,300           787           --
     Intercompany eliminations .....        (1,219)       (1,194)          (183)
Operating loss:
     United States .................        10,292        10,813          7,366
     Europe ........................         1,457           919            230
     Intercompany eliminations .....            49            70           --
Identifiable assets:
     United States .................        13,041        24,449         34,813
     Europe ........................         1,748         1,062             73
</TABLE>


         Intercompany    eliminations   between   geographic   areas   represent
intercompany export sales of U.S.A.-produced  goods, and are accounted for based
on  established  sales  prices  between  the  related  companies.  In  computing
operating loss for the foreign  subsidiary,  no allocations of general corporate
expenses or interest have been made.

         Identifiable  assets of the foreign  subsidiary  directly relate to its
operations.  United States assets consist of all other assets of the Company. Of
the $1.8 million of  identifiable  assets in Europe at September 30, 1997,  $1.4
million were accounts  receivable,  net of allowances for returns, bad debt, and
amounts that the Company  believes a respective  third-party  payor might deduct
from the price of the SAFHS device. The European accounts  receivable is derived
principally from sales in Germany,  where the Company has received limited local
reimbursement  on a case-by-case  basis. To assist the collection of outstanding
claims and to expedite the reimbursement  process on future claims,  the Company
is  seeking  nationwide  approval  by  the  National  Krankenkasse,  the  German
governing   organization  that  establishes  medical  reimbursement  policy  for
health-care  providers.  To this end,  in August  1997 the  Company  submitted a
formal  application  to  the  National  Krankenkasse.  The  application  process
includes a scientific assessment and a reimbursement assessment;  the Company is
currently in the  scientific-assessment  phase. In the interim,  the Company has
elected to sell SAFHS devices in Germany only when reimbursement is preapproved.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


6.   Development Agreement Revenues

         The Company  recorded  revenues of $400,000  and $1.1 million in fiscal
1997 and 1996,  respectively,  related to  development  agreements  with  Teijin
Limited, a Japanese corporation. No such revenues were reported for fiscal 1995.
These development  agreements cover two of the Company's  technologies:  (i) the
SAFHS device and (ii) the  mechanical-stress  device under  development to treat
the loss of bone mass associated with osteoporosis. The SAFHS agreement provides
for nonrefundable  milestone payments to the Company for Teijin's development of
the product for launch in Japan.  The Company will  manufacture and supply SAFHS
devices to Teijin for clinical trials and subsequent  sales in Japan.  Teijin is
responsible for complying with the regulatory requirements and for marketing and
distributing the SAFHS device in Japan. The mechanical-stress agreement provides
for nonrefundable  milestone payments to the Company that will support, in part,
the  Company's  clinical  trials in the United  States in  exchange  for a first
option in favor of Teijin to negotiate a development and distribution  agreement
for this device for the Japanese market.

7.   Inventories

         Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                             September 30,
                                                       -------------------------
                                                        1997               1996
                                                       ------             ------
<S>                                                    <C>                <C>
Finished goods ...........................             $1,218             $  768
Parts and components .....................                297                471
                                                       ------             ------
                                                       $1,515             $1,239
                                                       ======             ======
</TABLE>
8.   Furniture, Fixtures and Equipment

         Furniture,   fixtures  and  equipment  consist  of  the  following  (in
thousands):
<TABLE>
<CAPTION>
                                                              September 30,
                                                         ----------------------
                                                           1997           1996
                                                         -------        -------
<S>                                                      <C>            <C>  
Furniture, fixtures and equipment ................       $ 1,573        $ 1,421
Leasehold improvements ...........................            80             71
                                                         -------        -------
                                                           1,653          1,492
Accumulated depreciation and amortization ........          (895)          (513)
                                                         -------        -------
                                                         $   758        $   979
                                                         =======        =======
</TABLE>
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


         Depreciation  and  amortization  expense was  $383,000,  $319,000,  and
$176,000, for the years ended September 30, 1997, 1996, and 1995, respectively.


9.   Accrued Liabilities

         Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                              September 30,
                                                        ------------------------
                                                         1997              1996
                                                        ------            ------
<S>                                                     <C>               <C>
Compensation and benefits ..................            $  637            $  490
Taxes other than income ....................               446               241
Warranty expenses ..........................               156               157
Research and development ...................               312               136
Other ......................................               627               601
                                                        ------            ------
                                                        $2,178            $1,625
                                                        ======            ======

</TABLE>

10.   Redeemable Preferred Stock

         In March 1993, the Company entered into a Stock Purchase  Agreement for
the sale of an  aggregate  of  7,500,000  of its  authorized  shares of Series A
Preferred Stock issuable in two tranches at a purchase price of $1.00 per share.
The first tranche of 1,846,154  shares of Series A Preferred Stock was issued in
March 1993,  and was  convertible  into an aggregate of 923,073 shares of Common
Stock at an  as-converted  price of $2.00  per  share.  The  second  tranche  of
5,653,846 shares of Series A Preferred  Stock,  issuance of which was contingent
upon  receipt of the  Company's  PMA for its SAFHS  device  (which  occurred  in
October 1994), was issued in October 1994, and was convertible into an aggregate
of 2,826,918 shares of Common Stock at an as-converted price of $2.00 per share.
Of the second tranche,  753,846  Preferred  shares were issued in August 1994 at
the election of a certain stockholder.

         Shares of Redeemable Preferred Stock outstanding at September 30, 1994,
were 2,600,000.

         In November 1994, the Company  entered into a Stock Purchase  Agreement
for the sale of an aggregate of 3,680,303 of its  authorized  shares of Series B
Preferred  Stock at a  purchase  price of  $2.75,  which was  converted  into an
aggregate of 1,840,145 shares of Common Stock at an as-converted  price of $5.50
per share.

         On July 25, 1995,  concurrent with the completion of the Company's IPO,
11,180,303  shares of Redeemable  Preferred  Stock were converted into 5,590,136
shares of Common Stock.

<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

11.   Commitments and Contingencies

         The Company  leases a facility  in  Piscataway,  New Jersey;  the lease
commenced  May 1995 and has a remaining  term of four  years.  The length of the
lease is subject to  adjustment,  under  certain  conditions,  as defined in the
lease agreement.

         The approximate  minimum annual rentals for the  above-mentioned  lease
are as follows (in thousands):
<TABLE>
<CAPTION>

                                                               Operating Lease
                                                               ---------------
<S>                                                               <C>
         1998...............................................      $     457
         1999...............................................            464
         2000...............................................            471
         2001...............................................            478
                                                                  --------- 
                                                                  $   1,870
                                                                  =========
</TABLE>
         Rent expense was $493,000,  $353,000,  and $233,000 for the years ended
September 30, 1997, 1996, and 1995, respectively.

         The Company is also  committed to pay  royalties on sales of certain of
its  products.  Royalty  expense in fiscal 1997,  1996,  and 1995 was  $417,000,
$346,000, and $112,000, respectively.

         The  Company's  SAFHS  device is  currently  both  manufactured  by the
Company  and  produced by a contract  manufacturer.  The  agreement  between the
Company  and this  manufacturer  is  documented  by  specific  purchase  orders,
effective to June 1999,  covering  anticipated  requirements.  At September  30,
1997,  these  purchase  orders  amounted to commitments  of  approximately  $1.5
million.

         In March 1996, the Company  settled a legal action brought  against the
Company on March 15, 1995, by a former sales  representative of the Company. The
settlement was recorded in Other expense, net.

         The Company is also a party to two  lawsuits  (one  initiated in fiscal
1995, the other in fiscal 1997) that to date have not been settled.  The Company
does not  believe  that these  lawsuits  have any  merit,  and  accordingly,  no
provision  has  been  established  in the  accompanying  consolidated  financial
statements.  Management  believes  that these  lawsuits will not have a material
adverse effect on the Company's financial  position,  its results of operations,
or its cash flows.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


12.   Stock Option Plans and Stockholders' Equity

   Stock Option and Stock Option / Stock Issuance Plans

         The Company's 1995 Stock  Option/Stock  Issuance Plan (the "1995 Plan")
was adopted by the Board of Directors and  stockholders  as of May 25, 1995, for
the purpose of  attracting  and  retaining  the  services of selected  employees
(including  officers and directors) and  consultants.  The Plan is the successor
equity  incentive  program to the  Company's  1993 Stock  Option Plan (the "1993
Plan"),  and options  outstanding under the 1993 Plan were incorporated into the
1995 Plan. The 1995 Plan provides for options designated as either  nonqualified
or incentive  stock options with a term of no more than 10 years.  The 1995 Plan
became  effective  with the IPO and will  terminate  on April 30,  2005,  unless
sooner terminated by the Board of Directors. A total of 750,000 shares of Common
Stock has been  authorized  for issuance  under the 1995 Plan, and 64,961 shares
remained  available  for future  grant as of September  30, 1997. 

         The  1995  Plan is  divided  into  four  separate  components:  (i) the
Discretionary Option Grant Program, under which employees, nonemployee directors
(other than the members of the Compensation Committee),  and consultants may, at
the discretion of the plan administrator,  be granted options to purchase shares
of Common  Stock at an exercise  price of not less than the fair market value of
the Common Stock on the grant date,  and under which stock  appreciation  rights
may be issued that will allow the holders to surrender their outstanding options
for an  appreciation  distribution,  in cash or Common Stock,  from the Company;
(ii) the Stock  Issuance  Program,  under  which such  persons  may, in the plan
administrator's  discretion, be issued shares of Common Stock directly,  through
the  purchase of such  shares at a price not less than the fair market  value of
the Common  Stock at the time of issuance or as a bonus tied to the  performance
of  services;  (iii) the Salary  Investment  Option Grant  Program,  under which
selected  officers and other key executives may elect to have a portion of their
base salaries applied each year to the acquisition of options to purchase shares
of Common Stock at an aggregate  discount  from the then fair market value equal
to their  salaries'  investment;  and (iv) the Automatic  Option Grant  Program,
under which option grants will  automatically  be made at periodic  intervals to
eligible nonemployee directors to purchase shares of Common Stock at an exercise
price  equal to 100% of the fair market  value of the Common  Stock on the grant
date.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         Stock option activity pursuant to the 1993 and 1995 Plans is summarized
as follows:
<TABLE>
<CAPTION>
                                                              Exercise Price
                                                     ------------------------------
                                                                          Weighted-
                                         Shares         Low       High     Average
                                         ------         ---       ----     -------
<S>                                    <C>           <C>       <C>        <C>
Balance at September 30, 1994 ....       55,000      $   0.02  $    0.02  $    0.02
     Granted .....................      296,450      $   0.02  $   13.00  $    5.88
     Exercised ...................         (125)     $   0.02  $    0.02  $    0.02
     Canceled/Forfeited ..........       (2,025)     $   0.02  $    5.50  $    3.28
                                       --------
Balance at September 30, 1995 ....      349,300      $   0.02  $   13.00  $    4.98
     Granted .....................      173,250      $   8.00  $   25.50  $   15.27
     Exercised ...................      (19,989)     $   0.02  $   10.00  $    1.84
     Canceled/Forfeited ..........      (12,524)     $   0.02  $   18.50  $    4.49
                                       --------
Balance at September 30, 1996 ....      490,037      $   0.02  $   25.50  $    8.76
     Granted .....................      450,175      $   3.50  $    4.75  $    4.17
     Exercised ...................      (31,952)     $   0.02  $    0.60  $    0.39
     Canceled/Forfeited ..........     (275,287)     $   0.02  $   25.50  $   11.89
                                       --------
Balance at September 30, 1997 ....      632,973      $   0.02  $   25.50  $    4.55
                                       ========
</TABLE>


         At  September  30,  1997,  1996,  and 1995,  stock  options to purchase
119,124,  86,417,  and  15,999  shares  of  Common  Stock  were  exercisable  at
weighted-average prices of $5.21, $6.71, and $0.02, respectively.

         During  fiscal  1997,  148,000  options  previously  issued to  certain
consultants and employees with a weighted-average  exercise price of $14.96 were
canceled and reissued at the fair market value of the Company's  Common Stock on
the date of  reissuance.  The  weighted-average  exercise  price of the reissued
options was $4.15 per share and the vesting  period of these  options  commenced
from the reissuance date.

         Options generally become exercisable in ratable installments over four-
to five-year periods.  In the opinion of management,  options were issued at the
fair market value of the Company's Common Stock on the date of grant.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         The  following  table  summarizes   information   about  stock  options
outstanding at September 30, 1997:
<TABLE>
<CAPTION>
                                             Options Outstanding                Options Exercisable
                                         ------------------------------     ----------------------------
                                           Weighted-
                                           Average            Weighted-                        Weighted-
                        Shares            Remaining            Average       Shares             Average
  Range of            Outstanding        Contractual           Exercise     Exercisable         Exercise
Exercise Prices        at 9/30/97           Life                Price        at 9/30/97          Price
---------------        ----------           ----                -----        ----------          -----
<S>                      <C>              <C>                 <C>             <C>              <C>      
 $0.02 - $0.60           110,873          7.08 years          $    0.41        49,324          $    0.31
 $3.50 - $3.50            33,000          9.21 years          $    3.50          --            $   --
 $4.00 - $4.00           267,475          9.32 years          $    4.00         5,000          $    4.00
 $4.50 - $4.75           122,000          9.34 years          $    4.73        23,750          $    4.67
 $5.50 - $5.50            16,500          7.51 years          $    5.50         8,256          $    5.50
 $8.00 - $8.00            40,750          8.38 years          $    8.00        12,876          $    8.00
$11.00 - $13.00           25,750          8.09 years          $   12.51        11,293          $   12.45
$18.50 - $25.50           16,625          8.31 years          $   20.08         8,625          $   21.54
                        --------                                              -------
$0.02 - $25.50           632,973          8.74 years          $    4.55       119,124          $    5.21
                        ========                                              =======

</TABLE>

         There were no direct  issuances of Common  Stock or stock  appreciation
rights under the 1995 Plan as of September 30, 1997.

   Employee Stock Purchase Plan

         The Company's  Employee Stock  Purchase Plan (the "Purchase  Plan") was
adopted by the Board of  Directors  and  stockholders  as of May 25,  1995.  The
Purchase Plan,  which is in accordance with Section 423 of the Internal  Revenue
Code, is designed to allow eligible  employees of the Company and  participating
subsidiaries  to purchase  shares of Common  Stock,  at  semi-annual  intervals,
through periodic payroll  deductions.  Payroll  deductions may not exceed 10% of
the  participant's  total cash  earnings  in each  semi-annual  period,  and the
purchase price per share will be  eighty-five  percent (85%) of the lower of (i)
the fair market  value of the Common  Stock on the  participant's  date of entry
into  the  offering  period  or (ii) the fair  market  value on the  semi-annual
purchase date.

         A total of  150,000  shares  of  Common  Stock  has been  reserved  for
issuance  under the Purchase  Plan.  Stock issued  pursuant to the Purchase Plan
during fiscal 1997, 1996, and 1995 was 56,996,  38,944 and 0,  respectively,  at
weighted-average purchase prices of $3.60, $6.47 and $0.00, respectively.  As of
September 30, 1997, 54,060 shares remained  available for future grant under the
Purchase Plan.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         The  Purchase  Plan will  terminate  upon the  earliest of (i) the last
business  day in July  2005,  (ii) the date on which all  shares  available  for
issuance  under the  Purchase  Plan have been sold  pursuant to purchase  rights
exercised  under the  Purchase  Plan,  or (iii)  the date on which all  purchase
rights are exercised in connection  with a Corporate  Transaction  as defined in
the Purchase Plan.

   Stock Warrants

         In  September  1997,  the  Company  and a  consultant  entered  into an
advisory agreement whereby the consultant acquired a warrant (at a cost of $0.20
per share) to purchase up to 100,000 shares of the Company's  Common Stock at an
exercise price of $4.50 per share.  The warrant is fully vested and  immediately
exercisable  and  expires  five  years  after  issuance  subject,   however,  to
expiration  on August 1, 1998,  in the event that the Company does not, by April
30,  1998,  consummate  a  strategic  partnering  transaction  relating  to  the
commercialization of certain of the Company's non-invasive  technologies (each a
"Strategic  Partnering  Transaction").  Further, for each of the three Strategic
Partnering  Transactions  described in the advisory  agreement and  subsequently
entered into by the Company,  the consultant will receive a warrant (at no cost)
to purchase 75,000 shares of the Company's  Common Stock at an exercise price of
$4.50 per share  (the  "Transaction  Warrant").  For each  Strategic  Partnering
Transaction consummated prior to April 30, 1998, the consultant will receive, in
lieu of the foregoing  Transaction  Warrant,  a Transaction  Warrant to purchase
125,000  shares of the Company's  Common Stock at an exercise price of $4.50 per
share (subject to  adjustment).  Such  Transaction  Warrants,  if issued,  would
expire five years after issuance.

         As of  September  30,  1997,  the  warrant  was  not  exercised  and no
additional warrants were due to the consultant.

   Fair Value Disclosures

         Stock options granted to employees (and nonemployee  directors) are set
at the closing price of the Company's Common Stock on the date of grant, and the
related  number of shares  granted  are fixed at that point in time.  Therefore,
under the  principles  of APB 25, the Company  does not  recognize  compensation
expense  associated  with  the  grant  of  such  options.  Additionally,   under
provisions of APB 25, employee stock purchase plans such as the Company's do not
require the recognition of compensation expense.  However,  under the provisions
of SFAS 123, the Company is required to use an option valuation model to provide
supplemental pro forma  information  regarding  options granted and stock issued
under the employee stock purchase plan after September 30, 1995.

         Stock  options and warrants  issued to  consultants  are  accounted for
under SFAS 123.  Compensation  expense  recognized for such options and warrants
was  $182,000  and  $52,000  for the years  ended  September  30, 1997 and 1996,
respectively.

         The fair value of the options and warrants was estimated at the date of
grant  using  the   Black-Scholes   option  pricing  model  with  the  following
weighted-average  assumptions for fiscal 1997 and 1996, respectively:  risk-free
interest  rates of 6.13% and  5.67%;  dividend  yields of 0% and 0%;  volatility
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

factors for the expected market price of the Company's Common Stock of 38.4% and
40.6%;  and  expected  lives of the options of 3.55 years and 4.44 years.  These
assumptions  resulted  in  weighted-average  fair  values of $1.45 and $6.17 per
share for stock  options and  warrants  granted to  employees  (and  nonemployee
directors) and consultants in fiscal 1997 and 1996, respectively.

         The fair value of shares under the Company's  employee  stock  purchase
plan  was  estimated  at the  subscription  date  (i.e.,  "enrollment"  date) of
participants  into the respective  offering periods under the purchase plan. The
estimate was based upon a Black-Scholes  option pricing model with the following
weighted-average  assumptions for purchase  periods during fiscal 1997 and 1996,
respectively: risk-free interest rates of 6.05% and 5.48%; dividend yields of 0%
and 0%; volatility factors for the expected market price of the Company's Common
Stock of 37.0% and 50.1%; and expected term length of 1.94 years and 1.17 years.

         Pro forma  information  regarding  net loss and net loss per share,  as
shown below,  was  determined  as if the Company had  accounted for its employee
stock options and shares sold under its employee  stock  purchase plan under the
fair  value  method of SFAS 123.  For  purposes  of pro forma  disclosures,  the
estimated fair value is amortized over the applicable vesting periods. Since the
SFAS 123 method of accounting  has not been applied during fiscal years prior to
October 1, 1995,  the  resulting  pro forma  compensation  expense  might not be
representative  of that to be expected in future years.  The Company's pro forma
information is as follows (in thousands, except per share information):
<TABLE>
<CAPTION>
                                                    Years Ended September 30,
                                                 -------------------------------
                                                     1997                1996
                                                 -----------         -----------
<S>                                              <C>                 <C>
Net loss:
     As reported .......................         $  (11,152)         $  (10,588)
     Pro forma .........................         $  (11,370)         $  (10,733)


Net loss per share:
     As reported .......................         $    (1.12)         $    (1.07)
     Pro forma .........................         $    (1.14)         $    (1.09)
</TABLE>

   Restricted Stock Agreements

         All holders of Common  Stock  issued prior to the IPO have entered into
restricted stock purchase agreements that grant certain repurchase rights to the
Company upon the sale, assignment,  transfer,  encumbrance, or other disposition
of the Company's  shares or upon  termination  of service with the Company.  The
repurchase  rights  terminate  over time with  respect  to any and all shares in
which the purchaser's  interest has vested.  Of the Common Stock issued prior to
the IPO,  1,357,332 and 1,060,836 shares are vested as of September 30, 1997 and
1996, respectively.  The unvested 27,666 shares at September 30, 1997, vest over
the next two months.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

   The Stockholder Rights Plan

         The Company's Second Amended and Restated Certificate of Incorporation,
dated July 25, 1995,  grants the Board of Directors the authority to issue up to
3,000,000 shares of preferred stock of the Company,  $0.0001 par value per share
(the  "Preferred  Stock"),  in one  or  more  series  and  to  fix  the  rights,
preferences,  privileges,  and restrictions thereof,  including dividend rights,
dividend  rates,   conversion  rights,   voting  rights,  terms  of  redemption,
redemption   prices,   liquidation   preferences,   and  the  number  of  shares
constituting any series or the designation of such series,  without further vote
or action by the stockholders.

         Effective  December  6, 1996,  pursuant to a  Preferred  Shares  Rights
Agreement  (the  "Rights  Agreement")  between  the Company  and  Registrar  and
Transfer Company,  as Rights Agent (the "Rights Agent"),  the Company's Board of
Directors  declared  a  dividend  of one  right  (a  "Right")  to  purchase  one
one-hundredth  share of the Company's  Series A  Participating  Preferred  Stock
("Series  A  Preferred")  for  each  outstanding  share of  Common  Stock of the
Company.  The dividend was payable on December 19, 1996 (the "Record Date"),  to
stockholders  of record as of the close of  business  on that  date.  Each Right
entitles the registered holder to purchase from the Company one one-hundredth of
a share of Series A  Preferred  at an exercise  price of $30.00  (the  "Purchase
Price"),  subject to adjustment in the event the Company  declares a dividend on
the Common Stock payable in Common Stock,  subdivides  the number of outstanding
shares of Common  Stock into a larger  number of such  shares,  or combines  the
number  of  outstanding  shares of Common  Stock  into a smaller  number of such
shares,  among other  circumstances.  In addition,  under certain  circumstances
described more fully in the Rights Agreement,  the Rights may become exercisable
for a number of shares of  Common  Stock  having a value  equal to two times the
Purchase Price.

         The Rights will expire December 19, 2006, which should give the Company
adequate  time to determine  whether any further  protection  is  required.  The
Rights may be redeemed by the Company at the direction of the Board of Directors
at one cent per Right prior to 10 business days after the accumulation,  through
open-market  purchases,  a tender  offer,  or  otherwise,  of 15% or more of the
combined number of the Company's  shares of Common Stock by a single acquirer or
group,  and  thereafter in certain  circumstances.  Thus,  the Rights should not
interfere  with any  merger or  business  combination  approved  by the Board of
Directors prior to that time.

13.  Income Taxes

         As a result of the losses  generated,  the Company has no provision for
income taxes.  The Company has recorded a full valuation  allowance  against its
deferred  tax  assets as  realizability  of such  asset is  predicated  upon the
Company's  achieving  profitability.  The change in valuation  allowance  during
1997, 1996, and 1995 was $5,050,000, $3,478,000, and $2,813,000, respectively.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         The types of temporary  differences between the tax bases of assets and
liabilities and their financial reporting amounts that give rise to the deferred
tax asset and their approximate tax effects are as follows (in thousands):
<TABLE>
<CAPTION>
                                                             September 30,   September 30,
                                                                  1997           1996
                                                             -------------   -------------
<S>                                                             <C>            <C>
Deferred Tax Asset:
    Start-up costs .....................................        $   488        $   732
    Research and development costs .....................            548            548
    Research and development and related patent acquired              7            184
    Vacation accrual ...................................             52             18
    Allowances for returns, disallowances, and bad debts            650            555
    Net operating loss .................................          9,936          5,736
    German net operating loss ..........................          1,135            575
    Other ..............................................            708            126
                                                                -------        -------
    Deferred tax asset .................................         13,524          8,474

Less: Valuation Allowance ..............................        (13,524)        (8,474)
                                                                -------        -------
                                                                $     0        $     0
                                                                =======        =======
</TABLE>
         At September 30, 1997, the Company has net operating loss carryforwards
for United States  federal income tax purposes of  approximately  $24.8 million.
These net operating loss  carryforwards  expire on various dates beginning 2007.
The Company's ability to utilize its net operating loss carryforwards is subject
to annual  limitations  in future  periods  pursuant to the "change in ownership
rules" under Section 382 of the Internal Revenue Code, as amended.  At September
30,  1997,  the Company also has net  operating  loss  carryforwards  for German
income tax purposes of $2.3 million, which are not subject to any limitations.


14.  Supplemental Disclosure of Cash Flow Information

         Cash paid for interest was $12,000, $9,000, and $169,000 in 1997, 1996,
and 1995, respectively.

         The Company paid $4,000 in income taxes in fiscal 1997. No income taxes
were paid in fiscal 1996 or 1995.

         The Company  recorded  $0, $0, and $35,000 of  amortization  related to
Preferred Stock issuance costs in 1997, 1996, and 1995, respectively.


15.  Subsequent Events

         On October 20,  1997,  the Company  completed  a $7.5  million  private
placement of  1,799,019  shares of its Common  Stock.  The  participants  in the
private placement included several shareholders of record on September 30, 1997,
and two new investment groups. The Company will use the financing's proceeds for
general corporate purposes.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         On November 14, 1997,  the Board of Directors of the Company  approved,
subject to stockholder approval at the 1998 Annual Meeting of Stockholders,  (i)
an amendment to the 1995 Stock Option / Stock Issuance Plan, which
includes  an  increase  in the number of shares of Common  Stock  available  for
issuance  thereunder  from 750,000 to 1,350,000  shares and (ii) an amendment to
the  Employee  Stock  Purchase  Plan to increase  the number of shares of Common
Stock  available  for  issuance  thereunder  from  150,000  to  350,000  shares.
Information  regarding the  amendments to the 1995 Stock Option / Stock Issuance
Plan and Employee Stock  Purchase Plan is set forth in the Company's  Definitive
Proxy Statement,  which the Company expects will be mailed to stockholders on or
about  January  8,  1998,  in  connection   with  the  1998  Annual  Meeting  of
Stockholders.

<PAGE>
<TABLE>
<CAPTION>
                                                   EXOGEN, INC.

                                  SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
                                  ----------------------------------------------
                                                  (in thousands)



                                                            Additions
                                                   --------------------------
                                     Balance at    Charged to      Charged to                            Balance
                                    Beginning       Costs and        Other                               at End
      Description                    of Period      Expenses        Accounts         Deductions         of Period
      -----------                    ---------      --------        --------         ----------         ---------
<S>                                    <C>           <C>           <C>               <C>                 <C>
Year ended September 30, 1995

Allowance for returns, bad
debt, and price deductions
by third-party payors .........        $ --          $  352        $     --          $   154 (a)         $  198

Year ended September 30, 1996

Allowance for returns, bad
debt, and price deductions
by third-party payors .........        $  198        $1,667        $     --          $ 1,519 (a)         $  346

Year ended September 30, 1997

Allowance for returns, bad
debt, and price deductions
by third-party payors .........        $  346        $3,811        $(58) (b)         $ 2,313 (a)         $1,786

</TABLE>


  (a) Returns and write-offs.
  (b) Foreign currency translation adjustments.