Forward-Looking Statements:
The disclosures in this Form 10-Q include "forward-looking statements" made under the Private Securities Litigation Reform Act of 1995. Without limiting the foregoing, words such as "should", "could", "may", "will", "expect", "believe", "anticipate", "estimate" or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. All forward-looking statements in this document are based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any forward-looking statements. You are advised, however, to consult any future disclosures we make on related subjects in future filings with the Securities and Exchange Commission ("SEC"). Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Certain important factors that could cause results to differ materially from those anticipated by the forward-looking statements made herein include the timing of product introductions, the ability of our expanding direct sales force to grow revenues, outcomes of clinical and marketing trials as well as regulatory submissions, the number of certain surgical procedures performed, the ability to identify, acquire and successfully integrate suitable acquisition candidates, the cost and outcome of intellectual property litigation, any operational or financial impact from the current global economic downturn, current market conditions affecting our investments, any claims for indemnification related to the sale of the interventional business, as well as other factors found in the Company's filings with the SEC, such as the "Risk Factors" section in Item 1A of the Annual Report on Form 10-K, as amended by Form 10-K/A (Amendment No. 1), for the year ended October 31, 2008. Business Overview
Synovis Life Technologies, Inc. is a diversified medical device company engaged in developing, manufacturing, marketing and selling implantable biomaterial products, devices for microsurgery and surgical tools, all designed to reduce risk and/or facilitate critical surgeries, improve patient outcomes and reduce health care costs. Our products serve a wide array of medical markets, including general surgery, bariatric, vascular, cardiac, thoracic, neurological and microsurgery.
As discussed in Note 2 to our unaudited consolidated condensed financial statements, on January 31, 2008 we sold our interventional business. Operating results related to those operations for the three and six months ended April 30, 2009 and 2008 have been reclassified and presented as discontinued operations. Unless otherwise indicated, the following management discussion and analysis refers only to continuing operations of the Company.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED

Results of Operations
Comparison of the Three Months Ended April 30, 2009 with the Three Months Ended
April 30, 2008 (in thousands except per share data)
The following table summarizes our consolidated condensed operating results for
the second quarter of fiscal 2009 and fiscal 2008:

                                 For the quarter ended                For the quarter ended
                                    April 30, 2009                       April 30, 2008                         Change
                                  $                  %                 $                  %                $               %

Net revenue                  $   14,755            100.0 %        $   12,413            100.0 %        $ 2,342            18.9 %
Cost of revenue                   4,076             27.6               4,010             32.3               66             1.7

Gross margin                     10,679             72.4               8,403             67.7            2,276            27.1

Selling, general and
administrative                    6,992             47.4               6,200             49.9              792            12.8
Research and
development                         913              6.2                 806              6.5              107            13.3

Operating expenses                7,905             53.6               7,006             56.4              899            12.8

Operating income             $    2,774             18.8 %        $    1,397             11.3 %        $ 1,377            98.6 %

We generated net revenue of $14,755 in the second quarter of fiscal 2009, an increase of $2,342 or 19% from $12,413 in the year-ago quarter. The following table summarizes net revenue by product group and geography:

                                                   For the quarter ended
                                                         April 30,
                                           2009         %         2008         %

            Peri-Strips®                 $  4,969        34 %   $  4,317        35 %
            Biomaterial patch products      6,199        42 %      4,896        39 %
            Devices for microsurgery        2,101        14 %      1,793        15 %
            Surgical tools and other        1,486        10 %      1,407        11 %

            Total                        $ 14,755       100 %   $ 12,413       100 %


            Domestic                     $ 12,400        84 %   $ 10,387        84 %
            International                   2,355        16 %      2,026        16 %

            Total                        $ 14,755       100 %   $ 12,413       100 %

The increase in net revenue in the second quarter of fiscal 2009 compared to the prior-year was due to the following:
• Incremental worldwide units sold (inclusive of new product introductions) and product mix changes increased revenue approximately $1,875; and

• Higher average net selling prices, primarily due to various worldwide hospital list price increases for certain of our products, increased revenue by approximately $467.

The increase in worldwide units sales was primarily attributable to our direct sales force (which was expanded from 43 to 49 sales representatives in the first half of fiscal 2009) growing product sales, as well as increased market acceptance of Veritas® Collagen Matrix ("Veritas") into the domestic hernia and general surgery markets and Peri-Strips in the domestic and European markets.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED

Worldwide net revenue from Peri-Strips was $4,969 in the second quarter of fiscal 2009, an increase of 15% from $4,317 in the second quarter of fiscal 2008. Peri-Strips growth rate exceeded the estimated growth of procedures in which the product is used, which we believe was attributable to product performance, our direct sales force communicating the benefits of Peri-Strips, and the increased international market penetration of Peri-Strips. Peri-Strips is a bovine pericardium-based staple-line buttress used primarily to control bleeding and leakage of bodily fluids in various medical procedures, primarily gastric bypass surgery. Our Peri-Strips product line includes both linear and circular buttresses, and are produced in a wide assortment of sizes to fit staplers of the two leading surgical stapler companies.
Revenue from Biomaterial patch products increased $1,303 or 27% to $6,199 in the second quarter of fiscal 2009. A 50% increase in Veritas units sold in the current quarter, driven by the hernia, reconstructive and general surgery markets, was the primary driver of the increase. Veritas is a remodelable tissue platform used in surgery to repair and replace soft tissue. Other drivers of the revenue increase included a 9% increase in unit volumes of Tissue-Guard sold worldwide in the current quarter and list price increases of our Tissue-Guard and Veritas products in most worldwide geographies in the first half of fiscal 2009. Our Tissue-Guard family of products is a permanent tissue platform used to repair and replace damaged tissue in an array of surgical procedures, including cardiac, vascular, thoracic, and neurological procedures.
Revenue from devices for microsurgery was $2,101 in the second quarter of fiscal 2009, an increase of $308 or 17% from $1,793 in the year-ago quarter. The revenue growth was driven by Coupler unit sales growth of 22% in the current quarter as well as list price increases to the Coupler in late fiscal 2008. The Coupler is a device used to connect extremely small arteries or veins, without sutures, quickly, easily and with consistently excellent results.
Our gross margin increased to 72% in the second quarter of fiscal 2009 from 68% during the second quarter of fiscal 2008. The margin increase was due primarily to favorable product sales mix in the current period, improved production and overhead rate utilization associated with product sold in the current period and higher average net selling prices. Factors which affect gross margin include sales mix among geographies and product lines, volume and other production activities. Accordingly, our gross margins may fluctuate from period to period based on variations in these factors.
Selling, general and administrative ("SG&A") expense during the second quarter of fiscal 2009 was $6,992, an increase of $792 or 13% from SG&A expense of $6,200 in the second quarter of fiscal 2008. As a percentage of net revenue, SG&A expense was 47% in the second quarter of fiscal 2009 as compared to 50% in the prior-year quarter. The current quarter SG&A increase was due to the expansion of our direct sales force from 43 to 49 sales representatives in the first half of fiscal 2009, increased legal expense as well as general and administrative investments in new business development, clinical personnel and information technology. Additionally, stock-based compensation expense was $246 in the current quarter, up from $122 in the second quarter of fiscal 2008. In the second half of fiscal 2009, we expect to expand our domestic sales force by 16 sales representatives. Upon completion, we expect to have as many as 65 sales representatives by the end of fiscal 2009. In addition, we expect to invest in post market clinical study activity in fiscal 2009 to provide data in support of our product lines in several market indications. As a result, we expect SG&A expense to increase significantly in fiscal 2009 as compared to fiscal 2008.
Research and development ("R&D") expense totaled $913 during the second quarter of fiscal 2009 as compared to $806 in the prior-year quarter. R&D activity in the current quarter focused on several activities, including research to support current indications for use of Veritas, exploring potential opportunities for further expanding the indications for use of Veritas, improving the delivery system for our Peri-Strips products and advancing the technology of the Coupler, among others. R&D expense fluctuates from period to period based on the timing and progress of internal and external project-related activities and the timing of such expense will continue to be

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED

influenced primarily by the number of projects and the related R&D personnel requirements, development and regulatory approval path, and expected timing and nature of costs for each project.
We recorded operating income of $2,774 in the second quarter of fiscal 2009, an improvement of $1,377 compared to operating income of $1,397 in the second quarter of fiscal 2008. Interest income was $237 in the second quarter of fiscal 2009 compared with $575 in the second quarter of fiscal 2008, primarily due to lower investment yield in the current period.
We recorded a provision for income taxes in the second quarter of fiscal 2009 of $929 at an effective tax rate of 31%. In the second quarter of fiscal 2008 we recorded a provision for income taxes of $671 at an effective rate of 34%. On a year to date basis, our provision for income taxes reflects an effective tax rate of 33%, which is our current expected tax rate for fiscal 2009. Our fiscal 2009 effective tax rate is expected to be lower than the prior-year due to an expected lower overall rate for state taxes, primarily due to a change in state apportionment factors caused by the current expected mix of our product sales by state.
Comparison of the Six Months Ended April 30, 2009 with the Six Months Ended April 30, 2008 (in thousands except per share data) The following table summarizes our consolidated condensed operating results for the first six months of fiscal 2009 and fiscal 2008:

                                  For the six months ended                 For the six months ended
                                       April 30, 2009                           April 30, 2008                           Change
                                    $                   %                    $                   %                  $               %

Net revenue                   $    28,169               100.0 %        $    23,719               100.0 %        $ 4,450            18.8 %
Cost of revenue                     8,049                28.6                7,695                32.4              354             4.6

Gross margin                       20,120                71.4               16,024                67.6            4,096            25.6

Selling, general and
administrative                     13,339                47.3               11,855                50.0            1,484            12.5
Research and
development                         1,767                 6.3                1,489                 6.3              278            18.6

Operating expenses                 15,106                53.6               13,344                56.3            1,762            13.2

Operating income              $     5,014                17.8 %        $     2,680                11.3 %        $ 2,334            87.1 %

We generated net revenue of $28,169 in the first half of fiscal 2009, an increase of $4,450 or 19% from $23,719 in the year-ago period. The following table summarizes net revenue by product group and geography:

                                                 For the six months ended
                                                         April 30,
                                           2009         %         2008         %

            Peri-Strips                  $  9,844        35 %   $  8,202        34 %
            Biomaterial patch products     11,470        41 %      9,155        39 %
            Devices for microsurgery        3,886        14 %      3,546        15 %
            Surgical tools and other        2,969        10 %      2,816        12 %

            Total                        $ 28,169       100 %   $ 23,719       100 %


            Domestic                     $ 23,667        84 %   $ 19,846        84 %
            International                   4,502        16 %      3,873        16 %

            Total                        $ 28,169       100 %   $ 23,719       100 %

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED

The increase in net revenue in the first half of fiscal 2009 compared to the prior-year period was due to the following:
• Incremental worldwide units sold (inclusive of new product introductions) and product mix changes increased revenue approximately $3,580; and

• Higher average net selling prices, primarily due to various worldwide hospital list price increases for certain of our products, increased revenue by approximately $870.

The increase in worldwide units sales was primarily attributable to our direct sales force (which was expanded from 43 to 49 sales representatives in the first half of fiscal 2009) growing product sales, as well as increased market acceptance of Veritas into the domestic hernia and general surgery markets and Peri-Strips in the domestic and European markets.
Worldwide net revenue from Peri-Strips was $9,844 in the first two quarters of fiscal 2009, an increase of 20% from $8,202 in the same period of fiscal 2008. Peri-Strips growth rate exceeded the estimated growth of procedures in which the product is used, which we believe was attributable to product performance, our direct sales force communicating the benefits of Peri-Strips, and the increased international market penetration of PSD Veritas.
Revenue from Biomaterial patch products increased $2,315 or 25% to $11,470 in the first half of fiscal 2009 from $9,155 in the year-ago period. A 45% increase in Veritas units sold, driven by the hernia, reconstructive and general surgery markets, was the primary driver of the increase. Other drivers of the revenue increase included an 8% increase in unit volumes of Tissue-Guard sold worldwide in the current period and list price increases of our Tissue-Guard and Veritas products in most worldwide geographies in the first half of fiscal 2009. Revenue from devices for microsurgery was $3,886 in the first half of fiscal 2009, as compared to $3,546 in the year-ago period. The revenue growth was driven by Coupler unit sales growth of 10% in the current year as well as list price increases to the Coupler in late fiscal 2008.
Our gross margin increased to 71% in the first two quarters of fiscal 2009 from 68% during the comparative period of fiscal 2008. The margin increase was due primarily to favorable sales mix (geographic and product) in the current period, improved production and overhead rate utilization associated with product sold in the current period and higher average net selling prices.
SG&A expense during the first two quarters of fiscal 2009 was $13,339, an increase of $1,484 or 13% from SG&A expense of $11,855 in the first two quarters of fiscal 2008. As a percentage of net revenue, SG&A expense was 47% in the first half of fiscal 2009 as compared to 50% in the prior-year period. The SG&A increase was due to the expansion of our direct sales force from 43 to 49 sales representatives in the first half of fiscal 2009, increased legal expense as well as general and administrative investments in new business development, clinical personnel and information technology. Additionally, stock-based compensation expense was $440 (3 cents per diluted share) in the first half of fiscal 2009, up from $234 (1 cent per diluted share) in the first half of fiscal 2008.
R&D expense totaled $1,767 during the first two quarters of fiscal 2009, an increase of $278 or 19% from the prior-year period, driven by increased project activity during the current-year period. R&D activity in the first six months of fiscal 2009 focused on several activities, including research to support current indications for use of Veritas, exploring potential opportunities for further expanding the indications for use of Veritas, improving the delivery system for our Peri-Strips products and advancing the technology of the Coupler, among others.
We recorded operating income of $5,014 in the first six months of fiscal 2009, an improvement of $2,334 compared to operating income of $2,680 in the first six months of fiscal 2008. Interest income was $576 in the first half of fiscal 2009 compared with $1,160 in the first half of fiscal 2008, primarily due to lower investment yields in the current year.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED

We recorded a provision for income taxes in the first two quarters of fiscal 2009 of $1,845 at an effective tax rate of 33%. In the first half of fiscal 2008, we recorded income tax expense of $1,344 at an effective rate of 35%. Our fiscal 2009 effective tax rate is expected to be lower than the prior-year due to an expected lower overall rate for state taxes, primarily due to a change in state apportionment factors caused by the current expected mix of our product sales by state.
During the first half of fiscal 2008, we recorded a net gain on sale of our interventional business of $5,340 which reflected a pre-tax gain of $11,423 and a tax provision of $6,083. Approximately $4,100 of book basis goodwill had a tax basis of $0, thereby resulting in a higher gain for tax purposes. Additionally in the first half of fiscal 2008, we recorded a net loss related to our discontinued operations of $20. Included within the net loss from discontinued operations was an operating loss of $30 and a benefit from income taxes of $10. Liquidity and Capital Resources
Cash, cash equivalents, restricted cash and investments totaled $67,166 at April 30, 2009, a decrease of $7,622 from $74,788 at October 31, 2008. Included in the above, we have $11,279 of investments (inclusive of $5,367 of ARS) classified as non-current and $2,950 of restricted cash as of April 30, 2009. Working capital at April 30, 2009 and October 31, 2008 was $65,041 and $62,097, respectively. We have no long-term debt. We currently expect our cash and investments on hand, along with funds from operations to be sufficient to cover both of our short- and long-term operating requirements, subject however, to numerous variables, including research and development priorities, acquisition opportunities and the growth and profitability of the business.
The decrease in cash, cash equivalents, investments and restricted cash during the six months ended April 30, 2009 was primarily due to the use of cash of $8,126 to repurchase 496,000 shares of our common stock in the first quarter of fiscal 2009, partially offset by cash provided by operating activities of $2,595 for the six months ended April 30, 2009.
Operating activities provided cash of $2,595 in the first six months of fiscal 2009, as compared to using cash of $2,199 during the first six months of fiscal 2008. Net income of $3,745 and non cash items of $1,350 during the first six months of fiscal 2009 were partially offset by $2,500 of cash used for working capital requirements. The working capital use of cash was driven by payments for year-end accruals of stock repurchases, sales commissions and incentive compensation as well as maintaining higher accounts receivable balances driven by higher revenue levels. The use of cash in fiscal 2008 was driven by income tax payments made of $4,312 in the first six months of fiscal 2008, driven by the gain on sale of the interventional business combined with higher taxable income from our continuing operations. Cash flow from operating activities for the first six months of fiscal 2008 from continuing operations was approximately $2,300, while operating cash flows from discontinued operations used cash of approximately $4,500.
Investing activities used cash of $18,980 during the first six months of fiscal 2009 compared to cash provided of $60,471 during the first six months of fiscal 2008. In the first six months of fiscal 2009, we used cash of $19,396 to purchase short- and long-term municipal bonds as part of our investment strategy. We also recorded $609 in purchases of property, plant and equipment, compared to purchases of $694 in the first half of fiscal 2008. In the first two quarters of fiscal 2008 we had net proceeds of $33,840 from the sale of investments as we liquidated a majority of our ARS holdings. Additionally in the first six months of fiscal 2008, we recorded $30,440 in proceeds from the sale of the interventional business. As noted above, $2,950 of the sale proceeds were recorded as restricted cash.
Financing activities used cash of $8,016 in the first half of fiscal 2009, primarily for the stock repurchase program noted above. Proceeds from stock-based compensation plans totaled $101 in the first half of fiscal 2009, as compared to $882 in the first half of fiscal 2008.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED

At April 30, 2009, our investments included six auction rate securities ("ARS") with a par value of $9,000 and an estimated fair value of $5,367. One of our ARS is a senior debt obligation of the issuer, which is a financial services company that offers credit risk protection on structured financial assets in the form of credit derivatives. The other five ARS we own are governed under the requirements of the Regulation Triple-X reinsurance trust and backed by the securitization of life insurance premiums. These five securities are further backed by monoline insurance. In January 2009, we received a notice of default from the issuer of one of its Regulation Triple-X ARS investments due to the issuer's failure to make the interest payment for the month. As a result, the monoline insurer for the ARS made the interest payments to us for January 2009 and each scheduled payment since that time, and we are currently dependent upon the monoline insurer for the credit support (interest and principal) for this holding. The issuers of the Company's other ARS have continued to meet their debt interest payment obligations as contractually required.
At April 30, 2009, the ARS investments were not liquid as the auctions for the securities have continued to fail, and in the event we would need to access these funds, we would not be able to do so without a significant loss of principal, unless a future auction on these investments is successful, the broker dealer redeems the securities or the securities mature. Since August 2008, several issuing and distributing ARS dealers have announced settlement agreements with various government agencies whereby the dealers plan to repurchase their customers' ARS at par over an extended time period. During the first half of fiscal 2009, the states of Washington and California each filed charges against our third-party broker-dealer, alleging violations of state securities law and demanding, among other items, restitution at par value for all of the broker-dealer's client ARS. Our third-party broker-dealer is disputing these allegations. The future timing, proceedings and outcome of the ARS matter between the states of Washington and California and our broker-dealer is currently unknown.
As of April 30, 2009, our third-party broker-dealer had not provided an estimate of fair value for the ARS, and there was no observable ARS market information available. In the absence of such information, and taking into account the volatility in the overall investment markets, we performed a valuation assessment to provide a fair value estimate of our ARS as of April 30, 2009. The primary criteria we considered in the fair value assessment of our ARS included the complexity and transparency of the investment's structure, the quality of collateral underlying each security (including monoline insurance where applicable), the current trading environment of the securities and a net present value ("NPV") model based on estimated future cash flows. Our NPV model assumptions considered the probability of a successful auction in the future, the probability of issuer and/or monoline insurer default, an estimated interest rate risk premium to account for the lack of current liquidity, and management's judgment, among other criteria. Furthermore, we deemed the assumptions applied . . .