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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the fiscal year ended December 31, 2000 Commission File Number 0-19278
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OSTEOTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3357370
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 (732) 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
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(Title of class)
Preferred Stock Purchase Rights
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(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 20, 2001 was approximately $82,098,000.
As of March 20, 2001, there were 13,989,307 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 2001 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.
2000 Form 10-K Annual Report
TABLE OF CONTENTS
Section Page
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PART I
Item 1. Business 1
Company Overview 1
Strategy 4
Business Summary 7
Allograft Bone Tissue Processing 9
Expansion of Allograft Bone Tissue Business in Europe 11
Other 12
Quality Assurance 13
Clients 14
Education and Marketing 14
Government Regulations 15
Research and Development 17
Competition 17
Environmental Matters 23
Patents and Proprietary Rights 23
Product Liability and Insurance 24
Employees 24
Item 2. Properties 24
Item 3. Legal Proceedings 25
Item 4. Submission of Matters to a Vote of Security Holders 32
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 33
Item 6. Selected Financial Data 34
Item 7. Management's Discussion And Analysis Of Financial
Condition And Results Of Operations 35
Risk Factors 40
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 45
Item 8. Financial Statements and Supplementary Data 45
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 45
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PART III
Item 10. Directors and Executive Officers of the Registrant 46
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners and
Management 46
Item 13. Certain Relationships and Related Transactions 46
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 47
The following trademarks and service marks appear in this Annual
Report: bio-d(TM) Threaded Cortical Bone Dowel, Graftech(TM) Bio-implants,
OsteoActive(TM) and Ovation(TM) Low Back Fixation System are trademarks and
Osteotech(R), Grafton(R) Demineralized Bone Matrix (DBM), Versalok(R) Low Back
Fixation System (Versalok(R) System), and Allogard(R) Packaging are registered
trademarks of Osteotech, Inc.; D-MINsm is a service mark of Osteotech, Inc.;
LUBBOC(R) AND LADDEC(R) are registered trademarks of OST Developpement SA and
OsteoPure(TM) is a trademark of OST Developpement SA; Vertebral Body Replacement
(VBR(TM)) is a trademark of Heinrich C. Ulrich, K.G.
iii
PART I
Item 1. Business
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 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 in the "Risk Factors" section of this
Annual Report and elsewhere in this Annual Report constitute cautionary
statements identifying factors with respect to such forward-looking statements,
including certain risks and uncertainties, that could cause 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.
Company Overview
Osteotech, Inc., or Osteotech, provides services and products primarily
focused in the repair and healing of the musculoskeletal system. These products
and services are marketed primarily to the orthopaedic, spinal, neurological,
oral/maxillofacial, dental and general surgery markets in the United States and
Europe. Based on our knowledge of the allograft bone tissue industry, we believe
that we are the world's largest processor and developer of human bone and bone
connective tissue, or allograft bone tissue, forms. The allograft bone tissue we
process is procured by independent tissue banks or other Tissue Recovery
Organizations, or TRO's, primarily through the donation of tissue from deceased
human donors and is used for transplantation. We have two primary operating
segments:
o the Grafton(R)Demineralized Bone Matrix (DBM) Segment, or the
Grafton(R)DBM Segment; and
o the Base Allograft Bone Tissue Segment, or the Base Tissue Segment.
All of our other products and services which do not meet the criteria to be
separately identified as a segment are aggregated under the category of "other."
In the Grafton(R) DBM Segment we process and market Grafton(R) DBM
which is generally distributed by our clients. To the extent that allograft bone
tissue is recovered by TRO's on our behalf, we will process and distribute such
tissue under our own label. Grafton(R) DBM is processed using our validated,
advanced, proprietary demineralization process. When applied to cortical bone,
this process yields allograft bone tissue which has osteoinductive (the process
by which bone is induced to grow) and osteoconductive (the matrix provided by
allograft bone tissue into which the host bone can grow) capabilities greater
than currently available forms of mineralized allograft bone tissue.
In the Base Tissue Segment we process primarily mineralized
weight-bearing allograft bone tissue which our clients generally market and
distribute. To the extent that TRO's recover
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allograft bone tissue on our behalf, we will process and distribute such tissue
under our own label. We also process the bio-d(TM) Threaded Cortical Bone Dowel
for posterior and anterior spinal fusion procedures, the Graftech(TM)
Bio-implant spacers and ramps for posterior and anterior spinal fusion
procedures and OsteoPure(TM) Femoral head bone tissue in the Base Tissue
Segment. We market these allograft bone tissue forms which are generally
distributed by our clients, unlike other tissue forms processed in this segment,
which are generally marketed and distributed by our clients.
We have leveraged our expertise in musculoskeletal tissue technology to
develop innovative processes and proprietary products that are widely used by
orthopaedic, spinal, neurological and oral/maxillofacial surgeons for spinal
fusion procedures; to repair and replace bone loss caused by trauma or certain
disease states; to augment prosthetic implant procedures; and to replace damaged
ligaments and tendons.
In addition to our Grafton(R) DBM Segment and Base Tissue Segment, we
provide ceramic and titanium plasma spray coating services and ceramic products
which are used as bone graft substitutes, to orthopaedic and dental implant
manufacturers. We distribute these products in Europe and the Middle East
through our operations based in Leiden, The Netherlands. In the United States,
we also market and distribute metal spinal implant products, including the
Versalok(R) Low Back Fixation System, or Versalok(R) System, a lumbosacral spine
fixation system with an innovative polyaxial screw. In January, 2001, we began
marketing the Vertebral Body Replacement, or VBR(TM), a patented device approved
as a vertebral body replacement device intended for use in the thoracolumbar
spine (T1 - L5) to replace a collapsed, damaged or unstable vertebral body due
to tumor or trauma. To our knowledge, this is the first time the Food and Drug
Administration, or the FDA, has specifically cleared any single device for
either of these indications, which establishes a new standard for this class of
device. In January, 2001, we also began marketing the Ovation(TM) Low Back
Fixation System, or Ovation(TM), a titanium, lumbosacral spine fixation system
with an innovative polyaxial screw.
In February, 2001, we entered into a distribution agreement to market a
pedicle screw system and a cervical plating system in the United States and
Canada, which are manufactured by Alphatec Manufacturing, Inc. Under the terms
of the agreement, which is for an initial term of two (2) years from the date
that the first order for the systems is completed (expected to be in August,
2001), we are required to purchase a minimum of $6 million of the two systems.
The agreement is automatically renewed for two (2) year periods unless either
party cancels it upon six months prior written notice. If the original agreement
is renewed, we are required to purchase a minimum of $8 million in the next two
years. Thereafter, minimums are to be negotiated in advance of each renewal.
Through our acquisition of 90% of OST Developpement, SA, or OST, which
was completed in January, 1999, we also process, market and distribute both
bovine bone tissue products which are utilized as bone graft substitutes by
surgeons and OsteoPure(TM) Femoral head processed human allograft bone tissue
grafts, primarily in Europe, Asia and the Middle East. We also market and
distribute Grafton(R) DBM through OST in these same markets.
2
We estimate that the total bone graft market in the U.S. for 2000 was
approximately $517 million, which includes allograft bone tissue procedures,
synthetic graft substitutes and autograft bone tissue procedures (transplant
tissue harvested from the patient). We estimate that the allograft bone tissue
portion of the total bone graft market in the U.S. in 2000 was approximately
$257 million. The allograft bone tissue market is growing at a substantially
faster rate than the general bone grafting market, as allograft bone tissue is
increasingly becoming accepted as either an augment to, or a surgical
alternative to autograft procedures. Autograft bone tissue often requires a
second surgical procedure to harvest bone from the patient's own body and,
therefore, exposes the patient to increased risk associated with blood loss,
infection and chronic pain. Increased use of allograft bone tissue is expected
to continue as physicians become increasingly educated about the benefits of
allograft bone tissue and concerns over disease transmission are diminished.
Moreover, allograft bone tissue is increasingly preferred for use in elderly
patients, who often lack sufficient harvestable bone.
Based upon our knowledge of the allograft bone tissue industry, we
estimate that we process about 40% of the allograft bone tissue donors in the
U.S. We believe that our strong market position is attributable to our
proprietary product line; our clients' national donor recovery programs; our
large national sales and marketing organization; and the substantial investment
we have made in processing technology to ensure stringent standards and high
quality control which, combined with extensive donor screening and testing
performed by our clients, has virtually eliminated the risk of transmission of
infectious agents.
Our clients pay us fees for our processing of the allograft bone tissue
that they provide to us. In the Grafton(R) DBM Segment, our clients pay fees on
a per unit basis for the Grafton(R) DBM products we process. In the Base Tissue
Segment, our clients pay fees on a per donor basis, except in the case of
bio-implants, for which fees are paid on a per unit basis.
In the United States we process allograft bone tissue pursuant to
contracts with a number of clients, including two large not-for-profit
organizations, American Red Cross Tissue Services, or ARC, and Musculoskeletal
Transplant Foundation, or MTF. Our clients are responsible for donor procurement
and generally for the distribution of the allograft bone tissue we process for
them. Our contract with ARC expires in December, 2006 and our contract with MTF
expires in August, 2005. However, the MTF contract may be canceled effective
March 31, 2002 and thereafter upon either party giving six months prior written
notice. We also are currently in litigation with MTF related to our Grafton(R)
DBM patents and other matters. See Item 3 "Legal Proceedings." We also process
allograft bone tissue for several smaller tissue banks in the United States and
Europe.
We market our proprietary allograft bone tissue products such as
Grafton(R) DBM and our line of bio-implants through independent agents and
direct field sales personnel. Generally, our clients market the non-proprietary
products we process in our Base Tissue Segment, primarily using direct field
personnel. Our products are gaining wide acceptance among surgeons in a broad
spectrum of orthopaedic procedures due to their flexibility, unique handling
characteristics and ability to enhance bone growth.
3
Revenue in our Grafton(R) DBM Segment increased to $45,226,000 in 2000
from $45,136,000 in 1999 and 2000 revenue in our Base Tissue Segment of
$26,204,000 was about 2% above 1999's revenue of $25,751,000. We expect that
both our Grafton(R) DBM and Base Tissue Segments will continue to be important
contributors to the growth of our consolidated revenues and profits in 2001, as
processed allograft bone tissue forms continue to gain increased acceptance.
Strategy
Overview
We intend to expand our business as follows:
o We intend to use our position as the leader in allograft bone tissue
processing and marketing to become a leading
orthopaedic/musculoskeletal company by bringing to market innovative
and cost-effective allograft bone tissue forms and non-allograft
products. We also will expand into new markets globally.
o We will continue to educate the medical community and the general
public concerning the benefits of allograft bone tissue.
o We intend to use our strong research and development capabilities
and expertise in musculoskeletal science to:
* enhance the performance of our existing allograft bone tissue
forms;
* expand the safety claims of these tissue forms using proprietary
processes; and
* continue to introduce new tissue forms with enhanced performance
profiles.
o We intend to add additional metal spinal implant systems to our
product line in order to provide the spinal surgeon with a greater
depth of products.
o We intend to utilize our marketing and distribution network to
enhance the market share of both our allograft bone tissue forms and
non-allograft product lines.
o To ensure that we have an adequate supply of allograft bone tissue
to meet the market demand for existing tissue forms that we process
and for any new tissue forms that we may process, we intend to work
with existing clients to expand the amount of tissue they recover,
obtain additional tissue bank clients and contract directly with
TRO's to obtain tissue on our behalf.
4
Grafton(R) DBM Segment
In the near term, we will continue to focus on marketing Grafton(R) DBM
through our direct marketing organization, our national agent network and
medical education programs. We will support these programs through prospective
clinical and outcome studies to further validate the performance, utility and
safety of our processed tissue. We also will continue to expand the Grafton(R)
DBM tissue line by adding additional forms and continue our expansion globally.
We expect to continue expansion of sales of Grafton(R) DBM through:
o the recently completed reorganization of our sales force to allow
for expanded market coverage and selling time with surgeons;
o providing the surgeon an expanded line of metal implant products and
allograft bone tissue forms which are usable with Grafton(R) DBM so
that we can better meet the needs of the surgeon;
o surgeon identified new procedures;
o surgeon oriented medical education programs;
o in-depth sales agent training programs;
o published clinical support;
o product line extensions;
o global expansion with an initial European focus; and
o continued expansion of the allograft bone tissue market in both the
United States and globally.
Base Tissue Segment
We expect to achieve continued growth in the Base Tissue Segment
through:
o introduction of additional allograft bone tissue grafts with
application in spinal and other surgical procedures;
o use of our new packaging system and, a new validated viral
inactivation claim, when available;
o global expansion of base allograft bone tissue grafts and the tissue
processing business in selected countries, initially in Europe;
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o development of proprietary tissue processing technology through
internal research;
o introduction of new allograft bone tissue forms with enhanced
performance profiles; and
o obtaining additional bone tissue processing clients and sources of
bone tissue.
Other
Non-Allograft Bone Tissue Spinal Implant Products
Our strategy in the non-allograft bone tissue spinal implant product
lines of business is to:
o continue focusing our European non-allograft bone tissue operations
to capture available opportunities for ceramic coating services and
ceramic products;
o capitalize on high-growth opportunities in the U.S. spinal products
market with innovative non-allograft bone tissue products;
o enter into agreements with other health care product companies to
utilize our technology and expertise in the non-allograft bone
tissue area for the development and manufacture of proprietary
product components; and
o expand our metal implant product line, either through internal
development, acquisition or licensing of products from other
companies, in order to increase our market share and provide the
surgeon with a more comprehensive product line so that we will be
able to meet all the surgical implant needs of the surgeon.
Spinal Strategy
Our strategy consists of two primary components involving our
Grafton(R) DBM and Base Tissue Segments and our non-allograft bone tissue spinal
implant product line of business:
o continue the U.S. market penetration of our non-allograft bone
tissue spinal implant products, including the Versalok(R) System,
the Ovation(TM) System, the introduction of VBR(TM) and the market
introduction of the pedicle screw system and cervical plating system
obtained under a distribution agreement with Alphatec Manufacturing,
Inc.;
o market our allograft bone tissue bio-implants and our non-allograft
bone tissue spinal implant products together with Grafton(R) DBM
through our extensive sales agency network.
Our intention is to educate surgeons to use Grafton(R) DBM, our
allograft bone tissue bio-implants and our metal spinal systems, either alone or
in conjunction with each other. Spinal implant products, both allograft and
non-allograft, which we add to our product mix in the future will be included in
this strategy.
6
Business Summary
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 disease conditions. For
certain procedures, autograft bone tissue can be acquired from another part of
the patient's skeleton by an additional operative procedure. For a large number
of procedures for which autograft bone tissue is not feasible or desirable,
allograft bone tissue previously obtained from cadavers or surgical patient
donors can be utilized. Allograft bone tissue is procured primarily from
cadavers by a network of organ procurement organizations and/or directly by
tissue banks.
We process allograft bone tissue for our clients and bone tissue
recovered by TRO's for us in both our Grafton(R) DBM and Base Tissue Segments.
Once processed, we typically return the allograft bone tissue to our clients for
distribution to surgeons and medical institutions, or if recovered by TRO's on
our behalf, we distribute it directly to surgeons and medical institutions. The
surgeons and medical institutions pay the fees established and charged by our
clients or us. 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 allograft bone tissue used. The cost to the patient for the
processed allograft bone tissue is generally reimbursable by medical insurance
carriers as part of the overall cost of the procedure.
In both our Grafton(R) DBM and Base Tissue Segments, our processing
yields a wide array of freeze-dried, frozen and demineralized allograft bone
tissue forms that are used by orthopaedic, neurological, plastic, dental,
periodontal and oral/maxillofacial surgeons for:
o spinal fusion procedures;
o repair and replacement of bone loss caused by trauma or certain
disease states;
o augmentation of prosthetic implant procedures; and
o replacement of damaged ligaments and tendons.
We believe our processing methods, our clients' tissue recovery
techniques and the multiple screening and testing procedures employed, virtually
eliminate the risk of transmission of infectious agents by the allograft bone
tissue we process.
In our Grafton(R) DBM Segment, we have a validated viral inactivation
process for our demineralized bone tissue. Studies completed by an independent
testing laboratory specializing in viral inactivation studies demonstrated that
this proprietary demineralization process virtually inactivates and eliminates
viruses such as HIV, hepatitis B, hepatitis C, cytomeglia and polio.
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We are in the process of implementing additional proprietary processing
technologies that, once fully implemented, will enable us to expand our viral
inactivation claims to include the mineralized weight-bearing allograft bone
tissue processed in our Base Tissue Segment.
We believe that allograft bone tissue transplantation is one of the
fastest growing areas of transplant medicine. We estimate that in 2000 there
were approximately 550,000 grafting procedures in the U.S. for which allograft
bone tissue could have been utilized, representing an estimated available
allograft bone tissue market of approximately $517 million. We estimate that the
allograft bone tissue portion of the total bone graft market in the U.S. in 2000
was approximately $257 million. Industry data indicates that the musculoskeletal
surgical market is growing. We believe this will expand the potential market for
allograft bone tissue in both our Grafton(R) DBM and Base Tissue Segments, due
to a number of factors, including:
o increasing frequency of surgical procedures that incorporate bone
grafting techniques;
o 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 and chronic pain;
o a reduction in the possibility of transmission of infectious agents
and toxicity because of improved allograft bone tissue processing
techniques and donor screening;
o increased awareness by, and training of, the medical community with
respect to the use of allograft bone tissue;
o an increasing number of musculoskeletal surgical procedures which
require more bone tissue than can be obtained through autograft
procedures;
o 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
o an increase in the availability of allograft bone tissue due to an
increase in bone tissue donations and improved recovery and
processing techniques.
Allograft bone tissue is employed in surgical procedures because of its
biologic and biomechanical 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 allows the bone to
be weight-bearing, and therefore, is commonly used in surgery in the spine and
in the extremities and in other procedures requiring strong transplant material.
Cancellous bone, the spongy portion of bone 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 weight-bearing strength is not paramount. Therefore, cancellous bone is
often used to fill smaller areas of bone loss and to augment more extensive
reconstructive procedures including knee and hip replacements. Most procedures
using
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allograft bone tissue, however, employ a combination of cortical and cancellous
bone in a variety of forms, shapes and sizes.
Allograft Bone Tissue Processing
Grafton(R) DBM Segment
In addition to the proprietary procedures which are particular to the
processing of Grafton(R) DBM, the technologies used in processing allograft bone
tissue in the Base Tissue Segment are also used in processing Grafton(R) DBM.
The methods used to process Grafton(R) DBM have been validated as a viral
inactivation process. This proprietary process virtually inactivates and
eliminates viruses such as HIV, hepatitis B, hepatitis C, cytomeglia and polio.
We have developed an advanced proprietary demineralization process for
cortical bone which yields Grafton(R) DBM -- 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. Our process
removes these inhibiting factors.
In our Grafton(R) DBM Segment we currently process five forms of
Grafton(R) DBM:
o Grafton(R) DBM Gel - a gel-like substance with unique handling
characteristics which are useful in performing bone graft procedures
as part of spinal fusions, joint replacements and repairs of osseous
defects;
o Grafton(R) DBM Putty - a moldable putty-like graft of entangled
fibers of demineralized bone, which is mixed easily with marrow and
other grafts, minimizes migration, can be molded easily and retains
its shape even in larger defects;
o Grafton(R) DBM Flex - a flexible "pressed fiber" form of
demineralized bone processed by utilizing a pressed fiber technique,
providing surgeons a pliable form of bone graft. It is available in
square or strip forms, conforms to the body's natural anatomy and
can be easily cut for precise adaptation to host bone;
o Grafton(R) DBF Matrix - a flexible "pressed fiber" form of
demineralized bone processed by utilizing a pressed fiber technique,
providing the surgeon with a pliable form of bone graft. It also
contains a "trough" into which the surgeon can place autologous bone
and bone marrow to aid in the osteoinduction process; and
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o Grafton(R) DBM Crunch - a ready to use mixture of demineralized bone
fibers and demineralized cortical cubes which packs and locks into
bone defects, providing structure and support to the graft site.
We expect that wider distribution and deeper market penetration of
Grafton(R) DBM utilizing our national network of independent agents in
combination with our direct marketing force, our expansion into European markets
and our marketing of metal spinal implant systems will drive the further growth
in the use of Grafton(R) DBM processed allograft bone tissue. Through December
31, 2000, Grafton(R) DBM forms had been utilized in over 410,000 procedures
domestically.
Base Tissue Segment
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 labeled. We process the allograft bone tissue utilizing
technology we have developed which yields a wide array of freeze-dried, frozen,
demineralized bone and connective tissue products. 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.
The suitability of an allograft bone tissue is partly dependent on the
methods used in the processing of the tissue. Processing includes the removal of
certain portions of the allograft 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, we have developed techniques that minimize the use of
chemicals and procedures that might render the allograft bone tissue less
suitable for use as a graft. We process allograft bone 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. We believe that our use of such clean room techniques, a controlled
environment, in-line disinfection and other technologies preserve 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
our current processing 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.
In December, 1998 we began to process the bio-d(TM) Threaded Cortical
Bone Dowel for spinal fusion. In late 2000, we began to introduce the
Graftech(TM) Bio-implants, including the Graftech(TM) Posterior Ramp,
Graftech(TM) Anterior Ramp, Graftech(TM) Cervical spacer and the Graftech(TM)
Cervical dowel. In addition to our normal processing techniques, the
Graftech(TM) Bio-implants are processed using our OsteoActive(TM) Process which
transforms the typically non-osteoinductive weight bearing graft into an
osteoinductive graft, thus allowing for faster incorporation of the graft into
the host bone. Additionally, the graft is processed using a new technology which
allows it to be available in a non-frozen form. Previously, these types of
grafts
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were available only in a frozen form, often resulting in the surgeon using more
of the grafts to successfully perform a procedure than is necessary when a
non-frozen graft is used. It is expected that the use of our new non-frozen
grafts will thus significantly reduce the cost of the surgery. All of our
bio-implant grafts have been tested and shown to withstand loads comparable to
those reported in the lumbar spine, and their inherent natural properties,
enhanced by our new processing technologies, will permit faster incorporation
and remodeling. Additionally, these bio-implant grafts can be used with
Grafton(R) DBM. Therefore, the bio-implants will provide structural support and
with Grafton(R) DBM added, will also aid in the fusion process by inducing bone
growth.
Expansion of Allograft Bone Tissue Business in Europe
In January, 1999, we completed the acquisition of 90% of OST, which is
located in Clermont-Ferrand, France. OST manufactures and markets bovine tissue
products for use as bone grafts in orthopaedic and dental surgery. These
products, marketed under the trade names of LUBBOC(R) and LADDEC(R), were
developed to address the shortage of safe and effective human allograft bone
grafts in France and other countries outside the United States. In the future,
as a complement to our human allograft tissue products, OST will continue to
market these products in certain markets.
We are expanding operations and staff at OST as we begin to use it as a
base for developing our human allograft tissue graft and tissue processing
business in Europe. OST has adapted its proprietary LUBBOC(R) and LADDEC(R)
processing technology to develop the OsteoPure(TM) Process for the processing of
human femoral heads recovered during hip replacement surgery. OST has concluded
an agreement with OsteoBanque D'Auvergne and five other European based tissue
banks. OST expects to enter into similar agreements with other European tissue
banks for the provision of tissue for the OsteoPure(TM) Process in the future.
Additionally, we are expanding the range of human allograft bone tissue grafts
available to orthopaedic and other surgeons in various countries in Europe by
supplying Grafton(R) DBM and other allograft bone tissue grafts processed in the
U.S.
In conjunction with OsteoBanque D'Auvergne and other European tissue
banks, we plan to help establish a cadaveric tissue recovery network in medical
centers throughout France and other European countries in order to meet the
growing demands by European surgeons for safe human allograft bone tissue forms.
France will continue to be the prime base of operation in our efforts to expand
the distribution of our human allograft bone tissue grafts throughout Europe on
a country-by-country basis. Facilities and staff will be added to our current
operations, as required, to support this expansion.
We believe the advantages of locating our European operations in France
are significant. The French market is one of the larger and more sophisticated
European markets for bone grafts. Also, French laws and regulations governing
tissue banking are well defined and the most advanced of all the major European
countries. Although tissue banking operations in France are generally restricted
to non-profit public health organizations approved by the government, French
11
regulations also provide for governmental approval of for-profit organizations
as tissue banks if these organizations are able to provide haute technicite
(high technology) unavailable in the non-profit sector. We believe that our
tissue processing technology meets this requirement and, therefore, OST has
filed a dossier with the French government to operate as a tissue bank. As a
result, during the course of 2001, we expect to receive approval from the French
government which will enable us to operate independently as an approved tissue
bank in addition to providing contract processing, marketing and management
services to non-profit tissue banks.
Other
Ceramic and Titanium Plasma Spray Coating Services and Products
We are providing ceramic hydroxyapatite, or HA, and titanium plasma
spray coating services to orthopaedic and dental implant companies in Europe.
The primary advantage of coating orthopaedic and dental prosthetic devices with
HA or titanium, is that it enables bone to grow onto the implanted device. This
enhances the stability of the device, which, in turn, lowers the amount of bone
loss and reduces pain caused by micro motion. We manufacture HA powder which we
use in our plasma spray coating operations from raw materials which are readily
available from several sources. We also supply HA powder to various companies
for use in their in-house plasma spray coating operations. Additionally, we
produce CE marked HA products that are used as grafting material to provide a
matrix into which bone will grow as part of the process of the repair of bone
defects.
Non-Allograft Bone Tissue Spinal Implants and Instruments
The human spine is subjected to various loading conditions including
tension, compression, torsion, bending and combinations of all four. When the
spine has been injured by tumors, fractures, degenerative conditions or
deformities, stabilizing instrumentation is required to maintain surgical
correction of the condition during the healing and fusion process. We offer
several metal spinal implant systems to achieve these results.
The Versalok(R) System, which is marketed by our national network of
direct and independent agency representatives in combination with our allograft
and other non-allograft spinal products, is a lumbo-sacral spine fixation system
with innovative polyaxial screw. The Versalok(R) System is designed in a manner
to allow the sharing of the forces to which the spine are subjected with the
system, which in turn is thought to provide improved results in spinal fusion
procedures.
Beginning in the first quarter 2001, we will market the VBR(TM). This
patented device, which we will distribute under an exclusive distribution
agreement with Heinrich C. Ulrich, K.G., or Ulrich, of Ulm, Germany, the
manufacturer of the product, has been cleared for sale by the FDA to replace a
collapsed, damaged or unstable vertebre due to a tumor or trauma.
In February, 2001, we entered into a distribution agreement to market a
pedicle screw system and a cervical plating system in the United States and
Canada, which are manufactured by
12
Alphatec Manufacturing, Inc. Under the terms of the agreement, which is for an
initial term of two (2) years from the date that the first order for the systems
is completed (expected to be in August, 2001), we are required to purchase a
minimum of $6 million of the two systems. The agreement is automatically renewed
for two (2) year periods unless either party cancels it upon six months prior
written notice. If the original agreement is renewed, we are required to
purchase a minimum of $8 million in the next two years. Thereafter, minimums are
to be negotiated in advance of each renewal.
We expect to continue to expand our metal spinal implant product line
so that we are able to offer surgeons implant systems capable of solving a
variety of spinal problems.
Quality Assurance
We have stringent quality assurance programs in place covering all of
our lines of business, including our Grafton(R) DBM and Base Tissue Segments,
our HA-titanium plasma spray coating services, and our non-allograft bone tissue
spinal implants and instruments. Our facilities in Clermont-Ferrand, France and
Leiden, The Netherlands have received International Standardization
Organization, or ISO, certification for their quality systems.
In both the Grafton(R) DBM and Base Tissue Segments, our allograft bone
tissue quality assurance program commences with the recovery of allograft bone
tissue which is procured under strict aseptic conditions. The tissue is
recovered primarily in hospitals and, to a lesser extent, coroners' facilities
which have been prepared for recovery. Recovered allograft 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 allograft bone tissue for processing.
Upon satisfactory completion of all testing, the allograft bone tissue is
processed in a microbially-controlled environment. Under constant monitoring,
the allograft bone tissue is cleaned, soaked in antibiotics and then cut and
shaped in accordance with client specifications. Before being released to our
clients, our quality assurance team inspects and again tests all processed bone
tissue for microbiological contaminants.
We believe that the serologic screening of donors, the extensive
screening of donor profiles and medical histories performed by our clients and
TRO's and our processing technologies virtually eliminate the likelihood of the
presence of infectious agents, including HIV and hepatitis viruses, in our
processed allograft bone tissue. Studies completed by an independent testing
laboratory specializing in viral inactivation studies demonstrated that our
proprietary demineralization process used in our Grafton(R) DBM Segment can
virtually inactivate and eliminate viruses such as HIV, hepatitis B, hepatitis
C, cytomeglia and polio.
In addition to the proprietary demineralization process used in our
Grafton(R) DBM Segment, we have begun to implement additional processing
technologies that once fully implemented will enable us to expand our viral
inactivation claims to include virtually all of the allograft bone tissue we
process in our Base Tissue Segment. These proprietary, tissue-specific
technologies are expected to further enhance graft safety while maintaining the
tissue's biologic and physical properties.
13
To our knowledge, none of the approximately 2.3 million transplanted
grafts we have processed in our Grafton(R) DBM and Base Tissue Segments have
caused a confirmed transmission of infectious diseases. This record is due to
the rigorous donor screening and tissue recovery techniques used by our clients,
extensive donor testing, as well as our demanding quality assurance and
processing protocols.
Clients
We are the processor of allograft bone tissue for two large United
States clients. In the Base Tissue Segment, with the exception of the bio-d(TM)
Threaded Cortical Bone Dowel and Graftech(TM) Bio-implants for which we are paid
on a per unit basis, we are paid fees on a per donor basis for processing,
finishing and packaging our clients' mineralized, weight-bearing allograft bone
tissue. In the Grafton(R) DBM Segment our clients pay us fees on a per unit
basis. During 2000, MTF and ARC accounted for approximately 50% and 40%,
respectively, of our consolidated revenues. We receive revenues in both our
Grafton(R) DBM and Base Tissue Segments from each of these clients. We have
processing agreements with MTF and ARC which run through August 31, 2005 and
December 31, 2006, respectively. The agreement with MTF may be terminated,
effective March 31, 2001 and thereafter, by either party upon giving six (6)
months prior written notice. We also are currently in litigation with MTF
related to our Grafton(R) DBM patents and other matters. See Item 3 "Legal
Proceedings."
In June, 2000, we entered into a five year agreement with Bone Bank
Allografts, or BBA, to process donor allograft bone tissue procured by BBA. This
tissue is processed in our Grafton(R) DBM and Base Tissue Segments.
We generally rely on our clients to obtain the donor allograft bone
tissue which we process and, generally, to distribute the processed allograft
bone tissue to hospitals and physicians for transplantation. We perform
marketing services which generate demand for our products. See "Education and
Marketing."
In the fourth quarter of 1999, we commenced using the OsteoPure(TM)
System for processing allograft bone tissue grafts for French tissue bank
clients and we also concluded a contract with BioImplant Services of The
Netherlands for expanded distribution of Grafton(R) DBM in Europe, which we
began doing in the first quarter of 2000.
Our plasma spray coating customers and non-allograft bone tissue spinal
implant product customers generally purchase our services and products pursuant
to purchase orders or non-exclusive supply agreements which are cancelable at
any time by either party.
Education and Marketing
We believe the markets for processed allograft bone tissue will
continue to be general orthopaedic, spinal, neurological, and oral/maxillofacial
surgical specialties. Our future growth in these areas will depend upon
availability of adequate supplies of allograft bone tissue and a wider
14
acceptance by these specialties of the use of allograft bone tissue as an
alternative to autograft bone tissue and other available materials and
treatments.
As of December 31, 2000, in the United States, we employed 16 persons
engaged directly in efforts to educate surgeons as to the benefits and
applications of processed allograft bone tissue and nine employees engaged in
training our independent sales agents. We complement our direct sales
organization with a national network of independent sales agents who market
Grafton(R) DBM, our bio-implant allograft bone tissue spinal implants and our
non-allograft bone tissue spinal implant products. These agents also educate the
medical community about processed allograft bone tissue. At December 31, 2000,
we had appointed 42 agencies which employ over 195 sales representatives.
Currently, a small group of marketing and sales employees located in
Clermont-Ferrand, France markets and sells our LUBBOC(R) and LADDEC(R) Bovine
bone grafts to orthopaedic surgeons and dentists. This staff is being retrained
to market our OsteoPure(TM) Human femoral head and cancellous bone grafts,
Grafton(R) DBM and other human allograft tissue products in connection with a
network of agents and distributors we have retained.
A small in-house marketing staff located at our Leiden facility markets
our plasma spray coating services. 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. We market our HA
powders and ceramic products directly and through a small number of independent
contract representatives in Europe.
Government Regulations
Both of our Grafton(R) DBM and Base Tissue Segments involve the
processing of human tissue intended for transplantation and are subject to the
same regulations in the U.S.
The procurement and transplantation of allograft bone tissue is subject
to federal law pursuant to the National Organ Transplant Act, or NOTA, a
criminal statute which prohibits the purchase and sale of human organs,
including bone and related 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. We provide services in all of these areas, with the exception of
removal and implantation.
The FDA currently regulates human tissue-based products such as the
allograft bone tissue that we process, including Grafton(R) DBM, under certain
provisions (Section 361) of the Public Health Services Act. Such products are
not regulated as drugs, medical devices or blood products, but as "human tissue
for transplantation." FDA regulations do not require a premarket clearance for
such products, though these products are subject to regulations concerning
tissue donor screening and testing, processing and record keeping, and other
controls. Tissue-based and cellular products that are not classified as human
tissue intended for transplantation will be regulated under different
regulations as either drugs, devices or biologics.
15
In August 1995, the FDA designated Grafton(R) DBM as within the scope
of human tissue intended for transplantation. Human tissue such as demineralized
bone matrix has been considered, and still is considered, exempt from FDA
premarketing clearance requirements imposed upon medical products such as drugs,
devices and biologics. Grafton(R) DBM is a demineralized bone matrix that is
mixed with glycerol, a basically inactive substance, to provide desirable
physical handling characteristics to the demineralized bone matrix.
The FDA has proposed a more comprehensive regulatory framework that
will, if adopted, build upon and supersede the existing regulations for human
tissue-based products. Implementation of this proposed regulatory approach would
lead to new regulations for the allograft bone tissue we process. One set of new
regulations requiring facility registration and listing of products has been
published in the Federal Register and is currently effective. In January, 2001,
the FDA also published in the Federal Register a proposed rule, Good Tissue
Practices, or GTP, which proposes to further regulate tissue processing and
quality. This rule is not expected to become effective for another two years. We
believe that we will be able to fully comply with the regulation requiring
facility registration and listing of products, and with the GTP regulation once
it becomes effective.
The allograft bone tissue bio-implants we process are currently
regulated as human tissue for transplantation. If these implants were to be
regulated by the FDA as a medical device in the future, we may be required to
halt or to limit the marketing of these products until we conduct clinical
trials to support an application to receive marketing clearance from the FDA.
Allograft bone tissue and tissue processing operations are regulated in
most major countries, though with different regulations and standards in each
country. We believe that we and our subsidiaries comply with the national
regulations of the various countries in which we currently, or plan to operate,
although there can be no assurances that we will be able to in the future.
The metal spinal implant products that we distribute in the U.S., are
regulated as Class II medical devices under Section 510-K of the Federal Food,
Drug and Cosmetic Act. The Versalok(R) System, the Ovation(TM) System and the
VBR(TM) System are being marketed pursuant to 510-k marketing approval issued by
the FDA. Additionally, the new pedicle screw and cervical plate system that we
will market under an agreement with Alphatec Manufacturing, Inc. will be
marketed pursuant to 510-k marketing approval which has been issued by the FDA.
ISO certification for production facilities was made mandatory in 1998
for companies that market or distribute products within the European Union. Our
facility located in Clermont-Ferrand, France has received ISO 9002 certification
for the quality systems used in the manufacture of bovine tissue products. The
LUBBOC(R) and LADDEC(R) Bovine Grafts produced and marketed by OST are regulated
as medical devices in Europe and most other international markets in which these
products are marketed.
Our European HA plasma spray coating services meet existing regulatory
requirements in the specific countries where they are marketed. Our facility in
Leiden, The Netherlands has
16
received ISO 9001 certification for its quality systems used in the development
and manufacture of ceramic products and ceramic and titanium spray coatings. The
certification was awarded by Tuv Product Service, GmbH of Munich, Germany, a
leading Notified Body in medical devices. Notified Bodies are independent
organizations authorized by the European Union member countries to administer
the ISO certification process. Upon certification, a company may then affix a CE
Mark to its device products, thus allowing for the sale of the products
throughout the European Union.
Ceramic products produced by us in The Netherlands are currently
distributed only in Europe. These products meet existing regulatory requirements
in the specific countries where they are produced and marketed. We do not
currently intend to market these products in the U.S.; however, if we decide to
do so, these products would require premarket clearance by the FDA as medical
devices.
HA powder produced and sold in bulk by us in the U.S. 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.
Research and Development
During 2000, 1999 and 1998, we spent approximately $5,772,000,
$5,506,000, and $4,610,000, respectively, on research and development
activities. The majority of these expenditures were made in our Grafton(R) DBM
and Base Tissue Segments. We are engaged in continuing research and development
efforts in the allograft bone tissue processing field which include our
continuing efforts to improve upon and maintain the safety and performance of
the processed allograft bone tissue, increase the amount of transplantable
allograft bone tissue derived from each donor, reduce processing costs through
efficiency advances and develop new forms of allograft bone tissue.
Competition
Market Overview
The bone grafting market is an extension of the general orthopaedic
surgery market, as bone grafts are used adjunctively in a broad range of
reconstructive orthopaedic surgical procedures such as the repair of fractures
and skeletal defects, spinal and joint arthrodeses, and revision arthroplasties.
These procedures are performed by virtually all orthopaedic subspecialties and
by neurosurgeons, some plastic surgeons and certain other surgical specialties.
Dental and other oral maxillofacial procedures are not considered to be a
primary portion of the bone graft market, but are instead considered to
constitute a secondary market. Three basic categories of products or
alternatives currently compete in the bone graft market:
o autograft bone tissue;
o allograft bone tissue; and
o synthetic bone void fillers.
17
A potential fourth product category, growth factor products, is still in the
investigational stage.
We estimate that total domestic allograft bone tissue sales in 2000 was
$257 million, comprising approximately 50% of the U.S. bone graft market.
U.S. Bone Graft Market
2000 Allograft
Specialty Graft Procedures(1) Market Size(1)
- - --------- ---------------- --------------
Spinal Fusions ....................... 260,000
General Orthopaedics ................. 205,000
Craniomaxillofacial .................. 85,000
--------
Total ................................ 550,000
Average Selling Price(2) ............. $ 940
Market Size (000) .................... $517,000 $257,000 (49.7%)
(1) Source: Datamonitor, "US Bone Substitutes"
(2) Source: Osteotech estimate
The number of bone graft procedures is forecast to increase during the
next five years due to an expected increase in the number of reconstructive
orthopaedic surgical procedures utilizing bone grafts, particularly in spinal
procedures using bio-implants, pedicle screw implants and spinal cages.
Factors producing the continued growth in the number of reconstructive
orthopaedic surgical procedures that incorporate a bone graft include the
following:
o the aging of the U.S. population;
o improving success rates for surgical procedures that involve a bone
graft procedure;
o development of less invasive reconstructive orthopaedic surgical
procedures that will be used in a wider patient population; and
o the increasing number of revision, spinal fusion and joint
arthroplasty procedures resulting from a more active and longer
living U.S. population.
While the general bone graft market has experienced low-single-digit
growth in recent years, we estimate that allograft bone tissue sales have
increased at an average annual rate of approximately 16% since 1994. This
displacement trend is expected to continue as physicians gain confidence in, and
experience with, allograft bone tissue. Some of the factors contributing to the
increased use of allograft bone tissue include:
18
o the desire by surgeons to avoid the additional procedure needed to
acquire autograft bone tissue, which often increases costs due to
additional operating time, medical supplies and extended hospital
stay, and patient risks due to excessive blood loss, infection,
chronic pain and morbidity;
o increased awareness by, and training of, the medical community with
respect to the use and safety of processed allograft bone tissue;
o 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
o an increase in the availability of allograft bone tissue due to an
increase in bone tissue donations and to improved recovery and
processing techniques.
Competitive Overview
In both our Grafton(R) DBM and Base Tissue Segments we compete in the
bone graft market with autograft bone tissue, synthetic bone void fillers and
allograft bone tissue processed by others. Autograft bone tissue has
traditionally been the primary choice for surgeons and we believe it still
maintains an approximate 50% share of the U.S. bone graft market. Due to factors
such as the increased cost and potential complications associated with an
additional procedure needed to acquire autograft bone tissue, more surgeons are
beginning to choose allograft bone tissue over autograft bone tissue for their
bone grafting needs.
Grafton(R) DBM Segment
We have been successful in persuading many surgeons to switch to
Osteotech processed allograft bone tissue through the introduction of our
proprietary tissue processing technology. We have expanded the applications of
allograft bone tissue through Grafton(R) DBM, a proprietary form of allograft
bone tissue. The demineralization process used in Grafton(R) DBM removes most of
the minerals, thus exposing the proteins that promote bone growth
(osteoinduction) and creating a lattice work for new bone (osteoconduction).
Grafton(R) DBM has a validated viral inactivation process for HIV, hepatitis B
and C, cytomeglia and polio. Grafton(R) DBM is produced in five forms - gel,
flex, putty, crunch, and DBF Matrix - and is packaged in sterile, single patient
delivery systems. We introduced Grafton(R) DBM Crunch, a mixture of
demineralized bone fibers and demineralized cortical cubes, into the market in
December, 1999 and Grafton(R) DBF Matrix in January, 2001. With the varying
textural and handling characteristics of its five forms, Grafton(R) DBM can be
used in virtually all non-weight-bearing bone graft procedures and has been used
in over 410,000 procedures through December 31, 2000.
Given its osteoinductive and osteoconductive properties, Grafton(R) DBM
has a distinct advantage over synthetic bone void fillers, all of which are
exclusively osteoconductive.
Grafton(R) DBM's advantages over synthetic grafting materials in the
market for non-weight-bearing applications include:
19
o superior handling and performance qualities, including providing a
matrix for bone to grow into and inducing bone to grow; and
o the suitability of Grafton(R) DBM for all non-weight-bearing bone
graft procedures versus the limited applications of competitive
products.
GRAFTON(R) DBM VERSUS COMPETITIVE ALLOGRAFT PRODUCTS(1)
Validated Viral
Product/ Mechanisms(s) of Inactivation Available
Company Bone Healing Process Ingredients/Forms
------- ------------ ------- -----------------
Grafton(R) Osteoinduction & Yes DBM/Glycerol
DBM (Osteotech) Osteoconduction o Gel
o Flex
o Matrix
o Putty
o Crunch
Dyna Graft Osteoinduction(3) & No DBM/Collagen
(Gen Sci/ Osteoconduction o Matrix
DePuy)(2) DBM/Pluronic F-127
o Gel
o Putty
Osteofil Osteoconduction & No DBM/Porcein
(Reg. Tech/ Partially o Gel
Sofamor Danek) Osteoinductive o Paste
o Putty
o Cortical cancellous
chip blend
AlloMatrix Osteoconductive & o Paste
(Allosource/Wright Medical) Osteoinductive
(1) Source: Based upon Osteotech's Survey of Competition
(2) As a result of a patent lawsuit settlement with Osteotech, DePuy ceased
to market DynaGraft in February, 2001.
(3) GenSci claims that its DynaGraft Products are osteoinductive.
Although it already occupies a leading position in the U.S. market for
non-weight-bearing grafting materials, in recent years, our Grafton(R) DBM
products have faced increasing competitive pressures as more companies have
developed, or have announced they are developing, products with characteristics
similar to Grafton(R) DBM. We expect that this competition will continue to
increase in the future. Many of these competitors have research and development,
marketing and other resources that are significantly greater than ours. Certain
of our competitors also offer a full line of metal implants and other products
used in spinal surgeries. This could give them a competitive advantage over us
since they can offer surgeons a more complete line of products than we currently
can.
Notwithstanding the increasing competition, Grafton(R) DBM has
significant opportunities for growth. Currently, Grafton(R) DBM sales are
primarily domestic. We estimate that Grafton(R) DBM was used in only 19% of the
total bone graft procedures performed in the U.S. during 2000.
20
We estimate the potential non-domestic bone graft market to be at least as large
as that of the U.S. market. The European market, in particular, provides us with
an opportunity in an area where we already have a sales presence, and,
therefore, we began marketing Grafton(R) DBM in nine European countries during
2000.
Grafton(R) DBM U.S. Procedure Penetration
2000
------------------------------------------
Grafton(R) DBM
------------------------------------------
Percent
Specialty Potential(1) Actual(2) Penetration
- - --------- ------------ --------- -----------
Spinal Fusions 260,000 47,844 18.4%
General Orthopaedics 205,000 34,795 17.0%
Craniomaxillofacial 85,000 24,087 28.3%
------- ------- ----
Total 550,000 106,726 19.4%
(1) Source: Data monitor, "US Bone Substitutes"
(2) Source: Osteotech estimate
Base Tissue Segment
Allograft bone tissue is still the only alternative to autograft bone
tissue for bone grafting procedures which require weight-bearing tissue. Our
primary competition in this segment is surgeons who use autograft bone tissue
instead of allograft bone tissue. We plan to continue to differentiate our Base
Tissue Segment operations from those of other allograft bone tissue processors
by expanding our viral inactivation claim to include our mineralized
weight-bearing bone tissue. In late 2000, we introduced our Allogard(R)
Packaging plastic tray for most of the base allograft bone tissue processed in
our Base Tissue Segment. This packaging will be easier for operating room nurses
to work with. In addition, this will allow us to differentiate our "Osteotech
processed bone" from most competitive allograft processed bone which is usually
packaged in glass bottles.
In this segment, we process both our base allograft bone tissue and
bio-implants. In December, 1998, we introduced the bio-d(TM) Threaded Cortical
Bone Dowel for posterior and anterior spinal fusion procedures. In the fourth
quarter 2000, we began the limited market introduction of the Graftech(TM)
Bio-implant line of spacers and ramps for posterior and anterior lumbar spinal
fusion procedures and for cervical spinal fusion procedures. In the first
quarter 2001, two of the Graftech(TM) Bio-implant tissue forms became available
nationally and the others are expected to be available nationally by the fourth
quarter 2001. We market these bio-implants and our clients generally distribute
them.
21
In order to maintain our leading position in the allograft bone tissue
processing market and to encourage more surgeons to switch from autograft bone
tissue to our processed allograft bone tissue, we plan to:
o leverage our knowledge of allograft bone tissue processing to expand
our proprietary tissue safety claims to our weight-bearing
mineralized allograft bone tissue;
o expand our external scientific presence through publication and
presentation of clinical research and outcome studies;
o expand our market differentiation through tissue performance
improvements, including line extensions of existing base allograft
bone tissue products and new product introductions; and
o increase education of surgeons regarding the use of allograft bone
tissue through expanded grand rounds, seminars and workshops.
The various national markets in Europe for bone grafts are currently
dominated by the use of autograft and synthetic bone graft substitutes.
Autograft remains the bone graft of choice due to surgeons' attitudes and
concerns about bone graft safety and performance. There is also a significant
number of surgeons who have not yet become aware of the safety and performance
advantages of processed allografts and who continue to use unprocessed
autografts. Our OsteoPure(TM) Process, Grafton(R) DBM and base allograft bone
tissue are designed to address these needs. However, other firms have developed
or are developing allograft bone tissue grafts and allograft bone tissue-based
products to also address these needs. Tissue Bank of France, a unit of Groupe
Lepine of France and Tutogen, Inc. of Germany offer allograft bone tissue grafts
which directly compete with the OsteoPure(TM) Processed human femoral head
tissue grafts in certain European countries. Also, several U.S. tissue bank
organizations have formed strategic alliances with orthopaedic device firms to
market allograft bone tissue grafts in European markets.
Other
Our ceramic and titanium 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, we also face competition
from medical implant companies which have in-house plasma spray coating
operations. We compete primarily on the quality of our coatings and price. We
believe that the spraying technology we use, which is computer controlled and
utilizes robotics enables us to provide high quality coatings at competitive
prices. It should be noted, however, that the ceramic and titanium coating
industry is highly competitive.
Although we have not been a significant competitor in the metal spinal
implant market to date, we are expanding into this market, which is highly
competitive.
22
Environmental Matters
Our allograft bone tissue processing in both the United States and
Europe generates waste which, in the United States, is classified as medical
hazardous waste by the United States Environmental Protection Agency and the New
Jersey Department of Environmental Protection. We segregate this waste and
dispose of it through a licensed hazardous waste transporter in compliance with
applicable regulations in both the United States and Europe. The production of
HA powder at our facility in The Netherlands generates small amounts of
hazardous waste, which we segregate and dispose of through a licensed hazardous
waste transporter. Although we believe we are in compliance with applicable
environmental regulations, the failure 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 our business.
Patents and Proprietary Rights
We consider our processing technology and procedures proprietary and
rely primarily on trade secrets to protect our technology and innovations.
Significant research and development activities have been conducted on our
behalf 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 our projects
which have been independently developed by the consultants or researchers at the
medical institutions.
At February 28, 2001, we held an aggregate of 101 United States patents
and patent applications and 112 foreign patent and patent applications
consisting of: (i) 34 United States patents and 13 foreign patents relating to
our aseptic processing technology and our transplant support products, including
15 United States Grafton(R) DBM patents and 3 foreign Grafton(R) DBM patents,
(ii) 5 United States and 26 foreign patents relating to our biomaterials
technology, (iii) 54 United States and 56 foreign patent applications relating
to aspects of our processing technology and our osteogenic and other products
under development, (iv) 1 United States patent related to instrumentation, (v) 4
United States patent applications and 16 foreign patent applications relating to
our biomaterials technology and (vi) 3 United States patent applications and 1
foreign patent application relating to instrumentation. We believe that our
Grafton(R) DBM patents are significant in maintaining our competitive position.
These patents expire on various dates ranging from 2009 to 2020. Our other
patents expire at various dates ranging from 2007 to 2020.
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 us with sufficient protection in the case of an
infringement of our technology or that others will not independently develop
technology comparable or superior to ours. We are currently involved in four
patent-related lawsuits. See Item 3. "Legal Proceedings."
23
Product Liability and Insurance
The testing and use of allograft bone tissue and the implantation of
medical devices coated with our HA powder, medical devices developed with our
biomaterials technology and medical devices manufactured by others and
distributed by us entail inherent risks of medical complications for patients,
and therefore may result in product liability claims against us. Further, our
agreements with our bone tissue processing clients provide them with
indemnification by us for liabilities arising out of defects in allograft bone
tissue caused as a result of processing performed by us.
We presently maintain product liability insurance in the amount of $102
million per occurrence and per year in the aggregate. We cannot assure you that
we will be able to maintain such insurance in the future or that such insurance
will be sufficient to cover the amount of claims asserted against us on all
types of liabilities.
Employees
At December 31, 2000, we had 350 employees, of whom 214 were engaged in
allograft bone tissue processing, ceramic plasma spray coating and the
manufacture of products; 27 were engaged in research and development; 51 were
engaged in education, sales and marketing; and 58 were engaged in regulatory,
finance and administration. Our employees are not covered by any collective
bargaining agreement. We consider relations with our employees to be good.
Item 2. Properties
Our 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 our corporate, financial,
administration, marketing, research and development, regulatory and clinical
affairs staff.
Our processing facility is located in approximately 45,000 square feet
of space in Shrewsbury, New Jersey, which is occupied pursuant to a lease which
expires in October, 2008 and provides for a base annual rental of approximately
$247,000 through October 2003 and $309,000 for the remaining term of the lease.
The lease is renewable at our option for an additional five year term. Both the
Grafton(R) DBM and Base Tissue Segments utilize this facility. In addition, we
rent 4,600 square feet of space in Eatontown, New Jersey principally as
warehouse space for our non-allograft bone tissue spinal implant products. The
lease expires in January 2005 and provides for base annual rental of
approximately $27,000.
Our subsidiary in Leiden, the Netherlands, which is engaged in the
biomaterial business line, occupies a 21,000 square foot facility. The lease for
this facility expires in May, 2008 and the annual rent is dfl 626,000
(approximately $268,000 at the December 31, 2000 exchange rate). We are
subleasing 6,400 square feet of this facility to an unrelated third party at an
annual rent of dfl
24
234,000 (approximately $100,000 at the December 31, 2000 exchange rate). The
sublease agreement expires in March, 2004.
Our subsidiary in France, OST Developpement SA, which is engaged in the
production, processing and distribution of bovine bone graft substitute products
and human allograft tissue products, occupies an 11,000 square foot facility
in Clermont-Ferrand, France. The lease for this facility expires in June, 2002
and has an annual rent of FRF 556,000 (approximately $80,000 at the December 31,
2000 exchange rate). We have the option to acquire the building and related land
for the fair market value of the property at the time of purchase as determined
by an independent appraisal.
In 1997, we purchased approximately 13 acres of land surrounding our
Eatontown, New Jersey facility. We plan to utilize this land for future
expansion to meet our anticipated facilities requirements. In connection with
the first stage of this expansion, we have engaged a developer to build an
additional 74,000 square foot processing facility to our specifications. We
expect to occupy this facility in the second half of 2001. We are financing the
construction of this facility with a $4.5 million loan from our bank which will
be secured by a mortgage on the real property, building and fixtures, proceeds
from a $17 million equipment line of credit from our bank which will be secured
by the equipment purchased with the proceeds from this loan facility, through
our current cash reserves and from cash generated by operations.
Item 3. Legal Proceedings
GenSci Regeneration Laboratories, Inc. v. Osteotech, Inc.;
Osteotech, Inc. v. GenSci Regeneration Sciences, Inc.,
10111-MRP (Eex) (C.D. Cal.)
- - ----------------------------------------------------------
In January, 1998, we filed a patent infringement action against GenSci
Regeneration Laboratories, Inc., or GenSci Labs, and GenSci Regeneration
Sciences, Inc., or GenSci Sciences, alleging that the GenSci parties violated
claims of one of our patents involving the Grafton(R) Demineralized Bone Matrix
(DBM) process. Approximately two weeks after our filing, GenSci Labs filed a
suit against us alleging that our Grafton(R) DBM Flex tissue form infringes two
patents assigned to GenSci Labs in addition to allegations against us for
tortious interference with a business expectancy, negligent interference with a
prospective economic advantage and inducing breach of contract and seeking a
declaratory judgment of the invalidity of our patents U.S. Patent Nos. 5,284,655
and 5,290,558 covering Grafton(R) DBM. In February, 1998, GenSci Labs amended
its complaint alleging essentially the same causes of action but adding a third
patent to the allegation of patent infringement. In August, 1998, the actions
were consolidated into one case before the United States District Court for the
Central District of California.
In September, 1998, GenSci Labs served an amended complaint, which
asserted, in addition to the previously asserted claims, claims of false
advertising under Federal law. In September, 1998, we served our answer to this
amended complaint, asserted counterclaims against GenSci Labs and served a
third-party complaint against GenSci Sciences, and DePuy AcroMed, Inc., or
DePuy. Our counterclaims and third party complaint accused the GenSci parties of
infringing a second patent of ours, in addition to the patent referred to above,
and
25
accused the DePuy and GenSci parties of acting jointly and severally in
infringing on the claims of both patents.
In May, 1999, GenSci Labs amended its complaint to allege that in
addition to our Grafton(R) DBM Flex tissue form, our Grafton(R) DBM Gel and
Putty tissue forms infringe on the GenSci Lab's patents at issue. GenSci Labs
also amended its complaint to modify its false advertising claim, alleging that
in addition to Osteotech, individuals acting on our behalf engaged in false
advertising. We filed and served our answer and counterclaims to the amended
complaint in May, 1999.
In November, 1999, we settled all claims which we had filed against
DePuy. As part of the settlement, DePuy has agreed to stop selling the GenSci
products accused of infringing our patents, no later than February 4, 2001 and
to pay us $3,000,000. Payments of $1,000,000 and $2,000,000 were received in
2000 and 1999, respectively.
In April, 2000, we, GenSci Labs and GenSci Sciences reached an
agreement to dismiss with prejudice all of GenSci's patent infringement claims
against our proprietary Grafton(R) DBM allograft bone tissue forms and to stay
any action in GenSci's anti-trust suit, which it had filed against us on March
6, 2000, until the completion of the trial of our patent infringement claims
against GenSci. GenSci also agreed to dismiss all of the tort claims that it had
brought against us in its patent lawsuit without prejudice and to transfer the
claims to the anti-trust action. As a result of these dismissals, GenSci will no
longer have any claims against us in the patent action. This agreement was
subject to court approval, which approval has been received. The only remaining
claims in the patent action involve our allegations that GenSci has infringed
certain of our patents through the sale of the Dynagraft(TM) Gel and
Dynagraft(TM) Putty products.
In July, 2000, we filed a motion seeking summary judgment in our favor
on GenSci Labs' and GenSci Sciences' reverse doctrine of equivalents defense on
the basis that the GenSci parties failed to assert that defense in a timely
manner and that the defense is otherwise meritless. We also filed a motion
seeking judgment that the portion of the case GenSci dismissed with prejudice be
ruled as exceptional based on GenSci Labs having asserted and maintained
baseless allegations that we infringed GenSci Labs' patents, thus warranting an
award of attorneys' fees and costs to us.
Also, in July, 2000, GenSci filed various motions for summary judgment
seeking orders that GenSci does not infringe on our patents and/or that such
patents are invalid.
In October, 2000, the court held a claims construction hearing, also
known as a Markman hearing, to construe the scope of the claims of the
patents-in-suit. In December, 2000, the court issued its ruling adopting our
interpretation of the claims.
In January, 2001, we filed a motion for summary judgment of
infringement of U.S. Patent No. 5,290,558. Also in January, 2001, GenSci filed a
second motion for summary judgment of noninfringement of U.S. Patent No.
5,284,655, and stated to the court that there no longer was a
26
need for the court to rule on GenSci's first motion for summary judgment of
noninfringement of U.S. Patent No. 5,284,655.
In March, 2001, the court rejected GenSci's various motions for summary
judgment. Osteotech's motion for summary judgment of infringement of U.S. Patent
No. 5,290,558 has not as yet been ruled on.
We will continue to vigorously defend any claims against us, prosecute
the claims we have asserted in this action, and vigorously and affirmatively
protect our products and intellectual property to the fullest extent possible
under the law.
GenSci Orthobiologics, Inc. v. Osteotech, Inc., Civil Action
No. 02313-LGB (C.D. Cal.)
- - ------------------------------------------------------------
On March 6, 2000, GenSci Orthobiologics, Inc., or GenSci, filed a
complaint in the United States District Court for the Central District of
California against us, alleging unlawful monopolization, attempt to monopolize
the market for demineralized bone matrix and for entering agreements in
restraint of trade, in violation of Sections 1 and 2 of the Sherman Antitrust
Act and Section 3 of the Clayton Act; and that we engaged in unlawful and unfair
business practices in violation of Section 17200 of the California Unfair
Competition Law. GenSci has alleged that we have monopoly power in the market
for demineralized bone matrix products in the United States, and have engaged in
anticompetitive conduct by improperly asserting our patents through patent
infringement actions, seeking to have the FDA remove certain of GenSci's
products from the market, restricting competitors' access to raw materials,
interfering with GenSci's arrangements to manufacture demineralized bone matrix
implants, interfering with GenSci's marketing and distribution arrangements, and
disparaging GenSci's products. GenSci seeks compensatory, incidental,
consequential, and punitive damages in an unspecified amount, and injunctive
relief to stop us from restricting the tissue banks for which we process tissue
from supplying processed demineralized bone matrix to our competitors and
distributing the demineralized bone matrix implant products of our competitors.
Certain of these allegations had previously been asserted by GenSci in its
patent litigation with us in the Central District of California federal court.
In April, 2000, we reached an agreement with GenSci whereby tort claims
that were dismissed from the patent litigation would be transferred to this
action and this action was stayed until the completion of the trial of our
patent infringement claims against GenSci.
We believe the claims made in this lawsuit are without merit and we
intend to vigorously defend against these claims.
Osteotech, Inc. v. GenSci Orthobiologics, Inc. CV 00-11342 MRP (EEx)
- - --------------------------------------------------------------------
On October 25, 2000, we filed suit against GenSci Orthobiologics, Inc.,
in the United States District Court for the Central District of California,
alleging that GenSci Orthobiologics' demineralized bone matrix materials sold
under the name Orthoblast, infringe our U.S. Patent No. 5,290,558 and infringe
the reexamined claims of our U.S. Patent No. 5,676,146. Our complaint seeks
injunctive relief, treble damages, costs and attorneys fees.
27
In its second amended answer and counterclaim filed in March, 2001,
GenSci Orthobiologics denies infringement, asserts a number of affirmative
defenses, and asserts a counterclaim seeking a declaratory judgment that the
patents-in-suit are invalid, not infringed and/or unenforceable together with
costs and attorneys fees.
We intend to pursue our claims against GenSci Orthobiologics and defend
against the counterclaims.
"O" Company, Inc. v. Osteotech, Inc., Case No. Civ. 98-981 BB/LFG (D.N.M.)
- - --------------------------------------------------------------------------
In July, 1998, a complaint was filed against us in the Second Judicial
District Court, Bernallilo County, New Mexico, which alleges negligence, strict
liability, breach of warranties, negligent misrepresentation, fraud, and
violation of the New Mexico Unfair Trade Practices Act arising from allegedly
defective dental implant coating and coating services provided to plaintiffs by
our subsidiary, Cam Implants BV. Plaintiffs have demanded unspecified monetary
damages. In August, 1998, we removed this action to the United States District
Court for the District of New Mexico and filed and served our answer, denying
any and all liability in this action, and moved to dismiss five of the seven
claims alleged against us. In March, 1999, the court dismissed with prejudice
the plaintiff's negligence and strict liability claims. Remaining are claims for
breach of warranties, negligent misrepresentation, fraud, and violation of the
New Mexico Unfair Trade Practices Act. As to those claims, we have moved for
summary judgment on the basis that all of the remaining claims are barred by
their applicable statutes of limitations. At plaintiffs' request, the court
permitted limited discovery on the matters related to the statute of limitations
issue, which is ongoing.
We believe that the claims made against us in this action are without
merit and we will continue to vigorously defend against such claims.
University of Florida Tissue Bank, Inc. v. Osteotech, Inc.,
Case No. 1:99cv33 MMP (N.D. Fla.)
- - -----------------------------------------------------------
In February, 1999, a complaint was filed against us in the United
States District Court for the Northern District of Florida. This action, which
has been brought by plaintiffs, University of Florida Tissue Bank, Inc.,
Regeneration Technologies, Inc., Sofamor Danek Group, Inc., and Sofamor Danek
L.P. alleges that our bio-d(TM)Threaded Cortical Bone Dowel and Endodowel
infringe on the claims of U.S. Patent Nos. 5,814,084 and 4,950,296. The
plaintiffs have sought injunctive relief and monetary damages in an amount not
yet specified. In May, 1999, we filed our answer and counterclaim seeking
declaratory judgment that the patents in question in this action are invalid and
otherwise not infringed by us. In May, 1999, plaintiffs filed their reply to our
counterclaims.
In October, 2000, the Court granted plaintiffs permission to amend
their complaint to allege that we, in addition to infringing on the claims of
the patents mentioned above, infringed upon the claims of a related patent owned
by plaintiffs, U.S. Patent No. 6,096,081. As with their infringement claims
regarding the other patents, plaintiffs seek injunctive relief and unspecified
damages.
28
Discovery on all of the claims asserted in this litigation is ongoing.
We believe that the claims made against us in this action are without merit and
we will continue to vigorously defend against such claims.
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor
Holdings, Inc. v. Osteotech, Inc., Case No. 99-2656 (W.D. Tenn.)
- - ---------------------------------------------------------------
In July, 1999, Medtronic Sofamor Danek Inc., Sofamor Danek L.P. and
Sofamor Danek Holdings, Inc., or collectively Danek, sued us in the United
States District Court for the Western District of Tennessee alleging that
instruments and instrument sets relating to cortical bone dowel products,
including the bio-d(TM) Threaded Cortical Bone Dowel and Endodowel,
manufactured, sold and/or otherwise distributed by us infringe on certain claims
of U.S. Patent Nos. 5,741,253 and 5,484,437 which are owned by Danek. In
addition to injunctive relief, plaintiffs seek unspecified monetary damages. In
September, 1999, we filed our answer and counterclaims seeking a declaratory
judgment that the patents in question in this action are invalid and otherwise
not infringed by us. Plaintiffs filed their reply to the counterclaims in
October, 1999.
In October, 2000, the Court granted plaintiffs permission to amend
their complaint to allege that we also infringed upon the claims of a related
patent owned by plaintiffs, U.S. Patent No. 6,096,038. As with their
infringement claims regarding the other patents, plaintiffs seek injunctive
relief and unspecified damages.
Discovery on all of the claims asserted in this litigation is ongoing.
We believe that the claims made against us in this action are without merit and
we will continue to vigorously defend against such claims.
Regner v. Inland Eye & Tissue Bank of Redlands, SCVS66746 (Superior Ct.,
San Bernardino County, California)
- - ------------------------------------------------------------------------
In May, 2000, Regner brought suit against us and fifteen or more other
defendants in the Superior Court for the State of California, San Bernardino
County. The suit seeks class action status and alleges a cause of action based
on a violation of the California Business and Professional Code, as well as a
number of common law causes of action, including negligence, deceit, and
intentional and negligent infliction of emotional distress. Plaintiff claims
that we are violating the California Business and Professional Code by engaging
in the activity of buying or selling organs or tissue for valuable consideration
or profit. It appears that the plaintiff is seeking only injunctive relief with
respect to its California Business and Professional Code claim. To the extent
any of the other causes of action exist against us, the plaintiffs are seeking
damages in an unspecified amount in addition to class certification.
In June, 2000, Regner filed a motion for preliminary injunction and a
hearing was held on June 28, 2000. The Court denied the motion. We also filed a
demurrer to the complaint requesting that the complaint be dismissed.
29
In September, 2000, plaintiffs voluntarily dismissed without prejudice
their claims filed in the Superior Court for the State of California, San
Bernardino County. At or about the time of the dismissal, the plaintiffs
"refiled" the action in the Superior Court for Los Angeles County. In October,
2000, the defendants, including us, moved to vacate plaintiffs' dismissal of the
San Bernardino County action and have the action reinstated. The Court granted
that motion and scheduled a hearing on defendants' demurrers to the plaintiffs'
complaint. Plaintiffs subsequently moved to voluntarily dismiss the action
without prejudice. The Court granted that motion. In February, 2001, we were
served with the action that was refiled in Los Angeles County. The defendants
have filed a motion asking the Court to move this action back to San Bernardino
County.
We deny that we engaged in the activity complained of and assert that
we are licensed by the State of California to do precisely what we are doing,
and that our activities are fully in accord with all state and federal laws.
Therefore, we believe this suit to be without merit and we will vigorously
defend against the claims.
Thacker v. Inland Eye & Tissue Bank, BC241929 (Superior Ct.,
Los Angeles County, California)
- - ------------------------------------------------------------
In February, 2001, Thacker brought suit against us and fifteen or more
defendants in the Superior Court for the State of California, Los Angeles
County. The suit is substantially identical to the Regner v. Inland Eye & Tissue
Bank of Redlands suit discussed above. We are assessing the claims against us
and have not yet responded to them. The defendants have filed a motion asking
the Court to move this action to the Superior Court for the State of California,
San Bernardino County, or in the absence to do so, to consolidate this action
with the Regner action.
We deny that we engaged in the activity complained of and assert that
we are licensed by the State of California to do precisely what we are doing,
and that our activities are fully in accord with all state and federal laws.
Therefore, we believe this suit to be without merit and we will vigorously
defend against the claims.
Steele v. Inland Eye and Tissue Bank, SCVS59024 (Superior Ct.,
San Bernardino County, California)
- - --------------------------------------------------------------
In October, 2000, we were served with a summons and second amended
complaint naming us as a "Doe" defendant in an action pending in the Superior
Court for the State of California, San Bernardino County. Plaintiff has asserted
claims against defendants for intentional misrepresentation, negligent
misrepresentation and tortious interference in connection with certain tissue
procurement activities allegedly engaged in by defendants. Plaintiff seeks
damages in an unspecified amount. In February, 2001, plaintiffs agreed to
dismiss this case with prejudice.
Condos v. Musculoskeletal Transplant Foundation,
Civil No. 2:00-CV-0190ST (D. Utah)
- - ------------------------------------------------
In June, 2000, we were served with an action brought in the United
States District Court for the District of Utah against us and MTF. The suit
alleges causes of action for strict liability, breach of implied warranty and
negligence arising from allegedly defective allograft bone tissue
30
processed and/or provided by us and MTF which was allegedly implanted into the
plaintiff, Chris Condos, during two spinal surgeries. Plaintiffs, which include
Mr. Condos' family members, demand monetary damages in an unspecified amount. On
July 25, 2000, we answered the complaint, denying any and all liability.
Discovery on all of the claims in this action has commenced.
We maintain a general liability insurance policy and have notified the
insurance company of this action and the insurance company has agreed to defend
us in this action.
Musculoskeletal Transplant Foundation v. Osteotech, Inc.,
Civil Action No. 00-4869 (JWB)
- - ---------------------------------------------------------
In October, 2000, MTF filed a complaint in the United States District
Court for the District of New Jersey against us seeking a declaratory judgment
that MTF, through its manufacture, use, sale and/or offer for sale of
demineralized bone matrix products, does not infringe any claim of our U.S.
Patent Nos. 5,284,655 and 5,290,558, and that the claims of those patents are
invalid and unenforceable. The complaint was then amended to add Synthes Spine
Company, L.P., or Synthes, as a plaintiff. MTF and Synthes seek declaratory and
injunctive relief.
We answered the complaint, denying all claims asserted and we have
asserted claims against MTF and Synthes for patent infringement, unfair
competition, misappropriation of trade secrets, product disparagement, breach of
implied covenant of good faith and fair dealing, intentional interference with
contractual relations, and for constructive trust, arising from certain wrongful
acts committed by MTF and/or Synthes for developing and selling their DBX(R)
Products and/or their underlying technology. We seek injunctive relief and
monetary damages in an amount to be determined. MTF and Synthes have denied any
liability.
Discovery has commenced on all claims. We believe that the claims made
against us in this action are without merit and we will vigorously defend
against the claims.
Glancy v. Interpore International, Inc.,
Case No. 2:00-CV-585RL (N.D. Ind.)
- - ----------------------------------------
In November, 2000, plaintiffs Bonnie and Ivan Glancy commenced an
action in the United States District Court for the Northern District of Indiana
against Interpore International, Inc. and Interpore Cross International, Inc.,
or collectively Interpore, and us. The suit seeks recovery from defendants for
alleged personal injuries suffered by plaintiffs as a result of allegedly
defective spinal implants, manufactured and/or distributed by Interpore, and/or
demineralized bone matrix material, processed by us - both are alleged to have
been implanted into plaintiff Bonnie Glancy during a spinal surgery. Plaintiffs
have asserted against us a products/strict liability claim relating to the
demineralized bone matrix material. Plaintiffs demand monetary damages in an
unspecified amount. In January, 2001, we answered the complaint, denying any and
all liability. Discovery on all of the claims in this action have commenced.
We maintain a general liability policy and have informed the insurance
company of this action. The insurance company has agreed to defend this action.
31
Criti-Cal, Inc. v. Osteotech, Inc., Case No. OOCC15620
(Superior Ct., Orange County, California)
- - ------------------------------------------------------
In December, 2000, Criti-Cal, Inc. commenced an action in the Superior
Court for the State of California, Orange County, against us, Second Act
Medical, Inc. and Ronald Letner. The plaintiff alleges causes of action for
breach of contract, misappropriation of trade secrets, quantum merit and
violations of the California Independent Wholesale Sales Representatives
Contractual Relations Act of 1990 arising from the termination of an agreement
between us and plaintiff. In addition to injunctive relief, plaintiff seeks
unspecified monetary damages.
We answered the complaint denying any and all liability and we intend
to vigorously defend against all claims.
Medtronic, Inc. v. Osteotech, Inc., Case No. CT-000843-01,
Div 7 (Cir. Ct., Shelby County, Tennessee)
- - ----------------------------------------------------------
In February, 2001, Medtronic, Inc. and Medtronic Sofamor Danek, Inc.,
or collectively Medtronic, brought suit against us and Medtronic's former
employee, Timothy R. Miller, in the Circuit Court for Shelby County, Tennessee.
The plaintiffs seek to enjoin Mr. Miller, whom we recently hired, from using and
disclosing any of their trade secrets or other confidential information to any
third party, including us, and from working for us for a period of twelve
months. The plaintiffs have asserted a claim against us for tortious
interference with an employment agreement between Mr. Miller and plaintiffs. In
addition to injunctive relief, plaintiffs seek unspecified monetary damages.
Mr. Miller and we have both filed an answer denying any liability.
Medtronic has filed a motion for preliminary injunction which remains pending.
We intend to vigorously defend against these claims.
Other than the foregoing matters, we are not a party to any material
pending legal proceeding. Litigation is subject to many uncertainties and we are
unable to predict the outcome of the pending suits and claims. It is possible
that our results of operations or liquidity and capital resources could be
adversely affected by the ultimate outcome of the pending litigation or as a
result of the costs of contesting such lawsuits. We are unable to estimate the
potential liability, if any, that may result from the pending litigation.
Item 4. Submissions of Matters to a Vote of Security Holders
None.
32
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters
-----------------------------------------
Our Common Stock has been listed on the Nasdaq Stock Market(R) under
the trading symbol "OSTE" since our 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,
2000 and 1999 based on transaction data as reported by the Nasdaq Stock
Market(R).
Year Ended December 31, 2000 High Low
- - --------------------------------------------------------------------
First Quarter $ 20.00 $ 12.75
Second Quarter $ 14.13 $ 6.50
Third Quarter $ 14.25 $ 8.50
Fourth Quarter $ 9.50 $ 3.25
Year Ended December 31, 1999 High Low
- - --------------------------------------------------------------------
First Quarter $ 39.08 $ 25.42
Second Quarter $ 41.13 $ 24.75
Third Quarter $ 30.25 $ 12.20
Fourth Quarter $ 22.25 $ 11.75
On February 11, 1999, our Board of Directors authorized a three-for-two
stock split in the form of a 50% stock dividend that was distributed on March
19, 1999 to stockholders of record on March 5, 1999. The high and low sales
prices have been restated to give retroactive recognition to the stock split for
all periods prior to the effective date of the stock split.
As of March 20, 2001, there were 306 holders of record of Osteotech
Common Stock. We believe that there are approximately 5,600 beneficial owners of
our Common Stock.
We have never paid a cash dividend and do not anticipate the payment of
cash dividends in the foreseeable future as earnings are expected to be retained
to finance our growth. Declaration of dividends in the future will remain within
the discretion of our Board of Directors, which will review our dividend policy
from time to time.
33
Item 6. Selected Financial Data
Set forth below is the selected financial data for the five fiscal
years ended December 31, 2000. The following data should be read in conjunction
with our consolidated financial statements and related notes thereto contained
elsewhere herein and "Management's Discussion and Analysis of Financial
Condition and Results of Operations." All per share data have been adjusted for
the three-for-two stock split in the form of a 50% stock dividend in March,
1999.
- - ---------------------------------------------------------------------------------------------------------------------------
Selected Financial Data
(dollars in thousands except per share data)
For the Year ended December 31, 2000 1999 1998 1997 1996
- - ---------------------------------------------------------------------------------------------------------------------------
Consolidated Results of Operations
- - ---------------------------------------------------------------------------------------------------------------------------
Net revenues $ 75,683 $ 75,610 $ 59,201 $ 44,931 $ 34,895
- - ---------------------------------------------------------------------------------------------------------------------------
Gross profit 48,172 51,701 41,562 29,096 20,075
- - ---------------------------------------------------------------------------------------------------------------------------
Operating expenses (a) 41,317 33,849 25,281 20,109 18,326
- - ---------------------------------------------------------------------------------------------------------------------------
Income from litigation settlement 1,000 2,000 0 0 0
- - ---------------------------------------------------------------------------------------------------------------------------
Operating Income 7,855 19,852 16,281 8,987 1,749
- - ---------------------------------------------------------------------------------------------------------------------------
Other income, net 1,047 1,032 1,132 585 271
- - ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 8,902 20,884 17,413 9,572 2,020
- - ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) 4,828 12,351 10,304 5,686 (324)
- - ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) per share
- - ---------------------------------------------------------------------------------------------------------------------------
Basic .34 .88 .78 .46 (.03)
- - ---------------------------------------------------------------------------------------------------------------------------
Diluted .34 .84 .73 .43 (.03)
- - ---------------------------------------------------------------------------------------------------------------------------
Dividends per share 0 0 0 0 0
- - ---------------------------------------------------------------------------------------------------------------------------
Year End Financial Position
- - ---------------------------------------------------------------------------------------------------------------------------
Working capital $ 29,123 $ 37,082 $ 26,373 $ 19,922 $ 12,273
- - ---------------------------------------------------------------------------------------------------------------------------
Total assets 104,438 89,730 57,114 43,052 31,483
- - ---------------------------------------------------------------------------------------------------------------------------
Long-term obligations, net of current 19,930 6,359 0 203 840
portion
- - ---------------------------------------------------------------------------------------------------------------------------
Stockholders' equity 71,851 69,406 45,930 34,292 22,717
- - ---------------------------------------------------------------------------------------------------------------------------
(a) In 1996, operating expenses include a charge to earnings of $1,350,000
related to the restructuring of our operations located in Leiden, The
Netherlands.
34
Item 7. Management's Discussion And Analysis Of Financial
Condition And Results Of Operations
For the Three Years Ended December 31, 2000, 1999 and 1998
Results of Operations
Net Income (Loss)
Consolidated net income decreased to $4,828,000 or $.34 diluted income
per share in 2000 compared to net income of $12,351,000 or $.84 diluted income
per share in 1999 and $10,304,000 or $.73 diluted income per share in 1998. Net
income in 2000 and 1999 included approximately $600,000 or $.04 diluted income
per share and $1,200,000 or $.08 diluted income per share, respectively, related
to the patent litigation settlement with DePuy. See Part I, Item 3. "Legal
Proceedings" and Note 11 of "Notes to Consolidated Financial Statements."
Consolidated income before income taxes decreased to $8,902,000 in 2000
compared to $20,884,000 in 1999 and $17,413,000 in 1998. Income before income
taxes in 2000 and 1999 included $1,000,000 and $2,000,000, respectively, related
to the patent litigation settlement with DePuy.
The following is a discussion of factors affecting results of
operations for the years ended December 31, 2000, 1999, and 1998.
Net Revenues
Consolidated net revenues in 2000 were $75,683,000 as compared to
$75,610,000 in 1999. In December 2000, one of our clients purchased $1,000,000
of Grafton(R) DBM in advance of the January 1, 2001 price increase, but we
deferred recognition of the revenue until the first quarter of 2001 in
accordance with Generally Accepted Accounting Principles, or GAAP, specifically
Staff Accounting Bulletin 101. Revenues in 1999 included a $1,500,000 purchase
of Grafton(R) DBM in advance of a January 1, 2000 price increase. The 1999
Grafton(R) DBM purchase was not required to be deferred in accordance with GAAP
and SEC Staff Accounting Bulletin 101. Domestic net revenues, which consist
principally of revenues from the Grafton(R) DBM and Base Tissue Segments, were
$71,468,000 in 2000 as compared to $71,517,000 in 1999. Revenues from
bio-implants increased 111% in 2000 offsetting the 7% decline in base allograft
tissue processing revenues, which resulted from a 16% decline in the number of
donors processed, and a 2% decline in domestic Grafton(R) DBM revenues. Foreign
net revenues were $4,215,000 in 2000 compared to $4,093,000 in 1999. Revenues
associated with the European introduction of Grafton(R) DBM and a 162% increase
in OsteoPure(TM) Femoral head processing revenue offset decreased revenues from
bovine tissue sales and ceramic and titanium coating services.
Consolidated net revenues increased 28% in 1999 to $75,610,000 from
$59,201,000 in 1998. The increase was principally due to higher revenues in both
the Grafton(R)
35
DBM and Base Tissue Segments. Domestic net revenues, which consist principally
of revenues from the Grafton(R) DBM and Base Tissue Segments, increased 26% to
$71,517,000 from $56,876,000 in 1998. Foreign revenues increased 76% to
$4,093,000 from $2,325,000 in 1998. The increase in foreign net revenues
resulted primarily from our January 1999 acquisition of OST.
Grafton(R) DBM Segment net revenues in 2000 were $45,226,000 as
compared to $45,136,000 in 1999. Grafton(R) DBM Segment revenues were positively
affected by the introduction of Grafton(R) DBM in Europe, which offset a 2%
decrease in domestic revenues. In addition, 1999 revenues included $1,500,000 of
Grafton(R) DBM purchased by our clients in December, 1999 in advance of the
January 1, 2000 price increase, while revenue recognition of a similar December,
2000 $1,000,000 purchase of Grafton(R) DBM by one of our clients was deferred
until 2001 in accordance with GAAP and SEC Staff Accounting Bulleting 101. In
2000, Grafton(R) DBM faced and we expect it will continue to face, increasing
competition as more companies develop products with characteristics similar to
Grafton(R) DBM. Base Tissue Segment net revenues increased 2% in 2000 to
$26,204,000 from $25,751,000 in 1999. The increase was principally due to a 111%
increase in bio-implant processing revenues and a 162% increase in OsteoPure(TM)
Femoral head processing revenue. These increases were partially offset by a 7%
decline in base allograft tissue processing revenues as a result of a 16%
decline in the number of donors processed, due in part to the decline in base
tissue needs of surgeons as they shift to using more highly advanced tissues
such as our line of Graftech(TM) bio-implants.
Grafton(R) DBM Segment net revenues increased 15% in 1999 to
$45,136,000 from $39,128,000 in 1998. The increase resulted from increased
demand for Grafton(R) DBM. Base Tissue Segment net revenues increased 49% in
1999 to $25,751,000 from $17,323,000 in 1998. The increase occurred as a result
of increased unit volume of allograft bone tissue processed for our clients.
During 2000, 1999, and 1998, two of our clients in the Grafton(R) DBM
and Base Tissue Segments accounted for 50% and 40%, 56% and 38%, and 56% and
39%, respectively, of consolidated net revenues. We have processing agreements
with each of these clients which expire in August, 2005 and December, 2006,
respectively. The agreement which expires in August 2005, may be terminated by
either party commencing in March 31, 2002, or any date thereafter upon giving
six months prior written notice.
Gross Profit
Gross profit as a percentage of net revenues was 64% in 2000, 68% in
1999, and 70% in 1998. The decline in gross profit as a percentage of net
revenues in 2000 resulted primarily from the underabsorption of costs related
to: increased capacity, new processing technologies, a 16% decline in the number
of donors processed, and allograft bone tissue forms that have not yet achieved
revenue levels sufficient to fully absorb production costs while they are in
launch mode. The decline in gross profit as a percentage of net revenues in 1999
results from: the absorption of costs associated with additional allograft
tissue processing capacity which was added to meet the anticipated growth in our
allograft tissue business, and a decline in the percentage of consolidated
36
revenues coming from the Grafton(R) DBM Segment, which has a higher gross profit
than other services and products.
In the fourth quarter of 1998, we commenced construction of a new
allograft tissue processing facility in Eatontown, New Jersey which is expected
to be in use during the second half of 2001, see Item 2, "Properties" and Note 6
of "Notes to Consolidated Financial Statements." We expect that the incremental
expenses associated with this facility will only be partially offset by
increased volume in 2001, and therefore consolidated gross profit as a
percentage of net revenues in 2001 is expected to decline slightly from the
level achieved in 2000.
Marketing, General and Administrative Expenses
Marketing, general and administrative expenses increased 25% in 2000 to
$35,545,000 from $28,343,000 in 1999. In 1999, marketing, general and
administrative expenses were 37% higher than 1998 expenses of $20,671,000. In
2000, this increase is primarily due to increases in legal fees associated with
patent lawsuits, see Part I, Item 3. "Legal Proceedings" and Note 11 of "Notes
to Consolidated Financial Statements", and increased costs associated with
marketing, selling and promotional activities, especially with respect to new
bio-implant tissue forms. The increase in 1999 was primarily attributable to:
incremental agent commissions resulting from increased volume in the Grafton(R)
DBM Segment, expanded marketing and promotional activities associated with the
launch of two new products, the bio-d(TM) Threaded Cortical Bone Dowel which is
included in the Base Tissue Segment and the SSCS(TM) system, increased legal
fees associated with patent infringement lawsuits, and the inclusion of OST's
operating expenses. We are committed to aggressively asserting and defending our
technology and related intellectual property. As a result we are currently
involved in four patent lawsuits. Prosecuting and defending these lawsuits is
expensive and has had, and will likely have, a negative impact on our operating
results. However, we believe it is necessary to defend our technology and
related intellectual property in which we invest significant amounts of money to
develop.
Research and Development Expenses
Consolidated research and development expenses increased 5% in 2000 to
$5,772,000 from $5,506,000 in 1999. Research and development expenses in 1999
were 19% higher than 1998 research and development expenses of $4,610,000. These
increases were primarily attributable to increased spending in the Grafton(R)
DBM and the Base Tissue Segments associated with the continued development of
several new processing technologies, development of new allograft bone tissue
forms, specifically new bio-implant tissue forms, and ongoing support for
existing products and services.
Income From Litigation Settlement
In November, 1999, we settled all claims which we had filed against
DePuy in the patent infringement lawsuit against GenSci Labs and GenSci
Sciences. As part of the settlement, DePuy has agreed to stop selling the GenSci
products accused of infringing our patents no later than February 4, 2001 and to
pay us $3,000,000. We received payments and recognized income, of
37
$250,000 in each quarter of 2000 and a payment of $2,000,000 in the fourth
quarter of 1999, of which $1,750,000 and $250,000 was recognized in income in
the third and fourth quarters, respectively, of 1999.
Operating Income
Consolidated operating income decreased 60% in 2000 to $7,855,000 from
$19,852,000 in 1999 primarily as a result of declines in the Grafton(R) DBM and
Base Tissue Segments. In 1999, consolidated operating income was 22% higher than
1998 operating income of $16,281,000. Grafton(R) DBM Segment operating income
decreased 33% in 2000 to $11,389,000 from $17,063,000 in 1999 primarily due to:
lower gross margins due to underabsorption of costs, increased legal fees
associated with patent lawsuits, increased costs associated with marketing,
selling and promotional activities, and a decrease of $1,000,000 in patent
litigation settlement payments. In 1999 Grafton(R) DBM Segment operating income
was 27% higher than 1998 operating income of $13,404,000 principally due to
increased revenues and, in 1999, the litigation settlement with DePuy. Base
Tissue Segment operating income decreased 89% in 2000 to $694,000 from
$6,434,000 in 1999 as a result of lower gross margins due to underabsorption of
costs, increased legal fees associated with patent lawsuits, and increased costs
associated with marketing, selling and promotional activities, especially with
respect to new bio-implant tissue forms. Base Tissue Segment operating income in
1998 was $4,170,000. Other segment operating income declined 16% in 2000 to a
loss of $4,228,000 and declined 182% in 1999 to a loss of $3,645,000 from a loss
of $1,293,000 in 1998.
Other Income (Expense)
In 2000, other income increased $15,000 to $1,047,000. Other income
decreased $100,000 in 1999 principally due to lower interest income resulting
from a decline in interest rates.
Income Tax Provision
Our effective income tax rate in 2000 was 46% and was 41% in 1999 and
1998. The effective income tax rate exceeded the federal statutory income tax
rate principally due to the non-recognition for tax purposes of foreign
operating losses and the impact of domestic state income taxes.
Liquidity and Capital Resources
At December 31, 2000, we had cash and short-term investments of
$12,858,000 compared to $20,716,000 at December 31, 1999. We invest our excess
cash in U.S. Government-backed securities and investment grade commercial paper
of major U.S. corporations. Working capital decreased $7,959,000 to $29,123,000
at December 31, 2000 compared to $37,082,000 at December 31, 1999. The decrease
resulted primarily from utilization of cash and short-term investments to
partially fund capital expenditures, including construction of the new allograft
tissue processing facility, and the purchase and retirement of 330,500 shares of
common stock for an aggregate purchase price of $3,124,000.
38
Net cash provided by operating activities decreased to $10,214,000 in
2000 from $14,459,000 in 1999. The decrease resulted primarily from a reduction
of income tax benefits related to stock options, partially offset by increased
non-cash charges, principally depreciation and amortization.
Cash used in investing activities increased to $27,167,000 in 2000 from
$22,173,000 in 1999. The increase is due to an increase in capital expenditures
to $28,382,000 from $18,743,000 resulting from our continued investment in
facilities and equipment needed for current and future business requirements. In
the fourth quarter of 1998, we commenced construction of a new allograft tissue
processing facility in Eatontown, New Jersey. See Item 2. "Properties" and Note
6 of "Notes to Consolidated Financial Statements." The estimated aggregate cost
for the construction of the facility, including furniture, fixtures and
equipment, is approximately $37,000,000. A portion of the aggregate construction
costs have been, and will continue to be, funded through a $4,500,000 building
mortgage loan and an equipment line of credit of $17,000,000. The remaining
balance will be funded through available cash reserves or anticipated cash flow
from operations. Through December 31, 2000, we have incurred $32,197,000 of
capital expenditures, including capitalized interest of $761,000, related to the
new allograft tissue processing facility, of which $17,883,000 has been funded
through bank financing.
Net cash provided by financing activities in 2000 increased to
$11,271,000 from $9,388,000 in 1999. The increase results principally from
increased borrowings under the credit facility partially offset by a reduction
of cash proceeds received from stock option exercises and the purchase and
retirement of 330,500 shares of common stock for an aggregate purchase price of
$3,124,000.
In June, 1999, we replaced our then existing domestic lines of credit
with a credit facility that includes a $5,000,000 revolving line of credit, a
$4,500,000 building mortgage loan and a $17,000,000 equipment line of credit. At
December 31, 2000, $4,500,000 was outstanding under the building mortgage and
$15,531,000 was outstanding under the equipment line of credit. No amounts were
outstanding under the revolving line of credit.
We also have a line of credit with a Dutch bank, which provides for
borrowings of up to dfl 3,000,000, or approximately $1,283,000 at the December
31, 2000 exchange rate. Additionally, we have a line of credit with a French
bank which provides for borrowings of up to FRF 1,750,000, or approximately
$251,000 at the December 31, 2000 exchange rate. At December 31, 2000, there
were no borrowings outstanding under either the Dutch or French credit lines.
At December 31, 2000, certain of our foreign-based subsidiaries have
net operating loss carryforwards aggregating $4,415,000 at the December 31, 2000
exchange rate ($525,000 with no expiration date; $3,890,000 expiring 2004
through 2008). See Note 10 of "Notes to Consolidated Financial Statements."
In September, 2000 and February, 2001, we entered into two distribution
agreements. We will market pursuant to these agreements, VBR(TM) and, a pedicle
screw system and a cervical
39
plating system, respectively. These agreements require us to make minimum
purchase commitments over the next two years of $3,000,000 and $6,000,000,
respectively.
We believe that our cash and cash equivalents, short-term investments
and available lines of credit, together with anticipated future cash flow from
operations, will be sufficient to meet our near-term requirements. From time to
time, we may seek additional funds through equity or debt financing. However,
there can be no assurance that such additional funds will be available to us or,
if available, that such funds will be available to us on favorable terms.
Recent Developments
In June, 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities," or SFAS No. 133. SFAS No. 133, as amended,
is effective for fiscal years beginning after June 15, 2000. We believe adoption
of SFAS No. 133 will have no effect on our results of operations or financial
condition.
Impact of Inflation and Foreign Currency Exchange Fluctuations
The results of operations for the periods discussed have not been
materially affected by inflation or foreign currency fluctuations.
Litigation
We are involved in various legal proceedings involving product
liability and patent infringement claims. For a complete discussion of these
matters see, Part I, Item 3. "Legal Proceedings" and Note 11 of "Notes to
Consolidated Financial Statements." It is possible that our results of
operations or liquidity and capital resources could be adversely affected by the
ultimate outcome of the pending litigation or as a result of the costs of
contesting such lawsuits.
Risk Factors
We are dependent upon two primary clients who provide the bulk of our
revenues.
We are the processor of allograft bone tissue for large national and
international not-for-profit organizations. During 2000, MTF and ARC accounted
for approximately 50% and 40%, respectively, of our revenues. We entered into a
10-year exclusive processing agreement with ARC in December, 1996 and a
five-year processing agreement with MTF in September, 2000. However, the MTF
contract may be canceled effective March 31, 2002 and thereafter upon either
party giving six months prior written notice. The loss of either MTF or ARC as a
client or a substantial reduction in the amount of allograft bone tissue which
we process for either entity would have a material adverse effect on our
business, financial condition and results of operations. We are currently in
litigation with MTF. See Item 3 "Legal Proceedings."
40
Our dependence upon a limited supply of human donors may curtail
business expansion.
Our allograft bone tissue processing business primarily depends upon
the availability of bone and related connective tissue from human donors
recovered by our clients and TRO's who recover donated human cadaveric tissue
for us. We rely on the efforts of not-for-profit donor procurement agencies,
including our current clients, to educate the public and foster an increased
willingness to donate bone tissue. These organizations may not be able to find a
sufficient number of persons to donate, or may not be willing to provide,
sufficient amounts of tissue to meet present or future demand for either
allograft bone tissue or any allograft bone tissue-based osteogenic materials we
are developing. Our ability to secure enough donor tissue to meet our demands
could have a material adverse effect on our business, financial condition and
results of operations.
We face strong competitive threats from firms with greater financial
resources and lower costs.
The allograft bone tissue we process competes in the bone graft market
with autograft bone tissue, synthetic bone void fillers and allograft bone
tissue processed by others, primarily tissue banks. Autograft bone tissue has
traditionally been the primary choice for surgeons and we believe autograft bone
tissue still maintains approximately a 50% share of the United States bone graft
market. In Europe, bone graft substitutes, such as bovine bone tissue and
synthetics, currently comprise most of the bone grafting market. Certain of our
competitors have greater financial resources than we do. For numerous
circumstances and procedures for which autograft bone tissue transplantation is
either not feasible or not desirable, there are a number of competing
alternatives available, including allograft bone tissue processed by others and
bone graft substitutes.
In recent years, our Grafton(R) DBM products have faced increasing
competitive pressures as more companies have developed, or have announced they
are developing, products with characteristics similar to Grafton(R) DBM. We
expect that this competition will continue in the future. Many of these
competitors have research and development, marketing and other resources that
are significantly greater than ours. They also offer a full line of metal
implants and other products used in spinal surgeries. This could give them a
competitive advantage over us since they can offer surgeons a more complete line
of products than we currently can.
We believe 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 we can. We compete with such entities on the basis of our
advanced processing technology and the quality and quantity of the bone tissue
our processing yields. Since we introduced our allograft bone tissue processing
technology in 1987, certain competing processors have claimed to have developed
technology similar to that which we use. Although we believe, based upon our
knowledge of the industry, that we process bone tissue from more donors than any
other processor in the world, we can not assure you that we will continue to
compete successfully in the area of allograft bone tissue processing.
41
We are currently involved in patent litigation which could have a
significant adverse impact on our business. We may become involved in additional
patent litigation in the future.
We are currently involved in four litigations involving our patents and
patents held by certain of our competitors. Prosecuting and defending these
lawsuits is very expensive and these expenses have had, and are likely to have,
an adverse affect on our results of operations. We are committed to aggressively
asserting and defending our technology and related intellectual property which
we have spent a significant amount of money to develop. In addition, the
industry in which we compete is known for having a great deal of litigation
involving patents. These factors could cause us to become involved in additional
patent litigations in the future. The expense of prosecuting or defending these
future lawsuits could also have a material adverse effect on our business,
financial condition and results of operations.
If we were to lose those litigations in which another party is
asserting that our products infringe its patents, we would likely be prohibited
from marketing those products and could also be liable for significant damages.
Either or both of these results may have a material adverse effect on our
business, financial condition and results of operations. If we lose those
litigations in which we are claiming that another party's products are
infringing our patents and thus, are unable to enforce our patents, it may have
a material adverse effect on our business, financial condition and results of
operations.
During the course of the patent litigations in which we are involved,
interim information about the status of each of these litigations may be
released. Although these interim releases may differ from the final
determinations in these litigations, such information may have a material
adverse effect on the market price of our common stock.
Our revenues will depend upon reimbursement from public and private
insurers and national health systems.
The continued ability of our clients to pay our processing charges for
the processing of allograft bone tissue, depends upon our clients' ability to
distribute processed allograft bone tissue and collect fees from their clients,
which are typically medical institutions. The ability of medical institutions to
pay fees to our clients, or directly to us for allograft bone tissue or
non-allograft spinal implant systems distributed directly by us to the medical
institutions, depends in part on the extent to which reimbursement for the costs
of such materials and related treatments will continue to be available from
government health administration authorities, private health coverage insurers
and other organizations. We may have difficulty gaining market acceptance for
our products and services if government and third-party payors do not provide
adequate coverage and reimbursement.
The medical community could choose not to use our allograft bone tissue
products.
We believe the market for allograft bone tissue will continue to be
based primarily upon the use of such products by physicians specializing in the
orthopaedic, neurological and oral/maxillofacial surgical areas. Our future
growth depends in part upon such physicians' wider
42
use of allograft bone tissue as an alternative to autograft bone tissue and
other available materials and treatments. We have tried to educate physicians
through our marketing activities. Although our education and marketing efforts
to date have enabled us to expand our business, our future efforts in this
regard may fail to generate additional demand.
Governmental regulation of organ transplantation could restrict the use
of our products.
In the United States the procurement and transplantation of allograft
bone tissue are subject to federal regulation pursuant to NOTA, a criminal
statute which prohibits the purchase and sale of human organs, including bone
and related 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. We
provide services in all of these areas, with the exception of removal and
implantation. We and other allograft bone tissue processors are engaged in
ongoing efforts designed to educate the medical community as to the benefits of
processed allograft bone tissue and we will continue to expand our educational
activities. Although we believe that NOTA permits reimbursement of these costs
as costs associated with the processing, transportation and implantation of our
allograft bone tissue products, our inability to be reimbursed for our education
efforts in the future could adversely affect our business and prospects. No
federal agency or court has determined whether NOTA is, or will be, applicable
to every allograft bone tissue-based material which our processing technologies
may generate. Assuming that NOTA applies to our processing of allograft bone
tissue, we believe that we comply 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 our method
of operations.
In various countries outside the United States, national laws and
regulations restrict or control the availability and/or use of tissues. There
can be no assurance that more restrictive laws, regulations or interpretations
will not be adopted in the future which would call into question one or more
aspects of our method of operations in those countries.
Loss of key persons could limit our success.
Our success depends upon the continued contributions of our executive
officers and scientific and technical personnel. The competition for qualified
personnel is intense, and the loss of services of our key personnel,
particularly members of senior management, could adversely affect our business.
If we are unable to enforce our patents or if it is determined that we
infringe patents held by others it could damage our business.
We consider our allograft bone tissue processing technology and
procedures proprietary and rely primarily on trade secrets and patents to
protect our technology and innovations. Consultants employed by third parties
and persons working in conjunction with medical institutions unaffiliated with
us have conducted significant research and development for our products.
Accordingly, disputes may arise concerning the proprietary rights to information
applied
43
to our projects which have been independently developed by such consultants or
medical institutions. In addition, you should recognize that although we have
attempted to protect our technology with patents, our existing patents may prove
invalid or unenforceable as to products or services marketed by our competitors.
Our pending patent applications may not result in issued patents. Moreover, our
existing or future products and technologies could be found to infringe the
patents of others. We are currently involved in four lawsuits in which we are
accused of infringing patents held by others. See Part I, Item 3 "Legal
Proceedings."
Our products face competitive threats from alternate technologies.
The primary advantage of synthetic bone substitutes as compared to
allograft bone tissue is that they do not depend on the availability of donated
human tissue. In addition, members of the medical community and the general
public may perceive synthetic materials as safer than allograft-based bone
tissue. The allograft bone tissue we process may be incapable of competing
successfully with synthetic bone substitutes and recombinant bone growth factors
which are developed and commercialized by others, which could have a material
adverse effect on our business, financial condition and results of operations.
Our spray coating, HA products and bovine tissue products operations
face intense competition.
Our plasma spray coatings, HA products and bovine tissue products
operations face intense 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, we also face
competition from medical implant companies which have in-house plasma spray
coating operations. We compete primarily on the quality of our coatings, bovine
tissue products and our prices. We believe that the spraying technology we use,
which is computer-controlled and utilizes robotics, enables us to provide high
quality coatings at competitive prices. You should note, however, that the
industries in which we compete in Europe are highly competitive, certain of our
competitors have greater resources than we do, and we may be unable to compete
successfully.
We may incur losses from product liability lawsuits.
The testing and use of human allograft bone tissue, bovine tissue
products and the implantation of medical devices coated with our HA powder or
titanium and medical devices manufactured by others and which we distribute,
entail inherent risks of medical complications for patients and therefore may
result in product liability claims against us. Further, our agreements with our
allograft bone tissue processing clients provide for indemnification by us for
liabilities arising out of defects in allograft bone tissue they distribute
which is caused by our processing. See Part I, Item 3 "Legal Proceedings."
We presently maintain product liability insurance in the amount of $102
million per occurrence and per year in the aggregate. We may be unable to
maintain such insurance in the
44
future and such insurance may not be sufficient to cover all claims made against
us or all types of liabilities which may be asserted against us.
We face potential lawsuits or governmental enforcement activities based
on hazardous waste we generate in our operations.
Our allograft bone tissue processing in both the United States and
Europe generates waste, which, in the United States, is classified as medical
hazardous waste by the United States Environmental Protection Agency and the New
Jersey Department of Environmental Protection. We segregate such waste and
dispose of it through a licensed hazardous waste transporter in compliance with
applicable regulations in both the United States and Europe. The production of
HA powder at our facility in The Netherlands generates small amounts of
hazardous waste, which we segregate and dispose of through a licensed hazardous
waste transporter
Although we believe we are in compliance with applicable environmental
regulations, our failure to fully comply with any such regulations could result
in the imposition of penalties, fines and/or sanctions or, in some cases,
private lawsuits, which could have a material adverse effect on our business,
financial condition and results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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.
45
PART III
Item 10. Directors and Executive Officers of the Registrant
The section of our 2001 Proxy Statement entitled "Election of
Directors" is incorporated herein by reference.
Item 11. Executive Compensation
The section of our 2001 Proxy Statement entitled "Executive
Compensation" is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The section of our 2001 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 our 2001 Proxy Statement entitled "Certain Relationships
and Related Transactions" is incorporated herein by reference.
46
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).
47
Exhibit
Number Description Number
- - ------ ----------- ------
3.1 Restated Certificate of Incorporation of Osteotech *
3.2 Amended and Restated Bylaws of Osteotech #
3.3 Form of Stock Certificate **
3.4 Certificate of Amendment of Restated Certificate of Incorporation of ^^^^
Osteotech, Inc.
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 Osteotech and certain ***
employees, officers, directors and consultants or advisors of Osteotech ^
10.4 Senior Management Loan Program ^ ****
10.5 Lease for Osteotech's Leiden, The Netherlands facility dated May 28, 1993 +
10.6 Processing Agreement between Osteotech and Stichting Eurotransplant
Nederland, dated September 26, 1988- **
10.9 Lease for Osteotech's Eatontown facility dated October 20, 1994 ******
10.10 Form of Confidentiality Agreement and Non-Competition Agreement with ******
executive officers
10.12 Amendment to the lease for Osteotech's Leiden, The Netherlands facility ++++
dated June 27, 1995
10.13 Agreement dated December 10, 1996 between American Red Cross Tissue ********
Services and Osteotech-
10.14 Lease for Osteotech's Shrewsbury, New Jersey processing facility ********
10.16 Credit Agreement between Osteotech b.v. and ING Bank N.V. dated +++++
March 14, 1996
10.21 License & Option Agreement between HC Implants BV and Matrix Medical ++++++
Holding BV dated June 6, 1997
10.22 Change in Control Agreement by and between Osteotech and Richard W. +++++++
Bauer ^
10.23 Change in Control Agreement by and between Osteotech and Michael J. +++++++
Jeffries ^
10.24 Change in Control Agreement by and between Osteotech and James L. +++++++
Russell ^
10.25 Change in Control Agreement by and between Osteotech and Roger +++++++
Stikeleather ^
48
10.26 Employment Agreement with Michael J. Jeffries dated January 1, 1998 ^ ^^
10.27 Employment Agreement with James L. Russell dated December 18, 1997 ^ ^^
10.28 The Management Performance Bonus Plan ^ ^^^
10.29 Employment Agreement with Richard Russo dated April 1, 1997 ^ ^^^
10.30 Change in Control Agreement by and between Osteotech Inc. and Richard ^^^
Russo ^
10.31 Employment Agreement with Richard W. Bauer dated December 4, 1998 ^ ^^^
10.32 Employment Agreement with Arthur A. Alfaro dated September 13, 1999 ^ ^^^^
10.33 Change in Control Agreement by and between Osteotech Inc. and Arthur A. ^^^^
Alfaro^
10.34 Settlement Agreement and General Release Between DePuy Acromed, Inc. and ^^^^
DePuy, Inc. and Osteotech, Inc.
10.35 Loan and Security Agreement among Summit Bank, Osteotech, Inc., ^^^^^
Osteotech Investment Corp., Cam Implants Inc., Cam Implants B.V.,
Osteotech/CAM Services B.V. and OST Developpement dated June 10, 1999.
10.36 Amended and Restated Processing Agreement entered into September 11, ^^^^^^
2000 by Osteotech, Inc., Musculoskeletal Transplant Foundation and
Biocon, Inc.-
10.37 Mortgage Term Note among Summit Bank, Osteotech, Inc., Osteotech E-2
Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants,
B.V., Cam Implants, B.V., Osteotech/CAM Services, B.V. and OST
Developpement dated December 8, 2000
10.38 Allonge to Loan and Security Agreement among Summit Bank, Osteotech, E-7
Inc., Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V.,
H.C. Implants, B.V., Cam Implants, B.V., Osteotech/CAM Services, B.V.
and OST Developpement dated December 8, 2000
10.39 Allonge to Equipment Loan Note among Summit Bank, Osteotech, Inc., E-10
Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C.
Implants, B.V., Cam Implants, B.V., Osteotech/CAM Services, B.V. and OST
Developpement dated December 8, 2000
10.40 Distribution Agreement entered into February, 2001 by Osteotech, Inc. E-12
and Alphatec Manufacturing, Inc. for which Osteotech is requesting
confidential treatment pursuant to Rule 24b-2
49
10.41 Second Allonge to Loan and Security Agreement among Fleet National Bank, E-34
Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech
Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants,
B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST
Developpement dated March 8, 2001
10.42 Second Allonge to Equipment Loan Note among Fleet National Bank, E-37
Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech
Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants,
B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST
Developpement dated March 8, 2001
10.43 Allonge to Convertible Revolving Note among Fleet National Bank, E-39
Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech
Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants,
B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST
Developpement dated March 8, 2001
21.1 Subsidiaries of the Registrant E-41
23.1 Consent of PricewaterhouseCoopers LLP E-42
* Previously filed as exhibits to Osteotech'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 Osteotech's Registration Statement
on Form S-1 (File No. 33-40463) and incorporated herein by
reference thereto.
*** Previously filed as exhibits to Osteotech's Registration Statement
on Form S-8 (File No. 33-44547) and incorporated herein by
reference thereto.
**** Previously filed as exhibits to Osteotech'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 Osteotech'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 Osteotech'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 Osteotech's Annual Report on Form
10-K for the fiscal year ended December 31, 1996 and incorporated
herein by reference thereto.
+ Previously filed as exhibits to Osteotech'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 Osteotech's Current Report on Form
8-K filed with the Commission on May 26, 1992.
+++ Previously filed as exhibits to Osteotech'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 Osteotech'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 Osteotech's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference thereto.
++++++ Previously filed as exhibits to Osteotech's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997 and incorporated
herein by reference thereto.
+++++++ Previously filed as exhibits to Osteotech's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997 and
incorporated herein by reference thereto.
^ Management contracts or compensatory plans and arrangements
required to be filed pursuant to Item 14(c)
51
^^ Previously filed as Exhibits to Osteotech's Annual Report on Form
10-K for the fiscal year ended December 31, 1997 and incorporated
herein by reference thereto.
^^^ Previously filed as Exhibits to Osteotech's Annual Report on Form
10-K for the fiscal year ended December 31, 1998 and incorporated
herein by reference thereto.
^^^^ Previously filed as exhibits to Osteotech's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999 and incorporated
herein by reference thereto.
^^^^^ Previously filed as exhibits to Osteotech's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1999 and
incorporated herein by reference thereto.
^^^^^^ Previously filed exhibit to Osteotech's Quarterly Report on Form
10-Q for the quarter ended September 30, 2000 and incorporated
herein by reference.
# Previously filed as exhibits to Osteotech'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.
(b) Reports on Form 8-K
On December 12, 2000, we announced that the U.S. District Court for the
Central District of California, has adopted our interpretation of claims in two
patents asserted by us against GenSci Orthobiologics, Inc. In this lawsuit,
commenced in January, 1998, we asserted that GenSci's Dynagraft putty and gel
products infringe our patents. The ruling was issued on December 8, 2000,
following a claims construction hearing, also known as a Markman hearing, held
on October 24 through 26, 2000.
On October 18, 2000, we announced that in response to earlier letters
from us informing the Musculoskeletal Transplant Foundation, or MTF, that
products made by MTF pursuant to the patent issued to MTF in February, 2000 may
infringe on the claims of two of our Grafton(R) Demineralized Bone Matrix, or
DBM, patents; U.S. Patent No. 5,284,655 and U.S. Patent No. 5,290,558, issued in
February and March 1994, respectively, MTF had filed a lawsuit in the United
States District Court for the District of New Jersey asking the court to rule
that MTF does not infringe the claims of our patents. The suit also requests the
court to declare our patents invalid and unenforceable. We believe that this
lawsuit is without merit and we intend to vigorously defend against these
claims.
52
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 30, 2001 OSTEOTECH, INC.
By: /s/ Richard W. Bauer
-------------------------------
Richard W. Bauer
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 March 30, 2001
- - --------------------- Board of Directors
Donald D. Johnston
/s/RICHARD W. BAUER Chief Executive Officer March 30, 2001
- - ------------------- (Principal Executive
Richard W. Bauer Officer) and Director
/s/ARTHUR A. ALFARO President, Chief Operating March 30, 2001
- - ------------------- Officer and Director
Arthur A. Alfaro
/s/MICHAEL J. JEFFRIES Executive Vice President March 30, 2001
- - ---------------------- Chief Financial Officer
Michael J. Jeffries (Principal Financial
Accounting Officer),
Secretary and Director
/s/KENNETH P. FALLON III Director March 30, 2001
- - ------------------------
Kenneth P. Fallon III
/s/JOHN P. KOSTUIK Director March 30, 2001
- - ------------------
John P. Kostuik
/s/STEPHEN J. SOGIN Director March 30, 2001
- - -------------------
Stephen J. Sogin
53
OSTEOTECH, INC. AND SUBSIDIARIES
-------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Page
1. FINANCIAL STATEMENTS
Report of Independent Accountants...................................F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999 .......F-3
Consolidated Statements of Operations
for the years ended December 31, 2000, 1999 and 1998.............F-4
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2000, 1999 and 1998.....................F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 2000, 1999 and 1998.............F-6
Notes to Consolidated Financial Statements..........................F-7
2. SCHEDULE
II. Valuation and Qualifying Accounts
for the years ended December 31, 2000, 1999 and 1998 .........S-1
Report of Independent Accountants on Financial Statement Schedule ..S-2
All schedules, except for the one 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.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows present fairly, in all material respects, the financial position of
Osteotech Inc. and Subsidiaries (the "Company") at December 31, 2000 and
December 31, 1999, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2000, in conformity
with accounting principles generally accepted in the United States of America.
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 of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Florham Park, New Jersey
February 20, 2001, except as to certain
information presented in Note 11 for
which the date is March 28, 2001.
F-2
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
December 31, 2000 1999
- - -------------------------------------------------------------------------------------------
ASSETS
- - -------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 10,923 $ 16,770
Short-term investments 1,935 3,946
Accounts receivable, net of allowance of
$123 in 2000 and $129 in 1999 13,503 15,095
Deferred processing costs 5,914 5,310
Inventories 3,584 3,405
Deferred income taxes 683 931
Prepaid expenses and other current assets 4,027 4,856
----------------------
Total current assets 40,569 50,313
Property, plant and equipment, net 58,290 33,995
Excess of cost over net assets of business acquired, net of
accumulated amortization of $2,477 in 2000 and $2,089 in 1999 3,294 3,682
Other assets 2,285 1,740
- - -------------------------------------------------------------------------------------------
Total assets $ 104,438 $ 89,730
===========================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- - -------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 11,345 $ 13,231
Current maturities of long-term debt 101
----------------------
Total current liabilities 11,446 13,231
Long-term debt 19,930 6,359
Other liabilities 1,211 734
- - -------------------------------------------------------------------------------------------
Total liabilities 32,587 20,324
- - -------------------------------------------------------------------------------------------
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; 70,000,000 shares
authorized; issued and outstanding 13,989,307
shares in 2000 and 14,194,126 shares in 1999 138 140
Additional paid-in capital 46,577 48,837
Accumulated other comprehensive loss (497) (376)
Retained earnings 25,633 20,805
- - -------------------------------------------------------------------------------------------
Total stockholders' equity 71,851 69,406
- - -------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 104,438 $ 89,730
===========================================================================================
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, 2000 1999 1998
- - ---------------------------------------------------------------------------------------------
Net revenues:
Service $ 72,546 $ 72,418 $ 58,077
Product 3,137 3,074 1,000
License fee and other revenue 118 124
--------------------------------------------
75,683 75,610 59,201
Cost of services 24,811 22,004 16,844
Cost of products 2,700 1,905 795
--------------------------------------------
27,511 23,909 17,639
--------------------------------------------
Gross profit 48,172 51,701 41,562
Marketing, general and administrative 35,545 28,343 20,671
Research and development 5,772 5,506 4,610
--------------------------------------------
41,317 33,849 25,281
--------------------------------------------
Income from litigation settlement 1,000 2,000
--------------------------------------------
Operating income 7,855 19,852 16,281
--------------------------------------------
Other income (expense):
Interest income 1,087 891 1,034
Interest expense (14) (62) (83)
Other (26) 203 181
--------------------------------------------
1,047 1,032 1,132
--------------------------------------------
Income before income taxes 8,902 20,884 17,413
Income tax provision 4,074 8,533 7,109
- - ---------------------------------------------------------------------------------------------
Net income $ 4,828 $ 12,351 $ 10,304
=============================================================================================
Net income per share:
Basic $ .34 $ .88 $ .78
Diluted $ .34 $ .84 $ .73
- - ---------------------------------------------------------------------------------------------
Shares used in computing net income per share:
Basic 14,057,931 14,024,468 13,259,784
Diluted 14,335,641 14,618,786 14,086,949
- - ---------------------------------------------------------------------------------------------
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, 2000, 1999 and 1998
Accumulated Retained
Common Stock Additional Other Earnings Total
------------------- Paid-In Comprehensive (Accumulated Stockholders'
Shares Amount Capital Income (Loss) Deficit) Equity
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 13,029,520 $ 130 $ 36,087 $ (75) $ (1,850) $ 34,292
Net income 10,304 10,304
Currency translation adjustments 86 86
--------
Total comprehensive income 10,390
Exercise of stock options 703,836 7 2,709 2,716
Common stock issued pursuant to
employee stock purchase plan 14,435 262 262
Tax benefits related to stock options 3,228 3,228
Repurchase of common stock (367,500) (4) (4,954) (4,958)
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 13,380,291 133 37,332 11 8,454 45,930
Net income 12,351 12,351
Currency translation adjustments (387) (387)
--------
Total comprehensive income 11,964
Exercise of stock options 791,512 7 4,553 4,560
Common stock issued pursuant to
employee stock purchase plan 22,323 410 410
Tax benefits related to stock options 6,542 6,542
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 14,194,126 140 48,837 (376) 20,805 69,406
Net income 4,828 4,828
Currency translation adjustments (121) (121)
--------
Total comprehensive income 4,707
Exercise of stock options 74,261 1 304 305
Common stock issued pursuant to
employee stock purchase plan 51,420 418 418
Repurchase of common stock (330,500) (3) (3,121) (3,124)
Tax benefits related to stock options 139 139
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 13,989,307 $ 138 $ 46,577 $(497) $ 25,633 $ 71,851
- - ----------------------------------------------------------------------------------------------------------------------------------
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, 2000 1999 1998
- - ----------------------------------------------------------------------------------------
Cash Flow From Operating Activities
Net income $ 4,828 $ 12,351 $ 10,304
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,636 3,298 2,403
Deferred income taxes 775 (121) (272)
Income tax benefit related to stock options 139 6,542 3,228
Changes in assets and liabilities:
Accounts receivable 1,629 (2,876) (4,398)
Inventories (218) (1,393) (760)
Deferred processing costs (604) (2,690) (1,550)
Prepaid expenses and other current
assets 764 (2,457) 681
Accounts payable and other liabilities (1,735) 1,805 1,930
- - ----------------------------------------------------------------------------------------
Net cash provided by operating activities 10,214 14,459 11,566
Cash Flow From Investing Activities
Capital expenditures (28,382) (18,743) (5,521)
Acquisition of business (1,523)
Proceeds from sale of investments 5,888 10,610 6,914
Purchases of investments (3,877) (11,634) (8,363)
Increase in other assets (796) (883) (830)
- - ----------------------------------------------------------------------------------------
Net cash used in investing activities (27,167) (22,173) (7,800)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 723 4,970 2,978
Repurchase of common stock (3,124) (4,958)
Proceeds from issuance of notes payable 116 864
Principal payments on notes payable (725) (862)
Proceeds from issuance of long-term debt 13,672 6,359
Principal payments on long-term debt
and obligations under capital leases (1,332) (634)
- - ----------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 11,271 9,388 (2,612)
Effect of exchange rate changes on cash (165) (23) 81
- - ----------------------------------------------------------------------------------------
Net increase in cash and cash equivalents (5,847) 1,651 1,235
Cash and cash equivalents at beginning of year 16,770 15,119 13,884
- - ----------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 10,923 $ 16,770 $ 15,119
========================================================================================
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") 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 the processing of human bone and bone connective
tissue (collectively, "allograft bone tissue") used for transplantation.
The Company has two primary operating segments: the Grafton(R)
Demineralized Bone Matrix (DBM) Segment (the "Grafton(R) DBM Segment") and
Base Allograft Bone Tissue Segment (the "Base Tissue Segment"). In addition
to these two primary segments, the Company markets and distributes metal
spinal implant products and processes, markets and distributes bovine bone
tissue products outside of the United States. The Company also provides
ceramic and titanium plasma spray coating services and ceramic products
used as bone graft substitutes to orthopaedic and dental implant
manufacturers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidated Financial Statements
The consolidated financial statements include the accounts of Osteotech,
Inc., its majority-owned subsidiaries and joint ventures controlled by the
Company. Investments in 20% to 50% owned affiliates are accounted for using
the equity method. Investments in less than 20% owned affiliates are
accounted for on the cost method. All intercompany transactions and
balances are eliminated in consolidation.
Revenue Recognition
The Company derives revenue from allograft bone tissue processing services
and sales of products. Processing revenues are recognized when processed
allograft bone tissue is returned to our clients or when shipped to
customers, and when collectability of the related revenue is reasonably
assured. Product revenues are recognized when title passes to the customers
and when collectability of the related revenue is reasonably assured.
In 2000, the Company adopted the provisions of Staff Accounting Bulletin
101, "Revenue Recognition in Financial Statements", the affects of which
are immaterial for all periods presented.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with original
maturities of three months or less, when purchased, 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.
Deferred Processing Costs
Costs related to allograft bone tissue processing are deferred until the
processed allograft bone tissue is released from final quality assurance
testing and shipped to clients.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
under the first-in, first-out method. Inventories consist of supplies,
which principally support the Company's two primary operating segments, and
raw materials and finished goods, which principally support the Company's
Other Segment.
F-7
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Major renewals and
betterments are capitalized while maintenance and repairs are expensed as
incurred. Interest, if any, is capitalized in connection with the
construction of major facilities. The capitalized interest is recorded as
part of the underlying asset and is amortized over the asset's estimated
useful life. 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. Depreciation is computed on the straight-line
method over the following estimated useful lives of the assets:
Building 15 years
Machinery and equipment 5 to 10 years
Computer hardware and software 5 years
Office equipment, furniture and fixtures 5 years
Loaner instruments 3 years
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 other income (expense) in the statement of
operations.
Whenever events and circumstances indicate that the carrying value of an
asset may not be recoverable, the Company reviews the asset's carrying
value for impairment principally on an analysis of undiscounted cash flows.
Excess of Cost Over Net Assets of Business Acquired
The excess of cost over the net assets of businesses acquired 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 an
impairment in the value. 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 period. Revenues and expenses are
translated at the weighted average exchange rates during the period.
Translation gains and losses are included in other comprehensive income,
which is a separate component of stockholders' equity. Foreign currency
transaction gains and losses are included in other income.
Concentrations of Credit Risk
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.
The Company provides credit, in the normal course of business, to tissue
banks and hospitals. The Company maintains an allowance for doubtful
accounts and charges actual losses to the allowance when incurred. The
Company has two customers who account for 90%, 94% and 95% of revenues in
2000, 1999 and 1998, respectively. As of December 31, 2000 and 1999, these
two customers accounted for 78% and 91%, respectively, of outstanding
accounts receivable.
F-8
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair Value of Financial Instruments
The carrying value of financial instruments, including accounts receivable,
accounts payable and other accrued expenses, approximate their fair values.
The carrying value of amounts outstanding under the credit facility
approximates fair value because the debt is subject to short-term variable
interest rates that were reflective of market rates of interest.
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. ACQUISITION OF OST DEVELOPPEMENT SA
Effective January 1, 1999, the Company completed the acquisition of a 90%
interest in OST Developpement SA ("OST"), a processor of bone tissue
products which are marketed and distributed outside of the United States.
The aggregate purchase price paid consisted solely of cash consideration of
9,000,000 French Francs ("FRF") or approximately $1,594,700, of which
496,662 FRF or approximately $84,400 was paid in 1998. In addition, the
Company incurred approximately $372,600 of transaction costs of which
approximately $310,000 was incurred in 1998. The acquisition was accounted
for as a purchase and the consolidated financial statements include the
accounts of OST beginning January 1, 1999. The acquisition resulted in an
excess of cost over the fair value of net assets acquired of $2,073,000
which is being amortized over 15 years. The Company also has the option to
purchase the remaining 10% of OST at a price to be determined at the time
of purchase.
4. ACQUISITION OF SPINAL FIXATION SYSTEM
In June, 1999, the Company acquired the Versalok(R) Low Back Fixation
System (the "Versalok(R) System"), including all patents, from a medical
device company for $600,000. Pursuant to the terms of the purchase
agreement, the Company also purchased approximately $1,120,000 of
inventory, consisting primarily of finished goods. The $600,000 payment to
acquire the product rights and patents will be amortized on a straight-line
basis over five years.
5. INVENTORIES
Inventories consist of the following at December 31:
(in thousands) 2000 1999
- - --------------------------------------------------------------------------------
Supplies $ 202 $ 248
Raw materials 891 664
Finished goods 2,491 2,493
- - --------------------------------------------------------------------------------
$3,584 $3,405
================================================================================
F-9
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at December 31:
(in thousands) 2000 1999
- - --------------------------------------------------------------------------------
Land $2,262 $2,262
Building 279 279
Machinery and equipment 22,139 19,842
Computer hardware and software 4,165 3,191
Office equipment, furniture and fixtures 3,483 3,013
Loaner instruments 2,710 1,308
Leasehold improvements 6,741 6,340
Construction in progress 33,199 10,809
----------------------
74,978 47,044
Less accumulated depreciation
and amortization 16,688 13,049
- - --------------------------------------------------------------------------------
$58,290 $33,995
================================================================================
During the fourth quarter of 1998, the Company commenced construction of a
new processing facility in Eatontown, New Jersey. At December 31, 2000 and
1999, approximately $32,197,000 and $10,272,000, respectively, had been
incurred, of which approximately $761,000 and $51,000, respectively,
represents capitalized interest.
7. ACCOUNTS PAYABLE AND accrued LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31:
(in thousands) 2000 1999
- - --------------------------------------------------------------------------------
Trade accounts payable $2,856 $5,532
Accrued compensation 494 548
Accrued taxes payable 3,110 3,170
Other accrued liabilities 4,885 3,981
- - --------------------------------------------------------------------------------
$11,345 $13,231
================================================================================
F-10
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. LEASING TRANSACTIONS
The Company leases office and production facilities and equipment under
various operating lease agreements which have non-cancelable terms through
October, 2008. The leases for office and production facilities include
renewal provisions at the Company's option. Additionally, certain of the
leases contain fair value purchase options.
Future minimum lease commitments as of December 31, 2000 are as follows:
Operating
Year Leases
--------------------------------------------
(in thousands)
2001 $ 1,040
2002 935
2003 860
2004 870
2005 and thereafter 2,113
-------
Total minimum lease payments $ 5,818
=======
Rental expense was $1,147,000, $1,157,000, and $1,013,000 for the years
ended December 31, 2000, 1999 and 1998, respectively.
9. DEBT AND FINANCING ARRANGEMENTS
The Company has a credit facility which includes a $5,000,000 unsecured
revolving line of credit, a $4,500,000 building mortgage loan and a
$17,000,000 equipment line of credit.
The revolving line of credit is committed through May 31, 2002. Interest is
payable monthly on the outstanding amount. In the absence of default, the
Company has the option to convert the revolving line of credit to a term
loan and the outstanding unpaid balance as of September 10, 2001 will be
repayable in forty-eight equal monthly installments of principal together
with accrued interest. A facility fee of .25% is payable on the unused
portion of the revolving loan. As of December 31, 2000, no amounts were
outstanding under this facility, although the full amount of the line is
available to the Company.
The mortgage loan was drawn in December, 2000 and is collateralized by the
building which will house the Company's new allograft tissue processing
facility and the land on which the building is located. The mortgage loan
is repayable in 120 equal monthly installments of principal and interest
based on a twenty-year mortgage amortization schedule. Upon the 120th
payment, the remaining amount of the unpaid principal will be due and
payable.
The equipment line of credit is collateralized by equipment and other
capital expenditures purchased using the proceeds of such line, with
advances of up to 80% of the cost thereof. Upon expiration of an initial
drawdown period, which was extended to September 10, 2001, the equipment
line of credit will be repayable in equal monthly installments of principal
plus interest based on a seven-year amortization schedule. During the
drawdown period, interest only will be payable monthly under the equipment
line of credit. A facility fee of .25% is payable on the unused portion of
the equipment line.
F-11
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. DEBT AND FINANCING ARRANGEMENTS (continued)
Pursuant to the terms of the loan and security agreement (the "Agreement"),
the Company is required to meet certain financial covenants regarding
minimum working capital, tangible net worth and interest coverage. In
addition, the Agreement contains limitations on sales of assets other than
in the ordinary course of business and additional indebtedness.
The effective weighted average interest rate for borrowings under the
credit facility in 2000 was 8.20%.
The Company has a line of credit with a Dutch bank which provides for
borrowing up to 3,000,000 Dutch Guilders ("DFL"), or approximately
$1,283,000 at the December 31, 2000 exchange rate. Borrowings under this
credit line bear interest at the bank's prime rate plus a margin of 2.25%.
Under certain circumstances the Company may elect to utilize a rate based
on the Amsterdam Interbank Offered Rate (AIBOR) plus a margin of .75%.
The Company also has a line of credit with a French bank which provides for
borrowings up to FRF 1,750,000 or approximately $251,000 at the December
31, 2000 exchange rate. At December 31, 2000 there were no borrowings under
these lines of credit.
Long-term debt consists of the following at December 31:
(in thousands) 2000 1999
- - --------------------------------------------------------------------------------
Domestic revolving line of credit, interest due
monthly at the bank prime rate minus .75%
(8.75% at December 31, 2000) $4,500
Domestic bank equipment line of credit, interest due
monthly at the bank prime rate minus .50%
(9.00% at December 31, 2000) $15,531 1,859
Domestic building mortgage loan, repayable in
monthly installments of $37, which include interest
at 7.38%, through December 2010 with a balloon
payment of $3,087 due January 2011. 4,500
- - --------------------------------------------------------------------------------
20,031 6,359
Less current portion 101
- - --------------------------------------------------------------------------------
$19,930 $6,359
================================================================================
F-12
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES
The income tax provision at December 31 is summarized as follows:
(in thousands) 2000 1999 1998
- - --------------------------------------------------------------------------------
Current:
Federal $ 2,897 $ 7,307 $ 5,893
State 402 1,347 1,488
- - --------------------------------------------------------------------------------
3,299 8,654 7,381
------------------------------
Deferred:
Federal 551 (148) (151)
State 224 27 (121)
- - --------------------------------------------------------------------------------
775 (121) (272)
------------------------------
Income tax provision $ 4,074 $ 8,533 $ 7,109
================================================================================
The difference between income tax expense and the expected tax which would
result from the use of the Federal statutory income tax rate is as follows:
(in thousands) 2000 1999 1998
- - --------------------------------------------------------------------------------
Computed tax at statutory Federal rate $ 3,027 $ 7,309 $ 5,920
State income taxes, net of Federal benefit 413 1,129 931
Foreign losses for which no tax benefit is
currently available 660 456 235
Other (26) (361) 23
- - --------------------------------------------------------------------------------
Income tax provision $ 4,074 $ 8,533 $ 7,109
================================================================================
Loss before income taxes from foreign operations was $1,151,000 in 2000,
$591,000 in 1999 and $266,000 in 1998. The losses before income taxes from
foreign operations negatively impact the Company's effective income tax
rate due to the non-recognition of such losses for tax purposes and the
need for a valuation allowance in the foreign jurisdictions.
The components of the deferred tax assets and deferred tax liabilities are
as follows at December 31:
(in thousands) 2000 1999
- - --------------------------------------------------------------------------------
Deferred Tax Assets:
Net operating loss carryforwards
Federal $ 275 $ 282
Foreign 1,736 1,408
State 24 25
Tax credits 62 41
Other 674 1,034
- - --------------------------------------------------------------------------------
2,771 2,790
Less valuation allowance 2,058 1,749
- - --------------------------------------------------------------------------------
Deferred tax assets 713 1,041
- - --------------------------------------------------------------------------------
Deferred Tax Liabilities:
Other 951 504
- - --------------------------------------------------------------------------------
Deferred tax liabilities 951 504
- - --------------------------------------------------------------------------------
Net deferred tax asset (liability) $ (238) $ 537
================================================================================
F-13
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES (continued)
The Company's valuation allowance results principally from foreign losses
for which the realization of future tax benefits is uncertain.
Foreign net operating loss carryforwards aggregate $4,415,000 ($525,000
with no expiration date; $3,890,000 expiring 2004 through 2008).
At December 31, the Company had prepaid Federal and state taxes of
approximately $1,552,000 in 2000 and $2,987,000 in 1999.
11. COMMITMENTS AND CONTINGENCIES
Service Agreements
Osteotech is the processor of allograft bone tissue for national and
international clients. The Company provides these processing services
pursuant to long-term service agreements. Osteotech's agreements with its
clients generally provide for cross-indemnification against liability
arising out of performance of the agreements. Effective January 1, 1997 the
Company entered into a new exclusive ten-year processing agreement with one
of its major allograft bone tissue processing clients, the American Red
Cross Tissue Services ("ARC").
In June, 2000, the Company entered into an exclusive five-year processing
agreement with Bone Bank Allografts ("BBA") of San Antonio, Texas. BBA,
coordinates the procurement and distribution of allograft bone tissue
nationally, with a focus in the Southern region of the United States.
In September, 2000, the Company entered into a new five-year agreement with
the Musculoskeletal Transplant Foundation ("MTF"). This new agreement
replaced the current agreement which would have expired March 31, 2002.
Under the new agreement, MTF is no longer required to exclusively provide
all donor tissue it recovers to Osteotech for processing. The new agreement
expires on August 31, 2005, and provides that either party has the right to
terminate the agreement effective March 31, 2002 and thereafter upon giving
six months prior written notice. Also, under the terms of the new
agreement, Osteotech will have the ability to directly contract with tissue
recovery organizations for the processing of tissue recovered by those
organizations. The Company is currently in litigation with MTF. (See
"Litigation" - "Musculoskeletal Transplant Foundation v. Osteotech, Inc.").
Customers of the Company's other products and services generally purchase
such products and services pursuant to purchase orders or non-exclusive
supply agreements which are cancelable at any time by either party.
Purchase Commitments
In September, 2000, the Company entered into a two-year non-cancelable
purchase order with Heinrich C. Ulrich, K.G. ("Ulrich") for the purchase of
$3,000,000 of inventory of a spinal vertebral body replacement system ("VBR
System"), which the Company began marketing in the United States in the
first quarter of 2001. The Company purchased $878,000 under the agreement
in 2000.
F-14
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
In February, 2001, the Company entered into an exclusive distribution
agreement with Alphatec Manufacturing, Inc. ("Alphatec") to market and
distribute a pedicle screw system and a cervical plating system in the
United States and Canada. The term of the agreement is two years from the
date of completion of the initial order, which is anticipated to be August,
2001. The agreement automatically renews for additional two-year terms
unless terminated, in writing, by either party six months prior to
expiration of the then current two-year term. The Company has agreed to
purchase $6,000,000 of inventory during the first two years of the
agreement, and $8,000,000 during the second two-year term, if the agreement
renews. Purchase commitments for each successive renewal period would be
negotiated prior to those renewals. If the Company fails to make the
minimum purchases in any period, the Company will pay Alphatec a penalty
payment equal to 50% of the shortfall.
License and Option Agreement
In June, 1997, the Company entered into an exclusive worldwide license
agreement for its proprietary PolyActive(TM) polymer biomaterial technology
and patents with IsoTis BV, The Netherlands. Additionally, IsoTis BV has an
option to acquire the technology for DFL 4,000,000 (approximately
$1,711,000 at the December 31, 2000 exchange rate) commencing in the third
year of the agreement and extending through the sixth year of the
agreement. In accordance with the license agreement, no license fee was
received in 2000 and license fee revenue of DFL 250,000, or approximately
$118,000, and DFL 250,000, or approximately $124,000, was received in 1999
and 1998, respectively.
Throughout the term of the agreement, which is the longer of ten years from
the first commercial sale of product or the life of the patents, the
Company will receive a royalty of 5% of net sales, declining to 2% of net
sales if the option to purchase the technology is exercised. Further, the
agreement requires IsoTis BV to achieve certain milestones during the first
three years of the agreement. Failure to do so will result in its loss of
exclusive rights to the patents and technology. Through December 31, 2000,
IsoTis has achieved all milestones associated with the agreement.
Litigation
GenSci Regeneration Laboratories, Inc. v. Osteotech, Inc.; Osteotech, Inc.
v. GenSci Regeneration Sciences, Inc.
In January, 1998, the Company filed a patent infringement action against
GenSci Regeneration Laboratories, Inc. ("GenSci Labs") and GenSci
Regeneration Sciences, Inc. ("GenSci Sciences", collectively, "GenSci")
alleging that GenSci violated claims of one of the patents involving the
Company's Grafton(R) Demineralized Bone Matrix (DBM) process. Approximately
two weeks after the Company's filing, GenSci Labs filed a suit against the
Company alleging that the Company's Grafton(R) DBM Flex tissue form
infringes two patents assigned to GenSci Labs in addition to allegations
against us for tortious interference with a business expectancy, negligent
interference with a prospective economic advantage and inducing breach of
contract and seeking a declaratory judgment of the invalidity of the
Company's patents U.S. Patent Nos. 5,284,655 and 5,290,558 covering
Grafton(R) DBM. In February, 1998, GenSci Labs amended its complaint
alleging essentially the same causes of action but adding a third patent to
the allegation of patent infringement. In August, 1998, the actions were
consolidated into one case before the United States District Court for the
Central District of California.
F-15
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
In September, 1998, GenSci Labs served an amended complaint, which
asserted, in addition to the previously asserted claims, claims of false
advertising under Federal law. In September, 1998, the Company served its
answer to this amended complaint, asserted counterclaims against GenSci
Labs and served a third-party complaint against GenSci Sciences, and DePuy
AcroMed, Inc. ("DePuy"). The Company's counterclaims and third party
complaint accused GenSci of infringing a second Company patent, in addition
to the patent referred to above, and accused DePuy and GenSci of acting
jointly and severally in infringing on the claims of both patents.
In May, 1999, GenSci Labs amended its complaint to allege that in addition
to the Company's Grafton(R) DBM Flex tissue form, the Company's Grafton(R)
DBM Gel and Putty tissue forms infringe on the GenSci Lab's patents at
issue. GenSci Labs also amended its complaint to modify its false
advertising claim, alleging that in addition to the Company, individuals
acting on the Company's behalf engaged in false advertising. The Company
filed and served its answer and counterclaims to the amended complaint in
May, 1999.
In November, 1999, the Company settled all claims which it had filed
against DePuy. As part of the settlement, DePuy has agreed to stop selling
the GenSci products accused of infringing the Company's patents, no later
than February 4, 2001 and to pay the Company $3,000,000. Payments of
$1,000,000 and $2,000,000 were received in 2000 and 1999, respectively.
In April, 2000, the Company, GenSci Labs, and GenSci Sciences reached an
agreement to dismiss with prejudice all of GenSci's patent infringement
claims against the Company's proprietary Grafton(R) DBM allograft bone
tissue forms and to stay any action in GenSci's anti-trust suit, which it
had filed against the Company on March 6, 2000, until the completion of the
trial of the Company's patent infringement claims against GenSci. GenSci
also agreed to dismiss all of the tort claims that it had brought against
the Company in its patent lawsuit without prejudice and to transfer the
claims to the anti-trust action. As a result of these dismissals, GenSci
will no longer have any claims against the Company in the patent action.
This agreement was subject to court approval, which approval has been
received. The only remaining claims in the patent action involve the
Company's allegations that GenSci has infringed certain of the Company's
patents through the sale of the Dynagraft(TM) Gel and Dynagraft(TM) Putty
products.
In July, 2000, the Company filed a motion seeking summary judgment in its
favor on GenSci Labs' and GenSci Sciences' reverse doctrine of equivalents
defense on the bases that the GenSci parties failed to assert that defense
in a timely manner and that the defense is otherwise meritless. The Company
also filed a motion seeking judgement that the portion of the case GenSci
dismissed with prejudice be ruled as exceptional based on GenSci Labs
having asserted and maintained baseless allegations that the Company
infringed GenSci Labs' patents, thus warranting an award of attorneys' fees
and costs to the Company.
Also, in July, 2000, GenSci filed various motions for summary judgement
seeking orders that GenSci does not infringe on the Company's patents
and/or that such patents are invalid.
In October, 2000, the court held a claims construction hearing, also known
as a Markman hearing, to construe the scope of the claim of the
patents-in-suit. In December, 2000, the court issued its ruling adopting
the Company's interpretation of the claims.
In January, 2001, the Company filed a motion for summary judgement of
infringement of U.S. Patent No. 5,290,558. Also in January, 2001, GenSci
filed a second motion for
F-16
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
summary judgement of non-infringement of U.S. Patent No. 5,284,655, and
stated to the court that there no longer was a need for the court to rule
on GenSci's first motion for summary judgement of non-infringement of U.S.
Patent No. 5,290,558.
In March, 2001, the court rejected GenSci's various motions for summary
judgement. The Company's motion for summary judgement of infringement of
U.S. Patent 5,290,558 has not yet been ruled on.
The Company will continue to vigorously defend any claims against it,
prosecute the claims it has asserted in this action, and vigorously and
affirmatively protect its products and intellectual property to the fullest
extent possible under the law.
GenSci Orthobiologics, Inc. v. Osteotech, Inc.
On March 6, 2000, GenSci Orthobiologics, Inc. ("GenSci") filed a complaint
in the United States District Court for the Central District of California
against the Company, alleging unlawful monopolization, attempt to
monopolize the market for demineralized bone matrix and for entering
agreements in restraint of trade, in violation of Sections 1 and 2 of the
Sherman Antitrust Act and Section 3 of the Clayton Act; and that the
Company engaged in unlawful and unfair business practices in violation of
Section 17200 of the California Unfair Competition Law. GenSci has alleged
that the Company has monopoly power in the market for demineralized bone
matrix products in the United States, and has engaged in anticompetitive
conduct by improperly asserting its patents through patent infringement
actions, seeking to have the Food and Drug Administration remove certain of
GenSci's products from the market, restricting competitors' access to raw
materials, interfering with GenSci's arrangements to manufacture
demineralized bone matrix implants, interfering with GenSci's marketing and
distribution arrangements, and disparaging GenSci's products. GenSci seeks
compensatory, incidental, consequential, and punitive damages in an
unspecified amount, and injunctive relief to stop the Company from
restricting the tissue banks for which it processes tissue from supplying
processed demineralized bone matrix to the Company's competitors and
distributing the demineralized bone matrix implant products of the
Company's competitors. Certain of these allegations had previously been
asserted by GenSci in its patent litigation with the Company in the Central
District of California federal court.
In April, 2000, the Company reached an agreement with GenSci whereby tort
claims that were dismissed from the patent litigation would be transferred
to this action and this action was stayed until the completion of the trial
of the Company's patent infringement claims against GenSci.
The Company believes the claims made in this lawsuit are without merit and
intend to vigorously defend against these claims.
Osteotech, Inc. v. GenSci Orthobiologics, Inc.
On October 25, 2000, the Company filed suit against GenSci Orthobiologics,
Inc. ("GenSci"), in the United States District Court for the Central
District of California, alleging that GenSci's demineralized bone matrix
materials sold under the name Orthoblast, infringe the Company's U.S.
Patent No. 5,290,558 and infringe the reexamined claims of the Company's
U.S. Patent No. 5,676,146. The Company's complaint seeks injunctive relief,
treble damages, costs and attorneys fees.
F-17
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
In its Second Amended Answer and Counterclaim filed in March, 2001, GenSci
denies infringement, asserts a number of affirmative defenses, and asserts
a counterclaim seeking a declaratory judgement that the patents-in-suit are
invalid, not infringed and/or unenforceable, together with costs and
attorneys fees.
The Company intends to pursue its claims against GenSci and vigorously
defend against the counterclaims.
"O" Company, Inc. v. Osteotech, Inc.
In July, 1998, a complaint was filed against the Company in the Second
Judicial District Court, Bernallilo County, New Mexico, which alleges
negligence, strict liability, breach of warranties, negligent
misrepresentation, fraud, and violation of the New Mexico Unfair Trade
Practices Act arising from allegedly defective dental implant coating and
coating services provided to plaintiffs by a subsidiary of the Company, Cam
Implants BV. Plaintiffs have demanded unspecified monetary damages. In
August, 1998, the Company removed this action to the United States District
Court for the District of New Mexico and filed and served its answer,
denying any and all liability in this action, and moved to dismiss five of
the seven claims alleged against it. In March, 1999, the court dismissed
with prejudice the plaintiff's negligence and strict liability claims.
Remaining are claims for breach of warranties, negligent misrepresentation,
fraud, and violation of the New Mexico Unfair Trade Practices Act. As to
those claims, the Company has moved for summary judgement on the basis that
all of the remaining claims are barred by their applicable statutes of
limitations. At plaintiffs' request, the court permitted limited discovery
on the matters related to the statute of limitations issue, which is
ongoing.
The Company believes that the claims made against it in this action are
without merit and will continue to vigorously defend against such claims.
University of Florida Tissue Bank, Inc. v. Osteotech, Inc.
In February, 1999, a complaint was filed against the Company in the United
States District Court for the Northern District of Florida. This action,
which has been brought by plaintiffs, University of Florida Tissue Bank,
Inc., Regeneration Technologies, Inc., Sofamor Danek Group, Inc., and
Sofamor Danek L.P. alleges that the Company's bio-d(TM)Threaded Cortical
Bone Dowel and Endodowel infringe on the claims of U.S. Patent Nos.
5,814,084 and 4,950,296. The plaintiffs have sought injunctive relief and
monetary damages in an amount not yet specified. In May, 1999, the Company
filed its answer and counterclaim seeking declaratory judgment that the
patents in question in this action are invalid and otherwise not infringed
by the Company. In May, 1999, plaintiffs filed their reply to the Company's
counterclaims.
In October, 2000, the Court granted plaintiffs permission to amend their
complaint to allege that the Company, in addition to infringing on the
claims of the patents mentioned above, infringed upon the claims of a
related patent owned by plaintiffs, U.S. Patent No. 6,096,081. As with
their infringement claims regarding the other patents, plaintiffs seek
injunctive relief and unspecified damages.
Discovery on all of the claims asserted in this litigation is ongoing. The
Company believes that the claims made against it in this action are without
merit and will continue to vigorously defend against such claims.
F-18
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings,
Inc. v. Osteotech, Inc.
In July, 1999, Medtronic Sofamor Danek Inc., Sofamor Danek L.P. and Sofamor
Danek Holdings, Inc. (collectively, "Danek") sued the Company in the United
States District Court for the Western District of Tennessee alleging that
instruments and instrument sets relating to cortical bone dowel products,
including the bio-d(TM) Threaded Cortical Bone Dowel and Endodowel,
manufactured, sold and/or otherwise distributed by the Company infringe on
certain claims of U.S. Patent Nos. 5,741,253 and 5,484,437 which are owned
by Danek. In addition to injunctive relief, the plaintiffs seek unspecified
monetary damages. In September, 1999, the Company filed its answer and
counterclaims seeking a declaratory judgement that the patents in question
in this action are invalid and otherwise not infringed by the Company.
Plaintiffs filed their reply to the counterclaims in October, 1999.
In October, 2000, the Court granted plaintiffs permission to amend their
complaint to allege that the Company also infringed upon the claims of a
related patent owned by plaintiffs, U.S. Patent No. 6,096,038. As with
their infringement claims regarding the other patents, plaintiffs seek
injunctive relief and unspecified damages.
Discovery on all of the claims asserted in this litigation is ongoing. The
Company believes that the claims made against it in this action are without
merit and will continue to vigorously defend against such claims.
Regner v. Inland Eye & Tissue Bank of Redlands
In May, 2000, Regner brought suit against the Company and fifteen or more
other defendants in the Superior Court for the State of California, San
Bernardino County. The suit seeks class action status and alleges a cause
of action based on a violation of the California Business and Professional
Code, as well as a number of common law causes of action, including
negligence, deceit, and intentional and negligent infliction of emotional
distress. Plaintiff claims that the Company is violating the California
Business and Professional Code by engaging in the activity of buying or
selling organs or tissue for valuable consideration or profit. It appears
that the plaintiff is seeking only injunctive relief with respect to its
California Business and Professional Code claim. To the extent any of the
other causes of action exist against the Company, the plaintiffs are
seeking damages in an unspecified amount in addition to class
certification.
In June, 2000, Regner filed a motion for a preliminary injunction and a
hearing was held on June 28, 2000. The Court denied the motion. The Company
also filed a demurrer to the complaint requesting that the complaint be
dismissed.
In September, 2000, plaintiffs voluntarily dismissed without prejudice
their claims filed in the Superior Court for the State of California, San
Bernardino County. At or about the time of the dismissal, the plaintiffs
"refiled" the action in the Superior Court for Los Angeles County. In
October, 2000, the defendants, including the Company, moved to vacate
plaintiffs' dismissal of the San Bernardino County action and have the
action reinstated. The Court granted that motion and scheduled a hearing on
defendants' demurrers to the plaintiffs' complaint. Plaintiffs subsequently
moved to voluntarily dismiss the action without prejudice. The Court
granted that motion. In February, 2001, the Company was served with the
action that was refiled in Los Angeles County. The defendants have filed a
motion asking the Court to move this action back to San Bernardino County.
F-19
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
The Company denies that it is engaged in the activity complained of and
asserts that it is licensed by the State of California to do precisely what
it is doing, and that its activities are fully in accord with all state and
federal laws. Therefore, the Company believes this suit to be without merit
and will vigorously defend against the claims.
Thacker v. Inland Eye & Tissue Bank of Redlands
In February, 2001, Thacker brought suit against the Company and fifteen or
more defendants in the Superior Court for the State of California, Los
Angeles County. The suit is substantially identical to the Regner v. Inland
Eye & Tissue Bank of Redlands suit discussed above. The defendants have
filed a motion asking the Court to move this action to the Superior Court
for the State of California, San Bernardino County, or in the absence, to
consolidate this action with the Regner action.
The Company denies that it is engaged in the activity complained of and
asserts that it is licensed by the State of California to do precisely what
it is doing, and that its activities are fully in accord with all state and
federal laws. Therefore, the Company believes this suit to be without merit
and will vigorously defend against the claims.
Steele v. Inland Eye and Tissue Bank
In October, 2000, the Company was served with a summons and second amended
complaint naming the Company as a "Doe" defendant in an action pending in
the Superior Court for the State of California, San Bernardino County.
Plaintiff has asserted claims against defendants for intentional
misrepresentation, negligent misrepresentation and tortious interference in
connection with certain tissue procurement activities allegedly engaged in
by defendants. Plaintiff seeks damages in an unspecified amount. In
February, 2001, plaintiffs agreed to dismiss this case with prejudice.
Condos v. Musculoskeletal Transplant Foundation
In June, 2000, the Company was served with an action brought in the United
States District Court for the District of Utah against the Company and MTF.
The suit alleges causes of action for strict liability, breach of implied
warranty and negligence arising from allegedly defective allograft bone
tissue processed and/or provided by the Company and MTF which was allegedly
implanted into the plaintiff, Chris Condos, during two spinal surgeries.
Plaintiffs, which include Mr. Condos's family members, demand monetary
damages in an unspecified amount. On July 25, 2000, the Company answered
the complaint, denying any and all liability. Discovery on all of the
claims in this action has commenced.
The Company maintains a general liability insurance policy and has notified
the insurance company of this action and the insurance company has agreed
to defend the action.
F-20
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Musculoskeletal Transplant Foundation v. Osteotech, Inc.
In October, 2000, MTF filed a complaint in the United States District Court
for the District of New Jersey against the Company seeking a declaratory
judgment that MTF, through its manufacture, use, sale and/or offer for sale
of demineralized bone matrix products, does not infringe any claim of the
Company's U.S. Patent Nos. 5,284,655 and 5,290,558, and that the claims of
those patents are invalid and unenforceable. The complaint was then amended
to add Synthes Spine Company, L.P. ("Synthes") as a plaintiff. MTF and
Synthes seek declaratory and injunctive relief.
The Company answered the complaint, denying all claims asserted and the
Company has asserted claims against MTF and Synthes for patent
infringement, unfair competition, misappropriation of trade secrets,
product disparagement, breach of implied covenant of good faith and fair
dealing, intentional interference with contractual relations, and for
constructive trust, arising from certain wrongful acts committed by MTF
and/or Synthes in developing and selling their DBX(R) products and/or their
underlying technology. The Company seeks injunctive relief and monetary
damages in an amount to be determined. MTF and Synthes have denied any
liability.
Discovery has commenced on all claims. The Company believes that the claims
made against it in this action are without merit and will vigorously defend
against the claims.
Glancy v. Interpore International, Inc.
In November, 2000, plaintiffs Bonnie and Ivan Glancy commenced an action in
the United States District Court for the Northern District of Indiana
against Interpore International, Inc. and Interpore Cross International,
Inc. (collectively, "Interpore") and the Company. The suit seeks recovery
from defendants for alleged personal injuries suffered by plaintiffs as a
result of allegedly defective spinal implants, manufactured and/or
distributed by Interpore, and/or demineralized bone matrix material,
processed by the Company - both are alleged to have been implanted into
plaintiff Bonnie Glancy during a spinal surgery. With respect to the
Company, plaintiffs have asserted a products/strict liability claim
relating to the demineralized bone matrix material. Plaintiffs demand
monetary damages in an unspecified amount. In January, 2001, the Company
answered the complaint, denying any and all liability and the Company
intends to vigorously defend against all claims. Discovery on all of the
claims in this action has commenced.
The Company maintains a general liability policy and has informed the
insurance company of this action. The insurance company has agreed to
defend this action.
Criti-Cal, Inc. v. Osteotech, Inc.
In December, 2000, Criti-Cal, Inc. commenced an action in the Superior
Court for the State of California, Orange County, against the Company,
Second Act Medical, Inc. and Ronald Letner. The plaintiff alleges causes of
action for breach of contract, misappropriation of trade secrets, quantum
merit and violations of the California Independent Wholesale Sales
Representatives Contractual Relations Act of 1990 arising from the
termination of an agreement between the Company and plaintiff. In addition
to injunctive relief, plaintiff seeks unspecified monetary damages.
The Company answered the complaint denying any and all liability and
intends to vigorously defend against all claims.
F-21
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Medtronic, Inc. v. Osteotech, Inc.
In February, 2001, Medtronic, Inc. and Medtronic Sofamor Danek, Inc.
(collectively, "Medtronic") brought suit against the Company and
Medtronic's former employee, Timothy R. Miller, in the Circuit Court for
Shelby County, Tennessee. The plaintiffs seek to enjoin Mr. Miller, whom
the Company recently hired, from using and disclosing any of their trade
secrets or other confidential information to any third party, including the
Company, and from working for the Company for a period of twelve months.
The plaintiffs have asserted a claim against the Company for tortious
interference with an employment agreement between Mr. Miller and
plaintiffs. In addition to injunctive relief, plaintiffs seek unspecified
monetary damages.
Mr. Miller and the Company have both filed an answer denying any liability.
Medtronic has filed a motion for a preliminary injunction which remains
pending. The Company intends to vigorously defend against these claims.
Other than the foregoing matters, the Company is not a party to any
material pending legal proceeding. Litigation is subject to many
uncertainties and management is unable to predict the outcome of the
pending suits and claims. It is possible that the results of operations or
liquidity and capital resources of the Company could be adversely affected
by the ultimate outcome of the pending litigation or as a result of the
costs of contesting such lawsuits. The Company is unable to estimate the
potential liability, if any, that may result from the pending litigation
and, accordingly, no provision for any liability (except for accrued legal
costs for services previously rendered) has been made in the consolidated
financial statements.
12. STOCKHOLDERS' EQUITY
Common Stock
In June, 1999, the stockholders of the Company approved an amendment to the
Certificate of Incorporation increasing the number of authorized shares of
Common Stock from 20,000,000 to 70,000,000.
Preferred Stock
The authorized capital of the Company includes 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,
2000 and 1999.
F-22
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Stock Repurchase Program
In May, 2000, the Board of Directors of the Company authorized the
repurchase and retirement of up to 1,000,000 shares of the Company's common
stock through open market purchases, or block purchases. As of December 31,
2000, the Company had repurchased and retired 330,500 shares of common
stock at a cost of approximately $3,124,000.
In June, 1998, the Board of Directors of the Company authorized the
repurchase and retirement of up to $5,000,000 of common stock through open
market purchases. During August, 1998, the Company completed this program
and had repurchased and retired 367,500 shares of common stock at a cost of
$4,958,000.
Stock Split
On February 11, 1999, the Board of Directors authorized a three-for-two
stock split in the form of a 50% stock dividend that was distributed on
March 19, 1999 to stockholders of record on March 5, 1999. Stockholders'
equity has been restated to give retroactive recognition to the stock split
for all periods presented. In addition, all references in the financial
statements to shares, per share data, stock option data and market prices
of the Company's common stock have been restated.
Stock Options
The Company has three stock option plans: the 2000 Stock Plan (the "2000
Plan"), the 1991 Stock Option Plan (the "1991 Plan") and the 1991
Independent Directors Stock Option Plan (the "Directors Plan").
The 2000 Plan authorizes the grant of up to 1,000,000 shares of the
Company's common stock in the form of incentive stock options,
non-qualified stock options or other stock-based awards to employees,
directors and consultants. Incentive stock options may be granted at prices
not less than 100% of the fair market value on the date of grant.
Non-qualified stock options and other stock-based awards may be granted at
the discretion of the Compensation Committee of the Board of Directors
under terms and conditions as determined by the Compensation Committee.
Options will expire ten years from the date of grant and vesting will be
determined by the Compensation Committee.
The 1991 Plan, as amended, authorizes the grant of up to 4,220,648 shares
of the Company's common stock in the form of incentive stock options or
non-qualified stock options to employees and consultants. Commencing in
June, 2000, the 2000 Plan replaced the 1991 Plan, and therefore, options
will no longer be issued under the 1991 Plan. At June 30, 2000, there were
outstanding options for 1,735,895 shares under the 1991 Plan.
The Directors Plan, as amended, authorizes the grant of up to 750,000
shares of the Company's common stock to members of the Board of Directors
who are not officers or employees of the Company. Option exercise prices
equal 100% of the fair market value on the date of grant. Options issued
prior to July 1, 1997 become exercisable in ratable installments over four
years with unexercised options expiring five years from the vesting date.
Effective July 1, 1997, the Directors Plan was amended to provide for
options issued to become 100% exercisable on the first anniversary of the
date of grant with unexercised options expiring ten years from the date of
grant.
F-23
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Stock option activity for the years 2000, 1999 and 1998 is as follows:
2000 1999 1998
------------------ -------------------- ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- - --------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 1,866,522 $ 11.93 2,280,732 $ 9.35 2,524,011 $ 5.41
Granted 686,000 5.76 404,500 18.17 491,250 18.55
Exercised 74,261 4.14 791,566 5.76 703,836 3.86
Canceled or expired 158,936 17.45 27,144 16.40 30,693 4.29
- - --------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2,319,325 $ 9.98 1,866,522 $ 11.93 2,280,732 $ 9.35
- - --------------------------------------------------------------------------------------------------------------
Exercisable at December 31, 1,236,336 $ 10.36 995,529 $ 8.35 1,310,544 $ 6.41
- - --------------------------------------------------------------------------------------------------------------
Available for grant at
December 31, 714,750 669,644 1,047,000
- - --------------------------------------------------------------------------------------------------------------
Weighted average fair value per share
of options granted during the period $ 3.28 $ 10.35 $ 11.03
- - --------------------------------------------------------------------------------------------------------------
The following table summarizes the information about stock options
outstanding at December 31, 2000:
Options Outstanding Options Exercisable
----------------------------------------------------- ----------------------------------
Weighted
Average
Number Remaining Number
Outstanding at Contractual Weighted Exercisable at Weighted
Range of December 31, Life Average December 31, Average
Exercise Prices 2000 (Years) Exercise Price 2000 Exercise Price
- - -------------------------------------------------------------------------------------------------------------
$2.33 to $3.83 486,687 8.8 $ 3.53 121,937 $ 3.60
4.08 to 5.50 249,950 6.1 4.83 189,389 4.70
6.33 to 10.50 796,750 7.1 7.98 579,250 8.03
11.00 to 18.75 502,375 8.3 13.80 178,812 13.95
20.66 to 21.59 220,313 7.9 20.68 114,573 20.68
34.37 to 37.88 63,250 7.9 37.54 52,375 37.59
- - -------------------------------------------------------------------------------------------------------------
$2.33 to $37.88 2,319,325 7.7 $ 9.98 1,236,336 $10.36
=============================================================================================================
F-24
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
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. Pro forma information follows:
(in thousands except per share data) 2000 1999 1998
- - --------------------------------------------------------------------------------
Net income
As reported $ 4,828 $ 12,351 $ 10,304
Pro forma 3,699 10,927 9,032
Net income per share
As reported
Basic $ .34 $ .88 $ .78
Diluted .34 .84 .73
Pro forma
Basic $ .26 $ .78 $ .68
Diluted .26 .75 .64
- - --------------------------------------------------------------------------------
The pro forma effect on net income for 2000, 1999, and 1998 is not
representative of the pro forma effect on net income in future years
because, in accordance with FAS 123, it does not take into consideration
pro forma compensation expense related to grants made prior to 1995.
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:
2000 1999 1998
- - --------------------------------------------------------------------------------
Expected life (years) 5 5 8
Risk free interest rate 5.7% 6.1% 5.1%
Volatility factor 60.0% 60.0% 50.0%
Dividend yield 0.0% 0.0% 50.0%
- - --------------------------------------------------------------------------------
Stock Warrants
As part of financing and contract arrangements, the Company has, at certain
times, issued warrants to purchase its Convertible Preferred Stock. During
2000, all outstanding Convertible Preferred Stock warrants expired. As of
December 31, 1999 and 1998 there were Convertible Preferred Stock warrants
to purchase 458 shares of Common Stock at an exercise price of $3.72.
F-25
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Stock Purchase Plan
The 1994 Employee Stock Purchase Plan provides for the issuance of up to
375,000 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, 2000, 193,140 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. Upon the
occurrence of certain events, each Right entitles the stockholder to
purchase from the Company one one-hundredth of a preferred share at a price
of $170.00 per one one-hundredth of a preferred 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 March 31, 2009. 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.
13. SUPPLEMENTAL STATEMENT OF OPERATIONS INFORMATION
Maintenance and repairs expense for the years ended December 31, 2000, 1999
and 1998 was $2,551,000, $2,240,000, and $1,344,000, respectively.
Depreciation and amortization expense related to property, plant and
equipment for the years ended December 31, 2000, 1999 and 1998 was
$3,956,000, $2,745,000, and $2,050,000, respectively.
14. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(in thousands) 2000 1999 1998
- - --------------------------------------------------------------------------------
Cash paid during the year for taxes $ 1,895 $4,476 $2,120
Cash paid during the year for interest, excluding
amounts capitalized 11 33 50
Acquisition of business:
Fair value of assets acquired 2,563
Liabilities assumed 2,669
F-26
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income (loss) per share:
Year Ended
----------------------------------------
(dollars in thousands except per share data) 2000 1999 1998
----------------------------------------
Net income available to common Shareholders $ 4,828 $ 12,351 $ 10,304
======================================================================================================
Denominator for basic net income per share:
Weighted average common shares outstanding 14,057,931 14,024,468 13,259,784
Effect of dilutive securities:
Stock options 277,601 593,933 826,810
Warrants 109 385 355
----------------------------------------
Denominator for diluted net income per share 14,335,641 14,618,786 14,086,949
======================================================================================================
Basic net income per share $ .34 $ .88 $ .78
======================================================================================================
Diluted net income per share $ .34 $ .84 $ .73
======================================================================================================
Weighted average shares issuable upon the exercise of stock options which
were not included in the calculation were 771,498 in 2000, 48,419 in 1999
and 24,188 in 1998. Such shares were not included because they were
antidilutive.
16. OPERATING SEGMENTS
The Company has two reportable business segments: the Grafton(R) DBM
Segment and Base Tissue Segment. The Grafton(R) DBM Segment engages in the
processing and marketing of Grafton(R) DBM. Grafton(R) DBM is processed
using the Company's advanced proprietary demineralization process. The Base
Tissue Segment primarily engages in the processing of mineralized
weight-bearing allograft bone tissue which is generally marketed by the
Company's clients.
The accounting policies of the reportable segments are the same as those
described in the Summary of Significant Accounting Policies. The Company
evaluates the performance of its operating segments based on revenue
performance and operating results. The Company does not produce information
about assets for its operating segments, and accordingly no asset
information is presented in the table below. All corporate related expenses
are allocated to operating segments and geographic areas in determining
operating income (loss) of the respective segments.
Summarized financial information concerning the Company's reportable
segments is shown in the following table. The "Other" column includes
information for other sources of revenue which do not meet the requirements
for reporting as a segment. The Company's other business units engage in
providing ceramic and titanium plasma spray coating services and ceramic
products to orthopaedic and dental implant manufacturers, marketing and
distributing metal spinal implant products and processing, marketing and
distributing bovine tissue products outside the United States.
F-27
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. OPERATING SEGMENTS (continued)
(in thousands)
Grafton(R) Base
DBM Tissue
Segment Segment Other Consolidated
- - --------------------------------------------------------------------------------
Revenues:
2000 $45,226 $26,204 $ 4,253 $75,683
1999 45,136 25,751 4,723 75,610
1998 39,128 17,323 2,750 59,201
- - --------------------------------------------------------------------------------
Operating income (loss):
2000 $11,389 $ 694 $(4,228) $ 7,855
1999 17,063 6,434 (3,645) 19,852
1998 13,404 4,170 (1,293) 16,281
- - --------------------------------------------------------------------------------
Depreciation and amortization:
2000 $ 2,198 $ 1,376 $ 1,023 $ 4,597
1999 1,203 1,153 942 3,298
1998 1,180 742 481 2,403
- - --------------------------------------------------------------------------------
Financial information by geographic area is summarized as follows:
(in thousands) United States Europe Consolidated
- - --------------------------------------------------------------------------------
Revenues
2000 $71,468 $4,215 $75,683
1999 71,517 4,093 75,610
1998 56,876 2,325 59,201
Long-lived Assets
2000 $56,618 $1,672 $58,290
1999 32,068 1,927 33,995
1998 15,449 595 16,044
Two of the Company's customers individually comprise 10% or more of the
Company's consolidated net revenues. Revenues by customer, which are
reported as part of the Company's Grafton(R) DBM and Base Tissue Segments,
are as follows:
(in thousands) 2000 1999 1998
- - --------------------------------------------------------------------------------
Revenues
MTF $37,743 $42,095 $33,286
ARC 30,469 28,436 23,020
- - --------------------------------------------------------------------------------
$68,212 $70,531 $56,306
================================================================================
F-28
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%
through December 31, 2000 and 35% effective January 1, 2001 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, 2000, 1999 and 1998 were $285,000,
$287,000, and $221,000, 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 $70,000, $53,000, and
$88,000 for the years ended December 31, 2000, 1999 and 1998.
The Company does not maintain any other pension or post retirement plans.
18. RECLASSIFICATIONS
In 2000, the Emerging Issues Task Force ("EITF") issued EITF 00-15,
"Classification in the Statement of Cash Flows of the Income Tax Benefit
Received by a Company upon Exercise of a Nonqualified Employee Stock
Option." In accordance with the EITF, in the statements of cash flows for
the years ended December 31, 1999 and 1998, the Company reclassified
$6,542,000 and $3,228,000, respectively, in income tax benefits from the
cash flows from financing activities section to the cash flows from
operating activities section.
In addition, certain other prior year amounts within the financial
statements have been reclassified to conform to the 2000 presentation.
19. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of the unaudited quarterly results for the years
ended December 31, 2000 and 1999:
Quarter Ended
-------------------------------------------------------
(in thousands except per share data) March 31 June 30 Sept. 30 Dec. 31
------------------------------------------------------------------------------------------------
2000
Net revenues $18,646 $20,619 $17,916 $18,502
Cost of services and products 6,211 6,742 6,996 7,562
Net income (a) 1,969 2,524 231 104
Net income per share (a)
Basic $ .14 $ .18 $ .02 .01
Diluted .13 .18 .02 .01
------------------------------------------------------------------------------------------------
1999
Net revenues $18,688 $19,720 $17,469 $19,733
Cost of services and products 5,857 6,115 5,643 6,294
Net income (a) 3,158 3,344 3,248 2,601
Net income per share (a)
Basic $ .23 $ .24 $ .23 $ .18
Diluted .22 .23 .22 .18
------------------------------------------------------------------------------------------------
(a) Net income in 2000 included approximately $150,000, or $.01 net income per
share, per quarter from a litigation settlement, while 1999 included
approximately $1,050,000, or $.07 net income per share, in the third
quarter and approximately $150,000, or $.01 net income per share, in the
fourth quarter from the litigation settlement.
F-29
SCHEDULE II
OSTEOTECH, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
Balance At --------------------- Balance At
Beginning Charged To Charged End
Of Period Expenses To Other Deductions Of Period
--------------------------------------------------------------
For the year ended December 31, 2000:
Allowance for doubtful accounts $ 129 $ 1 $ (3)(a) $ (4)(b) $ 123
Valuation allowance for deferred
tax asset 1,749 440(c) (122)(a) (9)(d) 2,058
For the year ended December 31, 1999:
Allowance for doubtful accounts 148 (3)(e) (10)(a) (6)(b) 129
Valuation allowance for deferred
tax asset 1,520 416(c) (123)(a) (64)(d) 1,749
For the year ended December 31, 1998:
Allowance for doubtful accounts 147 (3)(e) 6(a) (2)(b) 148
Valuation allowance for deferred
tax asset 1,187 272(c) 61(a) 1,520
(a) Represents foreign currency translation adjustments.
(b) Represents the write-off of accounts receivable.
(c) Represents the tax effect of temporary differences.
(d) Represents recognition of a deferred tax asset.
(e) Represents recovery on previously written-off accounts receivable.
S-1
Report of Independent Accountants on
Financial Statement Schedule
To the Board of Directors of Osteotech, Inc.
Our audits of the consolidated financial statements referred to in our report
dated February 20, 2001, except as to certain information presented in Note 11
for which the date is March 28, 2001, appearing on page F-2 of this 2000 Form
10-K also included an audit of the Financial Statement Schedule listed in Item
14(a)(2) of this 2000 Form 10-K. In our opinion, this Financial Statement
Schedule presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements.
PricewaterhouseCoopers LLP
Florham Park, New Jersey
February 20, 2001, except as to certain
information presented in Note 11 for
which the date is March 28, 2001.
S-2
EXHIBIT INDEX
Exhibit Page
Number Description Number
- - ------ ----------- ------
10.37 Mortgage Term Note among Summit Bank, Osteotech, Inc., E-2
Osteotech Investment Corp., Cam Implants Inc., Osteotech,
B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/CAM
Services, B.V. and OST Developpement dated December 8, 2000
10.38 Allonge to Loan and Security Agreement among Summit Bank, E-7
Osteotech, Inc., Osteotech Investment Corp., Cam Implants
Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants,
B.V., Osteotech/CAM Services, B.V. and OST Developpement dated
December 8, 2000
10.39 Allonge to Equipment Loan Note among Summit Bank, Osteotech, E-10
Inc., Osteotech Investment Corp., Cam Implants Inc.,
Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V.,
Osteotech/Cam Services, B.V. and OST Developpement dated
December 8, 2000
10.40 Distribution Agreement entered into February, 2001 by E-12
Osteotech, Inc. and Alphatec Manufacturing, Inc. for which
Osteotech is requesting confidential treatment pursuant to
Rule 24b-2
10.41 Second Allonge to Loan and Security Agreement among Fleet E-34
National Bank, Successor in Interest to Summit Bank,
Osteotech, Inc., Osteotech Investment Corp., Cam Implants
Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants,
B.V., Osteotech/Cam Services, B.V. and OST Developpement dated
March 8, 2001
10.42 Second Allonge to Equipment Loan Note among Fleet National E-37
Bank, Successor in Interest to Summit Bank, Osteotech, Inc.,
Osteotech Investment Corp., Cam Implants Inc., Osteotech,
B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/Cam
Services, B.V. and OST Developpement dated March 8, 2001
E-1
10.43 Allonge to Convertible Revolving Note among Fleet National E-39
Bank, Successor in Interest to Summit Bank, Osteotech, Inc.,
Osteotech Investment Corp., Cam Implants Inc., Osteotech,
B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/Cam
Services, B.V. and OST Developpement dated March 8, 2001
21.1 Subsidiaries of Registrant E-41
23.1 Consent of PricewaterhouseCoopers LLP E-42
E-2