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 [FEE REQUIRED]

    For the fiscal year ended          September 30, 1996
                                       ------------------ 

                                       OR

    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934 [NO FEE REQUIRED]

    For the transition period from                             to

                         Commission file number 0-26154


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


         Delaware                                             22-3208468
--------------------------------------------------------------------------------
(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)

       Registrant's telephone number, including area code (908) 981-0990



          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. [  ]

         While it is  difficult  to  determine  the  number of  shares  owned by
non-affiliates,  the  registrant  estimates  that the aggregate  market value of
outstanding  Common Stock on December  19, 1996 (based upon the closing  selling
price of such Common Stock on the Nasdaq  National  Market on December 19, 1996)
held by non-affiliates  was approximately  $23.3 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 December 19, 1996, there were outstanding 9,911,067 shares of the
registrant's Common Stock, par value $.0001.


                       DOCUMENTS INCORPORATED BY REFERENCE

         Proxy  Statement  of Exogen,  Inc.  relative  to the Annual  Meeting of
Stockholders to be held on February 7, 1997,  which is incorporated by reference
into Part III of this Form 10-K.
<PAGE>


                                  EXOGEN, INC.

                          1996 Form 10-K Annual Report

                                TABLE OF CONTENTS


                                      
                                     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
Company's  Pre-Market  Approval  ("PMA")  application for the SAFHS Model 2A was
approved by the U. S. Food and Drug Administration  ("FDA") in October 1994. The
SAFHS  Model  2A 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  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
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
<PAGE>
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.

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
<PAGE>
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  approximate  cost of $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.
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
<PAGE>
(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 25,000,000 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.  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 and in community-based practices.
<PAGE>
         Establish   Reimbursement  by  Third-Party   Payors.  The  Company  has
implemented a comprehensive plan to obtain reimbursement for the SAFHS device as
a new  treatment  device from a broad  range of  third-party  payors,  including
managed  care  organizations,   workers'  compensation   insurers,   traditional
indemnity insurers, and Medicare. The Company uses the scientific, clinical, and
patient-outcomes  data on the safety and effectiveness of the SAFHS treatment to
establish third-party reimbursement.

         Broaden  Sales and  Marketing  Efforts.  The Company has  established a
nationwide network of independent and direct sales representatives in the United
States.  At September 30, 1996,  there were 32 people  employed in the Company's
direct sales  organization  and 28  independent  sales  agencies  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
development  agreements 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 1995, the Company
initiated  pilot clinical  trials in Europe for internally  fixed  fractures and
leg-lengthening  procedures. In 1996, the Company commenced pre-clinical studies
in the United States for spine fusion and cartilage repair. 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 in the United
States.

         Establish   Manufacturing   Capability.   During   1996,   the  Company
established manufacturing capability at its facility in Piscataway,  New Jersey,
where the  Company is  currently  refurbishing  the SAFHS  Model 2A. The Company
believes  that  this  manufacturing   capability,   together  with  its  product
engineering capability, will advance its product design and development efforts,
provide better control over its costs, and reduce its dependence on its contract
manufacturer.

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.

Sonic Accelerated Fracture Healing System ("SAFHS")

         SAFHS Model 2A. SAFHS is a non-invasive device that delivers ultrasound
energy  to  accelerate   fracture  healing  through   specifically   programmed,
low-intensity  acoustic  pressure waves.  The SAFHS Model 2A 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
<PAGE>
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.  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.

         The SAFHS  treatment  was designed to maximize  ease of use.  Treatment
requires use of the device only once daily for 20 minutes.  The treatment period
averages  approximately  three  months for  treatment  of a tibia  fracture  and
approximately  six weeks for a distal  radius  fracture.  The device is portable
(weighing  approximately four pounds) 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 Model 2A produces  audible  tones to notify the patient that the treatment
has commenced or ended and alerts the patient in case of improper application or
performance  of the  device.  The  device  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 list price of the SAFHS
Model 2A is $2,950, regardless of the length of treatment.

         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  2000(R).  The Company  has  designed a  second-generation  SAFHS
device,  the SAFHS 2000,  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 the SAFHS Model 2A. The Company filed a
PMA  supplement  for the SAFHS 2000 in December  1995. No assurance can be given
that the PMA supplement will be granted by the FDA on a timely basis, or at all.
<PAGE>
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 intends to submit to the
FDA an IDE to commence  pivotal  clinical trials  following  completion of these
pilot trials. No assurance can be given 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  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
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.
<PAGE>
         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
and  in   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.  The Company has  established a direct sales  organization  of 32
people as of September 30, 1996,  and has contracted  with 28 independent  sales
agencies in the United States. The Company's direct 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  organizations,  with
coordinated  marketing  through  the  Company's  sales  force and  reimbursement
specialists.  The Company's  Regional Business Directors manage the entire sales
organization as well as the field reimbursement efforts.

International. The Company established a wholly owned German subsidiary in 1995,
and in 1996  introduced  the SAFHS  device in Germany  and  Austria  through its
network of  independent  sales agents.  In other European  countries,  primarily
Holland,  France, the Scandinavian countries, the United Kingdom, and Italy, the
Company  plans to select and train  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. In December 1995,
the Company  announced  that it had signed  development  agreements  with Teijin
<PAGE>
Limited, a Japanese corporation.  The development  agreements are 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 will be  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.
No assurance can be given that the Company or its collaborators 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, and
foreign regulations.

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, 1996,  the Company has been paid by over
700 third-party  payors including  automobile  insurers,  workers'  compensation
insurers,  health  insurers  including  Blue Shield  organizations,  and several
managed care and third-party administrator  organizations.  The Company believes
that  case-by-case  approval  will  continue  to be the  predominant  method  of
obtaining  pre-authorization  and  reimbursement  for  the  SAFHS  device  until
national  or  regional  reimbursement  approvals  are  obtained.  The Company is
seeking to  establish  separate  reimbursement  codes for the SAFHS  device with
various  payors  in order 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 is continuing  to pursue  coverage for
SAFHS by providing additional information to the HCFA staff. No assurance can be
given that the Company can be  successful  in  obtaining  coverage for the SAFHS
device under the Medicare program.
<PAGE>
         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
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. The
Company uses clinical and  reimbursement  data from the United States to augment
its international  reimbursement efforts. Some countries may have more stringent
reimbursement  requirements  than the United States.  The Company  currently has
limited  experience  in  obtaining  reimbursement  for its products in countries
other than the United States.

         There can be no assurance that 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
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  Company's  SAFHS  device is currently  manufactured  by a contract
manufacturer. The agreement between the Company and the contract manufacturer is
documented by specific purchase orders,  effective to 1998, covering anticipated
requirements.   This  contract   manufacturer   also  performs   certain  design
<PAGE>
engineering for the Company.  The FDA conducted a Good  Manufacturing  Practices
("GMP")  inspection  of  this  contract  manufacturer's  facility  prior  to PMA
approval, and found it to be in compliance with GMP requirements.  In connection
with the PMA  Supplement  for the SAFHS 2000, the FDA inspected and approved the
contract manufacturer's  facilities to manufacture the Company's SAFHS 2000. Any
failure by the contract  manufacturer to maintain its manufacturing  facility in
accordance with GMP requirements  could result in the inability of such contract
manufacturer  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.

         To improve control and flexibility in product design, supply, and cost,
the Company has developed in-house manufacturing  capability.  The Company began
refurbishing  the SAFHS  Model 2A at its  Piscataway,  New  Jersey  facility  in
November 1995. In January 1996, the Company's facility successfully  completed a
GMP  inspection  by the FDA.  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
Exogen conforms with the European  Community Medical Device Directive.  Prior to
commencing  in-house  manufacture  of the SAFHS  2000 for  commercial  use,  the
Company's  facilities  will require FDA  determination  of  compliance  with GMP
requirements  associated with the PMA Supplement for the SAFHS 2000. 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.
There  can be no  assurance  that  the  Company  will be able to  establish  its
manufacturing  capability for the SAFHS 2000,  obtain GMP approval,  or make the
transition to commercial manufacturing  successfully or manufacture its products
cost effectively, or at all.

         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.   After  commencing  its  own
manufacturing  operations,  Exogen plans to fabricate certain components,  while
other  components  will  continue  to  be  purchased  from  various  independent
suppliers.  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.
<PAGE>
         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 bony  ingrowth  into porous  prostheses,  the treatment of lower-back
spine fusion,  and 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,  1996,  the Company had eight  employees  engaged in
research and  development  and  regulatory  affairs and 11 employees  engaged in
engineering.  The Company's  expenditures  for research and  development  (which
includes   clinical  trials,   regulatory   affairs,   and   engineering)   were
approximately $4.0 million, $2.5 million, and $1.4 million in fiscal 1996, 1995,
and 1994, respectively.

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 six
issued United States patents,  one issued foreign  (Canadian) patent, 10 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.
<PAGE>
         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.

         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
<PAGE>
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
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.
<PAGE>
         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.

         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.  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
<PAGE>
Federal Trade Commission. Products may be promoted by the Company and any of its
distributors  only  for the  products'  approved  indications.  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.  The Company has
been  notified by the FDA that its labeling of the SAFHS device must be modified
to  reflect  the  types of  fractures  treated  in the  SAFHS  clinical  trials,
consistent with the Company's physician  instruction manual.  Consequently,  all
documents  pertaining to the SAFHS device now include the  following  statement:
"All  fractures in both clinical  studies were treated with SAFHS therapy within
seven  days  of  fracture."  No  assurance  can be  given  that  this  or  other
modifications  to the  labeling  in the  future  will not  adversely  affect the
Company's ability to market, sell, or be reimbursed for the SAFHS device.

         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 currently manufactured by a contract manufacturer.  The contract
manufacturer's  facility has been inspected by the FDA and is currently the only
facility  approved for the  production of the SAFHS  device.  Any failure by the
contract manufacturer to maintain its manufacturing  facility in accordance with
FDA GMP requirements could result in the inability of such contract manufacturer
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.

         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, and 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
<PAGE>
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
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 $3.0 million per occurrence and an annual aggregate  maximum of
$3.0 million. In addition,  the Company maintains umbrella liability  insurance,
including  product  liability  coverage,  of $5.0 million per  occurrence and an
annual  aggregate  maximum  of $5.0  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.
<PAGE>
Employees

         As of November 30, 1996, the Company had 102  employees,  consisting of
37 in sales and marketing, 11 in engineering,  20 in finance and administration,
seven in quality assurance,  10 in reimbursement and customer service,  eight in
research and development and regulatory  affairs,  and nine 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 an  approximately  36,000  square foot  facility in
Piscataway,  New Jersey. This facility contains approximately 12,000 square feet
of  manufacturing   space  and  24,000  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  this  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
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.  All parties are currently engaged in the discovery  process.
The Company  does not  believe  that the claims  against it have  merit,  and is
vigorously defending this action. There can be no assurance,  however,  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.
<PAGE>
Item 4.  Submission of Matters to a Vote of Security Holders

         None.


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.......................................   62    Chairman of the Board of Directors and Vice President of
                                                             Research and Development and Regulatory Affairs
Patrick A. McBrayer.................................   45    Chief Executive Officer, President, and Director
John Bohan..........................................   48    Vice President of Sales and Marketing
Richard H. Reisner..................................   53    Vice President, Chief Financial Officer, and Secretary
Roger J. Talish.....................................   54    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 until his  resignation  from such offices in 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.

         John Bohan  joined the Company in February  1994 as Vice  President  of
Sales and  Marketing.  Prior to joining  the  Company,  Mr.  Bohan held  various
positions from 1972 to 1994 at Johnson & Johnson, Inc., including Vice President
of Marketing  and Sales for Johnson & Johnson  Medical,  Inc.,  and for Ethicon,
Inc. Most recently,  he served as Vice President of Sales and Marketing and as a
member of the  Board of  Directors  of  Johnson  &  Johnson  Advanced  Materials
Company.
<PAGE>
         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 the fiscal quarter ended  September 30, 1995 and the
four  quarters  of fiscal  1996,  based on  transaction  data as reported by the
Nasdaq National Market.
<TABLE>
<CAPTION>

                Fiscal years ended
            September 30, 1995 and 1996           High             Low
            ---------------------------           ----             ---
            <S>                                  <C>               <C>
            1995

            Fourth quarter
                (commencing July 20, 1995)..     $16.00            $11.00

            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

</TABLE>

         On December 19, 1996,  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 December 19, 1996 there were  approximately 190 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
<PAGE>
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  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.

         A copy of the Rights Agreement is attached as Exhibit 99.1 to this Form
10-K, and is incorporated herein by reference.
<PAGE>
Item 6.  Selected Financial Data

         Set forth below is the  selected  consolidated  financial  data for the
Company for the three fiscal years ended  September 30, 1996. 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,
                                                                        ---------------------------------- 
                                                                            1996        1995         1994
                                                                            ----        ----         ----
<S>                                                                     <C>           <C>           <C>
Statement of Operations Data:
Revenues:
    Product sales ...................................................   $  5,777     $  1,852       $   --
    Revenues from development agreements ............................      1,100           --           --
                                                                        --------     --------       ------
        Total revenues ..............................................      6,877        1,852           --
                                                                        --------     --------       ------
Operating costs and expenses:
    Cost of product sales ...........................................      3,661        1,128           --
    Research and development ........................................      3,988        2,545        1,432
    Selling, general, and administrative ............................     11,030        5,775        1,782
                                                                        --------     --------       ------
        Total operating costs and expenses ..........................     18,679        9,448        3,214
                                                                        --------     --------       ------
    Operating loss ..................................................    (11,802)      (7,596)      (3,214)

Other income (expense):
    Interest income (expense), net ..................................      1,438          604         (185)
    Other expense, net ..............................................       (224)         (59)          (2)
                                                                        --------     --------       ------
        Total other income (expense) ................................      1,214          545         (187)
                                                                        --------     --------       ------
    Net loss........................................................    $(10,588)    $ (7,051)    $ (3,401)
                                                                        ========     ========     ======== 

Net loss per share..................................................   $   (1.07)
                                                                       ========= 
Weighted average shares outstanding .................................      9,875

Pro forma net loss per share ........................................                $  (0.93)    $  (0.48)
                                                                                     ========     ======== 
Pro forma weighted average shares outstanding .......................                   7,574        7,020


</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                                                           September 30,
                                                                            ------------------------------------------
                                                                               1996             1995              1994
                                                                               ----             ----              ----
<S>                                                                         <C>             <C>                 <C>
Balance Sheet Data:
Cash and cash equivalents and short- and long-term
    investments.....................................................        $19,534         $ 31,061            $  640
Working capital.....................................................         17,235           30,054               301
Total assets........................................................         25,511           34,886             1,773
Redeemable Preferred Stock..........................................              -                -             6,002
Total stockholders' equity (deficit)................................         23,077           33,342            (5,487)


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

         The Company's  product  sales are generated  entirely from sales of the
Company's Sonic  Accelerated  Fracture Healing System ("SAFHS") Model 2A device.
For fiscal 1996,  product  sales were $5.8 million as 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, a Japanese corporation.  No such
revenues were reported for fiscal 1995. These  development  agreements cover two
of  the   Company's   technologies:   (a)   the   SAFHS   device   and  (b)  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 will be responsible
for complying with the regulatory  requirements  and 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 $3.7 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 product  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 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 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.

Fiscal Year ended  September 30, 1995 compared with Fiscal Year ended  September
30, 1994

         Product  sales in fiscal 1995 were $1.9  million  due to the  Company's
commencement of commercial distribution of its initial SAFHS device, SAFHS Model
2A, in October  1994.  Cost of  product  sales of $1.1  million  in fiscal  1995
principally resulted from the cost of manufacture of the SAFHS device by outside
sources as well as the cost of  inspection  of the  manufactured  product.  Also
included in cost of sales were royalties and costs related to the  establishment
of in-house  manufacturing and ancillary  operations.  Gross profit for 1995 was
$724,000,  or 39% as a  percentage  of  revenues.  There  were  no  revenues  or
associated cost of product sales in fiscal 1994.

         Research  and  development  expenses in fiscal 1995  increased  to $2.5
million from $1.4 million in fiscal 1994.  The increase of $1.1 million (or 78%)
was primarily the result of expenditures  associated with the development of the
SAFHS 2000 (a  second-generation  model of the SAFHS Model 2A device);  expanded
efforts in designing and building the mechanical-stress device; increased staff;
and the cost of SAFHS  devices  shipped  in  connection  with  certain  clinical
prescriptions for which reimbursement is currently not available.
<PAGE>
         Selling,  general, and administrative expenses in fiscal 1995 increased
to $5.8 million from $1.8 million in fiscal 1994.  Of the $4.0 million (or 224%)
increase,  $2.2 million was due to sales and marketing efforts in the commercial
introduction of the SAFHS Model 2A, including hiring and training a direct sales
force. The remainder of the $4.0 million increase was primarily due to increased
expenses,  including rent,  utilities,  and  depreciation,  of the Company's new
facilities in  Piscataway,  New Jersey;  increased  legal fees related to patent
work  and  litigation;  expansion  of the  administrative  staff  and  increased
reimbursement activities; and the establishment of a subsidiary in Germany.

         Net interest  income in fiscal 1995 increased to $604,000 from $185,000
of net interest  expense in fiscal 1994,  principally  due to interest earned on
the proceeds  from the Series B Preferred  Stock  financing in November 1994 and
interest  earned in the  fourth  quarter  of fiscal  1995 on  proceeds  from the
Company's Initial Public Offering in July 1995.

         The Company  incurred net losses of $7.1  million,  or $0.93 per share,
and $3.4 million, or $0.48 per share, in fiscal 1995 and 1994, respectively (per
share  data based  upon pro forma  weighted  average  shares  outstanding).  The
increase  of $3.7  million (or 107%) 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 $23.2 million at September 30,
1996. Until July 1995, the Company had funded its operations  primarily  through
the private  placement of equity securities  aggregating $17.6 million.  On July
25, 1995, the Company  completed its Initial Public Offering 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 Initial  Public  Offering  purchased an additional  375,000 shares of Common
Stock,  pursuant to the  over-allotment  option,  for  aggregate net proceeds of
approximately $3.8 million.

         In  fiscal  1996,  the  Company  used  net cash of  $11.6  million  for
operating activities,  primarily for continued commercial marketing of the SAFHS
Model 2A; an increased level of research and development expenditures; and a net
increase  of $1.3  million in  working  capital  items.  The  Company's  capital
expenditures  in 1996 were  $411,000.  The Company  estimates that equipment and
furnishings  to  expand  in-house   manufacturing  and  administrative   support
activities will require capital  expenditures of  approximately  $800,000 during
each of the next two years.

         The  Company  plans to  finance  its  capital  needs  principally  from
existing  capital  resources,  which the Company  believes will be sufficient to
fund its operations  into fiscal 1998.  Additional  funding may 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.
<PAGE>
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
FDA approval for its SAFHS device,  developing  the Company's  initial sales and
marketing  organization,  supervising  the  manufacture of the SAFHS device by a
contract manufacturer, and commencing sales of 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 and began marketing its
SAFHS device in October 1994, and therefore has limited  experience in marketing
and selling its products in commercial  quantities.  The Company had no previous
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  has  been  approved  by the FDA to treat
closed, cast-immobilized,  fresh fractures of the tibia and distal radius within
approved indications. 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.  In addition, the proper placement of the device at the fracture
site is important for the proper delivery of the therapy,  and acceptance of the
therapy  will depend,  in part,  on whether the Company can continue to instruct
physicians  and  patients  in the  proper  use of the  device.  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, 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

         The Company  has not secured  general  reimbursement  approval  for its
SAFHS  device  from  any  large  third-party  payor,  and to date  has  received
reimbursement  approval from  third-party  payors only on a case-by-case  basis.
Successful  sales of SAFHS devices in the United States and other markets 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
<PAGE>
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,  not experimental or investigational,
medically  necessary,  appropriate for the specific patient, and cost-effective.
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.  There  can be no  assurance  that
third-party reimbursement will be consistently available for the SAFHS device or
any  of the  Company's  other  products  that  may be  developed  or  that  such
third-party  reimbursement  will be  adequate.  The United  States  Congress  is
currently  considering  various  proposals to significantly  reduce Medicare and
Medicaid expenditures. Such proposals, if enacted, could have a material adverse
effect on the Company's business,  financial  condition,  results of operations,
and cash flows.  Currently,  the SAFHS device is not covered  under the Medicare
program. 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 currently has limited experience in
obtaining  reimbursement  for its  products in  countries  other than the United
States.   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, 1996, had an accumulated  deficit of approximately  $23.2 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  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  manufacturing  capability.  In addition,  the
Company expects its operating  expenses to increase  significantly over the next
several years due to increased costs of research and  development,  primarily in
connection  with the  mechanical-stress  device and clinical trials for expanded
applications  of the SAFHS  technology,  expansion of direct sales and marketing
activities,  increase of in-house  manufacturing  capability,  and  expansion of
administrative functions. 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.
<PAGE>
Dependence on Principal Product

         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.

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 and Austria.  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.
<PAGE>
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 were 14% of total  product  sales in
fiscal  1996,  and such  revenues  are  expected  to continue  to  represent  an
increasing  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.

         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, extended accounts
receivable payment cycles,  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, and cash flows.

Dependence on Single Sources of Manufacture and Supply

         The  Company's  SAFHS  device is currently  manufactured  by a contract
manufacturer.   The  purchase  orders  between  the  Company  and  the  contract
manufacturer  requires the Company to purchase a minimum number of SAFHS devices
from the contract manufacturer for the term of the agreement, effective to 1998.
The  contract  manufacturer's  facility  has  been  inspected  by the FDA and is
currently  the only  facility  approved for the  production  of the SAFHS device
under the FDA's Good Manufacturing  Practices ("GMP") requirements.  Any failure
by  the  contract  manufacturer  to  maintain  its  manufacturing   facility  in
accordance with GMP requirements  could result in the inability of such contract
manufacturer to manufacture the SAFHS device and may 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>
No Manufacturing Experience

         The Company has  developed  in-house  refurbishing  capability  for the
SAFHS device, and is developing in-house manufacturing capability,  although the
Company  intends to  continue  to use its  current  manufacturer  as the primary
supplier of its products for the foreseeable  future.  Before  manufacturing the
SAFHS  devices for  commercial  use,  the  Company's  facility  will require FDA
determination  of compliance  with GMP  requirements.  There can be no assurance
that the Company will be able to establish manufacturing capability,  obtain GMP
approval,  make the  transition to  commercial  manufacturing  successfully,  or
manufacture its products cost-effectively, or at all.

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.
<PAGE>
Extensive Government Regulation

         The  manufacture  and sale of medical  devices is 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  will be  required  to file PMA  supplements  for new
indications for its SAFHS technology. In addition, if modifications to its SAFHS
Model 2A affect safety or efficacy,  a PMA supplement must be filed and approved
by the FDA. These  supplements may not be accepted by the FDA, in which case the
Company  would be required to  undertake  and complete the entire PMA process in
order to use the  SAFHS  Model  2A to  treat  those  additional  indications  or
commercialize a modified device. Furthermore, 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.   The  Company  has  made  certain
nonperformance-related  changes  to the  SAFHS  Model 2A since  the  device  was
approved 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. The Company filed a PMA supplement for its SAFHS
2000  in  December  1995.  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 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.

         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 it 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
<PAGE>
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
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
<PAGE>
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.

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 this  Form  10-K for more
information relating to the Stockholder Rights Plan.

         The Company's  By-Laws 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

         Certain  information in response to this item is incorporated herein by
reference  to  "Election  of  Directors"  in  Exogen,  Inc.'s  Definitive  Proxy
Statement  dated on or about January 8, 1997 to be filed with the Securities and
Exchange  Commission ("SEC") and to "Executive  Officers" in Part I of this Form
10-K.  Information on compliance  with section 16(a) of the Securities  Exchange
Act of 1934 is  incorporated  herein by reference to "Compliance  with Reporting
Requirements"  in the  Company's  Proxy  Statement  dated on or about January 8,
1997.


Item 11.  Executive Compensation

         Information  in  response  to  this  item  is  incorporated  herein  by
reference to "Executive  Compensation  and Other  Information"  in the Company's
Definitive  Proxy  Statement  dated on or about January 8, 1997 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 dated on or about January 8, 1997 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
dated on or about January 8, 1997 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, 1996
                         and 1995

                         Consolidated  Statements  of  Operations  for the years
                         ended  September 30, 1996,  1995, and 1994 

                         Consolidated  Statement  of  Changes  in  Stockholders'
                         Equity for the years ended  September  30, 1996,  1995,
                         and 1994

                         Consolidated  Statements  of Cash  Flows  for the years
                         ended  September  30,  1996,  1995,  and 1994  

                         Notes to Consolidated Financial Statements

          (2)      Financial  Statement  Schedules.  Schedule  II--Valuation and
                   Qualifying  Accounts for the years ended  September  30, 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 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).
<PAGE>
                      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    Employment   Agreement   dated  January  15,  1994
                              between  the  Company  and  Patrick  A.  McBrayer.
                              Incorporated  by  reference to Exhibit 10.3 to the
                              Company's   Form   S-1   Registration    Statement
                              (Registration No. 33-92740).
                      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).
                      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).
<PAGE>
                      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.
                      10.15+  Mechanical-Stress  Agreement  dated  November  30,
                              1995 between the Company and Teijin Limited.
                      11.1*   Statement regarding  Calculation of Shares Used in
                              Computing Net Loss Per Share.
                      21.1    List of Subsidiary.
                      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.

                              * 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
1996.
<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 20, 1996
      -----------------------
      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 20, 1996
      -----------------
      John P. Ryaby
      Chairman of the Board and Vice President of
      Research and Development and Regulatory Affairs

 
By:   /s/ Patrick A. McBrayer                                  December 20, 1996
      -----------------------
      Patrick A. McBrayer
      Chief Executive Officer, President, and Director
      (Principal Executive Officer)

 
By:   /s/ Richard H. Reisner                                   December 20, 1996
      ----------------------
      Richard H. Reisner 
      Vice President, Chief Financial Officer, and Secretary 
      (Principal Financial and Accounting Officer)


By:   /s/ Buzz Benson                                          December 20, 1996
      ---------------
      Buzz Benson 
      Director

 
By:   /s/ Donald J. Lothrop                                    December 20, 1996
      ---------------------
      Donald J. Lothrop 
      Director
<PAGE>
By:   /s/ David J. Ottensmeyer                                 December 20, 1996
      ------------------------
      David J. Ottensmeyer
      Director
 
By:   /s/ Terry J. Sullivan                                    December 20, 1996
      ---------------------
      Terry J. Sullivan
      Director
 
By:   /s/ Terence D. Wall                                      December 20, 1996
      -------------------
      Terence D. Wall 
      Director
<PAGE>
                                  EXOGEN, INC.

              INDEX TO FINANCIAL STATEMENTS AND FINANCIAL SCHEDULES


1. FINANCIAL STATEMENTS

           Report of Independent Public Accountants 

           Consolidated Balance Sheets as of September 30, 1996 and 1995 

           Consolidated Statements of Operations for the years ended
                September 30, 1996, 1995, and 1994 

           Consolidated Statement of Changes in Stockholders' Equity
                for the years ended September 30, 1996, 1995, and 1994 

           Consolidated Statements of Cash Flows for the years ended
                September 30, 1996, 1995, and 1994 

           Notes to Consolidated Financial Statements 


2. FINANCIAL STATEMENT SCHEDULES

           Schedule II--Valuation and Qualifying Accounts for the years ended
                September 30, 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, 1996 and 1995
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, 1996. 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, 1996 and 1995 and the results of their operations
and their cash flows for each of the three years in the period  ended  September
30, 1996 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 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 13, 1996 (except for Note 15, as to
         which the date is December 6, 1996)

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

                                 CONSOLIDATED BALANCE SHEETS
                              (in thousands, except share data)


                                                                          September 30,
                                                                    -----------------------
                                                                        1996           1995
                                                                    --------       --------
                    ASSETS
<S>                                                                 <C>            <C>
Current assets:
    Cash and cash equivalents ................................      $  8,115       $ 22,176
    Short-term investments ...................................         6,824          6,704
    Accounts receivable, net of allowances of $346 and $198 in
         1996 and 1995, respectively .........................         2,943            871
    Inventories ..............................................         1,239          1,553
    Interest receivable ......................................           202             44
    Other current assets .....................................           344            234
                                                                    --------       --------
                 Total current assets ........................        19,667         31,582
Furniture, fixtures and equipment, net .......................           979            888
Long-term investments ........................................         4,595          2,181
Other assets .................................................           270            235
                                                                    --------       --------
                 Total assets ................................      $ 25,511       $ 34,886
                                                                    ========       ========

                    LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable .........................................      $    685       $    523
    Accrued liabilities ......................................         1,625            990
    Capital lease obligations ................................            15             15
    Other current liabilities ................................           107           --
                                                                    --------       --------
                 Total current liabilities ...................         2,432          1,528
Capital lease obligations ....................................             2             16

Commitments and contingencies (Note 11)
<PAGE>
<CAPTION>
<S>                                                                 <C>            <C>
Stockholders' equity:
    Preferred Stock, $0.0001 par value; 3,000,000 shares
         authorized in 1996 and 1995; no shares issued or
         outstanding .........................................          --             --
    Common Stock, $0.0001 par value; 27,000,000 shares
         authorized in 1996 and 1995; 9,909,192 shares issued
         and outstanding in 1996 and 9,850,259 shares issued
         and outstanding in 1995 .............................             1              1
    Additional paid-in capital ...............................        46,272         45,938
    Cumulative translation adjustment ........................           (22)           (11)
    Accumulated deficit ......................................       (23,174)       (12,586)
                                                                    --------       --------
                 Total stockholders' equity ..................        23,077         33,342
                                                                    --------       --------
                 Total liabilities and stockholders' equity ..      $ 25,511       $ 34,886
                                                                    ========       ========

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

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


                                                      For the years ended September 30,

                                                       1996           1995           1994
                                                   --------       --------       --------
<S>                                                <C>            <C>            <C>
Revenues:
     Product sales ..........................      $  5,777       $  1,852       $   --
     Revenues from development agreements ...         1,100           --             --
                                                   --------       --------       --------
          Total revenues ....................         6,877          1,852           --
                                                   --------       --------       --------

Operating costs and expenses:
     Cost of product sales ..................         3,661          1,128           --
     Research and development ...............         3,988          2,545          1,432
     Selling, general, and administrative ...        11,030          5,775          1,782
                                                   --------       --------       --------
           Total operating costs and expenses        18,679          9,448          3,214
                                                   --------       --------       --------

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

Other income (expense):
     Interest income (expense), net .........         1,438            604           (185)
     Other expense, net .....................          (224)           (59)            (2)
                                                   --------       --------       --------
           Total other income (expense) .....         1,214            545           (187)
                                                   --------       --------       --------

     Net loss ...............................      $(10,588)      $ (7,051)      $ (3,401)
                                                   ========       ========       ========

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

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

Pro forma net loss per share ................                     $  (0.93)      $  (0.48)
                                                                  ========       ========

Pro forma weighted average shares outstanding                        7,574          7,020


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

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

                                      CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

                                       For the Years Ended September 30, 1996, 1995, and 1994
                                                           (in thousands)

                                                                           Additional      Cumulative
                                                      Common Stock           Paid-in       Translation      Accumulated
                                                  Shares       Amount        Capital       Adjustment        Deficit          Total
                                                  ------       ------        -------       ----------        -------          -----
<S>                                              <C>         <C>            <C>            <C>             <C>             <C>
Balance, October 1, 1993 ..............            925       $   --         $      4       $   --          $ (2,079)       $ (2,075)

   Amortization of Preferred
      Stock issuance costs ............           --             --             --             --               (20)            (20)
   Issuance of Common Stock ...........            460           --                9           --              --                 9
   Net loss ...........................           --             --             --             --            (3,401)         (3,401)
                                                 -----       ------         --------       ------          --------        --------

Balance, September 30,1994 ............          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
                                                 =====       ======         ========       ======          ========        ========


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

                                  CONSOLIDATED STATEMENTS OF CASH FLOWS
                                             (in thousands)

                                                                     For the years ended September 30,
                                                                   ------------------------------------
                                                                      1996           1995         1994
                                                                   --------      --------      --------
<S>                                                                <C>           <C>           <C>
Cash flows from operating activities:
     Net loss ................................................     $(10,588)      $(7,051)     $ (3,401)
     Adjustments to reconcile net loss to net cash used in
        operating activities:
          Depreciation and amortization ......................          330           186            57
          Amortization of net discount on short- and long-term
               investments ...................................         (196)          (75)         --
          Amortization of nonemployee stock
               option compensation ...........................           52          --            --
          Other adjustments ..................................           14            47            37
     Decrease (increase) in assets:
          Accounts receivable ................................       (2,081)         (871)         --
          Interest receivable ................................         (158)          (44)         --
          Inventories ........................................          311          (738)         (780)
          Other current assets ...............................         (131)         (148)          (30)
          Other assets .......................................          (46)         (188)          (11)
     Increase (decrease) in liabilities:
          Accounts payable ...................................          162            80           373
          Accrued liabilities ................................          637           577           364
          Notes payable ......................................         --            (380)         (250)
          Other current liabilities ..........................          107          --            --
                                                                   --------      --------      --------
               Net cash used in operating activities .........      (11,587)       (8,605)       (3,641)
                                                                   --------      --------      --------

Cash flows from investing activities:
     Purchase of short- and long-term investments ............      (20,868)      (16,310)         --
     Proceeds from sale of short- and long-term
       investments ...........................................       18,532         7,500          --
     Purchase of furniture, fixtures and equipment ...........         (411)         (916)         (129)
     Other investing activities ..............................            4            (4)            3
                                                                   --------      --------      --------
               Net cash used in investing activities .........       (2,743)       (9,730)         (126)
                                                                   --------      --------      --------

Cash flows from financing activities:
     Proceeds from Preferred Stock issuances, net of
       issuance expenses, and bridge financing ...............         --          11,379         4,224
     Proceeds from exercise of stock options .................           37          --            --
     Proceeds from sale of Common Stock, net of
       issuance expenses .....................................          245        28,508             9
     Principal payments under capital leases .................          (14)          (13)           (6)
                                                                   --------      --------      --------
               Net cash provided by financing activities .....          268        39,874         4,227
                                                                   --------      --------      --------
<PAGE>
<CAPTION>
                                              EXOGEN, INC.

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

                                                                     For the years ended September 30,
                                                                   ------------------------------------
                                                                      1996           1995         1994
                                                                   --------      --------      --------
<S>                                                                <C>           <C>           <C>

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

Net (decrease) increase in cash and cash equivalents .........      (14,061)       21,536           460
Cash and cash equivalents, beginning of year .................       22,176           640           180
                                                                   --------      --------      --------
Cash and cash equivalents, end of year .......................     $  8,115      $ 22,176      $    640
                                                                   ========      ========      ========


The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
</TABLE>
<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.  The majority of
primary  payors  for  significantly  all the  Company's  sales  are  third-party
insurers.  Changes in economic or other  conditions  could affect the ability of
these third-party payors to meet their obligations.

         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,  the Company
further strengthened its domestic sales and marketing infrastructure,  continued
its  research  and  development   activities  of  the  SAFHS  device  and  other
technologies,  and  commenced  commercial  distribution  of the SAFHS  device in
certain European  countries.  The Company's product sales are generated entirely
from sales of the SAFHS  device,  and  therefore,  the Company is subject to the
risks associated with a single product.


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,  the  Company  was
obligated to pay $600,000 for those  rights,  with  $100,000 paid at closing and
the balance  evidenced by a  noninterest-bearing  note  (discounted  at 9.0% per
annum).  The Company  prepaid  $120,000  of the note.  The balance of this note,
which was due within 10 days after  receipt of the  Company's  PMA for its SAFHS
device,  was  paid in  October  1994.  Under  the  terms of the  Asset  Purchase
Agreement,  the Company is also obligated to make royalty  payments to Interpore
based upon net revenues from sales of devices covered by the Initial Patent.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         Under the terms of the License Agreement,  the Company was obligated to
pay $475,000 to the patent holder.  The Company paid $225,000 on the date of the
agreement.  The  remaining  $250,000 was payable,  together with interest at the
rate of 9% per annum,  in various  amounts over a 19-month  period,  which ended
October 1, 1994. On September 30, 1994, the Company made the final payment under
the terms of this agreement.  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.


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, and
any 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,  bad debt,  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,
                                                           ---------------------
                                                              1996          1995
                                                           -------       -------
<S>                                                        <C>           <C>
Cash and cash equivalents
     Cash ..........................................       $   145       $   111
     Money markets .................................           917        10,020
     Commercial paper ..............................         7,053        12,045
                                                           -------       -------
                                                             8,115        22,176        
Short-term investments
     Commercial paper ..............................          --           4,027
     U. S. Agency notes ............................         2,171          --
     Certificates of deposit .......................          --           1,700
     Corporate bonds ...............................         2,955          --
     Bank notes ....................................         1,502           977
     Other .........................................           196          --
                                                           -------       -------
                                                             6,824         6,704       
Long-term investments
     Bank notes ....................................          --             990
     U. S. Agency notes ............................         2,017          --
     Corporate bonds ...............................         2,578         1,191
                                                           -------       -------
                                                             4,595         2,181        

Total cash, cash equivalents, and investments.......       $19,534       $31,061
                                                           =======       =======

</TABLE>
         In May 1993, the Financial  Accounting Standards Board issued Statement
of Financial  Accounting  Standards No. 115, "Accounting for Certain Investments
in Debt and Equity  Securities." This Statement  requires the  classification of
debt and equity  securities  based on  whether  the  securities  will be held to
maturity,  are  considered  trading  securities,  or  are  available  for  sale.
Classification within these categories may require the securities to be reported
at their fair market value with  unrealized  gains and losses included either in
current earnings or reported as a separate component of stockholders' equity. As
of September 30, 1996 and 1995, all short-term  and long-term  investments  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.  The maturities of
long-term investments range from October 1997 to September 1998.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

   Accounts Receivable

         Accounts  receivable  is recorded  net of  accumulated  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 (see also
"Revenue  Recognition and Cost of Sales" discussed above).  Management is of the
opinion that there is no  significant  concentration  of credit risk in accounts
receivable.

   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.

   Patent Costs

         Costs incurred relating to developing patents are expensed as incurred.

   Income Taxes

         Effective  October 1, 1993, the Company adopted  Statement of Financial
Accounting  Standards No. 109,  "Accounting  for Income  Taxes," which  requires
accounting  for  deferred  income  taxes under the asset and  liability  method.
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
basis of existing assets and liabilities.

   Net Loss Per Common Share

         For the year ended September 30, 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,  which includes  Preferred Stock
as  outstanding  for the entire  year and  options  issued  during the 12 months
preceding  the  Initial  Public  Offering  at prices  below the  Initial  Public
Offering price as outstanding through March 31, 1995.

         For the year ended  September 30, 1994, pro forma net loss per share is
determined  using  the  weighted  average  number  of  shares  of  Common  Stock
outstanding  during  the  period  presented.  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 and 1994 have not been
presented as such information is not meaningful.

   Stock Options

         Accounting  for stock  options  issued  to  employees  and  nonemployee
directors is based upon the  "intrinsic  value"  method set forth in  Accounting
Principles  Board  Opinion No. 25 ("APB 25"),  "Accounting  for Stock  Issued to
Employees."  Accounting  for  stock  options  issued  to  nonemployees  prior to
December 16, 1995 is also based upon APB 25. Accounting for stock options issued
to nonemployees  (excluding  nonemployee  directors)  after December 15, 1995 is
based  upon the  "fair  value"  method  set  forth  in  Statement  of  Financial
Accounting   Standards  No.  123  ("SFAS  123"),   "Accounting  for  Stock-Based
Compensation."  See "Recent  Pronouncements"  below for a further  discussion of
SFAS 123.

   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,
disallowed  amounts,  and 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 reserves for
obsolescence.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

   Recent Pronouncements

         In  March  1995,  the  Financial   Accounting  Standards  Board  issued
Statement of Financial  Accounting  Standards No. 121 ("SFAS 121"),  "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of," which is effective for the Company's  1997 financial  statements.  SFAS 121
requires that long-lived assets and certain identifiable  intangible assets held
and used by a company be reviewed 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, 1996,  no
assets covered by SFAS 121 have been impaired.

         In October 1995, the Financial  Accounting  Standards Board issued SFAS
123, which is effective for the Company's 1997  financial  statements.  SFAS 123
allows  companies to account for  stock-based  compensation  to employees  under
either (i) the new  provisions of SFAS 123 or (ii) the provisions of APB 25 with
pro forma  disclosure  in the  footnotes to the  financial  statements as if the
measurement  provisions of SFAS 123 had been adopted.  At this time, the Company
intends to continue accounting for its stock-based  compensation to employees in
accordance with the provisions of APB 25.

         In accounting for options issued to nonemployees, the implementation of
SFAS  123 did not  materially  impact  the  financial  position  or  results  of
operations of the Company, and had no effect on its cash flows.

   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 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,
                                                     ---------------------------
                                                         1996              1995
                                                         ----              ----
<S>                                                  <C>               <C>
Net revenues:
     United States .........................         $  7,284          $  2,035
     Europe ................................              787              --
     Intercompany eliminations .............           (1,194)             (183)
Operating loss:
     United States .........................           10,813             7,366
     Europe ................................              919               230
     Intercompany eliminations .............               70              --
Identifiable assets:
     United States .........................           24,449            34,813
     Europe ................................            1,062                73
</TABLE>
         Transfers 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.


6.   Development Agreement Revenues

         In fiscal 1996, the Company  recorded  revenues of $1.1 million 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:   (a)   the   SAFHS   device   and  (b)  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 will be responsible
for complying with the regulatory  requirements  and 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.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

7.   Inventories

         Inventories consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                              September 30,
                                                       -------------------------
                                                         1996               1995
                                                       ------             ------
<S>                                                    <C>                <C>  
Finished goods ...........................             $  768             $1,258
Parts and components .....................                471                295
                                                       ------             ------
                                                       $1,239             $1,553
                                                       ======             ======

</TABLE>

8.   Furniture, Fixtures and Equipment

         Furniture,   fixtures  and  equipment  consist  of  the  following  (in
thousands):
<TABLE>
<CAPTION>

                                                              September 30,
                                                         ----------------------
                                                            1996           1995
                                                         -------        -------
<S>                                                      <C>            <C>
Furniture, fixtures and equipment ................       $ 1,421        $ 1,024
Leasehold improvements ...........................            71             58
                                                         -------        -------
                                                           1,492          1,082
Accumulated depreciation and amortization ........          (513)          (194)
                                                         -------        -------
                                                         $   979        $   888
                                                         =======        =======
</TABLE>

         Depreciation  and  amortization  expense was  $319,000,  $176,000,  and
$50,000, for the years ended September 30, 1996, 1995, and 1994, respectively.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


9.   Accrued Liabilities

         Accrued liabilities consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                               September 30,
                                                        ------------------------
                                                          1996              1995
                                                        ------            ------
<S>                                                     <C>               <C>
                                                                                                
Compensation and benefits ..................            $  490            $  207
Taxes other than income ....................               241                59
Warranty expenses ..........................               157                70
Research and development ...................               136                36
IPO costs ..................................              --                 160
Other ......................................               601               458
                                                        ------            ------
                                                        $1,625            $  990
                                                        ======            ======

</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.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

         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.

11.   Commitments and Contingencies

         The Company  leases a facility  in  Piscataway,  New Jersey;  the lease
commenced  May 1995 and has a remaining  term of five  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>
               1997............................................ $    499
               1998............................................      506
               1999............................................      513
               2000............................................      520
               2001............................................      527
                                                                -------- 
                                                                $  2,565
                                                                ========
</TABLE>

               Rent expense was  $353,000,  $233,000,  and $83,000 for the years
ended September 30, 1996, 1995, and 1994, respectively.

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

               The  Company's  SAFHS device is currently  produced by a contract
manufacturer.  The  agreement  between  the  Company  and this  manufacturer  is
documented by specific purchase orders,  effective to 1998, covering anticipated
requirements.   At  September  30,  1996,  these  purchase  orders  amounted  to
commitments of approximately $3 million.  A change of the contract  manufacturer
could cause a delay in manufacturing  and a possible loss of sales,  which could
affect operating results adversely.

               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. (See Part I, Item 3, "Legal
Proceedings," for a further discussion.) Also in fiscal 1995, the Company became
a party to a certain other lawsuit that  continued  through  fiscal 1996 and has
not been settled.  Management is of the opinion that this other lawsuit 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  adopted the 1993 Stock Option Plan (the "1993 Plan")
for the purpose of attracting  and retaining the services of selected  employees
(including  officers  and  directors)  and  consultants.  The Plan  provides for
options designated as either nonqualified or incentive stock options with a term
of no more than 10 years.  Effective  with the IPO, the 1993 Plan was superseded
by the 1995 Stock  Option/Stock  Issuance  Plan (the "1995  Plan"),  and options
outstanding under the 1993 Plan were incorporated into the 1995 Plan.

               The Company's 1995 Stock  Option/Stock  Issuance Plan was adopted
by the  Board  of  Directors  and  stockholders  as of May 25,  1995  and is the
successor equity incentive  program to the Company's 1993 Stock Option Plan (the
"Predecessor  Plan").  The 1995 Plan became  effective  with the IPO. A total of
750,000  shares of Common Stock has been  authorized for issuance under the 1995
Plan. This share reserve is comprised of (i) the shares that remained  available
for  issuance  under the  Predecessor  Plan,  including  the  shares  subject to
outstanding options  thereunder,  plus (ii) an increase of 500,000 shares. In no
event may any one participant in the 1995 Plan receive option grants, separately
exercisable stock  appreciation  rights, or direct stock issuances for more than
300,000 shares in any calendar year.

         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)

         Under the Automatic  Option Grant Program,  each  nonemployee  director
first elected or appointed to the Board of Directors after the effective date of
the 1995 Plan will automatically be granted an option for 7,500 shares of Common
Stock  on the  date  of his or her  election  or  appointment  to the  Board  of
Directors,  provided  such  individual  has not been in the prior  employ of the
Company. In addition,  at each annual stockholders'  meeting held after the IPO,
each  individual  with at least six months of service on the Board of  Directors
who will continue to serve as a nonemployee  director following the meeting will
automatically be granted an option for 1,250 shares of Common Stock,  whether or
not such  individual  has been in the prior  employ of the Company or has joined
the Board of Directors prior to the IPO.

               The 1995 Plan will  terminate  on April 30, 2005,  unless  sooner
terminated by the Board of Directors.

               Stock  option  activity  pursuant  to the 1993 and 1995  Plans is
summarized as follows:
<TABLE>
<CAPTION>

                                                  Number of            Option
                                                   Options          Price Range
                                                   -------          -----------
<S>                                               <C>             <C>
Balance at September 30, 1993
     Granted ............................          55,000         $        0.02
                                                  -------                  
Balance at September 30, 1994 ...........          55,000         $        0.02
     Granted ............................         296,450         $ 0.60-$13.00
     Exercised ..........................             125         $        0.02
     Canceled ...........................           2,025         $ 0.02- $5.50
                                                  -------                 
Balance at September 30, 1995 ...........         349,300         $ 0.02-$13.00
     Granted ............................         173,250         $ 8.00-$25.50
     Exercised ..........................          19,989         $ 0.02-$10.00
     Canceled ...........................          12,524         $ 0.02-$18.50
                                                  -------                  
Balance at September 30, 1996 ...........         490,037         $ 0.02-$25.50
  (80,167 shares exercisable)                     =======
</TABLE>

           Options  generally become  exercisable in ratable  installments  over
four- or 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.  Accordingly,  no
compensation expense has been recorded for those options accounted for under APB
25. During fiscal 1996,  55,875 options were issued to  nonemployees  (excluding
nonemployee  directors),  and were  accounted  for under SFAS 123.  Accordingly,
$52,000 in  compensation  expense  associated with these options was recorded in
fiscal 1996.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

           There were no direct issuances of Common Stock or stock  appreciation
rights under the 1995 Plan as of September 30, 1996.

   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 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.  A total of 150,000 shares of
Common Stock has been reserved for issuance under the Purchase Plan.

           The  Purchase  Plan will be  implemented  in a series  of  successive
offering periods;  each offering period (other than the initial offering period)
will have a maximum  duration of 24 months.  The initial offering period started
upon the IPO and will end on the last business day in July 1997.

           Payroll deductions may not exceed 10% of the participant's total cash
earnings  in each  semi-annual  period.  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  entry date into the offering  period or (ii)
the fair market value on the semi-annual  purchase date.  However, no individual
may purchase Common Stock under the Purchase Plan at a rate in excess of $25,000
worth of  Common  Stock  (valued  as of the  participant's  entry  date into the
offering period) for each calendar year (or portion thereof) his or her purchase
rights remain outstanding.

           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.

           Stock issued through September 30, 1996 pursuant to the Purchase Plan
totaled 38,944 shares at prices ranging from $5.21 to $9.35.

   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  outstanding,
1,060,836  and  785,840  shares are vested as of  September  30,  1996 and 1995,
respectively.  The unvested  324,162  shares at September 30, 1996 vest over the
next 17 months.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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.   Upon  adopting  Statement  of  Financial
Accounting  Standards No. 109 on October 1, 1993,  the  valuation  allowance was
$825,000.  The change in valuation  allowance  during 1996,  1995,  and 1994 was
$3,433,000, $2,813,000, and $1,358,000, respectively.

           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,
                                                                       -------------          -------------
                                                                            1996                   1995
                                                                         -------                -------
<S>                                                                      <C>                    <C>
Deferred Tax Asset:
    Start-up costs ...............................................       $   732                $ 1,000
    Research and development costs ...............................           548                    518
    Research and development and related patent acquired .........           184                    247
    Vacation accrual .............................................            18                     20
    Allowances for returns, disallowances, and bad debts .........           555                    253
    Net operating loss ...........................................         6,311                  2,960
    Other ........................................................           126                     (2)
                                                                         -------                -------
    Deferred tax asset ...........................................         8,474                  4,996

Less: Valuation Allowance ........................................        (8,474)                (4,996)
                                                                         -------                -------
                                                                         $     0                $     0
                                                                         =======                =======
</TABLE>
         At September 30, 1996, the Company has net operating loss carryforwards
for United States  federal income tax purposes of  approximately  $14.3 million.
These net operating loss carryforwards expire on various dates through 2010. 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,
1996,  the Company also has net operating loss  carryforwards  for German income
tax purposes of $1.2 million, which are not subject to any limitations.
<PAGE>
                                  EXOGEN, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


14.  Supplemental Disclosure of Cash Flow Information

         Cash paid for interest  was $9,000,  $169,000,  and  $49,000,  in 1996,
1995, and 1994, respectively.

         The Company recorded $0, $35,000,  and $20,000 of amortization  related
to Preferred Stock issuance costs in 1996, 1995, and 1994, respectively.


15.  Subsequent Event

   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 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
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.
<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



(a) Returns and write-offs.
</TABLE>
<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      Employment Agreement dated January 15, 1994 between the
                         Company  and  Patrick  A.  McBrayer.   Incorporated  by
                         reference  to Exhibit  10.3 to the  Company's  Form S-1
                         Registration Statement (Registration No. 33-92740).
               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).
               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).
<PAGE>
               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 ending 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 ending September 30, 1995.
               11.1*     Statement  regarding  Calculation  of  Shares  Used  in
                         Computing Net Loss Per Share.
               21.1      List  of  Subsidiary.   Incorporated  by  reference  to
                         Exhibit  21.1 to the  Company's  Form 10-K for the year
                         ending September 30, 1995.
               23.1*     Consent  of  Arthur   Andersen  LLP.   Incorporated  by
                         reference  to Exhibit 23.1 to the  Company's  Form 10-K
                         for the year ending September 30, 1995.
               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.
               -----------------------
                           * Filed herewith.
                           + Confidential treatment granted.