Summary of SYNOVIS LIFE TECHNOLOGIES INC

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 such as Pegasus Biologics, 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, orthopedic, cardiac, thoracic, woundcare, neurological and microsurgery.
As discussed in Note 2 to our unaudited consolidated condensed financial statements, on July 17, 2009, we acquired, through our wholly-owned subsidiary Synovis Orthopedic and Woundcare, Inc., substantially all of the assets of Pegasus Biologics, Inc., located in Irvine, California. Operating results for Synovis Orthopedic and Woundcare, Inc. ("Ortho & Wound") from July 17, 2009 to July 31, 2009 are included in the Consolidated Condensed Statement of Operations for the three and nine month periods ended July 31, 2009. The assets acquired in the transaction are included in the Company's Consolidated Condensed Balance Sheet as of July 31, 2009 and the purchase transaction has been included in the Consolidated Condensed Statement of Cash Flows for the nine month period ended July 31, 2009.
As discussed in Note 3 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 three quarters ended July 31, 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.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Results of Operations
Comparison of the Three Months Ended July 31, 2009 with the Three Months Ended
July 31, 2008 (in thousands except per share data)
The following table summarizes our consolidated condensed operating results for
the third quarter of fiscal 2009 and fiscal 2008:

                                 For the quarter ended                For the quarter ended
                                     July 31, 2009                        July 31, 2008                          Change
                                  $                  %                 $                  %                $                %
Net revenue                  $   15,032            100.0 %        $   13,366            100.0 %        $  1,666            12.5 %
Cost of revenue                   4,257             28.3               4,171             31.2                86             2.1

Gross margin                     10,775             71.7               9,195             68.8             1,580            17.2

Selling, general and
administrative                    7,384             49.1               6,070             45.4             1,314            21.6
Research and
development                         945              6.3                 847              6.4                98            11.6
Other                             4,100             27.3                   0              0.0             4,100             n/m

Operating expenses               12,429             82.7               6,917             51.8             5,512            79.7

Operating
(loss) income                $   (1,654 )          (11.0 %)       $    2,278             17.0 %        $ (3,932 )           n/m

We generated net revenue of $15,032 in the third quarter of fiscal 2009, an increase of $1,666 or 12% from $13,366 in the year-ago quarter. The following table summarizes net revenue by product group and geography:

                                                   For the quarter ended
                                                         July 31,
                                           2009          %        2008          %
            Biomaterial patch products   $  6,395        43 %   $  4,987        37 %
            Peri-Strips®                    4,833        32 %      4,783        36 %
            Devices for microsurgery        2,414        16 %      2,191        16 %
            Surgical tools and other        1,390         9 %      1,405        11 %
            Orthopedic and woundcare            0         0 %          0         0 %

            Total                        $ 15,032       100 %   $ 13,366       100 %


            Domestic                     $ 12,705        84 %   $ 11,345        85 %
            International                   2,327        16 %      2,021        15 %

            Total                        $ 15,032       100 %   $ 13,366       100 %

The increase in net revenue in the third quarter of fiscal 2009 compared to the prior-year quarter was due to the following:
- Incremental worldwide units sold and product mix changes increased revenue approximately $1,190; and

- Higher average net selling prices, primarily due to various worldwide hospital list price increases for certain of our products, increased revenue by approximately $475.

We believe that expansion of our direct sales force is a key long-term strategy to increase revenues. During the first half of fiscal 2009, we expanded our direct sales force from 43 to 49 sales representatives in the U.S. In the second half of fiscal 2009, we expect to hire 16 additional sales representatives (excluding sales representatives expected to be hired for Ortho & Wound), giving us a total of 65 sales representatives in the U.S. In the third quarter of fiscal 2009, we hired 11 of the 16 additional sales representatives. We expect to hire the remaining 5 additional sales

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
representatives in the fourth quarter, giving us a total of 65 sales representatives by the end of fiscal 2009. The additional sales representatives were added with the expectation to grow revenues long-term; however, our sales expansion strategies have shifted sales management time and focus in the third quarter from short-term sales growth activities towards our longer-term strategy of hiring qualified, experienced sales personnel.
In addition to the impacts of our direct sales force expansion, the increase in worldwide units sales was primarily attributable to increased market acceptance of Veritas® Collagen Matrix ("Veritas") into the domestic hernia and general surgery markets and Peri-Strips in the European market.
We cannot fully assess the impact that the current economic downturn may have had on our results of operations. We believe, however, that the volume of certain surgical procedures in which our products are used, particularly those which may be considered elective, have been impacted by the current economic downturn. In addition, we believe the financial condition of certain of our hospital customers have been negatively impacted by the economic downturn. The impact of these items, as well as other factors, may be impacting our results of operations.
Revenue from biomaterial patch products increased $1,408 or 28% to $6,395 in the third quarter of fiscal 2009. An 82% increase in Veritas revenue in the current quarter was driven by sales into the domestic hernia, reconstructive and general surgery markets. 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 three quarters 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.
Worldwide net revenue from Peri-Strips was $4,833 in the third quarter of fiscal 2009, an increase of $50 from $4,783 in the third quarter of fiscal 2008. 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.
We believe increased market acceptance of Peri-Strips in the European market has been offset by the impact of increasing competition within the buttressing market. We believe Covidien, one of the two primary stapler companies, launched a buttress product integral with their staplers on a limited basis in early 2009 and fully launched in April 2009. During the third quarter, worldwide revenue from Peri-Strips products which adhere to Covidien staplers decreased 23% from the second quarter of fiscal 2009. This was partially offset by revenue for other Peri-Strips products increasing 10%. We are addressing the Covidien competitive threat through our expanded direct sales force, the development of product enhancements and strengthened efforts to convert additional non-buttressing surgeons.
Revenue from devices for microsurgery was $2,414 in the third quarter of fiscal 2009, an increase of $223 or 10% from $2,191 in the year-ago quarter. This revenue growth was driven by increased list prices for certain microsurgery products, most notably the Coupler. The Coupler is a device used to connect extremely small arteries or veins, without sutures, quickly, easily and with consistently excellent results.
We did not record any revenue from our newly acquired Ortho & Wound business in the third quarter of fiscal 2009. We are in the process of obtaining the California Department of Public Health manufacturing license necessary to repackage acquired inventory with Synovis labeling, as well as to manufacture new products. We presently expect to obtain this license late in our fiscal 2009 fourth quarter, and to begin manufacturing and selling Ortho & Wound product at that time.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
Our gross margin increased to 72% in the third quarter of fiscal 2009 from 69% during the third 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. We expect our overall gross margin to decrease in the future as we begin to sell our Ortho & Wound products. The gross margin of Ortho & Wound products will be lower as we sell the acquired inventory, which has a stepped-up basis, and due to expected unabsorbed manufacturing costs as we initiate Ortho & Wound manufacturing activity. 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 third quarter of fiscal 2009 was $7,384, an increase of $1,314 or 22% from SG&A expense of $6,070 in the third quarter of fiscal 2008. As a percentage of net revenue, SG&A expense was 49% in the third quarter of fiscal 2009 as compared to 45% in the prior-year quarter. The current quarter SG&A increase was due to the expansion of our direct sales force from 43 to 60 sales representatives in the first three quarters of fiscal 2009, $206 of operating expenses related to our Ortho & Wound business, increased legal expense as well as general and administrative investments in personnel and information technology. Additionally, stock-based compensation expense was $252 (2 cents per share) in the current quarter, up from $128 (1 cent per share) in the third quarter of fiscal 2008.
In the fourth quarter of fiscal 2009, we expect to incur significant additional operating expense as compared to the third quarter of fiscal 2009. This is expected to be driven by a full quarter of expense related to our expanded sales force, as well as expense related to operations of our acquired Ortho & Wound business. We will incur a full quarter of Ortho & Wound operating activity as compared to two weeks of operating activity in the third quarter. We presently expect Ortho & Wound operating costs in the fourth quarter of fiscal 2009 to be between $1,200 and $1,500.
Research and development ("R&D") expense totaled $945 during the third quarter of fiscal 2009 as compared to $847 in the prior-year quarter. 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. We do not expect to incur material R&D expense related to our Ortho & Wound business in the fourth quarter of fiscal 2009. 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 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.
In the third quarter of fiscal 2009, we recorded other operating expenses of $4,100. First, we expensed acquired in-process R&D costs of $3,500 related to our acquisition of the assets of Pegasus, as it was determined the related projects had not achieved technological feasibility. Second, we recorded an impairment charge of $600 related to identifiable intangible assets related to our fiscal 2007 acquisition of the 4Closure™ Surgical Fascia Closure System ("4Closure") following an impairment analysis. This analysis was performed as a result of a delay in the expected third quarter of fiscal 2009 re-launch and re-brand of the product, combined with actual revenues since acquisition not meeting projected expectations. No such other operating expenses were recorded in the third quarter of fiscal 2008.
We recorded an operating loss of $1,654 in the third quarter of fiscal 2009, compared to operating income of $2,278 in the third quarter of fiscal 2008. The operating loss in the third quarter of fiscal 2009 was driven by the acquired in-process R&D expense of $3,500 and identifiable intangible asset impairment of $600 discussed above.
Interest income was $190 in the third quarter of fiscal 2009 compared with $430 in the third quarter of fiscal 2008, primarily due to lower investment yield in the current period and lower overall investment balances. We recorded

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
an impairment of $4,100 related to an other-than-temporary write-down of our auction rate securities ("ARS") due to a change in our intent and ability to hold these investments until a complete recovery of par value.
We recorded a benefit from income taxes in the third quarter of fiscal 2009 of $690. This benefit is at an effective tax rate of 47% of pretax income excluding the $4,100 impairment of ARS. The $4,100 impairment represents a capital loss, and we presently do not believe we will have future capital income to realize the benefit. As such, we did not record any tax benefit related to the ARS impairment. In the third quarter of fiscal 2008 we recorded a provision for income taxes of $948 at an effective rate of 35%.
On a year to date basis, our provision for income taxes reflects our current expected effective tax rate for fiscal 2009 of 28% on pretax income excluding the $4,100 capital loss on ARS. Our fiscal 2009 effective tax rate is expected to be lower than the prior-year due to lower pretax income as well as 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. Our current expected fiscal 2009 effective tax rate is lower than the 33% rate we had recorded through our second quarter of fiscal 2009. Our current expected pretax fiscal 2009 income used to estimate our effective tax rate decreased in the third quarter due to costs incurred and expected to be incurred related to our acquired Ortho & Wound business, as well as the impairment of identifiable intangible assets in the third quarter of fiscal 2009. Our current estimate of permanent items is consistent with our estimate made in the second quarter.
Comparison of the Nine Months Ended July 31, 2009 with the Nine Months Ended July 31, 2008 (in thousands except per share data) The following table summarizes our consolidated condensed operating results for the first nine months of fiscal 2009 and fiscal 2008:

                                   For the nine months ended                 For the nine months ended
                                         July 31, 2009                             July 31, 2008                             Change
                                     $                    %                    $                    %                  $                 %

Net revenue                    $     43,201               100.0 %        $     37,085               100.0 %        $  6,116             16.5 %
Cost of revenue                      12,306                28.5                11,866                32.0               440              3.7

Gross margin                         30,895                71.5                25,219                68.0             5,676             22.5

Selling, general and
administrative                       20,723                47.9                17,925                48.3             2,798             15.6
Research and development              2,712                 6.3                 2,336                 6.3               376             16.1
Other                                 4,100                 9.5                     -                   -             4,100              n/m

Operating expenses                   27,535                63.7                20,261                54.6             7,274             35.9

Operating income               $      3,360                 7.8 %        $      4,958                13.4 %        $ (1,598 )          (32.2 %)

We generated net revenue of $43,201 in the first three quarters of fiscal 2009, an increase of $6,116 or 16% from $37,085 in the year-ago period. The following table summarizes net revenue by product group and geography:

                                           For the nine months ended
                                                    July 31,
                                          2009           %         2008         %
          Biomaterial patch products   $   17,865         41 %   $ 14,142        39 %
          Peri-Strips                      14,677         34 %     12,985        35 %
          Devices for microsurgery          6,300         15 %      5,737        15 %
          Surgical tools and other          4,359         10 %      4,221        11 %
          Orthopedic and woundcare              0          0 %          0         0 %


          Total                        $   43,201        100 %   $ 37,085       100 %


          Domestic                     $   36,372         84 %   $ 31,191        84 %
          International                     6,829         16 %      5,894        16 %

          Total                        $   43,201        100 %   $ 37,085       100 %

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
The increase in net revenue in the first three quarters 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 $4,770; and

- Higher average net selling prices, primarily due to various worldwide hospital list price increases for certain of our products, increased revenue by approximately $1,345.

The increase in worldwide units sales was primarily attributable to our expanding direct sales force 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.
Revenue from biomaterial patch products increased $3,723 or 26% to $17,865 in the first three quarters of fiscal 2009 from $14,142 in the year-ago period. An 83% increase in Veritas revenue in the first three quarters of fiscal 2009 was driven by sales into the domestic hernia, reconstructive and general surgery markets. 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 three quarters of fiscal 2009.
Worldwide net revenue from Peri-Strips was $14,677 in the first three quarters of fiscal 2009, an increase of 13% from $12,985 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, partially offset by increased competition.
Revenue from devices for microsurgery was $6,300 in the first three quarters of fiscal 2009, as compared to $5,737 in the year-ago period. This revenue growth was driven by Coupler unit sales growth in the current year as well as list price increases to the Coupler in late fiscal 2008.
Our gross margin increased to 72% in the first three 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 three quarters of fiscal 2009 was $20,723, an increase of $2,798 or 16% from SG&A expense of $17,925 in the first three quarters of fiscal 2008. As a percentage of net revenue, SG&A expense was 48% in both the first three quarters of fiscal 2009 and 2008. The SG&A increase was due to the expansion of our direct sales force from 43 to 60 sales representatives in the first three quarters of fiscal 2009, $206 of operating expenses related to our Ortho & Wound business, 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 $687 (4 cents per share) in the first three quarters of fiscal 2009, up from $362 (2 cents per share) in the first three quarters of fiscal 2008.
R&D expense totaled $2,712 during the first three quarters of fiscal 2009, as compared to $2,336 in the first three quarters of fiscal 2008. R&D activity in the first three quarters 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.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
In the first three quarters of fiscal 2009, we recorded other operating expenses of $4,100. First, we expensed acquired in-process R&D costs of $3,500 related to our acquisition of the assets of Pegasus, as it was determined the related projects had not achieved technological feasibility. Second, we recorded an impairment charge of $600 on identifiable intangible assets related to our fiscal 2007 acquisition of 4Closure following an impairment analysis. This analysis was performed as a result of a delay in the expected third quarter of fiscal 2009 re-launch and re-brand of the product, combined with actual revenues since acquisition not meeting projected expectations. No such other operating expenses were recorded in the first three quarters of fiscal 2008. We recorded operating income of $3,360 in the first three quarters of fiscal 2009, as compared to operating income of $4,958 in the first three quarters of fiscal 2008. The decrease in operating income in the first three quarters of fiscal 2009 as compared to the prior-year period was driven by the acquired in-process R&D expense of $3,500 and the identifiable intangible asset impairment of $600. . . .