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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
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For the fiscal year ended December 31, 1996 Commission File number 0-19278
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OSTEOTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3357370
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
51 James Way, Eatontown, New Jersey 07724
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(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (908) 542-2800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
(Title of class)
Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
The aggregate market value of the Common Stock, par value $.01 per
share, held by non-affiliates based upon the reported last sale price of the
Common Stock on March 3, 1997 was approximately $60,079,950.
As of March 3, 1997, there were 7,909,787 shares of Common Stock, par
value $.01 per share, outstanding.
The Index to Exhibits appears on page E-1.
Documents Incorporated by Reference
The registrant's definitive 1997 Proxy Statement which will be filed
pursuant to Regulation 14A is incorporated by reference into Part III of this
Annual Report on Form 10-K.
OSTEOTECH, INC.
1996 Form 10-K Annual Report
TABLE OF CONTENTS
Page
PART I
Item 1. Business......................................... 1
Item 2. Properties....................................... 21
Item 3. Legal Proceedings................................ 21
Item 4. Submission of Matters to a Vote of
Security Holders.............................. 23
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters.......................... 24
Item 6. Selected Financial Data................................. 25
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 26
Item 8. Financial Statements and Supplementary Data............. 30
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure............... 30
PART III
Item 10. Directors and Executive Officers of the
Registrant.................................... 31
Item 11. Executive Compensation........................... 31
Item 12. Security Ownership of Certain Beneficial
Owners and Management......................... 31
Item 13. Certain Relationships and Related Transactions... 31
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K........................... 32
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The following trademarks and service marks appear in this Annual
Report: PolyActive(TM) and OsteoActive Bone Substitute(TM) are trademarks and
Osteotech(R), Alloprep System(R) Allograft Tissue Reconstitution Solution, and
Grafton(R) Demineralized Bone Matrix are registered trademarks of Osteotech,
Inc.; D-Min(R) Aseptic Tissue Demineralization is a registered service mark of
Osteotech, Inc.; and USIS(R) is a registered trademark of Heinrich C. Ulrich,
KG.
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PART I
Item 1. Business
Introduction
Osteotech, Inc. (the "Company" or "Osteotech"), formed in 1986,
provides services and develops and markets products to the orthopaedic,
neurological, oral/maxillofacial, dental and general surgical markets in the
United States and Europe. The Company's current technology, products and
services, and those under development, are focused primarily on the repair and
healing of the musculoskeletal system. Osteotech is engaged in processing human
allograft bone, ligaments and tendons (collectively, "bone tissue") for
transplantation, ceramic (hydroxyapatite) and titanium plasma spray coating
services and producing and marketing ceramic based products to the orthopaedic,
dental and ear, nose and throat ("ENT") implant markets. The Company is the
exclusive United States distributor of all spinal instruments and implants
manufactured by Heinrich C. Ulrich, KG ("Ulrich"), a medical device company
based in Ulm, Germany.
Overview
Bone and related tissue transplants are often necessary to correct
deformities and repair and reconstruct defects caused by congenital
malformations, trauma, infections, cancer and other diseases. For such
procedures the surgeon may use autograft bone tissue, allograft bone tissue or a
combination of both. Autograft bone tissue is acquired from another part of the
patient's skeleton, most often by an additional operative procedure. Allograft
bone tissue is bone tissue previously obtained from cadavers or surgical patient
donors. The Company estimates that the current total U.S. bone graft market is
approximately $406 million annually, of which allograft bone grafting procedures
constitute approximately $122 million.
Allograft tissue is procured by a network of bone banks, substantially
all of which are not-for-profit organizations. Management believes, based upon
its knowledge of the industry, that the Company processes more allograft bone
tissue than any other processor in the world. Certain of the Company's
competitors, particularly those involved with synthetic bone substitute
materials, attempt to compete by fostering a perception that utilization of
processed allograft human bone tissue poses a significant threat of infectious
disease transmission. To the Company's knowledge, none of the approximately
1,200,000 transplanted grafts it has processed since it commenced processing
bone tissue in 1987 have resulted in a confirmed transmission of infectious
disease. This record is due to the rigorous donor
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screening and tissue recovery techniques employed by the Company's clients,
extensive donor testing, as well as Osteotech's demanding quality assurance and
processing protocols.
Osteotech processes allograft bone tissue for its customers which pay
the Company fees, on a per donor basis, for processing, finishing and packaging
their tissue. Once processed, the bone tissue is returned to these customers for
distribution to surgeons and medical institutions. The surgeons and medical
institutions pay the Company's customers' fees established by such customers.
The surgeons and medical institutions in turn charge their patients for the
various aspects of transplant surgery performed by them, including standard
charges established by the surgeon or institution for each unit of processed
bone tissue used. The cost to the patient for the processed bone tissue is
generally reimbursable by medical insurance carriers as part of the overall cost
of the procedure.
Processing by the Company yields a wide array of freeze-dried, frozen
and demineralized bone tissue that is used by orthopaedic, neurological,
plastic, dental, periodontal and oral/maxillofacial surgeons to repair and
replace bone loss caused by trauma or certain disease states, augment prosthetic
implant procedures, replace damaged ligaments and tendons and in connection with
spinal fusion procedures. Osteotech believes its processing methods, its
customers' tissue recovery techniques and the multiple screening and testing
procedures employed, reduce the risk of transmissions of infectious agents and
the potential toxicity of the allografts. Studies completed by an independent
testing laboratory specializing in viral inactivation studies demonstrated that
a proprietary demineralization process of the Company can virtually inactivate
and eliminate the HIV virus (the process reduces the probability of transmission
of the HIV virus to one in 2.8 billion), as well as the hepatitis B, hepatitis
C, cytomeglia and polio viruses. In addition to its proprietary demineralization
process, Osteotech expects to begin to implement additional processing
technologies in 1997 that once fully implemented will enable the Company to
expand its viral inactivation claims to include virtually all of the bone tissue
it processes. These proprietary, tissue-specific technologies are expected to
further enhance graft safety while maintaining the tissue's biologic and
physical properties. There can be no assurance, however, that despite the
quality control measures employed by the Company and its customers and the
processing methods utilized by the Company, processed bone tissue will be free
of infectious agents, including the HIV virus and hepatitis. See "Services and
Products - Allograft Processing Technology" and "Product Liability and
Insurance."
Osteotech processes allograft bone tissue pursuant to contracts with
several large national and international not-for-profit organizations which are
responsible for donor procurement and distribution of the processed bone tissue.
The Company is the
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exclusive processor for two of the largest tissue procurement organizations in
the United States - the Musculoskeletal Transplant Foundation ("MTF"), an
organization comprised of medical teaching institutions and independent
procurement agencies and American Red Cross Tissue Services ("ARC"). The Company
is also the exclusive processor for BioImplant Services, The Netherlands.
Industry data indicates that utilization of allograft bone tissue in
musculoskeletal surgical procedures is continuing to increase. The Company
estimates that the current total U.S. bone graft market is approximately $406
million annually, of which the allograft segment, which grew approximately 20%
in 1996, is approximately $122 million. Some of the factors contributing to the
increased utilization of allograft bone tissue include:
. increasing frequency of surgical procedures that
incorporate bone grafting techniques;
. the desire by surgeons to avoid the additional procedure
needed to acquire autograft bone tissue, which often
increases operating time and risks such as excessive
blood loss, infection, chronic pain and deformity;
. increased awareness by, and training of, the medical
community with respect to the use and safety of processed
allograft tissue;
. an increase in the number of patients who do not possess
the quality of bone tissue required for autograft
procedures as a result of the general aging of the
population; and
. an increase in the availability of allograft bone tissue
due to improved recovery and processing techniques and an
increase in bone tissue donations.
Allograft bone tissue is utilized in surgical procedures because of its
biomechanical and biologic properties. Bone from various locations in the body
can be processed to yield either dense cortical bone, porous cancellous bone or
units comprised of both cortical and cancellous bone. Cortical bone, the thick
outer portion of bone, provides biomechanical strength which gives the bone
weight-bearing properties, and therefore, is commonly used in surgery on the
extremities and the spine and in other procedures requiring strong transplant
material. Cancellous bone, the spongy internal tissue, is preferable for
surgical procedures, or aspects thereof, in which rapid penetration of new bone
into the pores of the transplant (a process known as osteoconduction) is
desirable but where the weight-bearing strength of the graft is not paramount.
Therefore, cancellous bone is often used to fill smaller areas of bone loss and
to augment more extensive
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reconstructive procedures, including knee and hip replacements. Most procedures
using allograft bone tissue, however, employ a combination of cortical and
cancellous bone in a variety of forms, shapes and sizes.
Through its subsidiary, HC Implants BV ("HC Implants"), based in
Leiden, The Netherlands, the Company was involved in manufacturing, marketing
and developing products utilizing its PolyActive polymer. In October 1996, the
Company discontinued development activities related to its PolyActive polymer.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations". HC Implants' subsidiary, CAM Implants BV ("CAM"), is providing
ceramic hydroxyapatite ("HA") plasma spray coating services to the European
orthopaedic and dental implant markets and also produces and markets ceramic
products for use in orthopaedic, dental and ENT surgical implant procedures in
Europe. Through a joint venture with APS-Materials, Inc. ("APS"), CAM has
expanded its operations in Europe to include titanium and combination
titanium-HA plasma spray coating services. HC Implants' subsidiary, CAM
Implants, Inc., has licensed its ceramic plasma spray coating operations in the
United States and Canada to APS. See "Services and Products - Ceramic Plasma
Spray Coating Services and Products."
In 1993, the Company entered into an agreement for the exclusive United
States marketing and distribution rights for the Universal Spine Instrumentation
System (USIS(R)) and all other implants and instruments for spine surgery
developed by Ulrich. Included in the USIS product group is the Zielke VDS spinal
implant system, which is comprised of instruments and implants used by
orthopaedic and neurological surgeons to correct curvatures of the spine caused
by disease, trauma and degeneration, and is currently in use worldwide.
Information contained throughout this Annual Report contains
"forward-looking statements" which can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should," or "anticipates" or the negative thereof or other variations thereon
or comparable terminology, or by discussions of strategy. No assurance can be
given that the future results covered by the forward-looking statements will be
achieved. Some of the matters set forth herein constitute cautionary statements
identifying important factors with respect to such forward-looking statements,
including certain risks and uncertainties, that could cause actual results to
vary materially from the future results indicated in such forward-looking
statements. Other factors could also cause actual results to vary materially
from the future results indicated in such forward-looking statements.
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Company Strategy
Since its formation in 1986, Osteotech has become the world's largest
processor of allograft bone tissue. The Company's strategy is to use its
position as a leader in this field to continue to educate the medical community
and the general public as to the benefits of allograft bone grafting procedures,
thereby increasing surgeon and patient demand for allograft bone tissue which
has been processed by Osteotech. The Company will also seek to use its expertise
in the allograft processing area to develop new forms of bone tissue and
products with a broader range of applications in musculoskeletal surgery, as
well as to increase the potential tissue yield from a single donor. In
furtherance of this goal, the Company has developed and is utilizing an advanced
proprietary demineralization process which, when applied to cortical bone,
results in allograft bone tissue which the Company believes retains osteogenic
capabilities greater than those of most currently available forms of allograft
bone tissue. As a result, the Company has been able to successfully introduce
the use of demineralized bone tissue in a broad spectrum of orthopaedic
procedures. See "Services and Products - Allograft Processing Technology."
Osteotech's leadership in allograft tissue processing continues to
strengthen through Grafton(R) Demineralized Bone Matrix ("Grafton DBM"), the
Company's innovative and proprietary demineralized bone grafts.
Grafton DBM Gel, the Company's first Grafton form, introduced in 1991,
offers surgeons unique handling characteristics when performing bone graft
procedures as part of spinal fusions, joint replacements and the repair of
osseous defects. With the introductions of two new innovative forms of Grafton
in 1996, Grafton DBM Flex and Grafton DBM Putty, plus wider distribution and
deeper market penetration achieved through a combination of effort by a national
network of independent agents and the Company's direct marketing force, the
Company anticipates further growth for Grafton processed allograft tissue. The
Company's Grafton DBM forms have been utilized in over 120,000 procedures.
In January 1996, Osteotech introduced Grafton DBM Flex. Grafton DBM
Flex is a flexible "pressed fiber" form of demineralized bone which for the
first time gives surgeons a pliable form of bone graft. Initially available in
5cm by 5cm square and 2.5cm by 10cm strips, Grafton DBM Flex conforms to the
body's natural anatomy and can be easily cut for precise adaptation to host
bone.
Additionally, in November 1996, Osteotech introduced Grafton DBM Putty,
a moldable, putty-like graft of entangled fibers of demineralized bone, which is
easily mixed with marrow and other grafts.
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Supporting the Company's Grafton DBM expansion is Osteotech's national
network of independent sales agencies. Specializing in orthopaedic products,
these agents develop and manage surgeon relationships in partnership with the
Company's direct field marketing organization. This two-pronged strategy affords
Osteotech the best opportunity to gain maximum coverage and market penetration
for its Grafton DBM processed allograft tissue. At the end of 1996, the network
totaled 47 agents and 216 representatives.
The Company believes that the product development and marketing
conducted by its subsidiaries in The Netherlands furthers the Company's strategy
of positioning itself as a provider of services and products in the areas of
musculoskeletal and general surgery, and that the Company's European operations
complement Osteotech's position in the United States orthopaedic and dental
markets. See "Services and Products - Ceramic Plasma Spray Coating Services and
Products" and "Research and Development."
In furtherance of its goal to become a leading provider of services and
products for musculoskeletal repair and to further leverage its marketing
force's contacts with orthopaedic and neurological surgeons, during 1993 the
Company obtained the exclusive United States' marketing rights to the USIS
spinal implant products and all other devices and instruments for spinal surgery
developed by Ulrich. Osteotech plans to continue expanding its line of spinal
implant devices and instrumentation through its relationship with Ulrich.
Subject to appropriate regulatory approvals and Osteotech obtaining appropriate
product liability insurance coverage, a spinal implant system currently in use
in several European countries and South Africa -- the SSCS System -- is being
readied for introduction in the U.S. The SSCS System offers surgeons a
proprietary hinge screw design that allows for load sharing and improves the
potential fusion rate in posterior thoracic and lumbar fusion procedures.
Services and Products
Allograft Processing Technology
Unlike organs which require transplantation within hours of recovery,
allograft bone tissue generally goes through a processing phase in which it is
cleaned, cut into different sizes and forms for specific surgical procedures,
preserved, packaged and labelled. Osteotech processes its customers' tissue
utilizing technology which yields a wide array of freeze-dried, frozen and
demineralized bone tissues. Frozen tissues include whole bones and major
sections thereof, bone segments, tendons and ligaments. Freeze-dried bone
tissues include various wedges, strips, struts, dowels, cancellous cortical
chips, blocks, strips and ribs. Demineralized bone tissue includes cortical
powders, segments and struts.
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The suitability of an allograft is partly dependent on the methods and
conditions used in the processing of the tissue. Processing includes the removal
of certain portions of the bone tissue in a manner which enables the tissue to
maintain as much of the native biological characteristics relating to the use of
such tissue in bone grafting procedures as possible. To provide suitable
allografts, techniques have been developed that minimize the use of chemicals
and procedures that might render the allograft less suitable for use as a graft.
The Company processes allograft tissue in a microbially-controlled environment,
substantially cleaner than that of a typical hospital operating room, created
through the use of advanced air filtration, water distillation and mineral
control systems and other "clean room" techniques. The Company believes that its
use of such clean room techniques, a controlled environment, in-line
disinfection and other technologies preserves the properties of the tissues that
make them suitable as grafts and address the medical community's and the general
public's perceptions and concerns regarding the possible transmission of
infectious disease and toxicity. Once processed using Osteotech's current
methods, freeze-dried bone tissues may be stored for up to three years and
frozen bone tissues may be stored for up to five years before they must be used
or discarded.
The Company has developed a proprietary demineralization process for
cortical bone which it believes yields a form of allograft bone tissue which can
be used to aid in the formation of new bone through the processes of
osteoconduction and osteoinduction. Osteoconduction is the process of providing
the matrix into which bone will grow and osteoinduction is the process by which
bone is induced to grow. Cortical bone is believed to be the principal reservoir
for various factors which are instrumental in osteoinduction. These biological
properties of cortical bone, however, are inhibited by the bone's structure and
various minerals, lipids and other substances comprising the bone. The Company's
process removes these inhibiting factors.
Grafton DBM Gel, the Company's first Grafton DBM form, was introduced
in 1991. Grafton DBM Gel utilizes the Company's proprietary demineralization
process and offers surgeons unique handling characteristics when performing bone
graft procedures as part of spinal fusions, joint replacements and repairs of
osseous defects. With the introductions of the two new innovative forms of
Grafton DBM in 1996, Grafton DBM Flex and Grafton DBM Putty, plus wider
distribution and deeper market penetration utilizing the national network of
independent agents in combination with the Company's direct marketing force, the
Company anticipates further growth in the use of Grafton DBM processed allograft
tissue. To date, the Company's Grafton DBM forms have been utilized in over
120,000 procedures.
In January, 1996, Osteotech introduced Grafton DBM Flex.
Grafton DBM Flex is a flexible "pressed fiber" form of
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demineralized bone which for the first time gives surgeons a pliable form of
bone graft. Initially available in 5cm by 5cm squares and 2.5cm by 10cm strips,
Grafton DBM Flex conforms to the body's natural anatomy and can be easily cut
for precise adaptation to host bone.
Additionally, in November 1996, Osteotech introduced Grafton DBM Putty,
a moldable, putty-like graft of entangled fibers of demineralized bone, which is
easily mixed with marrow and other grafts.
The FDA has the statutory authority to regulate allograft processing
and allograft-based bone tissue. On December 14, 1993, the FDA issued interim
rules regulating the recovery, processing, storage and distribution of banked
human tissue, including allograft bone tissue. In August 1995, the FDA
designated Grafton DBM as within the scope of the definition of banked human
tissue under the interim rules. See "Government Regulations."
Ceramic Plasma Spray Coating Services and Products
The Company is providing ceramic HA plasma spray coating services
generally to large orthopaedic and dental implant companies in Europe. The
primary advantage of coating orthopaedic and dental prosthetic devices with HA
is that it enables bone to grow into the implanted device, thus enhancing the
stability of the device. Increased stability for implanted medical devices
should lower the amount of bone loss incurred over time and result in a
significant reduction in pain caused by micro motion of the device. The Company
manufactures the HA powder which it uses in its plasma spray coating operations
from raw materials which are readily available from several sources. The Company
also supplies HA powder to various companies for use in their in-house plasma
spray coating operations. Additionally, the Company produces HA products which
are used to replace middle ear bones and for the repair of bone defects in
dental applications. Further, the Company is pursuing opportunities to utilize
its ceramic powders and technology as key components of products being developed
by other companies for the orthopaedic and incontinent care markets as well in
non-medical uses.
To enhance its plasma spray coating services to the orthopaedic and
dental implant markets and to reduce plasma spray coating operating costs, in
September 1993 the Company entered into a joint venture agreement with APS.
Pursuant to this agreement, in addition to its HA plasma spray coating services,
the Company began offering titanium and combination titanium-HA plasma spray
coating services in Europe. Titanium, like HA coating, is applied to prosthetic
devices to facilitate attachment of bone to the prothesis. Under the agreement,
the Company makes all decisions regarding the joint venture business and manages
its daily
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operations, and the Company's personnel perform the spray coating services, all
in return for a fee. The parties share equally in the joint venture's income and
losses. The joint venture absorbs certain of the Company's facility and
personnel costs because it utilizes the Company's facility and personnel in The
Netherlands.
The Company granted an exclusive license, with no right to sublicense,
to its HA plasma spray coating technology, to APS for the United States and
Canada. APS provides HA, titanium and combination HA-titanium plasma spray
coating services. The Company transferred to APS at its Dayton, Ohio facility,
the equipment and technology used in connection with the Company's HA plasma
spray coating services for APS' use during the term of the agreement. Under the
agreement, APS is required to pay the Company a royalty equal to 15% of net
sales of HA plasma spray coating services which utilize the Company's
technology, for customers or prospective customers contacted by the Company
prior to the date of the agreement, and 10% for all new customers obtained by
APS; provided, that the parties will review the reasonableness of the 10%
royalty on an annual basis and may adjust it downward if mutually agreed. Such
adjustment, if any, will be based on, among other things, competitive factors.
To date, no such adjustments have been made.
Transplant Support Products
The Company provides a line of transplant support products for use by
donor recovery teams and/or surgeons, including recovery kits containing sterile
drapes and supplies and items for collecting and transporting cadaveric
microbiologic cultures and blood samples for later analysis. The Company also
markets Alloprep System(R) Allograft Tissue Reconstitution Solution, a solution
for the reconstitution of freeze-dried allograft bone prior to transplantation.
Implants and Instruments
In the U.S., Osteotech markets implants and instrumentation for spinal
surgery through an exclusive distribution agreement with Ulrich.
Osteotech markets Ulrich's VDS Zielke System, an implant system used by
orthopaedic, spinal and neurological surgeons worldwide -- often in combination
with banked bone grafts -- for the anterior correction of spinal deformities
caused by disease, trauma and degeneration. The Company also markets an
extensive line of more than 250 high quality, specialty surgical instruments
manufactured by Ulrich.
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Like allograft tissue, the market for spinal implants continues to
grow. It is estimated that the spinal implant market in the U.S. increased 23%
to $252 million in 1996.
Osteotech plans to continue expanding its line of spinal implant
devices and instrumentation through its relationship with Ulrich. Subject to
appropriate regulatory approvals and Osteotech obtaining appropriate product
liability insurance coverage, a spinal implant system currently in use in
several European countries and South Africa -- the SSCS System -- is being
readied for introduction in the U.S. The SSCS System offers surgeons a
proprietary hinge screw design that allows for load sharing and improves the
potential fusion rate in posterior thoracic and lumbar fusion procedures.
Quality Assurance
All bone tissue processed by Osteotech is obtained from customers which
are required by their agreements with the Company to employ technicians and/or
surgeons trained in aseptic tissue recovery using sterile surgical techniques.
The Company's customers recover tissue primarily in hospitals and, to a lesser
extent, coroners' facilities which have been prepared for recovery. Bone tissue
is also required to be sterilely wrapped and shipped in special containers. Upon
receipt of this tissue, a quarantine period is imposed to permit serologic and
microbiologic testing prior to release of bone tissue for processing. Following
quarantine, the bone tissue is processed in a microbially-controlled
environment. Under constant monitoring, the tissue is cleaned, soaked in
antibiotics and then cut and shaped in accordance with customer specifications.
Before being released to customers, all processed bone tissue is inspected and
again tested for microbiological contaminants by the Company's quality assurance
team. Quality control is supported through the use of proprietary software
programs which provide traceability of bone tissue from donor to customer and
track each step of the processing operation.
The Company believes that the serologic screening of donors, the
extensive screening of donor profiles and medical histories performed by its
customers and its processing technologies reduce the likelihood of the presence
of infectious agents, including the HIV and hepatitis viruses, in processed bone
tissue. Studies completed by an independent testing laboratory specializing in
viral inactivation studies demonstrated that the Company's proprietary
demineralization process can virtually inactivate and eliminate the HIV virus
(the process reduces the probability of transmission of the HIV virus to one in
2.8 billion) as well as the hepatitis B, hepatitis C, cytomeglia and polio
viruses. To the Company's knowledge, none of the approximately 1,200,000
transplanted grafts it has processed since it commenced processing bone tissue
in 1987 have resulted in a confirmed transmission of
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infectious diseases. This record is due to the rigorous donor screening and
tissue recovery techniques used by the Company's clients, extensive donor
testing, as well as Osteotech's demanding quality assurance and processing
protocols. In addition to its proprietary demineralization process, Osteotech
expects to begin to implement additional processing technologies in 1997 that
once fully implemented will enable the Company to expand its viral inactivation
claims to include virtually all of the bone tissue it processes. These
proprietary, tissue-specific technologies are expected to further enhance graft
safety while maintaining the tissue's biologic and physical properties. However,
despite the Company's quality control measures, there can be no assurance that
processed bone tissue will be free of infectious agents. The Company believes
that its processing procedures and quality control measures comply with the
interim rules for banked human tissue instituted by the FDA on December 14,
1993. See "Government Regulations."
In December 1994, the Company's facility in The Netherlands received
International Standardization Organization ("ISO") certification for its quality
systems used in the development and manufacture of ceramic products and ceramic
and titanium spray coatings. ISO certification for production facilities will be
mandatory by 1998 for companies within the European Union ("EU"). The
certification was awarded by Tuv Product Service, GmbH of Munich, Germany, a
leading Notified Body in medical devices, following a series of audits. Notified
Bodies are independent organizations authorized by the EU member countries to
administer the ISO certification process.
Research and Development
During 1996, 1995 and 1994, the Company spent approximately $4.4
million, $3.7 million and $3.3 million, respectively, on research and
development activities. The Company is engaged in continuing research and
development efforts with respect to its processing technology, ceramic HA plasma
spray coating services and ceramic products. Research and development efforts in
the allograft processing field include the Company's continuing efforts to
improve upon and maintain the safety and performance of the processed bone
tissue, increase the amount of transplantable bone tissue derived from each
donor, reduce processing costs through efficiency advances and develop new forms
of allograft bone tissue.
Customers
Osteotech is the exclusive processor of allograft bone tissue for large
national and international not-for-profit organizations. The Company generally
charges its customers on a per donor basis, or for proprietary products, on a
per unit basis, for fees for
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direct and indirect processing costs and for finishing and packaging each unit
of bone tissue produced. Osteotech's agreements with its customers generally
provide for the Company to indemnify its customers against liability arising out
of defects in allograft bone tissue caused as a result of processing by the
Company and for the Company to provide such other services as may be requested
by the customer on such terms as the customers and the Company may agree from
time to time. During 1996, MTF and the ARC accounted for approximately 64% and
25%, respectively, of the Company's revenues. The Company has a new processing
agreement with ARC which runs through December 31, 2006. The Company's current
agreement with MTF expires on March 31, 1997 and the Company is engaged in
negotiations with MTF for a new agreement. There can be no assurance that a new
agreement with MTF will be completed on terms favorable to the Company, if at
all. The loss of either MTF or ARC as a customer or a substantial reduction in
the amount of allograft bone tissue used by each customer would have a material
adverse effect on the Company.
Osteotech does not engage in donor procurement or tissue
distribution and therefore relies on its not-for-profit customers
to obtain donor bone tissue for processing by the Company, and to
distribute the processed bone tissue to hospitals and physicians
for transplantation. See "Education and Marketing."
Customers of the Company's plasma spray coating services generally
purchase such services pursuant to purchase orders or non-exclusive supply
agreements which are cancelable at any time by either party.
Relationship with Musculoskeletal Transplant Foundation
In 1987, the Company assisted in the formation of MTF, an organization
comprised of medical teaching institutions and independent procurement agencies,
for the purpose of expanding the science of musculoskeletal transplantation. MTF
is now one of the largest bone tissue procurement organizations in the United
States, responsible for the procurement of allograft bone tissue for
distribution to its members as well as unaffiliated hospitals. MTF is governed
by a board of directors and a management team, all of whom are unaffiliated with
the Company.
In March 1987, Osteotech entered into a ten-year service agreement (the
"Service Agreement") with MTF whereby the Company serves as the exclusive
processor of all musculoskeletal allograft bone tissue procured by MTF. Pursuant
to the Service Agreement, the Company agreed to increase its capacity, if
necessary, to meet MTF's requirements for bone tissue processing. Osteotech has
agreed that the pre-tax profit earned from services which it performs for MTF
will not exceed the average pre-tax profit of the 15 largest pharmaceutical
concerns in the United States. MTF
-12-
assigned to the Company certain rights to license technology developed by its
members pursuant to research grants made by MTF.
Relationship with American Red Cross
In December 1996, the Company entered into an agreement (the "ARC
Agreement") with ARC whereby the Company serves as the exclusive processor of
all musculoskeletal allograft bone tissue donors procured by ARC. The Company
believes it can respond in a timely manner to any increase in demand by ARC or
other customers through the maximum utilization of its existing facilities or
the establishment of additional temporary or permanent processing facilities.
The ARC Agreement expires on December 31, 2006. Either party may terminate the
ARC Agreement at any time upon: (i) a material breach by the other party which
is unremedied for ninety days and (ii) the insolvency of the other party or any
bankruptcy or insolvency proceedings or the levy of any writ or judgment against
the other party. In addition, ARC may terminate the Processing Agreement in the
following circumstances: (i) upon ninety days written notice to the Company of
its determination to end its program of procuring or distributing tissue,
provided that, if ARC resumes such program, it shall provide prompt written
notice to the Company of such resumption and the ARC Agreement shall become
effective again on the same terms as prior to the termination, (ii) if a third
party develops a commercially feasible processing technology that a third party
review board determines to be safer or more effective than the Company's and the
Company is unable or unwilling to provide such product or service, and (iii) if
the FDA implements new regulations and the Company fails to implement changes to
its tissue processing to conform to such changes. If ARC enters an arrangement
with a third party whereby tissue processed by the Company is used in a third
party's technology or product, ARC shall inform the Company of this arrangement
and the Company shall have the right to terminate with 90 days prior written
notice or to renegotiate the terms of the agreement.
Other Customers
In September 1988, the Company entered into a ten-year agreement with
BioImplant Services ("BioImplant"), a tissue donor procurement and distribution
organization in Europe, whereby the Company has agreed, subject to certain
exceptions, to be the exclusive provider of allograft bone tissue processing
services for BioImplant. The Company has also agreed that it will not process
bone tissue for other procurement organizations in certain designated European
territories. The Company has agreed to meet the annual volume requirements of
BioImplant.
-13-
The Company also has an agreement with the University of California at
Irvine, a medical teaching institution, to provide allograft bone tissue
processing services which is renewable annually. To date, revenues to the
Company pursuant to this agreement have not been material.
Competition
Allograft bone tissue competes with autograft bone tissue which has
traditionally been utilized for human bone transplants. The Company believes
that where the use of autograft is feasible, surgeons and their patients will
generally continue, at least over the near term, to choose this option in view
of the perceived risk of transmission of infectious agents associated with the
transplant of allograft bone tissue. For numerous circumstances and procedures
for which autograft transplantation is either not feasible or not desirable,
there are a number of competing alternatives available, including allograft bone
tissue processed by others.
The Company believes that a majority of the cadaveric bone banks
operating in the United States are engaged in processing allograft bone tissue
for transplantation. Substantially all of these bone tissue banks are
not-for-profit organizations, and, as such, they may be able to supply
processing services at a lower cost than the Company. Osteotech believes it
competes with such entities on the basis of its advanced processing technology
and the quality and quantity of the bone tissue its processing yields. Since the
Company introduced its allograft tissue processing technology in 1987, certain
competing processors have responded with claims of having developed technology
similar to that used by the Company. Although the Company believes, based upon
its knowledge of the industry (but in the absence of reliable industry
statistics), that it processes bone tissue from more donors than any other
processor in the world, there can be no assurance that the Company can continue
to compete successfully in the area of allograft processing.
Allograft bone tissue also competes in certain bone grafting procedures
with synthetic bone void filler products. To date, these medical devices may be
legally promoted in the United States for only a minority of the types of
applications and procedures in which allograft bone tissues are used. Bone
grafting procedures in which allograft bone tissue might be used also sometimes
compete indirectly with non-invasive bone growth stimulator devices in those
cases in which bone graft surgery is not the preferred course of treatment.
With respect to allograft bone tissue, the Company expects
increased competition from synthetic bone substitutes and
recombinant bone growth stimulating materials. Synthetic
-14-
substitutes now being marketed include HA, a ceramic substance with an open
weave which allows for partial penetration of bone and fibrous tissue, and
combinations of HA and other substances, which have been approved by the FDA for
some oral surgical applications. The FDA has approved two of these HA synthetic
bone substitutes for certain orthopaedic procedures. The primary advantage of
synthetic bone substitutes is the absence of dependence on the availability of
human donors. In addition, synthetic materials may be perceived by members of
the medical community and the general public as safer than allograft-based bone
tissue. Osteotech believes, however, that the bone tissue it processes will be
able to compete with synthetic bone substitutes on the basis of the biologic and
physical properties, its multiple applications for various surgical procedures,
its successful use over an extended period of time without confirmed instances
of infectious disease transmission, and the fact that independent researchers
have reported that the Company's proprietary process can virtually inactivate
and eliminate the HIV virus and other viruses in demineralized tissue, should
they be present.
In addition to its proprietary demineralization process, Osteotech
expects to begin to implement additional processing technologies in 1997 that
once fully implemented will enable the Company to expand its viral inactivation
claims to include virtually all of the bone tissue it processes. These
proprietary, tissue-specific technologies are expected to further enhance graft
safety while maintaining the tissue's biologic and physical properties.
The Company is also aware of entities seeking to develop bone growth
factors using recombinant technology. Two such companies have announced that
human clinical trials are in progress on their recombinant bone growth factors.
There can be no assurance that the allograft bone tissues processed by the
Company will be able to compete successfully with synthetic bone substitutes and
recombinant bone growth factors which are developed and commercialized by
others. Lastly, other companies engaged in the manufacture of medicine implant
devices for the orthopaedic field may enter the allograft market in competition
with the Company. Such companies may have substantially greater resources and
expertise than the Company. Accordingly, there can be no assurance that the
Company would be able to compete successfully with any such companies.
The Company's plasma spray coating and HA product operations face
competition in Europe from divisions and subsidiaries of several large
corporations engaged in providing such services and products to others and from
several smaller independent companies. In addition, the Company also faces
competition from medical implant companies which have in-house plasma spray
coating operations. The Company competes primarily on the quality of its
coatings and price. Osteotech believes that the spraying
-15-
technology it uses, which is computer controlled and utilizes robotics, enables
it to provide high quality coatings at competitive prices. It should be noted,
however, that the ceramic coating industry is highly competitive, certain of the
Company's competitors have greater resources than the Company and there can be
no assurance the Company will be able to compete successfully.
Education and Marketing
Osteotech believes the markets for processed allograft bone tissue will
continue to be orthopaedic, neurological, plastic and oral/maxillofacial
surgical specialties. The Company's future growth in these areas will depend
upon a wider acceptance by these specialties of the use of allograft bone tissue
as an alternative to autograft bone tissue and other available materials and
treatments. There are currently 19 persons employed by the Company to engage in
efforts to educate surgeons as to the benefits and applications of processed
allograft bone tissue. Notwithstanding its internal marketing capability, the
Company is still dependent to a degree on the success of the education and
marketing activities conducted by its customers and their representatives. To
complement the Company's education and marketing strategy, the Company
commenced, in the fourth quarter of 1994, to develop a national network of
independent sales agents who assist in the Company's marketing of products and
services and further educate the medical community about processed allograft
bone tissue. Currently these sales agents are focusing their efforts primarily
on Grafton DBM and spinal instruments. At December 31, 1996, the Company had
appointed 47 agencies with 216 sales representatives.
The Company is pursuing a strategy of licensing or acquiring additional
products which are ready to be commercialized in order to take advantage of the
Company's expertise and relationships within the orthopaedic community.
A small in-house marketing staff located at the Company's Leiden
facility markets the plasma spray coating services of the Company and the
Company's joint venture with APS. These marketing activities consist primarily
of attendance at trade shows, placement of advertisements in trade journals and
direct mailings to orthopaedic and dental implant companies. The Company markets
its HA powders and ceramic products through independent contract representatives
in Europe.
Government Regulations
The procurement and transplantation of allograft bone tissue is subject
to federal regulation pursuant to the National Organ Transplant Act ("NOTA"), a
criminal statute which prohibits the purchase and sale of human organs,
including bone and related
-16-
tissue, for "valuable consideration." NOTA permits the payment of reasonable
expenses associated with the removal, transportation, processing, preservation,
quality control, implantation and storage of human bone tissue. The Company
provides services in all of these areas, with the exception of removal and
implantation. Osteotech and other bone processors are engaged in ongoing efforts
aimed at educating the medical community as to the benefits of processed
allograft bone tissue and the Company will continue to expand its activities
with respect to Grafton DBM. Although the Company believes that NOTA permits
reimbursement of these costs as costs associated with the processing,
transportation and implantation of bone tissue products, the inability to be
reimbursed for its education efforts in the future could adversely affect the
Company's business and prospects. No federal agency or court has determined
whether NOTA is, or will be, applicable to every allograft-based material which
may derive from the Company's processing technologies. Assuming that NOTA
applies to Osteotech's processing of allograft bone tissue, the Company believes
it is in compliance with NOTA, but there can be no assurance that more
restrictive interpretations of, or amendments to, NOTA will not be adopted in
the future which would call into question one or more aspects of the Company's
method of operations. See "Education and Marketing."
In December 1993, the FDA introduced interim regulations applicable to
human tissue intended for transplantation, including the types of allograft
tissues processed by the Company. The FDA had not previously treated the field
of tissue banking and tissue products as medical specialties and allowed the
organizations in the field to regulate themselves. However, the growth of the
field and other factors prompted the FDA to introduce universal basic standards
to reduce the risk of transmission of infectious diseases through the
inadvertent use of infected tissue. The Company's operations are dependent on
adequate compliance with these rules by both the Company and its clients. The
Company believes that its operations and those of its clients are in substantial
compliance with those rules. The FDA is moving to finalize the current interim
regulations. Additionally, on February 28, 1997, the FDA proposed a framework
for more comprehensive regulations of cellular and tissue-based products
including Allograft tissues such as those processed by the Company. There can be
no assurance that the Company or its clients will be in compliance with these
more comprehensive rules if and when they are promulgated by the FDA.
In August 1995, the FDA designated Grafton DBM as within the scope of
the definition of banked human tissue under the interim rule on human tissue
intended for transplantation. Banked human tissues such as demineralized bone
matrix have been considered, and still are considered, exempt from FDA
premarketing clearance requirements imposed upon medical products such as drugs,
devices and biologics. Grafton DBM is a demineralized bone matrix that is mixed
with glycerol, a basically inactive substance, to provide
-17-
desirable physical handling characteristics to the demineralized
bone matrix.
The Company maintains a master file for its HA plasma spray coating
processes with the FDA. The Company's customers are required to obtain FDA
clearance for the marketing in the United States of their implants which are
coated by the Company. These customers refer to the Company's master file in
their application for clearance by the FDA of their implants as medical devices.
The Company's European HA plasma spray coating services meet existing regulatory
requirements in the specific countries where they are marketed.
Ceramic (HA) products which are produced by the Company are currently
distributed only in Europe. These products meet existing regulatory requirements
in the specific countries where they are produced and marketed. The Company does
not intend currently to market these products in the United States; however, if
it does decide to do so, these products would require premarketing clearance by
the FDA as medical devices.
HA powder produced and sold in bulk by the Company in the United States
and Europe is considered to be a component product and, as such, is not
currently subject to regulation by the FDA and similar agencies in Europe.
Environmental Matters
The Company's bone tissue processing generates waste which is
classified as medical hazardous waste by the United States Environmental
Protection Agency and the New Jersey Department of Environmental Protection.
Such waste is segregated by the Company and disposed of through a licensed
hazardous waste transporter in compliance with applicable regulations. The
production of HA powder at the Company's facility in The Netherlands generates
small amounts of hazardous waste, which is segregated by the Company and
disposed of through a licensed hazardous waste transporter. The Company has been
issued a Nuisance Permit from the local government for its facility in The
Netherlands.
Although the Company believes it is in compliance with applicable
environmental regulations, the failure by the Company to fully comply with any
such regulations could result in the imposition of penalties, fines and/or
sanctions which could have a material adverse effect on the Company's business.
-18-
Patents and Proprietary Rights
Osteotech considers its processing technology and procedures
proprietary and relies primarily on trade secrets to protect its technology and
innovations. Significant research and development activities have been conducted
by consultants employed by third parties or in conjunction with unaffiliated
medical institutions. Accordingly, disputes could arise in the future concerning
the proprietary rights to information applied to Company projects which have
been independently developed by the consultants or researchers at the medical
institutions.
At March 3, 1997, the Company held a total of 24 patents in the United
States and foreign countries relating to its aseptic processing technology and
its transplant support products, two United States and three foreign patents
relating to its biomaterial technology, eight United States and four foreign
patent applications relating to aspects of its processing technology and its
osteogenic and other products under development and three United States and
three foreign patent applications relating to its biomaterial technology. There
can be no assurance that any pending patent applications will result in issued
patents or that any currently issued patents, or patents which may be issued,
will provide Osteotech with sufficient protection in the case of an infringement
of its technology or that others will not independently develop technology
comparable or superior to the Company's.
Product Liability and Insurance
The testing and use of human allograft bone tissue and the implantation
of medical devices coated with the Company's HA powder, medical devices
developed with the Company's biomaterial technology and medical devices
manufactured by others and distributed by the Company entail inherent risks of
medical complications for patients and therefore, may result in product
liability claims against the Company. Further, Osteotech's agreements with its
bone tissue processing customers provide for indemnification by the Company for
liabilities arising out of defects in allograft bone tissue caused as a result
of processing by the Company.
As a distributor of implants and instruments for spinal
surgery, including bone screws, manufactured by Ulrich, the Company
has been named as a defendant in a number of lawsuits in which
plaintiffs claim that they have suffered damages from the
implantation of allegedly defective spinal fixation devices. See
"Legal Proceedings."
The Company presently maintains product liability insurance in the
amount of $20 million per occurrence and per year in the
-19-
aggregate. There can be no assurance that the Company will be able to maintain
such insurance in the future or that such insurance will be sufficient to cover
all liabilities. In addition, the Company's current insurance policy will not
cover any claims made against the Company which are based upon a surgeon's use
of a device in a manner other than the use approved by the FDA for such device,
regardless of whether the Company advised the surgeon and/or healthcare provider
of the FDA approved use and provided adequate warnings against any unapproved
use by the surgeon and/or healthcare provider.
Of the twenty-nine lawsuits discussed in "Legal Proceedings,"
four such lawsuits would be covered by the Company's insurance
policies. Twenty-five of the current lawsuits, and any lawsuits
filed in the future which contain claims similar to those contained
in such current lawsuits, may not be covered by the Company's
current insurance policy. See "Legal Proceedings."
Pursuant to its distribution agreement with the Company, Ulrich has
agreed to indemnify the Company for all costs, and damages incurred by the
Company in connection with its distribution of products manufactured by Ulrich,
except such costs and damages which are caused by the Company's gross negligence
or willful misconduct or unauthorized claims made by the Company in marketing
the products. In accordance with such indemnification obligation, the Company is
entitled to be named as a co-insured on the product liability insurance policy
maintained by Ulrich. Vericherunges-Aktiengesellchaft ("Allianz"), Ulrich's
insurance carrier, has presented the Company with a certificate which indicates
that the Company is co-insured on such insurance policy, however, Allianz has
indicated that it does not believe the Company is a co-insured. This policy
provides coverage of 4,000,000 Deutsche Mark (DM) (approximately $2.6 million at
current exchange rates) per person and 16,000,000 DM (approximately $10.4
million at current exchange rates) in the aggregate. The Company and Allianz are
engaged in discussions concerning the Company's coverage under the insurance
policy maintained by Ulrich with Allianz. There can be no assurance that the
Company will in fact be indemnified by Ulrich or be provided coverage under
Ulrich's insurance policy or that such coverage, if provided, will be adequate.
Employees
At December 31, 1996, Osteotech had 210 employees, of whom 119 were
engaged in allograft processing, ceramic plasma spray coating and the
manufacture of products; 25 in research and development; 31 in education and
marketing and 35 in regulatory, finance and administration. The Company's
employees are not covered by any collective bargaining agreement. The Company
considers relations with its employees to be good.
-20-
Item 2. Properties
The Company's principal executive offices are located in approximately
38,000 square feet in Eatontown, New Jersey which is occupied pursuant to a
lease which expires in December 2004 and provides for a base annual rental of
approximately $264,000. This facility is occupied by the Company's corporate,
financial, administration, marketing, research and development, regulatory and
clinical affairs staff.
The Company's processing facility is located in approximately 30,000
square feet of space in Shrewsbury, New Jersey which is occupied pursuant to a
lease which expires in February 2007 and provides for a base annual rental of
approximately $239,000 for the first five years of the lease and $261,000 for
the remaining term of the lease. The lease is renewable at the Company's option
for an additional five year term.
The Company's European subsidiaries occupy a 21,000 square foot
facility in Leiden, The Netherlands. The lease for this facility expires in May
2008 and the annual rent is 626,000 dfl (approximately US $360,000 at the
December 31, 1996 exchange rates).
The Company believes that these facilities are adequate and suitable
for its current needs.
Item 3. Legal Proceedings
Orthopedic Bone Screw Products Liability Litigation
The Company has been named and served in approximately 28 lawsuits,
involving approximately 4000 plaintiffs, brought against spinal implant
manufacturers, distributors and promoters in various state and federal courts
throughout the country. The majority of these actions, all of which are
individual lawsuits and not class actions, are pending in federal court and have
been or are in the process of being consolidated with other similar actions for
coordinated proceedings in the District Court for the Eastern District of
Pennsylvania in an action entitled In re Orthopedic Bone Screw Products
Liability Litigation, MDL Dkt. 1014 (E.D. Pa.). These actions sound in products
liability and involve allegations of, either alone or in combination, negligence
and conspiracy or other concerted action.
The vast majority of the complaints in these cases have been amended or
refiled due to defective pleading as indicated by various court orders. Thus,
for these cases, responsive pleadings have not yet been filed by defendants,
including the Company. As to the remaining cases, they are still in the
preliminary discovery stages. Further, on a daily basis, the number of cases
naming the Company may increase or decrease. Generally, the Company will not
-21-
be aware that it has been named as a defendant in an action until it has been
served with the underlying complaint.
As to all of these actions, the Company believes that it has
affirmative defenses, including without limitation, defenses based on the
learned intermediary defense, the failure of a cause of action to exist where no
malfunction of a Company-distributed device occurred, the fact that the product
at issue was substantially modified in an unforeseeable manner, the fact that
the product distributed by the Company was not the product at issue, the fact
that the Company has not engaged in a conspiracy with other manufacturers or
distributors, and the fact that the claims in all of these actions are without
merit. Accordingly, all such cases are and will continue to be vigorously
defended.
All of the actions seek monetary damages of no less than $50,000 per
plaintiff. The aggregate monetary damages eventually sought by all of the
plaintiffs and the related costs to defend such action may be substantial.
Pursuant to the Company's distribution agreement with Ulrich, the manufacturer
of the spinal system distributed by the Company, Ulrich has agreed to indemnify
the Company for liabilities incurred in connection with the distribution of
Ulrich's products. However, there can be no assurance that Ulrich will have the
financial resources necessary to comply with its indemnification obligations to
the Company.
Additionally, the Company maintains its own products liability
insurance coverage from Lexington Insurance Company ("Lexington") and Lexington
has been notified of these actions. Lexington has denied coverage with respect
to certain of these cases. Further, Ulrich maintains its own products liability
coverage from Allianz. Allianz has indicated that it is reviewing the
possibility of extending insurance coverage to the Company with respect to
certain of these cases.
Kehr et al. v. Musculoskeletal Transplant Foundation and
Osteotech, Inc., Case No. 96-CV-334 (W.D. Mich.)
On March 26, 1996, the Company was served with a lawsuit that was filed
in Kent County Circuit Court in Grand Rapids, Michigan. The action is based on
products liability and negligence, alleging that the Company and co-defendant
MTF mislabeled and mispackaged processed human bone tissue. On April 24, 1996,
codefendant MTF, with the Company's consent, removed this action to the United
States District Court for the Western District of Michigan.
On May 29, 1996, the Company filed its answer, denying any and all
liability, and setting forth affirmative defenses, including, without
limitation, defenses based on substantial modification of the product and that
plaintiffs' injuries were caused by a superseding, intervening cause. On
November 4, 1996, the Company filed a motion for summary judgment requesting
that the Court
-22-
dismiss the plaintiffs' complaint. By order dated February 27, 1997, the Court
denied this motion. In doing so, however, the Court ruled that plaintiffs could
not proceed with this action under strict liability or implied warranty
theories. Rather, the plaintiffs' case could only proceed under a common law
negligence theory.
Pursuant to a service agreement between MTF and the Company regarding
the Company's tissue processing services, the Company has agreed to defend,
indemnify and hold MTF harmless with respect to this action.
The Company believes that this lawsuit is without merit and the case is
currently being defended, including the defense of MTF, by the Company's product
liability insurance carrier with a general reservation of rights.
Item 4. Submissions of Matters to a Vote of Security Holders
None.
-23-
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters
The Company's Common Stock has been traded in the over-the-counter
market and quoted on the NASDAQ National Market System under the trading symbol
"OSTE" since the Company's initial public offering in July 1991.
The following table sets forth the high and low sale prices for the
Common Stock for each of the fiscal quarters during the years ended December 31,
1995 and 1996 based on transaction data as reported by the NASDAQ National
Market System.
Year Ended December 31, 1995 High Low
First Quarter 6-1/4 3-3/4
Second Quarter 5-3/4 4-3/8
Third Quarter 9-1/4 4-7/8
Fourth Quarter 8-5/8 6
Year Ended December 31, 1996
First Quarter 8 6-13/16
Second Quarter 8-3/8 6
Third Quarter 7-7/8 5-1/2
Fourth Quarter 7-1/8 5-29/64
As of March 3, 1997 there were 219 holders of record of the Company's
Common Stock. The Company believes that there are approximately 2,300 beneficial
owners of its Common Stock.
The Company has never paid a cash dividend and does not anticipate the
payment of cash dividends in the foreseeable future as earnings are expected to
be retained to finance the Company's growth. Declaration of dividends in the
future will remain within the discretion of the Company's Board of Directors,
which will review the Company's dividend policy from time to time.
Item 6. Selected Financial Data
Set forth below is the selected financial data for the Company for the
five fiscal years ended December 31, 1996. The following
-24-
data should be read in conjunction with the Company's consolidated financial
statements and related notes thereto contained elsewhere herein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Selected Financial Data
(dollars in thousands
except per share data) 1996 1995 1994 1993 1992(a)
- ---------------------------------------------------------------------------------------------------------------------------------
For the Year
Net revenues $34,895 $27,934 $24,570 $19,124 $14,651
Costs and expenses (b) 33,146 27,696 23,935 20,817 16,440
Other income, net (c) 271 4,582 577 2,926 2,231
Income (loss) before income
taxes and unusual items (d) 3,370 1,653 1,212 (1,242) (803)
Income before income taxes 2,020 4,820 1,212 1,233 442
Net income (loss) (324) 4,582 1,747 1,107 414
Net income (loss) per share (.04) .57 .22 .14 .05
(e)
Dividends per share 0 0 0 0 0
- ---------------------------------------------------------------------------------------------------------------------------------
Year End Financial Position
Working capital $12,273 $12,135 $9,010 $7,239 $6,133
Total assets 31,483 30,170 22,594 19,706 18,420
Long-term obligations 840 1,598 1,027 375 309
Stockholders' equity 22,717 22,594 17,096 15,362 14,171
- ---------------------------------------------------------------------------------------------------------------------------------
(a) Includes the results of operations of HC Implants BV since April 1, 1992.
(b) Costs and expenses include: (i) a charge to earnings in 1996 of
$1,350,000 related to the restructuring of the Company's non-allograft
operations located in Leiden, The Netherlands; and (ii) a charge to
earnings in 1995 of $980,000 resulting from the termination of a
distribution agreement.
(c) Other income includes: (i) principal payments on a fully reserved note
from a major customer of $4,147,000 in 1995, $2,475,000 in 1993 and
$575,000 in 1992; and (ii) $670,000 gain on termination of a joint
development agreement in 1992.
(d) Excludes items of income and expense discussed in (b) and (c).
(e) Reflects primary earnings (loss) per share.
-25-
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Three Years Ended December 31, 1996, 1995 and 1994
Results of Operations
Net Income (Loss)
In 1996 the Company incurred a net loss of $324,000 compared to net
income of $4,582,000 in 1995 and $1,747,000 in 1994.
Income before income taxes and unusual items increased to $3,370,000 in
1996 compared to $1,653,000 in 1995 and $1,212,000 in 1994. Income, including
unusual items and before income taxes was $2,020,000 in 1996 compared to
$4,820,000 in 1995 and $1,212,000 in 1994. Income before income taxes in 1996
includes a charge to earnings of $1,350,000 related to the restructuring of the
Company's non-allograft operations located in Leiden, The Netherlands. Income
before income taxes in 1995 includes the receipt of note repayments on a fully
reserved note from a major customer of $4,147,000 and a charge to earnings of
$980,000 resulting from the termination of a distribution agreement for trauma
implant products. See "Provision for Restructuring" and "Provision for
Termination of a Distribution Agreement" included elsewhere herein.
Income tax expense in 1995 and 1994 was reduced by the
recognition of net deferred tax assets resulting primarily from the
realization of tax benefits associated with Federal and state tax
net operating loss carryforwards. See "Income Tax Provision
(Benefit), net" included elsewhere herein.
The table below shows the impact of these items:
1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------
Income before income taxes and unusual items $ 3,370,000 $ 1,653,000 $ 1,212,000
Unusual items:
Provision for restructuring (1,350,000)
Note repayments from major customer 4,147,000
Provision for termination of distribution (980,000)
agreement
- -------------------------------------------------------------------------------------------------------------------------
Income before income taxes 2,020,000 4,820,000 1,212,000
Recognition of net deferred tax assets 2,551,000 2,079,000
Income tax provision (2,344,000) (2,789,000) (1,544,000)
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (324,000) $ 4,582,00 $ 1,747,000
=========================================================================================================================
-26-
The following is a discussion of factors which affected results of
operations for the years ended December 31, 1996, 1995 and 1994.
Net Revenues
Revenues in 1996 increased 25% to $34,895,000 from $27,934,000 in 1995.
Revenues in 1995 were 14% higher than 1994 revenues of $24,570,000.
The increase in revenues in 1996 resulted principally from increased
demand for the Company's Grafton DBM Gel and the introduction of Grafton DBM
Flex in January 1996 and Grafton DBM Putty in November 1996. The increase in
revenues in 1995 resulted principally from increased demand for Grafton DBM Gel
and ceramic hydroxyapatite powders distributed by the Company.
Supporting the Company's Grafton DBM expansion is a national network of
independent agencies that manage surgeon relationships in partnership with the
Company's direct field marketing organization. At December 31, 1996, the network
consisted of 47 agencies with 216 representatives compared to 27 agencies with
126 representatives at December 31, 1995.
During 1996, 1995 and 1994, two of the Company's major customers, MTF
and ARC, accounted for 64% and 25%, 65% and 20%; and 63% and 22%, respectively,
of revenues. In December 1996, the Company entered into a new ten-year agreement
with ARC. The Company is currently in negotiations with MTF for a new agreement
to replace the existing agreement which expires on March 31, 1997. There can be
no assurance that the Company and MTF will enter into a new agreement or that
such agreement will contain terms favorable to the Company. The loss of either
MTF or ARC as a customer would have a material adverse effect on the Company.
Costs of Services and Products
Costs of services as a percentage of service revenues was 39% in 1996,
43% in 1995 and 44% in 1994. These declines in costs as a percentage of revenues
result from a shift in revenue mix toward services with higher gross margins and
fixed processing costs being distributed over a higher volume of donors
processed.
Costs of products as a percentage of product revenues was 97% in 1996,
77% in 1995 and 67% in 1994. The increase in costs as a percentage of revenues
resulted principally from an increase in product liability insurance premiums
associated with spinal implant products distributed by the Company pursuant to
an agreement with Ulrich, the manufacturer.
-27-
Marketing, General and Administrative Expenses
Marketing, general and administrative expenses increased $2,211,000 or
21% in 1996 and $817,000 or 9% in 1995. These increases are primarily
attributable to expanded marketing activities associated with the increased
allograft services provided by the Company, principally those related to Grafton
DBM, and increased facilities' costs resulting from an expansion of the
Company's facilities to support growth.
Marketing, general and administrative expenses declined as a percentage
of revenues in each year from 39% in 1994 to 37% in 1995 and 36% in 1996.
Research and Development Expenses
Research and development expenses in 1996 increased $608,000 or 16% to
$4,357,000 from $3,749,000 in 1995. Research and development expenses in 1995
increased $400,000 or 12% compared to $3,349,000 in 1994. The increases in both
years were primarily attributable to increased spending associated with the
development of additional allograft tissue forms which were introduced into the
market during 1996, expansion of the Company's viral inactivation process to a
broader range of allograft tissue and the development of PolyActive(R) products.
See "Provision for Restructuring."
Provision for Restructuring
In October 1996, the Company announced a plan to restructure its
non-allograft operations located in Leiden, The Netherlands in order to focus
those operations on: (i) the revenue and profit generating activities of
providing ceramic and titanium spray coating services and ceramic products to
the orthopaedic and dental markets and (ii) to pursue OEM business opportunities
for those technologies. In connection with the restructuring, the Company
discontinued its PolyActive polymer research and development program. As a
result of the restructuring, the Company recorded a pre-tax restructuring charge
of $1,350,000, consisting primarily of employee termination costs, write-off of
equipment, intangible assets, supplies and costs associated with the planned
sub-leasing of office space in Leiden on which the Company has a long-term
lease. See Note 3 of "Notes to Consolidated Financial Statements."
Provision for Termination of Distribution Agreement
In June 1995, the Company terminated its distribution agreement for
trauma implant products with its supplier, aap, GmbH, of Berlin, Germany. As a
result of this termination the Company recorded a pre-tax charge to earnings of
$980,000, consisting principally of inventory write-offs, employee termination
costs and legal fees. The Company has commenced legal proceedings to recover
these costs. Revenues from marketing trauma products were not
-28-
material in 1995. See Note 4 of "Notes to Consolidated Financial
Statements."
Other Income (Expense)
In 1996, other income decreased by $4,311,000 compared to
1995. Other income in 1995 included the receipt of $4,147,000 of
note repayments on a fully reserved note from a major customer.
See Note 5 of "Notes to Consolidated Financial Statements."
Income Tax Provision (Benefit), Net
The income tax provision in each of the years reflects a rate in excess
of the Federal statutory income tax rate due to state income taxes and foreign
losses for which no current tax benefits would be available. In 1995 and 1994,
the Company recognized net deferred tax assets of $2,551,000 and $2,079,000,
respectively, resulting from: (i) the realization of tax benefits of temporary
differences which reversed during each year ($1,335,000 in 1995 and $1,479,000
in 1994); and (ii) the Company's assessment that it would generate sufficient
future U.S. taxable income to realize a portion of the deferred tax benefits
associated with certain Federal and state net operating loss carryforwards and
tax credits ($1,216,000 in 1995 and $600,000 in 1994). See Note 13 of "Notes to
Consolidated Financial Statements."
Liquidity and Capital Resources
At December 31, 1996, the Company had cash and short-term investments
of $9,277,000 compared to $7,707,000 at December 31, 1995. Working capital
increased $138,000 to $12,273,000 at December 31, 1996 compared to $12,135,000
at December 31, 1995.
The Company has a loan and security agreement with a U.S. bank which
provides for borrowings of up to $3,000,000 under a revolving line of credit and
$4,000,000 under an equipment line of credit. At December 31, 1996, $1,377,000
was outstanding under the equipment line of credit and there were no borrowings
outstanding under the revolving line of credit. The Company also has a line of
credit with a Dutch bank which provides for borrowings of up to 5,000,000 dfl,
or approximately $2,872,000 at the December 31, 1996 exchange rate. Analysis of
the Company's cash position and anticipated cash flow indicated that it most
likely would not be necessary to utilize a significant portion of this line of
credit in 1996 and, therefore, the Company agreed with the bank to limit its
borrowings in 1996, if any, to no more than 3,000,000 dfl, or approximately
$1,723,000 at the December 31, 1996 exchange rate. Additionally, in connection
with the Leiden facility lease, the Company is required to maintain a declining
bank guarantee which reduced the current amount available for borrowings to
2,424,000 dfl, or approximately $1,392,000 at the December 31, 1996 exchange
rate. At December 31, 1996, there were no borrowings outstanding
-29-
under this credit line. See Note 11 of "Notes to Consolidated
Financial Statements."
At December 31, 1996, the Company had U.S. net operating loss
carryforwards which approximate $1,099,000 for Federal income tax purposes and
$216,000 for state income tax purposes. The Federal and state net operating loss
carryforwards, if unused, will expire from 2006 through 2011. The Company also
has research and development tax credits for Federal income tax purposes of
$11,000 which expire in 2009. The timing and manner in which the tax loss
carryforwards and credits are utilized in the future may be limited by Internal
Revenue Code Section 382. In addition, certain of the Company's subsidiaries
have foreign net operating loss carryforwards aggregating $10,041,000 ($350,000
with no expiration date; $9,691,000 expiring 1999 through 2004). See Note 13 of
"Notes to Consolidated Financial Statements."
During 1996 the Company incurred capital expenditures of $2,152,000 to
support the expansion of the Company's operations. Although the Company had no
significant commitments for capital expenditures as of December 31, 1996, it
expects 1997 capital expenditures to be approximately 50% higher than those of
1996. It is expected that these expenditures will be funded from cash reserves,
cash provided by operations or bank financing.
The Company believes that its cash and cash equivalents, short-term
investments and available lines of credit, together with anticipated cash flow
from operations will be sufficient to meet its near-term requirements, but may
not be adequate to fully develop and commercialize all products currently under
development by the Company. Further, from time to time, the Company may seek
additional funds through equity or debt financing. However, there can be no
assurance that such additional funds will be available to the Company, or if
available, that such funds will be available on terms favorable to the Company.
Item 8. Financial Statements and Supplementary Data
The response to this item is submitted as a separate section of this
Annual Report commencing on page F-1.
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Not applicable.
-30-
PART III
Item 10. Directors and Executive Officers of the Registrant
The section of the Company's 1997 Proxy Statement entitled "Election of
Directors" is incorporated herein by reference.
Item 11. Executive Compensation
The section of the 1997 Proxy Statement entitled "Executive
Compensation" is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
The section of the 1997 Proxy Statement entitled "Security
Ownership of Certain Beneficial Owners and Management" is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The section of the 1997 Proxy Statement entitled "Certain Relationships
and Related Transactions" is incorporated herein by reference.
-31-
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K
(a)(1) and (2). The response to this portion of Item 14 is submitted as
a separate section of this report commencing on page F-1.
(a)(3) and (c). Exhibits (numbered in accordance with Item
601 of Regulation S-K).
Exhibit Page
Number Description Number
3.1 Restated Certificate of Incorporation of *
the Company
3.2 Amended and Restated Bylaws of the Company #
3.3 Form of Stock Certificate **
4.1 Stock and Warrants Purchase Agreement, as **
amended
4.2 Amended Security Holders Agreement **
4.3 Rights Agreement dated as of February 1, #
1996 between Osteotech, Inc. and Registrar
and Transfer Co.
10.1 1991 Stock Option Plan, as amended *****
10.2 1991 Independent Directors Stock Option *****
Plan, as amended^
10.3 Various Written Option Agreements between ***
the Company and certain employees,
officers, directors and consultants or
advisors of the Company^
10.4 Senior Management Bonus Program^ ****
-32-
10.5 Senior Management Loan Program^ ****
10.6 Lease for the Company's Leiden, The *****
Netherlands facility dated December 4, 1991
10.7 Lease for the Company's Leiden, The +
Netherlands facility dated May 28, 1993
10.8 Service Agreement between the Company and **
the Musculoskeletal Transplant Foundation,
dated March 1, 1987~
10.9 Start-up Processing Fee Agreement between **
the Company and the Musculoskeletal
Transplant Foundation, dated June 29, 1990
10.10 Processing Agreement between the Company **
and Stichting Eurotransplant Nederland,
dated September 26, 1988~
10.11 Stock Purchase Agreement by and among ++
Osteotech, Inc., Osteotech BV and C.A. van
Blitterswijk, C.A. van Blitterswijk Holding
BV, K. de Groot, K. de Groot Holding BV,
R.G. van der Scheer and HOM Consultancy BV
10.12 License Agreement between the Company and ****
Abtox, Inc. dated April 1, 1992~
10.13 Line of Credit Agreement between Interna- ****
tionale Nederlanden Bank NV and Osteotech
BV dated October 6, 1992
10.14 Guaranty Agreement between the Company and ****
Internationale Nederlanden Bank NV dated
October 22, 1992 pursuant to which the
Company guarantees the payment of amounts
which may be loaned to the Company's
subsidiary, Osteotech BV
10.15 Loan and Security Agreement between the +
Company and United Jersey Bank/Central,
N.A. dated May 27, 1993
-33-
10.16 First Amendment to Loan and Security +++
Agreement between the Company and United
Jersey Bank/Central, N.A. dated July 14,
1994
10.17 Sublicense Agreement by and between CAM *****
Implants, Inc. and APS-Materials, Inc.
dated September 20, 1993
10.18 Partnership Agreement by and between *****
Osteotech/CAM Services BV and APS-
Materials, Inc. dated September 20, 1993
10.19 Employment Agreement with Michael J. *******
Jeffries dated January 1, 1996^
10.20 Employment Agreement with Roger C. *******
Stikeleather dated January 1, 1996^
10.21 Lease for the Company's Eatontown facility ******
dated October 20, 1994
*******
10.22 Employment Agreement with James L. Russell,
Ph.D. dated December 18, 1995^
Confidentiality Agreement and Non-
10.23 Competition Agreement with James L. *******
Russell, Ph.D. dated November 15, 1995
10.24 Second Amendment to Loan and Security ++++
Agreement between the Company and United
Jersey Bank/Central, N.A. dated June 30,
1995
10.25 Amendment to the lease for the Company's ++++
Leiden, the Netherlands facility dated
June 27, 1995
10.26 Agreement dated December 20, 1996 between E-2
American Red Cross and the Company~
10.27 Lease for the Company's Shrewsbury, New E-39
Jersey processing facility
10.28 Employment Agreement between the Company E-52
and Richard W. Bauer dated December 5, 1996
-34-
11.1 Computation of Primary Net Income (Loss) E-64
Per Share
11.2 Computation of Fully Diluted Net Income E-65
(Loss) Per Share
21.1 Subsidiaries of the Registrant E-66
23.1 Consent of Coopers & Lybrand E-67
* Previously filed as exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1991 and
incorporated herein by reference thereto.
** Previously filed as exhibits to the Company's Registration
Statement on Form S-1 (File No. 33-40463) and incorporated
herein by reference thereto.
*** Previously filed as exhibits to the Company's Registration
Statement on Form S-8 (File No. 33-44547) and incorporated
herein by reference thereto.
**** Previously filed as exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1992 and
incorporated herein by reference thereto.
***** Previously filed as exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993 and
incorporated herein by reference thereto.
****** Previously filed as exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994 and
incorporated herein by reference thereto.
******* Previously filed as exhibits to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995 and
incorporated herein by reference thereto.
+ Previously filed as exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1993 and incorporated
herein by reference thereto.
++ Previously filed as exhibits to the Company's Current Report on
Form 8-K filed with the Commission on May 26, 1992.
-35-
+++ Previously filed as exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1994 and incorporated
herein by reference thereto.
++++ Previously filed as exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1994 and incorporated
herein by reference thereto.
+++++ Previously filed as exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1995 and incorporated
herein by reference thereto.
# Previously filed as exhibits to the Company's Report on Form 8-A
dated February 2, 1996 and incorporated herein by reference
thereto.
~ Copy omits information which is subject to confidential
treatment.
^ Management contracts or compensatory plans and arrangements
required to be filed pursuant to Item 14(c).
(b) Reports on Form 8-K
Current Report on Form 8-K dated October 30, 1996. Current
Report on Form 8-K dated November 14, 1996. Current Report on
Form 8-K dated December 20, 1996.
-36-
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.
Dated: March 25, 1997
OSTEOTECH, INC.
By: /s/Richard W. Bauer
Richard W. Bauer
President, Chief Executive
Officer (Principal Executive
Officer) and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the dates indicated:
Signature Title Date
/s/DONALD D. JOHNSTON Chairman of the Board March 25, 1997
Donald D. Johnston of Directors
/s/RICHARD W. BAUER President, Chief March 25, 1997
Richard W. Bauer Executive Officer
(Principal Executive
Officer) and Director
/s/MICHAEL J. JEFFRIES Executive Vice March 25, 1997
Michael J. Jeffries President, Chief
Operating Officer,
Chief Financial Officer
(Principal Financial
Officer and Principal
Accounting Officer),
Secretary and Director
/s/STEPHEN J. SOGIN Director March 25, 1997
Stephen J. Sogin
/s/KENNETH P. FALLON III Director March 25, 1997
Kenneth P. Fallon III
Director
Walter J. McNerney
-37-
OSTEOTECH, INC. AND SUBSIDIARIES
-------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Page
1. FINANCIAL STATEMENTS
Report of Independent Accountants.....................................F-2
Consolidated Balance Sheets as of December 31, 1996 and 1995..........F-3
Consolidated Statements of Operations
for the years ended December 31, 1996, 1995 and 1994.................F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1996, 1995 and 1994.................F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 1996, 1995 and 1994.................F-6
Notes to Consolidated Financial Statements............................F-7
2. SCHEDULES
II. Valuation and Qualifying Accounts
for the years ended December 31, 1996, 1995 and 1994..............S-1
Report of Independent Accountants............................S-2
All schedules, except for those set forth above, have been omitted since the
information required is included in the financial statements or accompanying
notes or have been omitted as not applicable or not required.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and
Stockholders of Osteotech, Inc.:
We have audited the accompanying consolidated balance sheets of Osteotech, Inc.
and Subsidiaries as of December 31, 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 December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Osteotech, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Princeton, New Jersey
February 21, 1997
F-2
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
December 31, 1996 1995
ASSETS
- ---------------------------------------------------------------------------- -- ------------- -------------
Current assets:
Cash and cash equivalents $ 7,290 $ 2,788
Short-term investments 1,987 4,919
Accounts receivable, less allowance of
$163 in 1996 and $179 in 1995 6,280 4,561
Deferred processing costs 1,222 977
Inventories 729 1,081
Deferred income taxes 590 1,429
Prepaid expenses and other current assets 1,833 1,905
Total current assets 19,931 17,660
Equipment and leasehold improvements, net 8,170 8,624
Excess of cost over net assets of business acquired, less
accumulated amortization of $1,197 in 1996 and $945 in 1995 2,501 2,753
Other assets 881 1,133
Total assets $ 31,483 $ 30,170
============================================================================ == ============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------- -- ------------- -------------
Current liabilities:
Accounts payable and accrued liabilities $ 6,247 $ 4,078
Notes payable 655 647
Current maturities of long-term debt and
obligations under capital leases 756 800
Total current liabilities 7,658 5,525
Long-term debt and obligations under capital leases 840 1,598
Other liabilities 268 453
Total liabilities 8,766 7,576
- ---------------------------------------------------------------------------- -- ------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,676,595 shares
authorized; no shares issued or outstanding
Common stock, $.01 par value; 20,000,000 shares
authorized; issued and outstanding 7,826,779
shares in 1996 and 7,198,179 shares in 1995 78 72
Additional paid-in capital 30,288 29,782
Currency translation adjustments (113) (48)
Accumulated deficit (7,536) (7,212)
Total stockholders' equity 22,717 22,594
-----------------------------
Total liabilities and stockholders' equity $ 31,483 $ 30,170
============================================================================ =============================
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
Year ended December 31, 1996 1995 1994
- ------------------------------------------------------------------ ---- -------------- --------------- --------------
Net Revenues:
Service $ 31,717 $ 24,451 $ 22,076
Product 2,481 2,682 1,975
Grant 697 801 519
34,895 27,934 24,570
Costs and expenses:
Cost of services 12,406 10,481 9,673
Cost of products 2,414 2,078 1,322
Marketing, general and administrative 12,619 10,408 9,591
Research and development 4,357 3,749 3,349
Provision for restructuring 1,350
Provision for termination of distribution agreement 980
33,146 27,696 23,935
Other income (expense):
Recovery of principal on note
from a major customer 4,147
Interest income 448 605 509
Interest expense (232) (252) (111)
Other 55 82 179
271 4,582 577
Income before income taxes 2,020 4,820 1,212
Income tax provision (benefit), net 2,344 238 (535)
Net income (loss) $ (324) $ 4,582 $ 1,747
================================================================== ==== ============== =============== ==============
Net income (loss) per share:
Primary $(.04) $ .57 $ .22
Assuming full dilution $(.04) $ .55 $ .22
- ------------------------------------------------------------------ ---- -------------- --------------- --------------
Shares used in computing net income (loss) per share:
Primary 7,920,234 8,091,381 7,889,891
Assuming full dilution 7,920,234 8,263,764 7,894,759
- ---------------------------------------------------------------- -- ----------------- ---------------- ----------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in thousands)
Years ended December 31, 1996, 1995 and 1994
- ---------------------------------------------------- --- --------------- ---- -------------- ---- ------------------ --------------
Additional Currency Total
Common Stock Paid-In Translation Accumulated Stockholders'
Shares Amount Capital Adjustment Deficit Equity
- ------------------------------------------------------ --- -------------- --- -------------- --- -------------- --- ------------ -
Balance at December 31, 1993 6,932,985 $ 69 $ 28,926 $ (92) $ (13,541) $ 15,362
Exercise of stock options 194,975 3 121 124
Common stock issued pursuant to
employee stock purchase plan 11,916 51 51
Repurchase of stock (50,000) (1) (180) (181)
Currency translation adjustments (7) (7)
Net income 1,747 1,747
------------ -------- -- --------------- --- -------------- --- ------------------------
Balance at December 31, 1994 7,089,876 71 28,918 (99) (11,794) 17,096
Exercise of stock options 30,571 111 111
Exercise of stock warrants 55,616 1 (1)
Common stock issued pursuant to
employee stock purchase plan 22,116 136 136
Tax benefits related to stock options 618 618
51 51
Net income 4,582 4,582
Balance at December 31, 1995 7,198,179 72 29,782 (48) (7,212) 22,594
Exercise of stock options 85,866 1 317 318
Exercise of stock warrants 525,204 5 (5)
Common stock issued pursuant to
employee stock purchase plan 17,530 120 120
Tax benefits related to stock options 74 74
Currency translation adjustments (65) (65)
Net loss (324) (324)
Balance at December 31, 1996 7,826,779 $ 78 $ 30,288 $ (113) $ (7,536) $ 22,717
======================================================= ======== == =============== === ============== === ======== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year ended December 31, 1996 1995 1994
- ------------------------------------------------------------------- -------------- -------------- --------------
Cash Flow From Operating Activities
Net income (loss) $ (324) $ 4,582 $ 1,747
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,679 1,718 1,383
Provision for restructuring 1,350
Provision for termination of distribution agreement 980
Deferred income taxes 804 (582) (600)
Provision for doubtful accounts 17 15 (7)
Changes in assets and liabilities:
Accounts receivable (1,738) 30 (1,310)
Inventories 197 (594) (827)
Deferred processing costs (245) (207) (265)
Prepaid expenses and other current assets 7 (452) (535)
Accounts payable and other liabilities 1,301 62 254
- ------------------------------------------------------------------- -------------- -------------- --------------
Net cash provided by (used in) operating activities 4,048 5,552 (160)
Cash Flow From Investing Activities
Capital expenditures (2,152) (4,071) (1,777)
Proceeds from sale of investments 10,867 5,913 3,927
Purchases of investments (7,935) (9,860) (2,930)
Increase in other assets (300) (484) (104)
Net cash provided by (used in) investing activities 480 (8,502) (884)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 512 831 175
Repurchase of common stock (181)
Proceeds from issuance of notes payable 829 820 706
Proceeds from issuance of long-term debt 1,227 959
Principal payments on notes payable (821) (495) (501)
Principal payments on long-term debt
and obligations under capital leases (800) (596) (403)
Increase in other liabilities 150
Net cash provided by (used in) financing activities (280) 1,937 755
Effect of exchange rate changes on cash 254 16 (70)
- ------------------------------------------------------------------- -------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents 4,502 (997) (359)
Cash and cash equivalents at beginning of year 2,788 3,785 4,144
Cash and cash equivalents at end of year $ 7,290 $ 2,788 $ 3,785
=================================================================== ============== ============== ==============
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Osteotech, Inc. (the "Company"), formed in 1986, provides services and
develops and markets products to the orthopaedic, neurological,
oral/maxillofacial, dental and general surgery markets in the United States
and Europe. The Company's current technology, products and services, and
those under development, are focused primarily on the repair and healing of
the musculoskeletal system. Osteotech is engaged in: (i) the processing of
human bone, ligaments and tendons (collectively, "bone tissue") for
transplantation; (ii) providing ceramic (hydroxyapatite) and titanium
plasma spray coating services and ceramic based products to the
orthopaedic, dental and ear, nose and throat implant markets; and (iii)
distributing implant devices and specialized instruments for spinal
surgery.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidated Financial Statements
The consolidated financial statements include the accounts of Osteotech,
Inc. and its majority-owned subsidiaries. All intercompany transactions and
balances are eliminated in consolidation.
Revenue Recognition
Revenue is recognized at the time the Company provides services or ships
products to its customers.
Grant revenues are recognized when earned. Grant revenues are considered to
be earned in the period that qualifying research and development
expenditures are incurred and reflected in the Consolidated Statements of
Operations.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. Investments with
maturities in excess of three months but less than one year are classified
as short-term investments and are stated at cost, net of any unamortized
premiums or discounts, which approximates fair value.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
under the first-in, first-out method.
Deferred Processing Costs
Costs related to bone tissue processing in progress are deferred until
processed bone tissue is released from final quality assurance testing.
F-7
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost less accumulated
depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets which
range from three to ten years. The cost of leasehold improvements is
amortized on the straight-line method over the shorter of the lease term or
the estimated useful life of the asset. Major renewals and betterments are
capitalized. Maintenance and repairs are expensed as incurred. When
depreciable assets are retired or sold, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss
is reflected in operations.
Excess of Cost Over Net Assets of Business Acquired
The excess of cost over the net assets of business acquired ("goodwill") is
being amortized on a straight-line basis over 15 years. It is the Company's
policy to periodically review and evaluate whether there has been a
permanent impairment in the value of goodwill. Factors considered in the
valuation include current operating results, trends, prospects and
anticipated undiscounted future cash flows.
Translation of Foreign Currency
Assets and liabilities of foreign subsidiaries are translated at rates of
exchange in effect at the close of the year. Revenues and expenses are
translated at the weighted average exchange rates during the year.
Translation gains and losses are accumulated as a separate component of
stockholders' equity. Foreign currency transaction gains and losses are
included in other income.
Net Income (Loss) Per Share
The computation of net income (loss) per share is based on the weighted
average number of common shares and nominal warrants (warrants with an
exercise price of $.03) outstanding adjusted to reflect the assumed
exercise of outstanding stock options and other warrants using the treasury
stock method to the extent these items had a dilutive effect on the
computations.
Income Taxes
The Company follows Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes ("SFAS 109") which requires recognition of
deferred tax assets and liabilities based on differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, measured using the enacted tax rates in effect
for the years in which the differences are expected to be recovered or
settled.
Concentrations of Credit Risk
The Company provides credit, in the normal course of business, to tissue
banks, hospitals and Company agents. The Company maintains an allowance for
doubtful accounts and charges actual losses to the allowance when incurred.
The Company invests the majority of its excess cash in U.S.
Government-backed securities and investment grade commercial paper of major
U.S. corporations. The Company does not believe it is exposed to any
significant credit risk on its cash equivalents and short-term investments.
F-8
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Use of 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 and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results may differ from such estimates.
3. RESTRUCTURING OF THE NETHERLANDS OPERATIONS
In October 1996, the Company announced a plan to restructure its
non-allograft operations located in Leiden, The Netherlands. In connection
with the restructuring, the Company discontinued its PolyActive(TM) polymer
research and development program. As a result of the restructuring, the
Company recorded a pre-tax restructuring charge of $1,350,000, consisting
primarily of employee termination costs, write-off of equipment, intangible
assets, supplies and costs associated with the planned sub-leasing of
office space in Leiden on which the Company has a long-term lease.
4. TERMINATION OF DISTRIBUTION AGREEMENT
In June 1995, the Company terminated its distribution agreement for trauma
implant products with its supplier, aap, GmbH of Berlin, Germany. As a
result of this termination, the Company recorded a pre-tax charge to
earnings of $980,000 consisting principally of inventory write-offs,
employee termination costs and legal fees.
5. NOTE RECEIVABLE FROM A MAJOR CUSTOMER
The Company is the exclusive processor of allograft bone tissue procured
and distributed by the Musculoskeletal Transplant Foundation ("MTF"). (See
Note 8 and Note 16.) From MTF's inception in February 1987 through May
1989, the Company supplemented MTF's working capital requirements through
a series of cash advances and unpaid processing and service fees. In June
1990, the principal and interest on these advances at December 31, 1989
were converted into two notes which were fully reserved by the Company.
The first note had an original face value of $7,216,000. During 1995 the
Company received $4,147,000 of principal payments on this note reducing
the outstanding balance to $0. During 1994 the Company received no
principal payments on this note. During 1995 and 1994 the Company also
received interest payments from MTF on this note of $330,000 and $285,000,
respectively.
F-9
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. NOTE RECEIVABLE FROM A MAJOR CUSTOMER (continued)
The second note, with an original face value of $2,621,000, was
non-interest bearing and was subject to cancellation by the Company at the
rate of $524,000 per year on the anniversary of the note (June 30th),
provided MTF met certain annual requirements as defined in the note. During
1995, the Company canceled $524,000 of the note thereby reducing the
remaining amount outstanding to $0. The Company also canceled $524,000 of
the note on June 30, 1994. The cancellation of the note had no impact on
the Company's results of operations since the note was fully reserved.
6. INVENTORIES
Inventories consist of the following at December 31:
(in thousands) 1996 1995
----------------------------------- -------------- ---- --------------
Raw materials $ 379 $ 247
Finished goods 350 834
$ 729 $ 1,081
=================================== ============== ==== ==============
7. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following at December 31:
(in thousands) 1996 1995
-------------------------------------------------------------------------
Production and laboratory equipment $ 8,273 $ 7,116
Computer hardware and software 1,328 1,096
Office equipment, furniture and fixtures 1,450 1,183
Vehicles 74 32
Equipment under capital lease 391 402
Leasehold improvements 3,870 3,648
---------- ----------
15,386 13,477
Less accumulated depreciation
and amortization 7,216 4,853
$ 8,170 $ 8,624
========================================= ================ ==============
Accumulated depreciation and amortization above includes amortization on
equipment under capital lease of $152,000 and $56,000 in 1996 and 1995,
respectively.
8. COMMITMENTS AND CONTINGENCIES
Service Agreements
Osteotech is the exclusive processor of allograft bone tissue for large
national and international not-for-profit organizations. The Company
provides these processing services pursuant to long-term service
agreements. Customers are charged fees on a per donor basis, or for
proprietary
F-10
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. COMMITMENTS AND CONTINGENCIES (continued)
products on a per unit basis, for direct and indirect processing and for
finishing and packaging each unit of bone tissue produced. Osteotech's
agreements with its customers generally provide for the Company to
indemnify its customers against liability arising out of defects in
allograft bone tissue caused as a result of processing by the Company. In
December 1996, the Company entered into a new ten year agreement with one
of its major customers, the American Red Cross ("ARC"). The Company is
currently in discussions with its other major customer, MTF, to enter into
a new long-term agreement to replace the existing agreement which expires
on March 31, 1997. There can be no assurance that the Company and MTF will
enter into a new agreement or that such agreement will contain terms
favorable to the Company. (See Note 16.)
Customers of the Company's plasma spray coating services generally purchase
such services pursuant to purchase orders or non-exclusive supply
agreements which are cancelable at any time by either party.
Litigation
The Company has been named as a defendant in a number of lawsuits in which
patients claim that they have suffered damages from the implantation of
allegedly defective spinal fixation devices allegedly distributed by the
Company. Management believes that the suits and claims are without merit
and intends to defend such actions vigorously. It is the Company's position
that either a device distributed by the Company was not implanted in the
patient, or that if the allegations in the complaints regarding the use of
the device are assumed to be true, the device was used in a manner which
was contrary to the use approved by the FDA and the Company's warnings
concerning use. Pursuant to its distribution agreement with the Company,
the manufacturer of the spinal fixation devices, Heinrich C. Ulrich, KG
("Ulrich") has agreed to indemnify the Company for all costs, and damages
incurred by the Company in connection with its distribution of products
manufactured by Ulrich, except such costs and damages which are caused by
the Company's gross negligence or willful misconduct or unauthorized claim
made by the Company in marketing the products. In connection with this
indemnification, the Company received $59,000 from Ulrich in 1996 as
reimbursement for legal costs incurred by the Company.
The Company has also been named as a defendant in a lawsuit which alleges
that the Company and co-defendant MTF mislabeled and mispackaged processed
human bone tissue. Pursuant to a service agreement between MTF and the
Company regarding the Company's tissue processing services, the Company has
agreed to defend, indemnify and hold harmless MTF with respect to this
action. Management believes that this lawsuit is without merit and the case
is currently being defended, including the defense of MTF, by the Company's
products liability insurance carrier.
The Company maintains products liability insurance coverage in the amount
of $20 million per occurrence and per year in the aggregate, however, there
can be no assurance that these claims will be covered by the Company's
insurance policy. Management is unable to predict the outcome of the
pending suits and claims or whether or not their ultimate disposition will
have a material effect upon the consolidated financial position, results of
operations and liquidity of the Company.
F-11
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. LEASING TRANSACTIONS
The Company leases office and production facilities and equipment under
various capital and operating lease agreements which have non-cancelable
terms through May 2008. The leases for office and production facilities
include renewal provisions at the Company's option. Additionally, certain
of the leases contain purchase options.
Future minimum lease commitments as of December 31, 1996 are as follows:
Capital Operating
Year Leases Leases
----------------------------------------------------- ----------------
(in thousands)
1997 $ 108 $ 974
1998 108 928
1999 36 879
2000 861
2001 and thereafter 5,320
Total minimum lease payments 252 $ 8,962
=========
Less amount representing interest 32
----------------------------------------------------
Present value of minimum lease payments $ 220
==================================================== ======
Rental expense was $1,045,000, $956,000 and $653,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
10. STOCKHOLDERS' EQUITY
Preferred Stock
In July 1991, upon completion of the Company's initial public offering, the
authorized capital of the Company was amended to reflect 5,675,595 shares
of Preferred Stock, the rights and provisions of which will be determined
by the Board of Directors at the time any such shares are issued, if at
all. No shares of Preferred Stock were issued or outstanding at December
31, 1996 and 1995.
Stock Options
The Company has two stock option plans currently in effect under which
future grants may be issued: the 1991 Stock Option Plan (the "1991 Plan")
and the 1991 Independent Directors Stock Option Plan (the "Directors
Plan"). These plans, as amended, provide for the issuance of up to
1,813,765 and 500,000 shares respectively, of the Company's Common Stock.
The 1991 Plan provides for option grants to officers, employees and
consultants designated as either non-qualified or incentive stock options.
The Directors Plan provides for option grants to members of the Board of
Directors who are not officers or employees of the Company. The Directors
Plan is a non-statutory stock option plan covering the issuance of options
that will not qualify as incentive stock options. Options generally become
exercisable in ratable installments over a four-year period.
F-12
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (continued)
Prior to the adoption of the 1991 Plan, the Company issued options to
officers, employees and consultants pursuant to written option agreements
which were not subject to a formal plan. The option price was periodically
set by the Board of Directors based upon an evaluation of the fair market
value of the Company's Common Stock. Options issued pursuant to written
option agreements generally became exercisable in ratable installments over
a four-year period. The Company no longer issues options not covered by a
formal plan. At December 31, 1996, the Company reserved an aggregate of
42,391 shares of its Common Stock for issuance upon exercise of options
granted pursuant to written option agreements.
Stock option activity for the years 1996, 1995 and 1994 is as follows:
1996 1995 1994
----------------------------------------------------------------------- -------------------------- --------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price Shares
---------------------------------------------------------- ------------ ---------------- ------------ - --------------
Outstanding at January 1, 1,582,162 $ 5.41 1,710,292 $ 6.07 1,831,250
Granted 303,500 7.44 533,177 5.97 550,150
Exercised 85,866 3.71 30,571 3.64 194,975
Canceled or expired 47,253 6.33 630,736 7.75 476,133
Outstanding at December 31, 1,752,543 $ 5.82 1,582,162 $ 5.41 1,710,292
Exercisable at December 31, 1,009,545 $ 5.55 841,318 $ 5.36 738,203
---------------------------------------------------------- ------------ -------------- ------------ --------------
Available for grant at
December 31, 507,745 514,904 417,563
---------------------------------------------------------- ------------ -------------- ------------ --------------
Weighted average fair value of
options granted during the period $ 3.52 $ 2.95
---------------------------------------------------------- ------------ ---------------- ------------ - --------------
In April 1995, the Company instituted a stock option exchange program
whereby optionees with options having an exercise price of $6.00 or more
were offered repriced options on the basis of a 65% exchange ratio. The
exercise price of the new options was the then current fair market value of
the Common Stock which was $5.25 per share. As a result of the exchange
program, options for 327,458 shares were canceled and options for 213,477
shares were issued.
F-13
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (continued)
The following table summarizes the information about stock options
outstanding at December 31, 1996:
Options Outstanding Options Exercisable
------------------------------------------------- ----------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding at Remaining Average Exercisable at Average
Range of December 31, Contractual Exercise December 31, Exercise
Exercise Prices 1996 Life (Years) Price 1996 Price
--------------------- -- ----------------- -- -------------- --------------- -- ----------------------------------
$ .56 to $ 3.94 73,391 3 $ 1.88 55,291 $ 1.33
4.00 to 6.94 1,322,900 5 5.32 762,502 5.25
7.00 to 10.00 350,627 6 8.40 186,127 7.74
12.25 to 17.00 5,625 3 14.91 5,625 14.91
--------- ---- ------------------------ - ---------------- ------------- -- ----------------- -- -------------
$ .56 to $ 17.00 1,752,543 5 $ 5.82 1,009,545 $ 5.55
========================================== ============================= ====================== =============
The Company has adopted the "disclosure only" provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock Based
Compensation ("SFAS 123") and, accordingly, no compensation cost has been
recognized in the Statements of Operations. Pro forma information regarding
net income and net income per share is required by SFAS 123, and has been
determined as if the Company accounted for its stock options under the Fair
Value Method of that Statement. For purposes of the pro forma disclosures,
the estimated fair value of the options is amortized to expense over the
options' vesting period. The Company's pro forma information follows (in
thousands except for per share information):
1996 1995
---------------------------------------------------------- ------------
Net income (loss), as reported $ (324) $ 4,582
Net income (loss), pro forma (865) 4,054
Net income (loss) per share, as reported
Primary $ (.04) $ .57
Assuming full dilution (.04) .55
Net income (loss) per share, pro forma
Primary $ (.11) $ .52
Assuming full dilution (.11) .50
---------------------------------------------------------- ------------
The pro forma effect on net income for 1995 and 1996 is not representative
of the pro forma effect on net income in future years because it does not
take into consideration pro forma compensation expense related to grants
made prior to 1995.
F-14
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (continued)
The fair value for the option grants was estimated at the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions:
1996 1995
----------------------------------------------- ------ -----------------
Expected life (years) 6 5
Risk free interest rate 6.6% 6.9%
Volatility factor 50.0% 50.0%
Dividend yield 0.0% 0.0%
---------------------------------------------- ------ ------------------
Stock Warrants
As part of financing and contract arrangements, the Company has, at certain
times, issued warrants to purchase the Company's Convertible Preferred
Stock and Common Stock. Warrant activity for the years ended December 31,
1994, 1995 and 1996 is summarized as follows:
Convertible Preferred
Stock Warrants Common
Series Series Stock
A D Warrants
- -------------------------------------------- -------------- ---- --- --------------------------------------
Outstanding at December 31, 1993 96,343 248,061 620,326
- -------------------------------------------- -------------- --- ---- --------------- ---- --------------
Outstanding at December 31, 1994 96,343 248,061 620,326
Exercised 16,637 52,488
Outstanding at December 31, 1995 96,343 231,424 567,838
Exercised 85,190 15,709 437,474
Outstanding at December 31, 1996 11,153 215,715 130,364
- -------------------------------------------- -------------- ---- --- -------------- --- ---------------
Exercise price $ 0.03 $ 5.58 $ 0.03
Expiration date 1997 1997-2001 2001
- -------------------------------------------- -------------- ---- --- --------------- -- -------------
Convertible Preferred Stock warrants are immediately convertible into
Common Stock upon exercise on a share for share basis. In January 1994, the
Board of Directors approved amending all outstanding warrants to allow for
cashless exercise of such warrants. Under the cashless exercise method, the
number of shares issued upon exercise of such warrant is determined by
calculating the aggregate number of shares represented by the warrants
using the closing price of the Company's Common Stock on the exercise date,
deducting the aggregate exercise cost and dividing the net remaining amount
by the market value per share on the exercise date.
F-15
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (continued)
Stock Purchase Plan
The 1994 Employee Stock Purchase Plan provides for the issuance of up to
250,000 shares of Common Stock. Eligible employees may purchase shares of
the Company's Common Stock through payroll deductions of 1% to 7 1/2% of
annual compensation. The purchase price for the stock is 85% of the fair
market value of the stock on the last day of each calendar quarter. At
December 31,1996, 198,438 shares were available for future offerings under
this plan.
Stockholder Rights Agreement
In January 1996, the Board of Directors of the Company unanimously adopted
a stockholder rights agreement (the "Rights Agreement") declaring a
dividend of one preferred stock purchase right (the "Right") for each
outstanding share of common stock as of February 12, 1996. Each Right
entitles the stockholder to purchase from the Company one one-hundredth of
a preferred share at a price of $35.00 per share, subject to adjustment.
The Rights will not be exercisable or separable from the common shares
until ten business days after a person or group acquires or tenders for 20%
or more of the Company's outstanding common shares ("triggering event").
The Rights Agreement also provides that, after a triggering event occurs,
the Rights convert into a Right to buy common stock and entitle its holder
to receive upon exercise that number of common shares having a market value
of two times the exercise price of the Right. In the event the Company is
acquired in a merger or other business combination transaction, each Right
will entitle its holder to receive upon exercise of the Right, at the
Right's then current exercise price, that number of the acquiring company's
common shares having a market value of two times the exercise price of the
Right. The Company is entitled to redeem the Rights at a price of $.01 per
Right at any time prior to their becoming exercisable, and the Rights
expire on February 12, 2006. The Rights Agreement was adopted to maximize
the value of all stockholders' ownership interest in the Company by
establishing a deterrent to abusive takeover tactics sometimes used in
challenges for corporate control.
11. DEBT AND FINANCING ARRANGEMENTS
The Company has a loan and security agreement with a U.S. bank which
provides for borrowing up to $3,000,000 under a revolving line of credit
and $4,000,000 under an equipment line of credit. The annual interest rate
on revolving loan advances is based upon the bank's prime rate whereas the
annual rate of interest on equipment advances is based upon the bank's
prime rate plus a margin of .25%. Borrowings under the equipment line of
credit are repayable over a 48 month term and are collateralized by
equipment purchased with such borrowings. The Company is required under the
agreement to maintain certain financial ratios and meet certain net worth
and indebtedness tests. An annual commitment fee of .25% is payable on the
unused portion of the revolving line of credit. At December 31, 1996 and
1995, $1,377,000 and $2,080,000, respectively, was outstanding under the
equipment line of credit and there were no borrowings under the revolving
line of credit.
F-16
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. DEBT AND FINANCING ARRANGEMENTS (continued)
The Company has a line of credit with a Dutch bank which provides for
borrowing up to 5,000,000 dfl, or approximately $2,872,000 at the December
31, 1996 exchange rate. Borrowings under this credit line bear interest at
the Dutch Central Bank discount rate for promissory notes plus a margin of
2.5%. Under certain circumstances the Company may elect to utilize a rate
based on the Amsterdam Interbank Offered Rate (AIBOR) plus a margin of 1%.
Analysis of the Company's financial position and anticipated cash flow
indicated that it most likely would not be necessary to utilize a
significant portion of this line of credit in 1996 and, therefore, the
Company agreed with the bank to limit its borrowings in 1996, if any, to be
no more than 3,000,000 dfl, or approximately $1,723,000 at the December 31,
1996 exchange rate. Additionally, in connection with the Leiden facility
lease, the Company is required to maintain a declining bank guarantee which
reduced the current amount available for borrowings to 2,424,000 dfl or
approximately $1,392,000 at the December 31, 1996 exchange rate. At
December 31, 1996 and 1995, there were no borrowings under this line of
credit.
The weighted average interest rate on short-term notes payable outstanding
was 5.87% in 1996 and 5.73% in 1995.
Long-term debt consists of the following at December 31:
(in thousands) 1996 1995
---------------------------------------------------------------------------------------- ------------- --- -------------
Term loan payable to a bank, collateralized by equipment and repayable
in monthly installments of $59,000 plus accrued
interest at the bank prime rate plus .25% (8.75% at December 31, 1996). $ 1,377 $ 2,080
Term note payable to a bank, collateralized by accounts receivable
and equipment of a subsidiary and repayable in quarterly installments
of $15,000 plus accrued interest at 11%. 15
1,377 2,095
Less current portion 668 719
$ 709 $ 1,376
Aggregate long-term debt maturities are $668,000 in 1997, $537,000 in
1998 and $172,000 in 1999.
F-17
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31:
(in thousands) 1996 1995
-------------------------------------------- ---- ----------------
Trade accounts payable $ 1,391 $ 1,826
Accrued compensation 1,051 470
Accrued research and development 1,264 598
Other accrued liabilities 2,541 1,184
$ 6,247 $ 4,078
============================================== ==== ===============
13. INCOME TAXES
The income tax provision (benefit) is summarized as follows at December 31:
(in thousands) 1996 1995 1994
---------------------------------------------------- --- ---------------- --- ----------------
Current:
Federal $ 1,338 $ 294 $ 65
State 470 152
1,808 446 65
------------ --- ---------------- --- ----------------
Deferred:
Federal 508 (124) (600)
State 28 (84)
536 (208) (600)
------------ --- ---------------- --- ----------------
Income tax provision (benefit), net $ 2,344 $ 238 $ (535)
===================================================== === ================ === ================
The difference between income tax expense (benefit) and the expected tax
which would result from the use of the Federal statutory income tax rate is
as follows:
(in thousands) 1996 1995 1994
------------------------------------------------------------ ----- -------------- ----- --------------
Computed tax at statutory Federal rate $ 687 $ 1,639 $ 412
State income taxes 352 416 311
Amortization of excess of cost over
fair value of assets acquired 86 86 86
Net operating losses for which no tax
benefit is currently available 1,184 601 644
Change in valuation allowance allocated to
income tax expense (2,551) (2,079)
Alternative minimum tax 65
Other 35 47 26
----------------------------------------------------------- ----- -------------- ----- --------------
Income tax provision (benefit), net $ 2,344 $ 238 $ (535)
=========================================================== ===== ============== ===== ==============
F-18
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. INCOME TAXES (continued)
Loss before income taxes from foreign operations was $3,652,000 in 1996,
$1,910,000 in 1995 and $1,839,000 in 1994, respectively. The components of
the deferred tax assets and deferred tax liabilities are as follows at
December 31:
(in thousands) 1996 1995
----------------------------------------------------------- -----------
Deferred Tax Assets:
Net operating loss carryforwards
Federal $ 374 $ 714
Foreign 4,016 2,751
State 57 55
Tax credits 11 654
Other 637 496
Total gross deferred tax assets 5,095 4,670
Less valuation allowance 4,530 3,134
----------------------------------------------------------- ----------
Deferred tax assets 565 1,536
----------------------------------------------------------- ----------
Deferred Tax Liabilities:
Other 153 320
Total gross deferred tax 153 320
----------------------------------------------------------- ----------
Net deferred tax asset $ 412 $ 1,216
=========================================================== ==========
In 1996, the Company increased its valuation allowance as a result of
foreign losses for which the realization of future tax benefits is
uncertain. In 1995 and 1994 the Company reduced its valuation allowance
resulting in the recognition of net deferred tax assets of $2,551,000 and
$2,079,000, respectively, resulting from (i) the realization of tax
benefits of temporary differences which reversed during each year
($1,335,000 in 1995 and $1,479,000 in 1994); and (ii) the Company's
assessment that it would generate sufficient future U.S. taxable income to
realize a portion of the deferred tax benefits associated with certain
Federal and state net operating loss carryforwards and tax credits
($1,216,000 in 1995 and $600,000 in 1994).
At December 31, 1996, the Company had U.S. net operating loss carryforwards
which approximate $1,099,000 for Federal income tax purposes and $216,000
for state income tax purposes. The Federal and state net operating loss
carryforwards, if unused, expire from 2006 through 2011. The Company also
has research and development tax credit carryforwards for Federal income
tax purposes of approximately $11,000 which expire 2009. The timing and
manner in which the U.S. net operating loss carryforwards and credits are
utilized in the future may be limited by Internal Revenue Code Section 382.
In addition, certain of the Company's subsidiaries have foreign net
operating loss carryforwards aggregating $10,041,000 ($350,000 with no
expiration date; $9,691,000 expiring 1999 through 2004).
Approximately $214,000 of the net operating loss carryforwards were
acquired in connection with the acquisition of HC Implants BV in May 1992.
Subsequently recognized tax benefits which result from the utilization of
these acquired net operating loss carryforwards will be applied to reduce
the excess of cost over net assets of business acquired.
F-19
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(in thousands) 1996 1995 1994
------------------------------------------------------------------- -------------- -------------- --------------
Cash paid during the year for interest $ 188 $ 240 $ 105
Cash paid during the year for taxes 1,120 101 61
Capital lease obligations entered into during the year 309
------------------------------------------------------------------- -------------- -------------- --------------
15. SUPPLEMENTARY STATEMENT OF OPERATIONS INFORMATION
Maintenance and repairs expense for the years ended December 31, 1996, 1995
and 1994 was $981,000, $773,000 and $610,000, respectively. Depreciation
and amortization expense related to equipment and leasehold improvements
for the years ended December 31, 1996, 1995 and 1994 was $2,020,000,
$1,374,000 and $1,119,000, respectively.
16. SEGMENT AND MAJOR CUSTOMER DATA
The Company operates principally in one business segment - the repair and
healing of the musculoskeletal system. Financial information by geographic
area is summarized as follows:
(in thousands) United States Europe Consolidated
------------------------------------------------- -------------------- ---- -------------- ----- ---------------------
Revenues
1996 $ 31,582 $ 3,313 $ 34,895
1995 24,293 3,641 27,934
1994 21,938 2,632 24,570
Net income (loss)
1996 $ 2,628 $ (2,952) $ (324)
1995 5,904 (1,322) 4,582
1994 2,883 (1,136) 1,747
Identifiable Assets
1996 $ 26,768 $ 4,715 $ 31,483
1995 24,929 5,241 30,170
1994 17,246 5,348 22,594
- ------ -------------------------------------------------- ---------------- ------- ---------------- ------- ----------------
Customers comprising 10% or greater of the Company's consolidated net
revenues are summarized as follows:
Revenues
(in thousands) 1996 1995 1994
--------------------------------------------------- -------------- ------ -------------- ------- --------------
MTF $22,224 $18,009 $15,529
ARC 8,735 5,544 5,495
$30,959 $23,553 $21,024
=================================================== ============== ======= ============== ====== ==============
F-20
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. RETIREMENT BENEFITS
The Company has a 401(k) plan which covers substantially all full time U.S.
employees. The Company has agreed to contribute an amount equal to 25% of
each participant's contribution. A participant's contribution may not
exceed 15% of annual compensation, or the maximum allowed by the Internal
Revenue Code, if less than 15% of compensation. Provisions of the plan
include graduated vesting over five years of service. Total Company
contributions for the years ended December 31, 1996, 1995 and 1994 were
$133,000, $105,000 and $87,000, respectively.
Certain of the Company's foreign subsidiaries provide retirement benefits
to their employees through the purchase of non-participating annuity
contracts. The expenses for these contracts were $31,000, $44,000 and
$14,000 for the years ended December 31, 1996, 1995 and 1994.
The Company does not maintain any other pension or post retirement plans.
18. RECLASSIFICATIONS
Certain of the 1995 and 1994 amounts have been reclassified for comparative
purposes.
19. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of the unaudited quarterly results for the years
ended December 31, 1996 and 1995:
Quarter Ended
(dollars in thousands except per share data) March 31 June 30 Sept. 30 Dec. 31
- -------------------------------------------- --------------- ---- ------------- ---- ------------- ---- -------------
1996
Net revenues $ 8,409 $ 8,375 $ 9,010 $ 9,101
Cost of services
and products 3,597 3,615 3,849 3,759
Net income (loss) 171 202 251 (948)
Net income (loss) per share $ .02 $ .02 $ .03 $ (.12)
1995
Net revenues $ 6,982 $ 6,626 $ 6,977 $ 7,349
Cost of services
and products 3,083 3,031 3,151 3,294
Net income (loss) 36 (745) 4,709 582
Net income (loss) per share $ .01 $ (.10) $ .58 $ .07
- ---------------------------------------------- -------------- ---- ------------- ----- ------------- ----- -------------
The quarter ended December 31, 1996 includes a pre-tax charge of $1,350,000
related to the restructuring of the Company's non-allograft operations in
Leiden, The Netherlands (See Note 3). The quarter ended June 30, 1995
includes principal payments on a fully reserved note from a significant
customer of $69,000 (See Note 5) and a pre-tax charge to earnings of
$980,000 resulting from the termination of a distribution agreement (See
Note 4). The quarter ended September 30, 1995 includes principal payments
on a fully reserved note from a significant customer of $4,078,000 and a
tax benefit of $2,232,000 resulting from the recognition of a net deferred
tax asset (See Note 5 and Note 13).
F-21
SCHEDULE II
OSTEOTECH, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance At Additions Balance At
-------------------------------
Beginning Charged To Charged End
Of Period Expenses To Other Deductions Of Period
--------------- --------------- --------------- --------------- ---------------
For the year ended December 31, 1996:
Allowance for doubtful accounts $ 179 $ 17 $ (10)(a) $ (23)(b) $ 163
Valuation allowance for deferred
tax asset 3,134 1,396(d) 4,530
For the year ended December 31, 1995:
Allowance for doubtful accounts 158 18 3(a) 179
Allowance for loss on notes receivable
from a significant customer 4,672 (1) (4,671)(c) 0
Valuation allowance for deferred
tax asset 5,665 604(d) (3,135)(e) 3,134
For the year ended December 31, 1994:
Allowance for doubtful accounts 139 13 6(a) 158
Allowance for loss on notes receivable
from a significant customer 5,196 (524)(c) 4,672
Valuation allowance for deferred
tax asset 5,722 2,022(d) (2,079)(e) 5,665
a. Represents foreign currency translation adjustments.
b. Represents the write-off of accounts receivable.
c. Represents forgiveness of $524,000 in 1995 and 1994 on a
non-interest bearing note which was fully reserved and loan principal
repayments of $4,147,000 received during 1995, on a note which was
fully reserved.
d. Represents the tax effect of temporary differences.
e. Represents recognition of a deferred tax asset.
S-1
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and
Stockholders of Osteotech, Inc.:
Our report on the consolidated financial statements of Osteotech,
Inc. and Subsidiaries is included on page F-2 of this 1996 Form 10-K. In
connection with our audits of such consolidated financial statements, we
have also audited the related financial statement schedule listed in the
index on page F-1 of this Form 10-K.
In our opinion, the financial statement schedule referred to
above, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
COOPERS & LYBRAND L.L.P.
Princeton, New Jersey
February 21, 1997
S-2
EXHIBIT INDEX
Location of
Exhibit in
Sequential
Exhibit Number Description Numbering System
- --------------------------------------------------------------------------------
10.26 Agreement dated December 20, 1996 between E-2
American Red Cross and the Company(*)
10.27 Lease for the Company's Shrewsbury, New Jersey E-39
processing facility
10.28 Employment Agreement between the Company E-52
and Richard W. Bauer
11.1 Computation of Primary Net Income (Loss) E-64
Per Share
11.2 Computation of Fully Diluted Net Income E-65
Per Share
21.1 Subsidiaries of the Registrant E-66
23.1 Consent of Coopers & Lybrand E-67
(*) Document for which the Company is representing confidential treatment
pursuant to Rule 24b-2.