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, 2001 Commission File Number 0-19278
OSTEOTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3357370
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
51 James Way, Eatontown, New Jersey 07724
(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
(Title of class)
Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
The aggregate market value of the Common Stock, par value $.01 per share,
held by non-affiliates based upon the reported last sale price of the Common
Stock on March 15, 2002 was approximately $103,950,000.
As of March 15, 2002, there were 14,100,264 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 2002 Proxy Statement which will be filed
pursuant to Regulation 14A is incorporated by reference into Items 11 and 12 of
Part III of this Annual Report on Form 10-K.
OSTEOTECH, INC.
2001 Form 10-K Annual Report
TABLE OF CONTENTS
Section Page
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PART I
Item 1. Business 1
Item 2. Properties 29
Item 3. Legal Proceeding 30
Item 4. Submissions of Matters to a Vote of Security Holders 37
PART II 38
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 38
Item 6. Selected Financial Data 39
Item 7. Management's Discussion And Analysis Of Financial
Condition And Results Of Operations 40
Liquidity and Capital Resources 47
Impact of Inflation and Foreign Currency Exchange Fluctuations 51
Risk Factors 51
Item 8. Financial Statements and Supplementary Data 61
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 62
PART III 63
Item 10. Directors and Executive Officers of the Registrant 63
Item 11. Executive Compensation 65
Item 12. Security Ownership of Certain Beneficial
Owners and Management 65
Item 13. Certain Relationships and Related Transactions 65
ii
PART IV 67
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 67
The following trademarks and service marks appear in this Annual Report:
Threaded Cortical Bone Dowel, Graftech(TM) Bio-Implants, OsteoActive(TM),
Ovation(TM) Low Back Fixation System, Sentinal(TM) Pedicle Screw System,
Affirm(TM) Cervical Plating System, Clear Bone(TM), and Grafton Plus(TM) DBM are
trademarks and Osteotech(R), Grafton(R) Demineralized Bone Matrix (DBM),
bio-d(R), 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
We provide 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 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. We also process allograft bone tissue
recovered by TRO's on our behalf and distribute such tissue under our own label.
Although our distribution of allograft bone tissue under our own label has
represented an immaterial portion of our revenue through 2001, we expect revenue
generated from allograft bone tissue distributed by us under our own label to
represent a growing percentage of our Grafton(R) DBM revenues in the future. See
Item 7. "Management's Discussion And Analysis of Financial Condition and Results
of Operations" for a discussion on the anticipated impact of this method of
distributing tissue on our gross profit margins.
We process Grafton(R) DBM using our validated, advanced, proprietary
demineralization process. When applied to cortical bone, this process yields
allograft bone tissue which has osteoinductive (the
1
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, and we believe, greater than other competitive demineralized
allograft bone tissue forms.
In the Base Tissue Segment we process primarily mineralized weight-bearing
allograft bone tissue. Bio-implants, which are included in this segment, are
marketed and generally distributed by us and other tissue forms processed in
this Segment are generally marketed and distributed by our clients. To the
extent that TRO's recover allograft bone tissue on our behalf, we will process
and distribute such tissue directly to the end-user. Through 2001, our direct
distribution of allograft bone tissue has not represented a material portion of
the Base Tissue Segment's revenue. However, we expect revenue generated from
allograft bone tissue distributed directly by us to end-users to represent a
growing percentage of our Base Tissue Segment revenues in the future. See Item
7. "Management's Discussion And Analysis of Financial Condition and Results of
Operations" for a discussion on the anticipated impact of this method of
distributing tissue on our gross profit margins. We also process the bio-d(R)
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 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
Ovation(TM) Low Back Fixation System, or Ovation(TM), a titanium, lumbosacral
spine fixation system with an innovative polyaxial screw. We also market 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.
In February, 2001, we entered into a distribution agreement with Alphatec
Manufacturing, Inc. to market and distribute the Sentinal (TM) Pedicle screw
system and the Affirm(TM) Cervical plating system in the United States and
Canada. Under the terms of this distribution agreement, which is for an initial
term of two (2) years from February, 2002, the date that the first order for the
systems was completed, we are required to purchase an aggregate 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 agreement is renewed after its original term, we are required to
purchase an
2
aggregate minimum of $8 million of the two systems in the two year renewal
period. Thereafter, any minimum purchase obligations are to be negotiated in
advance of each renewal.
Through OST Developpement, SA, or OST, our subsidiary located in
Clermont-Ferrand, France, we also process, market and distribute primarily in
Europe, Asia and the Middle East, bovine bone tissue products which are utilized
as bone graft substitutes by surgeons and OsteoPure(TM) Femoral head processed
human allograft bone tissue grafts. We also market and distribute Grafton(R) DBM
through OST in these same markets.
We estimate that the total bone graft market in the U.S. for 2001 was
approximately $521 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 2001 was approximately
$310 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. We believe, increased use of allograft bone tissue
will continue as physicians become increasingly educated about the benefits of
allograft bone tissue. Moreover, we believe allograft bone tissue is
increasingly preferred for use in elderly patients, who often lack sufficient
quantity of their own harvestable bone for use in a procedure.
Based upon our knowledge of the allograft bone tissue industry, we estimate
that we process about 40% of the allograft bone tissue grafts distributed 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
national sales and marketing organization; and the substantial investment we
have made in processing technology to ensure stringent standards and rigorous
quality control which, combined with extensive donor screening and testing
performed by our clients, has significantly reduced 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 us fees
on a per unit basis for the Grafton(R) DBM tissue forms we process and they
generally distribute. In the Base Tissue Segment, our clients pay us fees on a
per donor basis, and in the case of bio-implants, our clients pay us fees on a
per unit basis for the bio-implants we process and generally distribute. In the
second half of 2001 we implemented a new revenue model whereby we bill the
end-user for Grafton(R) DBM and bio-implants we distribute, in addition to our
historical revenue model in which we bill our clients for Grafton(R) DBM and
bio-implants they distribute. In the future, we expect to generate revenue from
a combination of these two distribution methods.
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
3
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 at any time 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." Additionally, we
process allograft bone tissue for several smaller tissue banks in the United
States and Europe.
In January, 2002, we entered into a five year agreement with LifeNet, one
of the largest Organ Procurement Organizations, or OPO based tissue banks and
processors in the United States. Under the terms of this agreement, LifeNet will
supply Allowash(TM) processed tissue to us and we will process the tissue into
our broad line of bio-d(R) and Graftech(TM) Bio-Implants. All of those
bio-implants will display the LifeNet name and Osteotech product brand names.
The bio-implants will be marketed through our national agent and direct sales
organizations and will be distributed to hospitals by us on behalf of LifeNet.
The agreement with LifeNet also provides us with the opportunity for the future
processing and marketing of LifeNet labeled tissue carrier products through a
mutually agreed upon third party.
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.
Revenue in our Grafton(R) DBM Segment was $43,637,000 in 2001 as compared
to $45,226,000 in 2000 and 2001 revenue in our Base Tissue Segment was
$27,692,000 as compared to 2000 revenue of $26,204,000. 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 2002, as
processed allograft bone tissue forms continue to gain increased acceptance.
Information relating to our revenues for the years ended December 31, 2001,
2000 and 1999 by geographic area is summarized as follows:
(in thousands) United States Europe Consolidated
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Revenues
For the year ended December 31,
2001 $71,776 $ 6,070 $77,846
2000 71,468 4,215 75,683
1999 71,517 4,093 75,610
For a discussion of (1) our long-lived assets as of December 31, 2001, 2000
and 1999 respectively see Note 16 of "Notes to Consolidated Financial
Statements" and (2) our deferred tax assets for the years ended December 31,
2001, 2000 and 1999 respectively see Note 10 of "Notes to Consolidated
Financial Statements".
Strategy
Overview
We intend to expand our business as follows:
o We intend to use our position as a leader in allograft bone tissue
processing and marketing to become a leading
orthopaedic/musculoskeletal company by continuing to bring 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. We intend to
accomplish this by sponsoring workshops,
4
conducting grand rounds presentations, increasing our presence at
conventions, publishing clinical studies, white papers and articles
and expanding our medical education internet site.
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
breadth 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.
5
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.
In this regard, in February, 2002, we launched Grafton Plus(TM) DBM which
contains a starch carrier instead of our traditional glycerol carrier and has
improved handling characteristics which we believe will enable us to compete
more effectively against competitive paste-like products.
We expect to expand sales of Grafton(R) DBM through:
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 ClearBone(TM)Viral
inactivation system;
o global expansion of base allograft bone tissue grafts and the tissue
processing business in selected countries, initially in Europe;
6
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 or 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 metal spinal implant
products, including our products currently on the market, the
Ovation(TM) System, the Affirm(TM) Cervical plate system, the VBR(TM)
and the Sentinal(TM) Pedicle screw system which we began to market in
February, 2002;
o market our allograft bone tissue bio-implants and our metal spinal
implant products together with Grafton(R) DBM through our national
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,
7
both allograft and non-allograft, which we add to our product mix in the future
will be included in this strategy.
8
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 hospitals, or if recovered by TRO's on our behalf,
or by agreement with certain clients, we distribute it directly to surgeons and
hospitals. The surgeons and hospitals pay the fees established and charged by
our clients or us. The surgeons and hospitals 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, significantly reduce
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.
9
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 2001 there were
approximately 583,000 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 $521 million. Currently, allograft tissue
competes with autograft bone tissue procedures and synthetic graft substitutes
for the total bone graft market in the United States. We estimate that the
allograft bone tissue portion of the total bone graft market in the U.S. in 2001
was approximately $310 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-
10
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 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, in addition to the newly introduced Grafton
Plus(TM) DBM, 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
11
also contains a "trough" into which the surgeon can place autologous
bone and bone marrow to aid in the osteoinduction process; and
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, 2001, Grafton(R) DBM forms had been utilized in over 539,000 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(R) 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
12
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 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.
Tissue Supply Initiative
To ensure that we have adequate supply of allograft bone tissue to meet the
market demand for Graftech(TM) Bio-Implants, Grafton(R) DBM and other existing
tissue forms that we process and for any new tissue forms that we may process in
the future, we have been engaged in an intense effort to solidify the
relationships we have with existing clients who provide donated allograft tissue
to us. We also intend to expand the amount of donated allograft tissue available
to us by obtaining additional tissue bank clients and by contracting directly
with TRO's to obtain tissue on our behalf, which we will process and distribute
under our own label.
As a result of these efforts, at the end of 2000 we participated in forming
the American Tissue Services Foundation, or ATSF, an independent not-for-profit
tissue bank with which we have a fifteen year agreement to provide donated
allograft tissue to us on an exclusive basis. In 2002, we expect ATSF to recover
and provide to us donated allograft bone tissue from between 350 and 500 donors.
In January, 2002, we entered into a five year agreement with LifeNet, one
of the largest OPO based tissue banks and processors in the United States. Under
the terms of this Agreement, LifeNet will supply Allowash(TM) processed tissue
which we will process into our broad line of bio-d(R) and Graftech(TM)
Bio-Implants. All bio-implants from LifeNet supplied tissue will display the
LifeNet name and Osteotech product brand names. We will market these
bio-implants through our national agent and direct sales organizations and will
distribute them to hospitals on behalf of LifeNet. We anticipate that tissue
provided by LifeNet in 2002 will provide us the opportunity to offer to surgeons
over 20,000 more bio-implants than would be available through our other existing
sources of donor tissue.
Further, we are developing a new processing technology, Plexus, which is
designed to maximize the utilization of donated human tissue and to increase the
number of bio-implants that can be processed from a single donor's bone tissue.
Utilizing the Plexus processing technology we will be able to use bone tissue
that was not otherwise available for weight bearing bio-implants to be used for
that purpose. Additionally, by eliminating the constraints that the anatomical
structure of bone tissue places on the number of bio-implants that can currently
be processed from bone tissue, the Plexus processing technology ultimately will
significantly increase the number of bio-implants that can be processed from a
13
single donor's bone tissue. We have not yet determined if products processed
with the Plexus technology will be regulated by the FDA as banked human tissue
or a medical device.
Expansion of Allograft Bone Tissue Business in Europe
OST, our subsidiary located in Clermont-Ferrand, France, 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 other European based tissue banks
and further 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. We will add facilities and staff 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
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. In 2001 the French
government awarded OST tissue bank status which will now 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.
In February, 2002, OST entered into a seven year agreement with the
Bulgarian National Center For Transplant Management Bultransplant and the
US-Bulgarian Fund For The Development of Medicine And Biotechnology, both of
which are agencies of the Bulgarian government responsible for
14
overseeing all activities in Bulgaria related to the recovery, processing and
allocation of human organs, tissues, cells and biomaterials for transplantation.
Under this agreement, OST will be exclusively responsible for the recovery and
processing of tissue, cells and biomaterials as well as the allocation and
distribution of these anatomical gifts throughout Europe and the rest of the
world. The bone tissue recovered under this agreement, which will meet all
standards of AATB and the FDA, will initially be processed at Osteotech's
facility in New Jersey and the resulting tissue forms will be distributed in
Europe through OST's network of distributors and agents. Once sufficient
quantities of donated tissue are obtained from this and other European sources,
it is our intention to expand OST's processing facilities in Clermont-Ferrand to
allow it to directly process the European sourced tissue.
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 Ovation(TM) System, is a lumbo-sacral spine fixation system with
innovative polyaxial screw, which is marketed by our national network of direct
and independent agency representatives in combination with our allograft and
other non-allograft spinal products. The Ovation(TM) System is designed in a
manner to allow the sharing of the forces to which the spine is subjected with
this system, which in turn is thought to provide improved results in spinal
fusion procedures.
In 2001, we began to market the VBR(TM). This patented device, which we
distribute under an exclusive 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 vertebra due to a
tumor or trauma.
15
In February, 2001, we entered into a distribution agreement to market and
distribute the Sentinal(TM) Pedicle screw system and the Affirm(TM) Cervical
plating system in the United States and Canada. These products are manufactured
by Alphatec Manufacturing, Inc. Under the terms of this distribution agreement,
which is for an initial term of two (2) years from February, 2002, the date that
the first order for the systems was completed, we are required to purchase an
aggregate 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 agreement is renewed after its
original term, we are required to purchase an aggregate minimum of $8 million of
the two systems in the two year renewal period. Thereafter, any minimum purchase
obligations are to be negotiated in advance of each renewal.
We expect to continue to expand our metal spinal implant product line
through acquisition or licensing of technology and products 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 and our facilities
in the United States are registered with the FDA and are accredited by the
American Association of Tissue Banks.
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 specifications. Before being released, 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 substantially reduce 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.
16
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.
To our knowledge, none of the approximately 2.6 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
During 2001, two of our clients, MTF and ARC each accounted for
approximately 37% of our consolidated revenue. We receive revenues in both our
Grafton(R) DBM and Base Tissue Segments from each of these clients. In the Base
Tissue Segment, with the exception of the bio-d(R) 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. 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 at any time 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."
Commencing in the first quarter 2002, we began to receive allograft bone
tissue for processing from LifeNet under the terms of a five year agreement
which will expire in January, 2007. The allograft bone tissue received from
LifeNet will be processed in our Base Tissue Segment and under the terms of the
Agreement, may also be processed in the Grafton(R) DBM Segment in the future if
we are able to contract with a third party marketing organization acceptable to
us and LifeNet to market carrier allograft products we will develop.
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 and
in December, 2000, we entered into a fifteen year agreement with ATSF to process
donor allograft bone tissue procured by ATSF. 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 surgeons for transplantation. However, certain of our
clients are recovering tissue on our behalf which will be distributed and
invoiced directly by us to the hospitals and physicians. In the future, we
expect a significant portion of our processed tissue will be distributed in this
manner and a significant portion of our revenue will be derived
17
in this manner. 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. We began distribution of
Grafton(R) DBM in Europe 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 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, 2001, in the United States, we employed 15 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, 2001,
we had appointed 38 agencies which employ over 176 sales representatives.
Currently, a small group of marketing and sales employees of OST located in
Clermont-Ferrand, France markets and sells our OsteoPure(TM) Femoral head and
cancellous bone grafts, Grafton(R) DBM and other human allograft tissue products
in conjunction with a network of independent agents and distributors we have
retained. This staff also markets and sells our LUBBOC(R) and LADDEC(R) Bovine
bone grafts to orthopaedic surgeons and dentists.
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.
18
Government Regulations
Our products are extensively regulated by federal and state agencies in the
United States and in other countries. Failure to comply with these requirements
may subject us to administrative or judicial sanctions, such as FDA's refusal to
clear pending applications, warning letters, product recalls, product seizures,
total or partial suspension of production or distribution, civil penalties,
injunctions and/or criminal prosecution.
In the United States, the allograft bone tissues that we process are
regulated by the FDA as human tissue-based products under section 361 of the
Public Health Service Act, and under certain circumstances, may be regulated as
a medical device under the Food, Drug, and Cosmetic Act.
FDA regulations do not require that human tissue-based products be cleared
or approved before they are marketed. We are, however, required to register and
list these products with FDA and to comply with regulations concerning tissue
donor screening and testing, and related procedures and record keeping. FDA
periodically inspects tissue processors to determine compliance with these
requirements. FDA has proposed, but not yet finalized, "Good Tissue Practice"
regulations that would impose requirements on the manufacture of human
tissue-based products, including tissue recovery, donor screening, donor
testing, processing, storage, labeling, packaging, and distribution. The human
tissue-based product category is a relatively new one in FDA regulations, and it
is possible that FDA will change its approach to human tissue-based products in
general or to particular categories of products to require FDA clearance or
approval or otherwise restrict distribution.
The metal spinal implant products that we distribute in the United States
are regulated by the FDA as medical devices. Medical devices generally require
FDA approval or clearance before they may be marketed. There are two processes
by which medical devices can receive approval or clearance. Some products may
qualify for clearance under the 510(k) process, in which the manufacturer or
processor demonstrates that its product is substantially equivalent to another
lawfully marketed product (i.e., that it has the same intended use and is as
safe and effective as a lawfully marketed product and does not raise different
questions of safety and effectiveness as the lawfully marketed product). 510(k)
submissions usually include safety and performance data, and in some cases, the
submission must include clinical data. Marketing may commence if and when FDA
issues a letter finding substantial equivalence.
If a medical device does not qualify for the 510(k) process, the product
may not be distributed until a premarket approval application has been approved
by FDA. Premarket approval applications must demonstrate product safety and
effectiveness. A premarket approval application is typically a complex
submission, usually including the results of preclinical and clinical studies.
The manufacturer must also pass a premarket inspection of its compliance with
FDA's Quality Systems regulation. Marketing may commence if and when FDA issues
a premarket approval. The Ovation(TM) System, the VBR(TM) System, the
Sentinal(TM) Pedicle screw system and Affirm(TM) Cervical plate system are being
marketed pursuant to 510(k) clearances.
19
After premarket clearance or approval has been obtained, manufacturers and
marketers of medical devices are subject to postmarket requirements. For
example, a manufacturer's quality control and manufacturing procedures and its
facilities must conform to FDA's Quality System Regulation, which governs, for
instance, design, manufacture, packaging, labeling, installation, and servicing.
Certain adverse events and product malfunctions must be reported to the FDA, and
product labeling and promotion must comply with FDA requirements. FDA
periodically inspects facilities to determine compliance with these
requirements.
We market Grafton(R) DBM as a human tissue-based product pursuant to an
August, 1995 designation from FDA. In March, 2002, FDA informed us that the
agency is changing the regulatory status of Grafton(R) DBM and will henceforth
regulate it as a medical device as well. We believe FDA's change in its position
regarding Grafton(R) DBM results from its decision to regulate all demineralized
bone with a carrier, including those processed and marketed by certain of our
competitors, as medical devices. We intend to try to persuade FDA that its
initial designation of Grafton(R) DBM as a human tissue-based product was and
still is correct. If we are unsuccessful in that effort, we will be required to
obtain a medical device approval or clearance, and to comply with medical device
postmarketing obligations. We believe that Grafton(R) DBM will be eligible for
510(k) clearance, but we cannot be sure that we will not be required to obtain
premarket approval, or that FDA will issue any clearance or approval in a timely
fashion, or at all. In its March letter regarding Grafton(R) DBM, FDA stated
that it intends to allow us a reasonable period of time to obtain clearance for
Grafton(R) DBM, and we will continue to process and distribute Grafton(R) DBM
during this period.
We also market Grafton Plus(TM) DBM as a human tissue-based product. FDA's
determination regarding Grafton(R) DBM is also likely to be applied to Grafton
Plus(TM) DBM. If FDA maintains its position that all demineralized bone with a
carrier is a medical device, we would also be required to obtain FDA clearance
or approval for Grafton Plus(TM) DBM, and to comply with other medical device
requirements for that product.
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 used in human
transplantation, including bone and related tissue, for "valuable
consideration." NOTA permits reasonable payments 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 make payments to certain of our
clients and TRO's for their services related to their recovering tissue on our
behalf.
The procurement of human tissue is also subject to state anatomical gift
acts and some states have statutes similar to NOTA. In addition, some states
require that tissue processors be licensed by the state. Failure to comply with
state laws could also result in enforcement action against us.
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
20
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.
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. Upon
receiving 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. 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 received ISO 9001 certification for its quality
systems used in the development and manufacture of ceramic products and ceramic
and titanium spray coatings.
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 marketed. We do not currently intend to
market these products in the United States; however, if we decide to do so,
these products would require premarket clearance by the FDA as medical devices.
Research and Development
During 2001, 2000, and 1999 we spent approximately $4,599,000, $5,772,000,
and $5,506,000, 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:
21
o autograft bone tissue;
o allograft bone tissue; and
o synthetic bone void fillers.
A fourth product category, growth factor products, is still in the
investigational stage. One such growth factor, Osteogenic Protein 1, or OP-1,
has recently received humanitarian device exemption status, or HDE status, from
the FDA for use as an alternative to autograft in long-bone nonunions where use
of autograft is unfeasible and alternative treatments have failed. In addition,
in January, 2002, the Orthopaedic Advisory Panel of the FDA recommended approval
of InFuse(TM), a combination of an absorbable collagen sponge and rhBMP-2. If
the FDA agrees and grants premarket approval, InFuse(TM) will be limited to use
in single level lumbar, anterior procedures with the LT(TM) Cage only.
We estimate that total domestic allograft bone tissue sales in 2001 was
$310 million, comprising approximately 60% of the U.S. bone graft market.
U.S. Bone Graft Market
2001
Specialty Graft Procedures(1) Allograft Market Size(1)
- --------- ------------------- ------------------------
Spinal Fusions 281,000
General Orthopaedics 215,000
Craniomaxillofacial 87,000
----------
Total 583,000
Average Selling Price(2) $ 894
Market Size (000) $521,000 $310,000 (59.5%)
(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
22
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 growth in recent years,
we estimate that allograft bone tissue sales have increased at a significantly
higher rate than the general bone graft market. 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:
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, allograft bone tissue processed by
others and synthetic bone void fillers. Autograft bone tissue has traditionally
been the primary choice for surgeons and we believe it still maintains an
approximate 40% 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
23
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 539,000
procedures through December 31, 2001. In February, 2002, we introduced Grafton
Plus(TM) DBM, which contains a carrier made from starch instead of glycerol.
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:
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.
In recent years, Grafton(R) DBM has faced increasing competitive pressures,
which we expect will continue in the future, as more companies have developed
products with characteristics similar to Grafton(R) DBM. Certain of these
competitors have, in turn, partnered with large orthopaedic and spine companies
to market the competitors' products. 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, which could give them a competitive advantage over us since
they can offer surgeons a more complete line of products then we currently can.
Grafton(R) DBM primarily competes with DBM products including:
DynaGraft(TM), manufactured and distributed by GenSci; Osteofil(TM), processed
by Regeneration Technologies, Inc. and distributed by Medtronic Sofomor Danek;
AlloMatrix(TM), manufactured and distributed by Wright Medical Technologies,
Inc.; and DBX(R), processed by MTF and distributed by Synthes Spine.
To counter this competition, we have expanded our line of Grafton(R) DBM in
order to offer the surgeon the ability to expand the type of procedures that DBM
grafting materials can be used in. Additionally, we introduced Grafton Plus(TM)
DBM in February, 2002, which offers improved handling characteristics. We have
also expanded our bio-implant line which Grafton(R) DBM is used with and also
expanded our line of metal spinal implant devices. When taken together, we are
now able to provide the spinal surgeon with the full range of products needed to
achieve the outcomes the surgeon is seeking for the patient.
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 only15% of the total bone
graft procedures performed in the U.S. during 2001. We estimate the potential
non-domestic bone graft market to be at least as large as that of the U.S.
market. The
24
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
2001
----------------------------------------------------
Grafton(R) DBM
----------------------------------------------------
Percent
Specialty Potential(1) Actual(2) Penetration
- --------- ------------ --------- -----------
Spinal Fusions 281,000 41,792 14.9%
General Orthopaedics 215,000 32,083 14.9%
Craniomaxillofacial 87,000 13,673 15.7%
-------- -------- -------
Total 583,000 87,548 15.0%
(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. 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 and through continued
technological advances. Our bio-implants face significant competition from
bio-implants processed by other tissue banks and processors such as MTF and
Regeneration Technologies, Inc. and which are marketed by companies such as
Medtronic Sofamor Danek and Synthes Spine which have larger marketing forces and
significantly greater resources then we have. Typically, weight-bearing tissues
are not osteoinductive. In late 2001, we introduced our OsteoActive(TM) surface
treatment of weight-bearing bone tissue. Application of this process to
weight-bearing tissue allows the surface of the tissue to become osteoinductive,
allowing for faster incorporation of the tissue into a patient's own bone,
thereby aiding the process of spinal fusions. We also introduced our non-frozen
version of weight-bearing tissue which allows these grafts to be stored on the
shelf instead of in freezers and for the surgeon to be more precise in selecting
the grafts he will use in a procedure, thus reducing the number of grafts a
hospital must order. Once we are able to use our new Plexus processing
technology on a commercial basis, of which there can be no assurance, it should
allow us to utilize more of the available allograft bone tissue in the future
for weight-bearing grafts, thus increasing the availability of such grafts. All
of these innovations will continue to differentiate Osteotech processed bone
from our competitors and, we believe, increase the demand for our processed
tissue in the future.
In this segment, we process both our base allograft bone tissue and
bio-implants. In December, 1998, we introduced the bio-d(R) Threaded Cortical
Bone Dowel for posterior and anterior spinal fusion
25
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. The Graftech(TM) Bio-implant tissue forms became available
nationally over the course of 2001. We market these bio-implants and, currently,
our clients generally distribute them. However, we have also begun to directly
distribute bio-implants and, in the future, expect a significant portion of the
bio-implants we process to be distributed in this manner.
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 continue to 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, workshops and the
internet.
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
26
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.
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 waste
and/or hazardous waste under regulations promulgated by the United States
Environmental Protection Agency and the New Jersey Department of Environmental
Protection. We segregate our waste materials and dispose of them through a
licensed hazardous waste transporter in compliance with applicable regulations.
In our facility in Clarmont-Ferrand, France, we segregate both bovine and human
tissue waste and dispose of it in a manner specified by the appropriate
regulatory authorities responsible for environmental matters in France. 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 March 22, 2002, we held an aggregate of 114 United States patents and
patent applications and 200 foreign patent and patent applications consisting
of: (i) 40 United States patents and 25 foreign patents relating to our aseptic
processing technology and our transplant support products, including 16 United
States Grafton(R) DBM patents and 6 foreign Grafton(R) DBM patents, (ii) 6
United States and 41 foreign patents relating to our biomaterials technology,
(iii) 50 United States and 117 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 10 foreign patent applications relating to
our biomaterials technology and (vi) 13 United States patent applications and 7
foreign patent applications relating to instrumentation. We believe that our
Grafton(R) DBM patents are significant in maintaining our competitive position.
These patents expire
27
on various dates ranging from 2009 to 2020. Our other patents expire at various
dates ranging from 2007 to 2020.
We can not assure you 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 three
patent-related lawsuits. See Item 3. "Legal Proceedings."
28
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 $70
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. We have had product liability claims asserted against us
in two pending lawsuits. See Item 3 "Legal Proceedings."
Employees
At December 31, 2001, we had 365 employees, of whom 214 were engaged in
allograft bone tissue processing, ceramic plasma spray coating and the
manufacture of products; 30 were engaged in research and development; 57 were
engaged in education, sales and marketing; and 64 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 an approximately 38,000
square foot building 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. Once we complete
the move of our processing operations into our new facility, discussed below, we
intend to use this facility for certain processing and as backup to our new
processing facility, as a pilot plant and for research and development. 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.
29
In 1997, we purchased land adjacent to our Eatontown, New Jersey facility.
We are currently completing the construction and validation of a new 74,000
square foot processing facility built on this land, which will be utilized by
the Grafton(R) DBM and Base Tissue Segments. We began occupying this facility in
the first quarter of 2002 and expect to fully occupy it by June, 2002. We have
financed the construction of this facility with a $4.5 million mortgage loan and
a $17 million equipment line of credit from our bank, which is secured, in part,
by the equipment purchased with the proceeds from this loan facility and through
our cash reserves and cash generated by operations. This facility is held by us
subject to a mortgage which secures the $4.5 million mortgage loan, our
equipment line of credit and a $5 million revolving line of credit with our
bank.
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 284,000 euros
(approximately $253,000 at the December 31, 2001 exchange rate). We are
subleasing 6,400 square feet of this facility to an unrelated third party at an
annual rent of 100,000 euros (approximately $95,000 at the December 31, 2001
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, 2005 and
has an annual rent of 85,000 Euros (approximately $76,000 at the December 31,
2001 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. OST also occupies a 3,100 square foot facility
which it utilizes for administrative purposes at an annual rental of 29,000
Euros (approximately $26,000). The lease on this facility expires in December,
2009.
Item 3. Legal Proceedings
GenSci Regeneration Laboratories, Inc. v. Osteotech, Inc.; Osteotech, Inc. v.
GenSci Regeneration Sciences, Inc.
In January, 1998, we 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 our 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 (the "655 Patent") and 5,290,558 (the "558 Patent") 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
30
the United States District Court for the Central District of California. In
April, 2000, GenSci Labs and GenSci Sciences agreed to dismiss with prejudice
all of GenSci's patent infringement claims against us. Between September, 1998
and September, 2001, there were numerous amendments to the complaints of both
parties and both parties filed numerous motions with the Court.
On October 31, 2001, the trial commenced in the United States District
Court for the Central District of California. In November, 2001, the jury
returned a verdict that the 558 Patent and the 655 Patent are valid and that
GenSci infringed on both patents through their sales of DynaGraft(TM) Gel and
Putty products. In arriving at its verdict, the jury rejected all of GenSci's
defenses.
In December, 2001, we were awarded damages in the amount of $17,533,634 for
GenSci's infringement of our patents. This damage award will be reduced by the
$3.0 million previously paid by DePuy in settlement of our claims against DePuy
in this lawsuit. On December 21, 2001, GenSci filed for bankruptcy protection
under Chapter 11 of the U.S. Bankruptcy Code.
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 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 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 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 pending completion of the trial of our patent
infringement case against GenSci. This case has remained stayed.
We believe the claims made in this lawsuit are without merit and intend to
vigorously defend against these claims.
31
Osteotech, Inc. v. GenSci Orthobiologics, Inc.
On October 25, 2000, we 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 our U.S. Patent No. 5,290,558 and infringe
the re-examined claims of our U.S. Patent No. 5,676,146. Our complaint seeks
injunctive relief, treble damages, costs and attorneys' fees.
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.
We intend to pursue our claims against GenSci and vigorously defend against
the counterclaims.
"O" Company, Inc. v. Osteotech, Inc.
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 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. As a result, the motion remains pending.
We believe that the claims made against us 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 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, 4,950,296 and 6,096,081. The plaintiffs
have sought injunctive relief and monetary damages of approximately $1.5
million. In May, 1999, we filed our answer and counterclaim
32
seeking declaratory judgment that the patents in question in this action are
invalid and otherwise not infringed by us.
Trial in this action is currently scheduled for September, 2002.
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
will continue to vigorously defend against such claims.
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 us in the United States
District Court for the Western District of Tennessee alleging that certain
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, 5,484,437 and 6,096,038 which are owned by Danek. In
addition to injunctive relief, the plaintiffs seek monetary damages of $2.5
million. We filed our answer and counterclaims seeking a declaratory judgement
that the patents in question in this action are invalid and otherwise not
infringed by us.
Currently pending before the Court are both parties' motions for summary
judgement. Trial in this matter has been scheduled for April, 2002.
We believe that the claims made against us in this action are without merit
and will continue to vigorously defend against such claims.
Regner v. Inland Eye & Tissue Bank of Redlands; Thacker v. Inland Eye & Tissue
Bank of Redlands
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. Through dismissals,
either by the Court or voluntarily by plaintiffs, only the California Business
and Professional Code claims, which are based on allegations that defendants are
engaging in the activity of buying or selling organs or tissue for valuable
consideration or profit, and negligence claims remain. It appears that the
plaintiff is seeking only injunctive relief with respect to their California
Business and Professional Code claims. 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.
Defendants, including us, have filed demurrers seeking dismissal of the
negligence claims. A hearing on those demurrers was scheduled for February 21,
2002. The Court granted the demurrer with respect to the negligence claim
asserted in the Thacker action. Additionally, the Court indicated that the
actions will be combined and treated as a single action.
33
We deny that we are 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 will vigorously defend
against the claims.
Condos v. Musculoskeletal Transplant Foundation
In July, 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 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. Condo's 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.
In January, 2002, plaintiffs amended their complaint, but no new claims
were asserted. In February, 2002, we moved for summary judgement in our favor on
all claims asserted against us. MTF has sought the same relief. Both motions
remain pending.
We maintain a general liability insurance policy and have notified the
insurance company of this action. We believe the claims made against us in this
action are without merit and will vigorously defend against the claims. The
insurance company has agreed to defend the action.
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 us seeking a declaratory judgment that
MTF, through its manufacture, use, sale and/or offer for sale of demineralized
bone matrix products, known as DBX(R), 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. ("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 in developing and selling MTF's DBX(R)
products and/or its underlying technology.
In June, 2001, we made a motion for an order preliminarily enjoining MTF
and Synthes from selling or offering to sell their DBX(R) products. A hearing
was held on that motion on July 23, 2001. On September 18, 2001, the Court
denied that motion. Discovery is otherwise continuing in this case.
34
We are seeking injunctive relief and monetary damages in an amount to be
determined. MTF and Synthes have denied any liability. We believe that the
claims made against us in this action are without merit and will vigorously
defend against the claims, and will vigorously pursue our claims against MTF and
Synthes.
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 us. In January, 2002, we settled all claims
pending against us in this case for an insignificant amount. The Court dismissed
us from this case in February, 2002.
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 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.
In March, 2001, we answered the complaint, denying any and all liability.
In January, 2002, the Court dismissed plaintiff's claim for misappropriation of
trade secrets. In February, 2002, the parties agreed to submit this matter to
mediation, which proved to be unsuccessful.
We answered the complaint denying any and all liability and intend to
vigorously defend against all claims.
Medtronic, Inc. v. Osteotech, Inc.
In February, 2001, Medtronic, Inc. and Medtronic Sofamor Danek, Inc.
(collectively, "Medtronic") brought suit against us and Medtronic's former
employee, Timothy R. Miller, in the Circuit Court for Shelby County, Tennessee.
The plaintiff sought to enjoin Mr. Miller, whom we had 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
On April 25, 2001, the Court lifted a temporary restraining order
preventing Mr. Miller from working with us and entered an order preliminarily
enjoining Mr. Miller from working with us in the area of spine surgery products.
In November, 2001, the parties settled this matter and the Court dismissed this
action.
35
Younger v. Hayes Medical Center, Inc.
In April, 2001, we were served in an action brought in the Twentieth
Judicial District Court in Ellis County, Kansas, against Hayes Medical Center,
Inc., the Musculoskeletal Transplant Foundation, Metropath, Inc. and us. With
respect to us, the suit alleges a cause of action for negligence in connection
with allegedly defective allograft bone tissue provided by the defendants and
allegedly implanted in the plaintiff during a surgical procedure. The plaintiff
seeks monetary damages in excess of $75,000.
In May, 2001, we answered the complaint denying any and all liability.
Discovery in this action has commenced.
We maintain a general liability insurance policy and have notified the
insurance company of this action. We believe the claims made against us in this
action are without merit and will vigorously defend against the claims. The
insurance company has agreed to defend the action.
Wright Medical Technology, Inc. v. Osteotech, Inc.
In June, 2001, we received a complaint filed by Wright Medical
Technologies, Inc. in an action in the United States District Court for New
Jersey, which alleges against us claims for false advertising, and tortious
interference with business relations and prospective business advantage relating
to certain statements allegedly made by us regarding a FDA Warning Letter
received by the plaintiff with respect to a tissue product marketed by the
plaintiff. In addition to injunctive relief, plaintiff seeks monetary damages in
an unspecified amount. On June 15, 2001, the Court granted plaintiffs a
temporary restraining order against us. On June 20, 2001, we obtained a stay of
that order from the United States Court of Appeals for the Third Circuit,
pending an appeal of that order. On June 29, 2001, the District Court issued an
order granting plaintiffs' motion for a preliminary injunction, and amended the
order on July 2, 2001, enjoining us from making the accused statements and
requiring us to issue a clarification of such statements. We issued a corrective
statement in a timely fashion and have appealed the District Court's order to
the Third Circuit Court of Appeals. That appeal is pending.
On October 22, 2001, we received an amended complaint in this action,
wherein plaintiffs named as additional defendants unidentified "Roe" parties and
alleged further misconduct on our part giving rise to the claims described
therein. We deny any and all liability. Discovery in this action has commenced.
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.
36
Item 4. Submissions of Matters to a Vote of Security Holders
None.
37
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, 2001
and 2000 based on transaction data as reported by the Nasdaq Stock Market(R).
Year Ended December 31, 2001 High Low
- ---------------------------------------------------------------------------
First Quarter $7.44 $4.50
Second Quarter $6.00 $4.00
Third Quarter $5.20 $2.13
Fourth Quarter $6.35 $2.91
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
As of March 15, 2002, there were 325 holders of record of Osteotech Common
Stock. We believe that there are approximately 5,400 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. Our loan agreement with our bank prohibits us from paying any
cash dividend without the written consent of the bank.
38
Item 6. Selected Financial Data
Set forth below is the selected financial data for the five fiscal years
ended December 31, 2001. 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 we effected in
March, 1999.
- -------------------------------------------------------------------------------------------------------
Selected Financial Data
(dollars in thousands except per share
data)
For the Year ended December 31, 2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------------------
Consolidated Results of Operations
- -------------------------------------------------------------------------------------------------------
Net revenues $ 77,846 $ 75,683 $ 75,610 $ 59,201 $ 44,931
- -------------------------------------------------------------------------------------------------------
Gross profit 43,498 48,172 51,701 41,562 29,096
- -------------------------------------------------------------------------------------------------------
Operating expenses 50,134 41,317 33,849 25,281 20,109
- -------------------------------------------------------------------------------------------------------
Income from litigation settlement 0 1,000 2,000 0 0
- -------------------------------------------------------------------------------------------------------
Operating Income (loss) (6,636) 7,855 19,852 16,281 8,987
- -------------------------------------------------------------------------------------------------------
Other income, net 128 1,047 1,032 1,132 585
- -------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (6,508) 8,902 20,884 17,413 9,572
- -------------------------------------------------------------------------------------------------------
Net income (loss) (4,410) 4,828 12,351 10,304 5,686
- -------------------------------------------------------------------------------------------------------
Net income (loss) per share
- -------------------------------------------------------------------------------------------------------
Basic (.31) .34 .88 .78 .46
- -------------------------------------------------------------------------------------------------------
Diluted (.31) .34 .84 .73 .43
- -------------------------------------------------------------------------------------------------------
Dividends per share 0 0 0 0 0
- -------------------------------------------------------------------------------------------------------
Year End Financial Position
- -------------------------------------------------------------------------------------------------------
Working capital $ 24,439 $ 29,123 $ 37,082 $ 26,373 $ 19,922
- -------------------------------------------------------------------------------------------------------
Total assets 107,244 104,438 89,730 57,114 43,052
- -------------------------------------------------------------------------------------------------------
Long-term obligations, net of current
portion 18,683 19,930 6,359 0 203
- -------------------------------------------------------------------------------------------------------
Stockholders' equity 67,786 71,851 69,406 45,930 34,292
- -------------------------------------------------------------------------------------------------------
39
Item 7. Management's Discussion And Analysis Of Financial
Condition And Results Of Operations
For the Three Years Ended December 31, 2001, 2000, and 1999
Results of Operations
Overview
We provide services and products primarily focused in the repair and
healing of the musculoskeletal system. 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. Historically, we have
provided services and technology associated with making human tissue safe for
transplantation. We also develop and process new forms of tissue for use in a
variety of surgical procedures. While we perform the medical education to teach
surgeons about the uses of these tissue forms, the tissue forms are generally
distributed to hospitals by our tissue bank clients. See below for a discussion
of an additional method we are utilizing to generate tissue processing revenues.
For the years ended December 31, 2000 and 1999, 93% and 94%, respectively, of
our consolidated revenues were generated from these tissue service activities.
Commencing in the first half of 2001, and expanding in the second half, we
began to distribute tissue forms directly to hospitals. We expect to continue to
expand our direct distribution efforts to hospitals in 2002 and beyond. As a
result, we expect that revenues from direct distribution of tissue will continue
to grow over the next several years. In turn, beginning in late 2002, this
should have a positive impact on our gross profit margins and operating income
because although we will incur recovery costs in connection with tissue we
distribute directly, we will not share a portion of the invoice price on these
tissue forms with our tissue bank clients as we do with the tissue that we
process for them, but they distribute. For the year ended December 31, 2001, 80%
of our consolidated revenues were generated from processing tissue that our
tissue bank clients distributed.
This change in distribution methodology has impacted our liquidity and cash
flow. We have had to make additional investments in inventories and deferred
processing costs to support our direct distribution efforts, and expect to make
additional investments in inventory and deferred processing costs, as necessary,
to support our efforts to expand direct distribution. In addition, our days
sales in accounts receivable have increased from 65 days in 2000 to 71 days in
2001, primarily as a result of the change in our customer mix resulting from our
direct distribution efforts. As a greater percentage of our revenues are
generated from direct shipments to hospitals and other healthcare providers,
which typically pay invoices slower than our historical tissue bank customer
base, we expect that our days sales in accounts receivable will remain at 2001
levels or increase slightly.
40
For the year ended December 31, 2001, we experienced a substantial decrease
in available cash and cash equivalents due to our continued investments in our
business. We expect to continue to make investments in our business to support
our direct distribution efforts and future programs and initiatives, which may
further deplete our available cash balances. We believe that our available cash
and cash equivalents, available lines of credit and anticipated future cash flow
from operations will be sufficient to meet our forecasted cash needs in 2002.
However, we intend to seek additional funding to meet the needs of our long-term
strategic plan and to re-build cash reserves. There can be no assurance that
such additional funds will be available, or if available, that such funds will
be available on favorable terms.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgements that effect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On a continual basis, we evaluate our estimates and may adjust
them based upon the latest information available to us. These estimates
generally include those related to product returns, bad debts, inventories,
deferred processing costs, intangible assets, income taxes and contingencies and
litigation. We base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgements about the carrying value
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates.
We believe the following critical accounting policies affect our more
significant judgements and estimates used in the preparation of our consolidated
financial statements.
o We maintain allowances for doubtful accounts primarily for our direct
distribution accounts for estimated losses resulting from the
inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances
may be required.
o We record reductions to revenue for estimated product and allograft
tissue forms returns based upon historical experience. If future
returns are less than our historical experience, a reduction in
estimated reserves would increase revenue. Alternatively, should
returns exceed historical experience, additional allowances would be
required, which would reduce revenue.
o We write down inventory and deferred processing costs for estimated
obsolescence or unmarketable products and allograft tissue forms equal
to the difference between cost and the estimated market value based
upon assumptions about future demand and market conditions.
Obsolescence could occur from numerous factors, including, but not
limited to, the competitive nature of the market, technological change
and changes in surgeon preference. If actual market conditions are
less favorable than those projected by management, additional
write-downs may be required.
41
o We depreciate/amortize our property, plant and equipment based upon
our estimate of the respective asset's useful life. In addition, we
evaluate impairments of our property, plant and equipment based upon
an analysis of estimated undiscounted future cash flows. If the
Company determines that a change is required in the useful life of an
asset, future depreciation/amortization is adjusted accordingly.
Alternatively, should we determine that an asset has been impaired, an
adjustment would be charged to income based on its fair market value,
or discounted cash flows if the fair market value is not readily
determinable, reducing income in that period.
o We record a valuation allowance to reduce our deferred tax assets to
the amount that is more likely than not to be realized. While we have
considered future taxable income, in the event we were to determine
that we would be able to realize our deferred tax assets in the future
in excess of our net recorded amount, an adjustment to the deferred
tax asset would increase income in the period such determination was
made. Likewise, should we determine that we would not be able to
realize all or part of our net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in the
period such determination was made.
o We accrue current and future tax liabilities based upon levels of
taxable income, tax planning strategies and assessments of the timing
of taxability of tax attributes. While we have considered current tax
laws in establishing our tax liabilities, in the event we were to
settle our tax liabilities for less than amounts accrued we would
increase income in the period such determination was made. Should we
determine it would cost us more to settle our tax liabilities, an
adjustment would be charged to income thus reducing income in that
period.
Net Income (Loss)
We incurred a consolidated net loss in 2001 of $4,410,000 or $.31 diluted
loss per share compared to net income of $4,828,000 or $.34 diluted income per
share in 2000 and $12,351,000 or $.84 diluted income per share in 1999. The net
loss in 2001 includes, before income tax benefit: (i) a provision of $1,845,000
primarily related to provisions for excess inventory and instrument sets for
spinal implant systems; (ii) a provision of $2,287,000 for equipment which will
no longer be utilized in the processing of allograft tissue; and (iii) a
provision of $700,000 primarily for severance costs associated with the
departure of an executive officer. 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 AcroMed, Inc. ("DePuy"). Consolidated loss before income
taxes was $6,508,000 in 2001 compared to income before taxes of $8,902,000 in
2000 and $20,884,000 in 1999. 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, 2001, 2000, and 1999.
42
Net Revenues
Consolidated net revenues increased 3% in 2001 to $77,846,000, compared to
consolidated revenues of $75,683,000 in 2000. The increase in 2001 was
principally due to higher revenues in bio-implants and product lines included in
other revenues mainly as a result of increased volume, partially offset by a
decrease in Grafton(R) DBM revenues as a result of reduced unit sales volume and
a decrease in base tissue processing revenues as a result of processing 33%
fewer donors in 2001 compared to 2000. Domestic net revenues increased slightly
in 2001 to $71,776,000 from $71,468,000 in 2000. Foreign-based revenues
increased 44% to $6,070,000 in 2001 from $4,215,000 in 2000. The increase in
foreign-based revenues was primarily as a result of increased unit sales volume
in all product lines. Consolidated net revenues in 2000 were $75,683,000 as
compared to $75,610,000 in 1999. Domestic net revenues, were $71,468,000 in 2000
as compared to $71,517,000 in 1999. Revenues from bio-implants increased in 2000
due to increased unit sales volume offsetting a decline in base allograft tissue
processing revenues, which resulted from a 16% decline in the number of donors
processed, and a decline in domestic Grafton(R) DBM revenues as a result of
lower unit volume. 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 an increase in OsteoPure(TM) Femoral head processing revenue
offset decreased revenues from bovine tissue sales and ceramic and titanium
coating services.
Grafton(R) Demineralized Bone Matrix ("DBM") Segment, or Grafton(R) DBM
Segment, revenues were $43,637,000 in 2001, a decrease of 4% from revenues of
$45,226,000 in 2000. Foreign-based Grafton(R) DBM Segment revenues increased
119% in 2001 to $1,954,000 from $891,000 in 2000, principally due to an increase
in unit sales volume. Domestic Grafton(R) DBM Segment revenues decreased
$2,652,000 or 6% to $41,683,000 in 2001. Domestic Grafton(R) DBM Segment
revenues were negatively impacted by a decrease in unit sales volume as a result
of increased competition. In 2001, Grafton(R) DBM faced, and we expect it will
continue to face, increasing competition as more companies develop and market
products with characteristics similar to Grafton(R) DBM.
Base Tissue Segment revenues increased 6% to $27,692,000 in 2001 from
$26,204,000 in 2000. The increase is principally the result of a 225% increase
in bio-implant revenues and a 29% increase in OsteoPure(TM) Femoral head
processing revenues, partially offset by a 31% decrease in base tissue
processing revenues resulting from a 33% decline in donors processed for our
clients. The increase in bio-implant revenues is principally due to increased
unit volume and the ability to charge higher unit sale prices as a result of our
direct distribution of some of those units to hospitals.
Revenue from other product lines increased 53% in 2001 to $6,517,000 from
$4,253,000 in 2000. The increase principally resulted from improved volume in
spinal metal implant systems, coatings, ceramic products and bovine products.
Metal spinal implant systems accounted for 65% and coating revenues accounted
for 16% of the overall increase in other revenues.
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 effected by
the introduction of Grafton(R) DBM
43
in Europe, which offset a 2% decrease in domestic revenues. In 2000, Grafton(R)
DBM revenues were adversely impacted by increased competition. 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
revenues. 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.
During 2001, 2000, and 1999, two of our clients, MTF and ARC, in the
Grafton(R) DBM and Base Tissue Segments together accounted for 75%, 90%, and 94%
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 us or MTF
upon six months prior written notice, which has not been given by either party
as of the date of this report.
Gross Profit
Gross profit as a percentage of net revenues was 56% in 2001, 64% in 2000,
and 68% in 1999. The decline in gross profit as a percentage of revenues in 2001
compared to 2000 principally resulted from: (i) our direct distribution efforts
which reduced gross profit margin by two percentage points in 2001 as a result
of incurring additional costs equivalent to the incremental revenue we are
recognizing from these efforts; (ii) the underabsorption of fixed costs due to
increased capacity as a result of our new processing facility and a 33% decline
in the number of donors processed, costs associated with implementation of new
processing technologies, and bio-implant and metal spinal implant product lines
that have not yet achieved revenue levels sufficient to fully absorb production
costs; (iii) a decline in base tissue processing revenue as a result of a 33%
decline in the number of donors processed; (iv) charges for excess metal spinal
implant inventory of $655,000; and (v) a $2,287,000 charge for equipment which
will no longer be utilized in our processing of allograft tissue.
We expect that as our direct distribution efforts continue to expand and we
incur the incremental costs and expenses, including depreciation, related to our
new allograft tissue processing facility, gross profit margin will decline
slightly in 2002 from the level achieved in 2001. Beginning in late 2002, our
direct distribution efforts should have a positive impact on our gross profit
margins because although we will incur recovery costs in connection with tissue
we distribute directly, we will not share a portion of the invoice price with
our tissue bank clients as we do with tissue that we process for them which they
distribute. In addition, we have implemented programs to improve gross profit
margin through cost cutting initiatives, efficiency gains and reductions in the
cost of materials. However, we cannot provide any assurance that any of these
programs will be successful.
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 had not yet achieved revenue
levels sufficient to fully absorb production costs while they are in launch
mode.
44
Marketing, Selling, General and Administrative Expenses
Marketing, selling, general and administrative expenses increased 28% in
2001 to $45,535,000 from $35,545,000 in 2000. In 2000, marketing, selling,
general and administrative expenses were 25% higher than 1999 expenses of
$28,343,000. The increase in 2001 relates mainly to: (i) activities to secure
additional sources of donated allograft tissue resulting in expenditures of
$2,714,000, which included provisions related to our funding of the American
Tissue Services Foundation; (ii) increased legal fees in connection with various
lawsuits to which we are a party, including the GenSci patent litigation
lawsuit, see Part I, Item 3, "Legal Proceedings" and Note 11 of "Notes to
Consolidated Financial Statements"; (iii) increased costs related to marketing,
selling and promotional activities associated with Grafton(R) DBM and the new
bio-implant tissue forms; (iv) a provision of $1,190,000 for excess instrument
sets associated with spinal implant systems; and (v) a $700,000 provision for
severance costs related primarily to the departure of an executive officer. In
2001 and 2000, we expended $4,158,000 and $4,185,000, respectively, for the
prosecution of our patents and resulting trial in the GenSci patent litigation.
The increase in 2000 over 1999 is primarily due to increases in 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.
We are committed to aggressively asserting and defending our technology and
related intellectual property. As a result we are currently involved in three
patent lawsuits. Prosecuting and defending these lawsuits is expensive and has
had, and will likely have, a negative impact on our future operating results,
although we anticipate 2002 expenditures for these activities to be
significantly less than in the previous year. However, we believe it is
necessary to defend our technology and related intellectual property in which we
have invested and continue to invest significant amounts of money to develop.
Research and Development Expenses
Consolidated research and development expenses decreased 20% in 2001 to
$4,599,000 from $5,772,000 in 2000. Research and development expenses in 2000
were 5% higher than 1999 research and development expenses of $5,506,000. The
decrease in 2001 was primarily related to the completion of development of
bio-implant tissue forms which were launched in 2001 and the completion of new
processing technology and packaging, which were implemented in 2001. The
increase in 2000 was 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 bio-implant tissue forms, and ongoing support
for existing products and services.
45
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 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 $250,000 in each
quarter of 2000 and a payment of $2,000,000 in the fourth quarter of 1999.
Operating Income (Loss)
We incurred a consolidated operating loss in 2001 of $6,636,000 compared to
consolidated operating income of $7,855,000 in 2000. Grafton(R) DBM Segment
operating income decreased 38% in 2001 to $7,014,000 from $11,389,000 in 2000.
The decrease results principally from: (i) increased costs associated with
marketing, selling and promotional activities; (ii) increased legal fees; (iii)
reduced revenue levels; and (iv) a decrease in patent litigation settlement
payments of $1,000,000. We incurred an operating loss in the Base Tissue Segment
of $7,979,000 in 2001 compared to operating income of $694,000 in 2000. The
operating loss principally resulted from lower: (i) gross margins due to our
direct distribution activities, (ii) a decline in donor processing revenue,
(iii) the underabsorption of processing costs, (iv) increased legal fees, (v)
provisions for excess instrument sets and equipment which will no longer be
utilized in our production process, and (vi) increased costs for marketing,
selling and promotional activities primarily associated with bio-implants.
Operating losses associated with other revenues were $5,671,000 and $4,228,000
in 2001 and 2000, respectively. The operating loss in 2001 increased over the
operating loss in 2000 principally as a result of provisions for excess
inventory and instrumentation for metal spinal implant systems and reserves for
our funding of the American Tissue Services Foundation.
Consolidated operating income decreased 60% in 2000 to $7,855,000 from
$19,852,000 in 1999 primarily as a result of declines in operating income in the
Grafton(R) DBM Segment and Base Tissue Segments. Grafton(R) DBM Segment
operating income decreased 33% in 2000 to $11,389,000 from $17,063,000 in 1999
primarily due to: (i) lower gross margins due to underabsorption of costs, (ii)
increased legal fees associated with patent lawsuits, (iii) increased costs
associated with marketing, (iv) selling and promotional activities, (v) and a
decrease of $1,000,000 in patent litigation settlement payments. Base Tissue
Segment operating income decreased 89% in 2000 to $694,000 from $6,434,000 in
1999 principally as a result of: (i) lower gross margins due to underabsorption
of costs, (ii) increased legal fees associated with patent lawsuits, and (iii)
increased costs associated with marketing, selling and promotional activities,
especially with respect to new bio-implant tissue forms. Operating income
associated with other revenues declined 16% in 2000 to a loss of $4,228,000 from
a loss of $3,645,000 in 1999.
Other Income (Expense)
In 2001, other income decreased $919,000 to $128,000 from $1,047,000 in
2000. The decrease was principally due to lower interest income as a result of a
decline in interest rates and lower
46
average cash balances available for investment and interest expense on our
long-term debt. Prior to 2001, the majority of our interest costs were
capitalized in connection with the construction of our new allograft tissue
processing facility. In late 2001, we began to charge such interest costs to
earnings since the facility was substantially complete. In 2002, interest
expense will continue to increase as we recognize a full year of interest
expense on our long-term debt and due to increases in our interest rates. See
discussion of the Amendment to our Credit Facility in "Liquidity and Capital
Resources" and Note 9 of "Notes to Consolidated Financial Statements". In 2000,
other income increased $15,000 to $1,047,000.
Income Tax Provision
In 2001, we provided a benefit for income taxes on our domestic losses due
to our ability to carryback and carryforward these losses. No income tax benefit
has been recorded for foreign losses, principally as a result of the uncertainty
of realization of such future tax benefits. Our effective income tax rate in
2000 was 46% and 41% in 1999. 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, 2001 we had cash and short-term investments of $5,192,000
compared to $12,858,000 at December 31, 2000. We invest excess cash in U.S.
Government-backed securities and investment grade commercial paper of major U.S.
corporations. Working capital decreased $4,684,000 to $24,439,000 at December
31, 2001 compared to $29,123,000 at December 31, 2000. The decrease resulted
primarily from utilization of cash and short-term investments to fund capital
expenditures, including construction of the new allograft tissue processing
facility, other production equipment and instruments for spinal implant systems.
Net cash used in operating activities was $2,019,000 in 2001 compared to
net cash provided by operating activities of $10,175,000 in 2000. The decrease
resulted primarily from the net loss incurred in 2001 compared to net income in
2000, investments in accounts receivable, inventories and deferred processing
costs to support our direct distribution efforts, partially offset by increased
non-cash charges, principally depreciation and amortization. Beginning in 2001,
we began to distribute tissue forms directly to surgeons and hospitals. This
change in distribution methodology has impacted our liquidity and cash flow. We
have had to make additional investments in inventories and deferred processing
costs to support our direct sales efforts, and expect to make additional
investments in inventory and deferred processing costs, as necessary, to support
our efforts to expand direct distribution. In addition, our days sales in
accounts receivable have increased from 65 days in 2000 to 71 days in 2001,
primarily as a result of the change in our customer mix resulting from our
direct distribution efforts. As a greater percentage of our revenues are
generated from direct shipments to hospitals and other healthcare providers,
which typically pay billings slower than our historical tissue bank customer
base, we expect that our days sales in accounts receivable will remain at 2001
levels or increase slightly.
47
Cash used in investing activities decreased to $5,360,000 in 2001 from
$27,128,000 in 2000. The decrease is principally due to a decrease in capital
expenditures to $8,955,000 in 2001 from $28,343,000 in 2000, due to reduced
spending on the construction of our new allograft tissue processing facility,
partially offset by proceeds from the sale of land of $1,500,000. 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." Through December 31, 2001, we incurred
$37,922,000 of capital expenditures, including capitalized interest of
$1,769,000, related to the new allograft tissue processing facility, of which
$19,352,000 has been funded through bank financing.
Net cash provided by financing activities in 2001 decreased to $1,627,000
from $11,271,000 in 2000. In 2001, we borrowed the remaining funds of $1,468,000
available under the equipment line of credit, while in 2000 we borrowed
$13,672,000 under our equipment line of credit. In September, 2001, our
equipment line of credit converted to an equipment term loan pursuant to the
provisions of the credit agreement.
We have a Credit Facility with a U.S. bank that includes: a $5,000,000
revolving line of credit, a building mortgage loan and an equipment term loan.
At December 31, 2001, there were no borrowings under the revolving line of
credit, $4,415,000 was outstanding under the building mortgage loan and
$16,798,000 was outstanding under the equipment term loan. In March, 2002, the
Credit Facility was amended, and among other things, the $5,000,000 revolving
line of credit, which was originally due to expire May 31, 2002, was extended to
April 30, 2004. In addition, the amendment to the Credit Facility establishes a
variable interest rate on all parts of the Credit Facility that changes the
interest rate to range from prime minus .25% to prime plus 1.50%, or from the
London Interbank Offered Rate ("LIBOR") plus 2.25% to LIBOR plus 4.0%, based
upon a leverage ratio as defined. Under the terms of the amendment, the new
interest rate, which initially is retroactive to January 1, 2002 and is
effective through November 14, 2002, is prime plus 1.50% or LIBOR plus 4.0%,
whichever we choose. Thereafter, the interest rate will be in the range
described above. In certain circumstances, as defined in the amendment, the
interest rate on the Credit Facility may increase up to an additional .35%.
The Credit Facility, as detailed in the amendment, is collateralized by
domestic accounts receivable, domestic inventory, the new allograft tissue
processing facility, including all equipment and improvements therein and a
pledge of 65% of our ownership in our foreign subsidiaries. The amendment
imposes on us certain restrictive operating and financial covenants. The
amendment established additional covenants including a restriction on our paying
cash dividends, a restriction on our incurring or maintaining additional
indebtedness, a restriction on our selling of assets or engaging in mergers or
acquisitions and limitations on our ability to make cash advances to our foreign
operations or investments. The amendment also resets the interest coverage
ratio, which we did not comply with for the year ended December 31, 2001, but
the bank permanently waived such non-compliance. The amendment also includes
subjective acceleration provisions. Such provisions are based upon, in the
reasonable opinion of the bank, the occurrence of any adverse or material change
in the condition or affairs, financial or otherwise, of our business, which
impairs the interests of the bank. The bank has the right to approve, in
advance, the form and substance of any equity capital transaction, except for a
common stock transaction resulting in the
48
issuance of less than 20% of our total issued and outstanding capital stock as
of the date of such transaction.
Failure to comply with any of these restrictions could result in a default
under this loan facility. Following a default, the bank may determine not to
make any additional financing available under the revolving line of credit,
could accelerate the indebtedness under the revolving credit facility, the
equipment loan and/or the mortgage, and could foreclose on the real and personal
property securing the loans.
At December 31, 2001, certain of our foreign-based subsidiaries have net
operating loss carryforwards aggregating $5,818,000 ($525,000 with no expiration
date; $5,293,000 expiring 2004 through 2009). We have not recognized any benefit
from these net operating loss carryforwards in the consolidated financial
statements because realization of the future tax benefits is uncertain. See Note
10 of "Notes to Consolidated Financial Statements."
In February, 2001, we entered into a distribution agreement to market a
pedicle screw system and a cervical plating system. This agreement requires us
to make minimum purchase commitments of $6,000,000 over the two-year period
beginning on February 1, 2002. In 2001, we purchased $3,046,000 of inventory in
advance of the beginning of the two-year commitment. We expect to purchase the
remaining balance of $2,954,000 in 2002 and 2003.
In February, 2001, we entered into a Loan Agreement with the American
Tissue Services Foundation, or ATSF, a not-for-profit tissue recovery
organization, which expires in December, 2010. Pursuant to the Loan Agreement,
ATSF has borrowed $2,208,000 from us as of December 31, 2001 to fund its
operations. In February, 2002, we amended the Loan Agreement to allow ATSF to
borrow up to an aggregate of $2,750,000. Based upon our discussions with
management of ATSF, we expect that ATSF will borrow approximately $250,000 in
2002. We have entered into a fifteen-year processing and distribution agreement
with ATSF effective December 7, 2000. Michael J. Jeffries, our Executive Vice
President and Chief Financial Officer, is one of the three members of ATSF's
Board of Directors. ATSF is a not-for-profit corporation, and neither Mr.
Jeffries nor us owns any equity or any other interest in ATSF. Mr. Jeffries
receives no compensation from ATSF.
The following table summarizes our contractual obligations at December 31,
2001, and the effects such obligations are expected to have on our liquidity and
cash flow in future periods.
Less Than After
(In thousands) Total One Year 1-3 Years 3 Years
--------------------------------------------------
Long-term debt $ 21,213 $ 2,530 $ 7,650 $ 11,033
Non-cancelable operating lease obligations 5,072 996 2,424 1,652
ATSF loan commitment(1) 250 250 -- --
Purchase commitment(2) 2,954 1,477 1,477 --
---------- ---------- ---------- ----------
$ 29,489 $ 5,253 $ 11,551 $ 12,685
========== ========== ========== ==========
(1) Assumes ATSF borrows $250,000 in 2002 and will not require the
remaining portion of the commitment.
(2) Assumes the purchase commitment is satisfied ratably over the two-year
commitment period.
49
For the year ended December 31, 2001, we experienced a substantial decrease
in available cash and cash equivalents due to our continued investments in our
business. We expect to continue to make investments in our business to support
our direct distribution efforts and future programs and initiatives, which may
further deplete our available cash balances. We believe that our available cash
and cash equivalents, available lines of credit and anticipated future cash flow
from operations will be sufficient to meet our forecasted cash needs in 2002.
Our future liquidity and capital requirements will depend upon numerous factors,
including:
o additional investments in inventories and deferred processing costs to
support our direct distribution efforts;
o the progress of our product development programs and the need and
associated costs relating to regulatory approvals which may be needed
to commercialize some of our products under development;
o the resources we devote to the development, manufacture and marketing
of our services and products; and
o the defense and outcome of pending litigation, including any outcomes
which are adverse to us, to the extent not covered by product
liability or other insurance. In this regard, we have two patent
lawsuits that are scheduled for trial in 2002 and in which any damages
that may be awarded against us are not covered by insurance.
We intend to seek additional funding to meet the needs of our long-term
strategic plan and to re-build cash reserves. We can provide no assurance that
such additional funds will be available, or if available, that such funds will
be available on favorable terms.
Recent Accounting Developments
In June, 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". As a
result of SFAS No. 141, all acquisitions completed after June 30, 2001 are
accounted for using the purchase method of accounting. We had no such
transactions in 2001. SFAS No. 142 primarily addresses the accounting of
goodwill and intangible assets subsequent to their initial recognition. SFAS No.
142 requires that goodwill and indefinite life intangible assets no longer be
amortized but rather be tested for impairment annually. Intangible assets with a
finite life shall continue to be amortized over the estimated useful life. SFAS
No. 141 is effective for business combinations initiated after June 30, 2001.
SFAS No. 142 is effective for fiscal years beginning after December 15, 2001.
SFAS No. 142 requires that the elimination of amortization is to be applied on a
prospective basis and prior periods are not to be restated. SFAS No. 142
requires that goodwill be tested annually for impairment using a two-step
process. The first step is to identify a potential impairment and, in
transition, this step is to be measured as of the beginning of the fiscal year
and must be completed within six months of adoption. The second step, which must
be completed by the end of the
50
Company's fiscal year, measures the amount of the impairment loss, if any, as of
the beginning of the year of adoption.
In June, 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 establishes accounting standards for the
recognition and measurement of a liability associated with the retirement of a
tangible long-lived asset that results from the acquisition, construction, or
development and/or normal operations of a long-lived asset. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002.
In August, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long Lived Assets" which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
discontinued operations. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001.
We are currently evaluating the impact of these pronouncements to determine
the effect they may have on the consolidated financial position and results of
operations. Under the provisions of SFAS No. 142, beginning in 2002 we will no
longer amortize goodwill. Amortization of goodwill in 2001 was $384,000.
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 may need to secure additional financing to fund our long-term strategic
plan and to re-build cash reserves.
For the year ended December 31, 2001, we experienced a substantial decrease
in available cash and cash equivalents due to our continued investments in our
business. We expect to continue to make investments in our business to support
our direct distribution efforts and future programs and initiatives, which may
further deplete our available cash balances. We believe that our available cash
and cash equivalents, available lines of credit and anticipated future cash flow
from operations will be sufficient to
51
meet our forecasted cash needs in 2002. Our future liquidity and capital
requirements will depend upon numerous factors, including
o additional investments in inventories and deferred processing costs to
support our direct distribution efforts;
o the progress of our product development programs and the need and
associated costs relating to regulatory approvals which may be needed
to commercialize some of our products under development;
o the resources we devote to the development, manufacture and marketing
of our services and products; and
o the defense and outcome of pending litigation, including any outcomes
which are adverse to us, to the extent not covered by product
liability or other insurance. In this regard we have two patent
lawsuits that are scheduled for trial in 2002 and in which any damages
that may be awarded against us are not covered by insurance.
We may need to raise additional funds through the issuance of equity and/or
debt financing in private placements or public offerings to provide funds to
meet the need of our long-term strategic plan and to re-build cash reserves. As
noted in Item 7 "Management's Discussion and Analysis of Financial Condition and
Results of Operations," we intend to seek such funding. Additional funds may not
be available, or if available, may not be available on favorable terms. Further
equity financings, if obtained, may substantially dilute the interest of our
pre-existing shareholders. Any additional debt financings may contain
restrictive terms that limit our operating flexibility. As a result, any future
financings could have a material adverse effect on our business, financial
condition or results of operations.
52
Failure to comply with covenants under our loan and security agreement
could materially adversely impact our business, financial condition and results
of operations.
We have recently amended our loan and security agreement and mortgage
relating to our headquarters and manufacturing facility in Eatontown, New
Jersey, among other things, to obtain a waiver of a breach of a financial
covenant for the year ended December 31, 2001, to provide revised financial
covenants, to grant additional security and to extend our revolving line of
credit for an additional two year period through April, 2004. This loan facility
provides a revolving credit facility, an equipment loan and a mortgage. It also
imposes on us certain restrictive operating and financial covenants. The loan
facility includes a covenant that provides for a .35% increase in the interest
rate payable under the loan facility if we fail to raise at least $15 million of
additional equity capital by June 30, 2002, which rate is subject to reduction
to the initial rates only after we have subsequently raised such additional
capital. The loan covenants significantly limit or prohibit, among other things,
our ability to advance or incur additional indebtedness, create liens on our
assets, pay dividends, sell assets, engage in mergers or acquisitions, or make
investments. Failure to comply with any of these restrictions could result in a
default under this loan facility. The loan facility also includes subjective
acceleration provisions. Such provisions are based upon, in the reasonable
opinion of the bank, the occurrence of any adverse or material change in our
condition or affairs, financial or otherwise, which impairs the interests of the
bank. Following a default, the lender may determine not to make any additional
financing available under the revolving line of credit, could accelerate the
indebtedness under the revolving credit facility, the equipment loan and/or the
mortgage, and could foreclose on the real and personal property securing the
loans. Foreclosure would adversely affect our continued operations and our
ability to repay the indebtedness under the loan facility. Without the
availability of the financing under the revolving line of credit, we may not be
able to meet our liquidity requirements during 2002 and would be required to
curtail our operations or raise additional funds, which may not be available. We
also may not have the funds to repay the debt upon acceleration. Even if
available, the terms of any additional debt or equity financing that we may
incur could restrict our operational flexibility and thereby adversely affect
our business, results of operations and financial condition.
Our cash flows are expected to be adversely impacted by our focus on direct
distribution.
Commencing in the first half of 2001, and expanding in the second half of
2001, we began to distribute tissue forms directly to surgeons and hospitals. We
expect to continue to expand our direct distribution efforts to surgeons and
hospitals in 2002 and beyond. As a result, we expect that revenues from direct
distribution of tissue will grow significantly as a percentage of our
consolidated revenues over the next several years. This change in distribution
methodology has impacted and is expected to continue to have an impact on our
cash flow. Our days sales in accounts receivable have increased from 65 days in
2000 to 71 days in 2001, primarily as a result of the change in our customer mix
resulting from our direct distribution efforts. As a greater percentage of our
revenues are generated from direct shipments to hospitals and other healthcare
providers, which typically pay invoices slower than our historical customer
base, we expect that our days sales in accounts receivable will remain at 2001
levels or increase slightly.
53
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 2001, MTF and ARC each
accounted for approximately 37% of our revenues. We entered into a 10-year
exclusive processing agreement with ARC in December, 1996 and a five year
non-exclusive processing agreement with MTF in September, 2000. However, the MTF
contract may be canceled at any time upon either party giving six months prior
written notice. We are currently in litigation against MTF. See Item 3 "Legal
Proceedings." 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.
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 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. To date, our inability to obtain sufficient amounts of donated
tissue to fulfill the demand for our bio-implants has limited the growth of
revenues we receive from these tissue forms. Although we have taken steps to
address this tissue supply problem, we cannot assure you that these efforts will
be successful or that we will otherwise be able to secure a sufficient supply of
tissue. Our inability 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 40% 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. Many 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
54
similar to Grafton(R) DBM. Certain of those competitors have, in turn, partnered
with large orthopaedic and spine companies to market the competing products they
have developed. 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. The intense competition in the
Grafton(R) DBM segment has caused our revenues in this Segment to stop growing
and to decline slightly in 2001.
We believe that a majority of the cadaveric bone banks operating in the
United States are engaged in processing allograft bone tissue for
transplantation. Many 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. Several for-profit companies, certain of which have
substantially greater resources then we do, are processing, marketing and
distributing allograft tissue. 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. We may not be able to compete
successfully in the area of allograft bone tissue processing and distribution.
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 litigation 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 and financial condition. 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.
As noted in Item 3 "Legal Proceedings," two patent lawsuits pending against
us are scheduled for trial in 2002. Given the current limitations on our
liquidity discussed in Item 7 "Management's Discussion and Analysis of Results
of Operations and Financial Conditions - Liquidity and Capital Resources", we
may be unable to pay any significant damages should a judgment be entered
against us in
55
these lawsuits or other lawsuits in which we are a party or we may be unable to
obtain a bond necessary to appeal any such judgment. Also, a judgement entered
against us in any of these lawsuits could cause us to violate one or more of the
covenants of our loan agreement.
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. See Part I, Item 3
"Legal Proceedings".
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 hospitals. The ability of hospitals 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 hospitals, 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 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. Our future efforts in this regard may fail to generate additional
demand for our allograft tissue forms.
Governmental regulation 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 used in human
transplantation, including bone and related tissue, for "valuable
consideration." NOTA permits reasonable payments associated with the removal,
transportation, processing, preservation, quality control, implantation and
storage of human bone tissue. We provide services in all of these areas and
receive payments for all such services, with the exception of removal and
implantation. We pay TROs and certain of our clients in connection with their
procuring tissue on our behalf. If NOTA is interpreted or enforced in a manner
which prevents us from receiving payment for services we render or which
prevents us from paying TROs or certain of our clients for the services they
render for us, our business could be materially, adversely affected. We are
engaged through our direct sales
56
employees and our independent sales representatives in ongoing efforts designed
to educate the medical community as to the benefits of processed allograft bone
tissue and in particular our allograft tissue forms, and we intend to continue
our educational activities. Although we believe that NOTA permits payments in
connection with these educational efforts as reasonable payments associated with
the processing, transportation and implantation of our allograft bone tissue
products, payments in connections with such education efforts are not exempt
from NOTA's restrictions and our inability to make such payments in connection
with our education efforts may prevent us from paying our sales representatives
for their education efforts and 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.
In the United States, the allograft bone tissues that we process are
regulated by the FDA as human tissue-based products under section 361 of the
Public Health Service Act, and under certain circumstances, may be regulated as
a medical device under the Food, Drug, and Cosmetic Act.
FDA regulations do not require that human tissue-based products be cleared
or approved before they are marketed. We are, however, required to register and
list these products with FDA and to comply with regulations concerning tissue
donor screening and testing, and related procedures and record keeping. FDA
periodically inspects tissue processors to determine compliance with these
requirements. FDA has proposed, but not yet finalized, "Good Tissue Practice"
regulations that would impose requirements on the manufacture of human
tissue-based products, including tissue recovery, donor screening, donor
testing, processing, storage, labeling, packaging, and distribution. The human
tissue-based product category is a relatively new one in FDA regulations, and it
is possible that FDA will change its approach to human tissue-based products in
general or to particular categories of products to require FDA clearance or
approval or otherwise restrict distribution.
The metal spinal implant products that we distribute in the United States
are regulated by the FDA as medical devices. Medical devices generally require
FDA approval or clearance before they may be marketed. There are two processes
by which medical devices can receive approval or clearance. Some products may
qualify for clearance under the 510(k) process, in which the manufacturer or
processor demonstrates that its product is substantially equivalent to another
lawfully marketed product (i.e., that it has the same intended use and is as
safe and effective as a lawfully marketed product and does not raise different
questions of safety and effectiveness as the lawfully marketed product). 510(k)
submissions usually include safety and performance data, and in some cases,
57
the submission must include clinical data. Marketing may commence if and when
FDA issues a letter finding substantial equivalence.
If a medical device does not qualify for the 510(k) process, the product
may not be distributed until a premarket approval application has been approved
by FDA. Premarket approval applications must demonstrate product safety and
effectiveness. A premarket approval application is typically a complex
submission, usually including the results of preclinical and clinical studies.
The manufacturer must also pass a premarket inspection of its compliance with
FDA's Quality Systems regulation. Marketing may commence if and when FDA issues
a premarket approval. The Ovation(TM) System, the VBR(TM) System, the
Sentinal(TM) Pedicle screw system and Affirm(TM) Cervical plate system are being
marketed pursuant to 510(k) clearances.
FDA has changed the regulatory status of our Grafton(R) DBM products and
the consequences of that decision are uncertain.
In March, 2002, FDA informed us that it is changing the regulatory status
of Grafton(R) DBM and will henceforth regulate it as a medical device as well.
Medical device regulation is a more stringent category of regulation and, in
particular, medical devices require FDA clearance or approval. We believe FDA's
change in its position regarding Grafton (R) DBM results from its decision to
regulate all demineralized bone with a carrier, including those processed and
marketed by some of our competitors, as medical devices. We intend to persuade
FDA that its initial designation of Grafton(R) DBM as a human tissue-based
product was and still is correct. If we are unsuccessful in that effort, we will
be required to obtain a medical device approval or clearance, and to comply with
medical device postmarketing obligations. We believe that Grafton(R) DBM will be
eligible for 510(k) clearance, but we cannot be sure that we will not be
required to obtain premarket approval, or that FDA will issue any clearance or
approval in a timely fashion, or at all. In its March letter regarding
Grafton(R) DBM, FDA stated that it intends to allow us a reasonable period of
time to obtain clearance for Grafton(R) DBM, and we will continue to process and
distribute Grafton(R) DBM during this period. We cannot be sure that FDA will
clear or approve our submission or will clear or approve all claims that we
currently make for Grafton(R) DBM. Failure to obtain FDA clearance or approval
or limitation on Grafton(R) DBM claims could adversely affect us.
We also market Grafton Plus(TM) DBM as a human tissue-based product. FDA's
determination regarding Grafton(R) DBM is also likely to be applied to Grafton
Plus(TM) DBM. If FDA maintains its position that all demineralized bone with a
carrier is a medical device, we would also be required to obtain FDA clearance
or approval for Grafton Plus(TM) DBM, and to comply with other medical device
requirements for that product. Failure to obtain FDA clearance or approval, if
required, or any limitation on Grafton Plus(TM) DBM could adversely affect us.
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 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
58
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 three 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 $70
million per occurrence and per year in the aggregate. We may be unable to
maintain such insurance in the 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.
59
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 materials, which, in the United States, are classified as
medical waste and/or hazardous waste under regulations promulgated by the United
States Environmental Protection Agency and the New Jersey Department of
Environmental Protection. We segregate our waste materials and dispose of them
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.
Our failure to fully comply with any environmental 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.
We rely on our independent sales agents and sales representatives to
educate surgeons concerning our products and to market our products.
Our success depends largely upon arrangements we have with independent
sales agents and sales representatives whereby they educate surgeons concerning
our products and market our products. These independent sales agents and sales
representatives may terminate their relationship with us, or devote insufficient
sales efforts to our products. We do not control our independent sales agents
and they may not be successful in implementing our marketing plans. Our failure
to attract and retain skilled independent sales agents and sale representatives
could have an adverse effect on our operations.
The issuance of preferred stock may adversely affect rights of common
stockholders or discourage a takeover.
Under our amended and restated certificate of incorporation, our board of
directors has the authority to issue up to 5,675,595 shares of preferred stock
and to determine the price, rights, preferences and privileges of those shares
without any further vote or action by our stockholders. The rights of the
holders of common stock will be subject to, and may be adversely affected by,
the rights of the holders of any shares of preferred stock that may be issued in
the future.
In January, 1996, our board of directors authorized shares of Series E
Preferred Stock in connection with its adoption of a stockholder rights plan,
under which we issued rights to purchase Series E Preferred Stock to holders of
the common stock. Upon certain triggering events, such rights become exercisable
to purchase common stock (or, in the discretion of our board of directors,
Series E Preferred Stock) at a price substantially discounted from the then
current market price of the Common Stock. Our stockholder rights plan could
generally discourage a merger or tender offer involving our securities that is
60
not approved by our board of directors by increasing the cost of effecting any
such transaction and, accordingly, could have an adverse impact on stockholders
who might want to vote in favor of such merger or participate in such tender
offer.
While we have no present intention to authorize any additional series of
preferred stock, such issuance, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could also
have the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting stock. The preferred stock may have other
rights, including economic rights senior to the Common Stock, and, as a result,
the issuance thereof could have a material adverse effect on the market value of
the common stock.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
In the United States, we are exposed to interest rate risk. Changes in
interest rates affect interest income earned on cash, cash equivalents and
short-term investments and interest expense on short-term and long-term debt. We
do not enter into derivative transactions related to our cash, cash equivalents,
short-term investments or debt. Accordingly, we are subject to changes in
interest rates. Based on our December 31, 2001 cash and cash equivalents and
long-term debt, a 1% change in interest rates would impact our results of
operations by approximately $100,000.
The value of the U.S. dollar affects our financial results. Although
currently not significant, changes in exchange rates may positively or
negatively affect revenues, gross margins, operating expenses and net income in
the future. We do not maintain hedging programs to mitigate the potential
exposures of exchange rate risk. Accordingly, our results of operations are
adversely affected by the strengthening of the U.S. dollar against currencies in
which we sell products and services or a weakening exchange rate against
currencies in which we incur costs. Based on the operating results of our
foreign operations for the year ended December 31, 2001, a 10% change in the
exchange rates would impact our results of operations by approximately $100,000.
Because of the foregoing factors, as well as other variables affecting our
operating results, past financial performance should not be considered a
reliable indicator of future performance.
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.
61
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Not applicable.
62
PART III
Item 10. Directors and Executive Officers of the Registrant
Our directors and executive officers, including their ages, are as follows
as of March 25, 2002:
Name Age Position
---- --- --------
Richard W. Bauer (1) ..................... 57 Chief Executive Officer, President, Chief
Operating Officer and Director
Michael J. Jeffries....................... 59 Executive Vice President, Chief Financial
Officer, Secretary and Director
Donald D. Johnston (1) (2) (3)............ 77 Chairman of the Board
Kenneth P. Fallon, III (2)................ 63 Director
John Phillip Kostuik, M.D., FRCS(C) (3)... 64 Director
Stephen J. Sogin, Ph.D. (1) (2) (3)....... 60 Director
James L. Russell, Ph.D.................... 51 Executive Vice President and Chief
Scientific Officer
Richard Russo............................. 53 Executive Vice President and General Manager
- ----------
(1) Member of the Executive Committee of our Board of Directors.
(2) Member of the Compensation Committee of our Board of Directors.
(3) Member of the Audit Committee of our Board of Directors.
Richard W. Bauer, 57, has served as our Chief Executive Officer and a member of
the Board since he joined Osteotech in February, 1994. Mr. Bauer also served as
our President from February, 1994 until September, 1999 and effective with Mr.
Alfaro's resignation on November 15, 2001 is serving as Osteotech's President
and Chief Operating Officer. Prior to joining Osteotech, from 1992 to 1993, Mr.
Bauer was President of the Prosthetic Implant Division of Zimmer, Inc., a
subsidiary of Bristol-Myers Squibb Company. From 1991 through 1992, Mr. Bauer
served as Senior Vice President and General Manager of Zimmer's Fracture
Management Division, and as Vice President of Marketing of its Orthopaedic
Implant Division from 1989 to 1991. Mr. Bauer previously served in positions of
significant responsibility with Professional Medical Products, Inc., Support
Systems International, Inc. and the Patient Care Division of Johnson & Johnson,
Inc. Mr. Bauer is a former member of the Board of Directors of the New Jersey
Chapter of the Arthritis Foundation. Mr. Bauer has B.S. and M.B.A. degrees from
Fairleigh Dickinson University.
Michael J. Jeffries, 59, Executive Vice President, Chief Financial Officer,
Secretary and member of the Board of Directors, has been with Osteotech for more
than eleven years. He joined Osteotech in January, 1990, originally as Senior
Vice President and Chief Financial Officer, became Secretary in May, 1991 and a
director in July, 1991, and was appointed Executive Vice President in October,
1992. Mr. Jeffries also served as our Chief Operating Officer from January, 1994
until September, 1999. Prior
63
to joining Osteotech, Mr. Jeffries had more than 25 years of business experience
in various positions of increasing responsibility in a number of publicly and
privately held companies, for some of which he was also a member of the board of
the directors. Mr. Jeffries serves as Chair of the American Association of
Tissue Bank's Finance Committee. He also is a member of the Board of Directors
of the American Tissue Services Foundation, which is a client of Osteotech's.
See Item 13 "Certain Relationships and Related Transactions". Mr. Jeffries has a
B.B.A. degree from the City College of New York and a M.B.A. degree in finance
from Fordham University.
Donald D. Johnston, 77, has been a director of Osteotech since September, 1991.
Mr. Johnston became Chairman of the Board in June, 1992. Over the course of 25
years Mr. Johnston held various positions of increasing responsibility with
Johnson & Johnson, Inc. At the time of his retirement in May, 1986 he was a
member of the Executive Committee and the Board of Directors of Johnson &
Johnson, Inc. From 1992 to 1998, Mr. Johnston was a founding Director and a
member of the Audit, Compensation and Executive Committees of Human Genome
Sciences, Inc. He is currently a member of the Board of Directors and Chairman
of the Audit Committee of Diversa Corp. Mr. Johnston has a B.A. in economics
from the University of Cincinnati.
Kenneth P. Fallon, III, 63, was elected to serve on the Board in June, 1995 and
is Chief Executive Officer and a Director of Axya Medical Inc., a Massachusetts
based, privately held medical device firm. In 1997, Mr. Fallon was President of
the surgical business at Haemonetics Corporation. In 1994 and 1995, Mr. Fallon
served as Chief Executive Officer and Chairman of the Board of UltraCision
Incorporated, a manufacturer of advanced technology medical devices. UltraCision
was sold to Ethicon EndoSurgery, a unit of Johnson & Johnson, Inc., in November,
1995. From 1992 through 1994, Mr. Fallon served as President and Chief Executive
Officer of American Surgical Technologies Corporation. Mr. Fallon was President,
U.S. Operations of Zimmer, Inc., a subsidiary of Bristol-Myers Squibb Company
from 1991 to 1992. From 1985 through 1991 he served as President of Zimmer's
Orthopaedic Implant Division, and from 1983 to 1985 as its Vice President of
Marketing. Mr. Fallon previously served in positions of significant
responsibility with the Codman and Orthopedic Divisions of Johnson & Johnson,
Inc. Mr. Fallon has a B.B.A. degree in marketing from the University of
Massachusetts and a M.B.A. degree from Northeastern University.
John Phillip Kostuik, M.D., FRCS(C), 64, was elected to serve on the Board in
June, 1997. Dr. Kostuik is currently and has since 1991 been a Professor and
Chairman of the Department of Orthopaedic Surgery, Johns Hopkins University,
School of Medicine, Chief Spine Division. He is the past president of the
Scoliosis Research Society and the North American Spine Society and he has
served on the Executive Committee of the North American Spine Society. He has
B.A. and M.D. degrees from Queens University, graduating in 1961.
Stephen J. Sogin, Ph.D., 60, has served as a director of Osteotech since
October, 1988. From December, 1984 until January 1, 1995, he was a founding
general partner of Montgomery Medical Ventures. Dr. Sogin currently serves as a
venture capital consultant and serves on the Board of Directors of Finet Inc,
and three private corporations. Dr. Sogin is also currently Chairman and Chief
Executive Officer of Icomomed, a start-up internet based medical information
data base. He has a B.S.,
64
M.S. and Ph.D. in microbiology from the University of Illinois. On July 1, 1997,
Dr. Sogin consented to a cease and desist order issued by the Securities and
Exchange Commission involving his late filing of Forms 3, 4 and 5, which he was
required to file in his capacity as a General Partner of Montgomery Medical
Ventures II. None of the Commission's findings involve charges that Dr. Sogin
received improper gains or personal benefits as a result of these violations.
Dr. Sogin has advised Osteotech that the trades in question were conducted by
the partnership (Montgomery Medical Ventures II) and none of these trades were
executed by him personally.
James L. Russell, Ph.D., 51, joined Osteotech in December, 1995 as Executive
Vice President and Chief Scientific Officer. He previously held research and
development positions of increasing responsibility for 16 years with Proctor &
Gamble Company, or P&G. Dr. Russell oversaw the development of several products,
in a variety of therapeutic areas, including bone-related therapeutic agents for
the treatment of Paget's disease, hypocalcemia of malignancy and osteoporosis.
In his prior position at P&G, he served as the Pharmaceutical Division's
Director of Product Development. Dr. Russell holds a B.S. in Biology from Boston
State College and a Ph.D. in Cellular Immunology from Purdue University.
Richard Russo, 53, joined Osteotech in September, 1991, and was elected
Executive Vice President and General Manager, International on July 1, 2000.
From April, 1998 to June, 2000 Mr. Russo served as Executive Vice President,
Strategic Planning and Business Development and from October, 1995 to April,
1998 he served as Senior Vice President, Strategic Planning and Business
Development. Prior thereto Mr. Russo had held a number of progressively more
responsible positions with Osteotech in the areas of marketing, business
development, clinical research and regulatory affairs. Prior to joining
Osteotech, Mr. Russo worked for several leading healthcare companies, having
positions of responsibility in marketing, sales, business development,
regulatory affairs and clinical research management. Mr. Russo earned a B.A. in
philosophy from Boston College and a M.B.A. in marketing from Columbia
University.
Item 11. Executive Compensation
The section of our 2002 Proxy Statement entitled "Executive Compensation"
is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The section of our 2002 Proxy Statement entitled "Security Ownership of
Certain Beneficial Owners and Management" is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
In February, 2001, we entered into a Loan Agreement with the American
Tissue Services Foundation ("ATSF") or ATSF which expires in December, 2010.
Pursuant to the Loan Agreement, as amended ATSF has borrowed $2,208,000 from us
as of December 31, 2001. In February, 2002, we
65
amended the Loan Agreement to allow ATSF to borrow up to an aggregate of
$2,750,000. We expect that ATSF will borrow approximately $250,000 in 2002. Each
loan matures five (5) years from the date it is made and bears interest at a
rate per annum equal to the five year Treasury Bill rate as reported in the Wall
Street Journal on the date immediately proceeding the date such loan is made,
plus one percent (1%). Interest is payable on a quarterly basis. ATSF is a
not-for-profit corporation organized under the laws of the State of Delaware
which we were involved in founding in December, 2000. Michael J. Jeffries, our
Executive Vice President and Chief Financial Officer, is one of three directors
of ATSF. Neither Mr. Jeffries nor we own any interest in ATSF. ATSF procures
human bone and related connective soft tissue on our behalf pursuant to a
long-term agreement which expires in December, 2015. We believe the amounts we
pay ATSF for its services to us under this agreement are comparable to those we
pay other TROs who procure tissue on our behalf.
66
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).
67
Exhibit Page
Number Description Number
- ------ ----------- ------
3.1 Restated Certificate of Incorporation of Osteotech, as amended E-2
3.2 Third Amended and Restated Bylaws of Osteotech E-14
3.3 Form of Stock Certificate **
4.3 Rights Agreement dated as of February 1, 1996 between Osteotech, E-41
Inc. and Registrar and Transfer Co., as amended
10.1 1991 Stock Option Plan, as amended ^ E-110
10.2 1991 Independent Directors Stock Option Plan, as amended ^ ***
10.4 Senior Management Loan Program ^ E-118
10.6 Processing Agreement between Osteotech and Stichting **
Eurotransplant Nederland, dated September 26, 1988 [*]
10.10 Form of Confidentiality Agreement and Non-Competition Agreement E-119
with executive officers
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, as amended through third modification
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 27, 1997 (Matrix Medical Holdings
BV subsequently changed its name to IsoTis, BV)
10.22 Change in Control Agreement by and between Osteotech and Richard +++++++
W. Bauer dated September 8, 1997^
10.23 Change in Control Agreement by and between Osteotech and Michael +++++++
J. Jeffries dated September 8, 1997^
10.24 Change in Control Agreement by and between Osteotech and James +++++++
L. Russell dated September 8, 1997 ^
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 ^
68
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. [Includes Equipment Loan Note, Convertible
Revolving Note, and Mortgage Term Note as exhibits.]
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 ^^^^^^^
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, 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., 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. and Alphatec Manufacturing, Inc. [*]
10.41 Second Allonge to Loan and Security Agreement among Fleet ^^^^^^^
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 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
10.43 Allonge to Convertible Revolving Note among Fleet National Bank, ^^^^^^^
Successor in Interest to Summit Bank, Osteotech, Inc.,
69
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
10.44 Primary Agreement Carrier and Bio-Implant Allografts by and ###
between LifeNet and Osteotech dated January 4, 2002 [_]
10.45 2000 Stock Plan dated February 9, 2000 E-126
10.46 Loan Agreement between American Tissue Services Foundation and E-137
Osteotech dated November 27, 2000, as amended
10.47 Third Allonge to Loan and Security Agreement among Fleet E-143
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 September 10, 2001
10.48 Third Allonge to Equipment Loan Note among Fleet National Bank, E-152
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 September 10, 2001
10.49 Second Allonge to Convertible Revolving Note among Fleet E-155
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 September 10, 2001
10.50 Separation Agreement and General Release by and between Arthur E-157
A. Alfaro and Osteotech^
10.51 Agreement of Amendment to Loan and Security Agreement, Mortgage, E-170
Assignment of Leases and Other Documents by and among Fleet
National Bank, Osteotech, Inc., Osteotech Investment
Corporation, Cam Implants, Inc., Osteotech, B.V., H.C. Implants,
B.V., Cam Implants, B.V., Osteotech/CAM Services, B.V.,
Osteotech, S.A., and Ost Developpement S.A. dated March 13, 2002
21.1 Subsidiaries of the Registrant E-212
23.1 Consent of PricewaterhouseCoopers LLP E-213
** 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.
70
******** 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, 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 10(iii)
^^ 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 thereto.
^^^^^^^ Previously filed exhibit to Osteotech's Annual Report on Form
10-K for the fiscal year ended December 31, 2000 and
incorporated herein by reference thereto.
### Previously filed exhibit to Osteotech's Current Report on Form
8-K filed with the Commission on March 8, 2002 and incorporated
herein by reference thereto.
/ Previously filed exhibit to Osteotech's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998 and incorporated
herein by reference thereto.
[*] Copy omits information for which confidential treatment has been
granted.
[_] Copy omits information for which confidential treatment has been
requested.
71
(b) Reports on Form 8-K
On December 12, 2001, we announced that in connection with the patent
lawsuit trial conducted in the United States District Court for the Central
District of California against GenSci Regeneration Sciences, Inc. and its
subsidiary GenSci Orthobiologics, Inc. (collectively, "GenSci"), we have been
awarded damages in the amount of $17,533,634. This damage award will be reduced
by the $3 million previously paid by DePuy AcroMed in settlement of Osteotech's
claims against DePuy AcroMed in this lawsuit. On November 29, 2001, the jury
determined that Osteotech's U.S. Patent Nos. 5,290,558 (the " `558 Patent") and
5,284,655 (the " `655 Patent") are valid and that GenSci infringed both the `558
and `655 Patents through their sale of DynaGraft(TM) Gel and Putty products.
On November 30, 2001, we announced that the conclusion of the liability
phase of the trial being conducted in the United States District Court for the
Central District of California, the jury returned a verdict that Osteotech's
U.S. Patent Nos. 5,290,558 (the " `558 Patent") and 5,284,655 (the " `655
patent") are valid and that both GenSci Regeneration Sciences, Inc. and its
subsidiary GenSci Orthobiologics, Inc. (collectively, "GenSci") infringe both
the `558 and `655 Patents through their sale of DynaGraft(TM) Gel and Putty
products. In arriving at its verdict, the jury rejected all of GenSci's
defenses.
On November 15, 2001, we announced that Arthur A. Alfaro had departed from
the Company, effective November 15, 2001, as its President and Chief Operating
Officer.
On November 8, 2001, we announced that at the patent lawsuit trial, which
commenced on Wednesday, October 31, 2001 in the United States District Court,
Central District of California, in which GenSci Orthobiologics and GenSci
Regeneration Science ("GenSci") are accused of infringing the claims of two of
Osteotech's patents, U.S. Patent 5,290,558 (the `558 Patent) and 5,284,655 (the
`655 Patent), the Court has granted Osteotech's motion to exclude a patent
recently issued to GenSci from being entered into evidence at the trial. GenSci
had attempted to enter the patent, U.S. Patent 6,309,659 (the "659 Patent)
titled "Reverse Phase Connective Tissue Repair Composition", which was described
in its press release of October 31, 2001, into evidence in order to support its
defense of reverse doctrine of equivalents. As a result of the Court's ruling,
GenSci may not introduced at trial or refer to evidence concerning its `659
Patent.
On October 24, 2001, we announced that at the Annual TechVest Conference,
Osteotech would announce that it expects to begin limited commercialization of
its revolutionary new-patented Plexus technology at the end of 2001. Utilizing
this technology, bone tissue is reduced to particulate and reassembled together
at the molecular level into virtually any shape or size. The Plexus technology
is designed to maximize the utilization of donated human tissue and it increase
the yield of bio-implants.
72
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 , 2002 OSTEOTECH, INC.
By: /s/Richard W. Bauer
--------------------------------------
Richard W. Bauer
President, Chief Executive Officer
(Principal Executive Officer) and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated:
Signature Title Date
- --------------------------------------------------------------------------------
/s/DONALD D. JOHNSTON Chairman of the March 26, 2002
- ------------------------ Board of Directors
Donald D. Johnston
/s/RICHARD W. BAUER President, Chief March 26, 2002
- ------------------------ Executive Officer (Principal
Richard W. Bauer Executive Officer) and Director
/s/MICHAEL J. JEFFRIES Executive Vice President March 26, 2002
- ------------------------ Chief Financial Officer
Michael J. Jeffries (Principal Financial
Accounting Officer),
Secretary and Director
/s/KENNETH P. FALLON III Director March 26, 2002
- ------------------------
Kenneth P. Fallon III
/s/JOHN P. KOSTUIK Director March 26, 2002
- ------------------------
John P. Kostuik
/s/STEPHEN J. SOGIN Director March 26, 2002
- ------------------------
Stephen J. Sogin
73
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, 2001 and 2000.........F-3
Consolidated Statements of Operations
for the years ended December 31, 2001, 2000 and 1999..............F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 2001, 2000, and 1999.............F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 2001, 2000, and 1999.............F-6
Notes to Consolidated Financial Statements...........................F-7
2. SCHEDULE
II. Valuation and Qualifying Accounts
for the years ended December 31, 2001, 2000, and 1999......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
To the Board of Directors and
Stockholders of Osteotech, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Osteotech Inc. and its subsidiaries (the "Company") at December 31, 2001 and
2000, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, 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
March 13, 2002
F-2
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
December 31, 2001 2000
- ---------------------------------------------------------------------------------------------------------------
ASSETS
- ---------------------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 5,192 $ 10,923
Short-term investments 1,935
Accounts receivable, net of allowance of
$303 in 2001 and $123 in 2000 15,093 13,503
Deferred processing costs 11,165 5,914
Inventories 8,803 3,584
Deferred income taxes 2,002 683
Prepaid expenses and other current assets 2,025 4,027
----------------------------
Total current assets 44,280 40,569
Property, plant and equipment, net 56,736 58,290
Goodwill, net of
accumulated amortization of $2,861 in 2001 and $2,477 in 2000 2,910 3,294
Other assets 3,318 2,285
- ---------------------------------------------------------------------------------------------------------------
Total assets $ 107,244 $ 104,438
===============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 17,311 $ 11,345
Current maturities of long-term debt 2,530 101
----------------------------
Total current liabilities 19,841 11,446
Long-term debt 18,683 19,930
Other liabilities 934 1,211
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 39,458 32,587
- ---------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,675,595 shares
authorized; no shares issued or outstanding
Common stock, $.01 par value; 70,000,000 shares
authorized; issued and outstanding 14,098,264
shares in 2001 and 13,989,307 shares in 2000 140 138
Additional paid-in capital 47,076 46,577
Accumulated other comprehensive loss (653) (497)
Retained earnings 21,223 25,633
- ---------------------------------------------------------------------------------------------------------------
Total stockholders' equity 67,786 71,851
- ---------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 107,244 $ 104,438
===============================================================================================================
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, 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------
Net revenues:
Service $72,811 $72,546 $72,418
Product 5,035 3,137 3,074
License fee and other revenue 118
----------------------------------------------
77,846 75,683 75,610
Cost of services 30,582 24,811 22,004
Cost of products 3,766 2,700 1,905
----------------------------------------------
34,348 27,511 23,909
----------------------------------------------
Gross profit 43,498 48,172 51,701
Marketing, selling, and general and administrative 45,535 35,545 28,343
Research and development 4,599 5,772 5,506
----------------------------------------------
50,134 41,317 33,849
----------------------------------------------
Income from litigation settlement 1,000 2,000
----------------------------------------------
Operating income (loss) (6,636) 7,855 19,852
----------------------------------------------
Other income (expense):
Interest income 506 1,087 891
Interest expense (406) (14) (62)
Other 28 (26) 203
----------------------------------------------
128 1,047 1,032
----------------------------------------------
Income (loss) before income taxes (6,508) 8,902 20,884
Income tax provision (benefit) (2,098) 4,074 8,533
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $ (4,410) $ 4,828 $12,351
==============================================================================================================
Net income (loss) per share:
Basic $ (.31) $ .34 $ .88
Diluted $ (.31) $ .34 $ .84
- --------------------------------------------------------------------------------------------------------------
Shares used in computing net income (loss) per share:
Basic 14,030,623 14,057,931 14,024,468
Diluted 14,030,623 14,335,641 14,618,786
- --------------------------------------------------------------------------------------------------------------
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, 2001, 2000, and 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other Total
------------------------ Paid-In Comprehensive Retained Stockholders'
Shares Amount Capital Income (Loss) Earnings Equity
- ------------------------------------------------------------------------------------------------------------------------------------
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
Net loss (4,410) (4,410)
Currency translation adjustments (156) (156)
----------
Total comprehensive loss (4,566)
Exercise of stock options 10,138 1 41 42
Common stock issued pursuant to
employee stock purchase plan 98,819 1 458 459
- ---------------------------------------------------------- -------------------------------------------------------------------------
Balance at December 31, 2001 14,098,264 $ 140 $ 47,076 $(653) $21,223 $ 67,786
====================================================================================================================================
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, 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------
Cash Flow From Operating Activities
Net income (loss) $ (4,410) $ 4,828 $ 12,351
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 8,598 4,597 3,298
Deferred income taxes (2,937) 775 (121)
Income tax benefit related to stock options 139 6,542
Changes in assets and liabilities:
Accounts receivable (2,146) 1,629 (2,876)
Inventories (5,073) (218) (1,393)
Deferred processing costs (5,390) (604) (2,690)
Prepaid expenses and other current assets 2,459 764 (2,457)
Accounts payable and other liabilities 6,880 (1,735) 1,805
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (2,019) 10,175 14,459
Cash Flow From Investing Activities
Capital expenditures (8,955) (28,343) (18,743)
Acquisition of business (1,523)
Proceeds from sale of investments 5,860 5,888 10,610
Purchases of investments (3,925) (3,877) (11,634)
Proceeds from the sale of land 1,500
Other, net 160 (796) (883)
- ---------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (5,360) (27,128) (22,173)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 499 723 4,970
Repurchase of common stock (3,124)
Proceeds from issuance of notes payable 116
Principal payments on notes payable (725)
Proceeds from issuance of long-term debt 1,468 13,672 6,359
Principal payments on long-term debt
and obligations under capital leases (340) (1,332)
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,627 11,271 9,388
Effect of exchange rate changes on cash 21 (165) (23)
- ---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (5,731) (5,847) 1,651
Cash and cash equivalents at beginning of year 10,923 16,770 15,119
- ---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 5,192 $ 10,923 $ 16,770
===============================================================================================================
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, markets and
sells 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.
The Company is engaged in the processing of human bone and bone connective
tissue (collectively, "allograft bone tissue") used for transplantation.
The Company also develops and processes new forms of tissue for use in a
variety of surgical procedures. While the Company performs the medical
education to teach surgeons about the uses of these tissue forms, the
tissue forms are generally distributed to hospitals by the Company's tissue
bank clients.
Commencing in the first half of 2001, and expanding in the second half, the
Company began to distribute tissue forms directly to hospitals. The Company
expects to continue to expand the direct distribution efforts to hospitals
in 2002 and beyond. This change in distribution methodology has impacted
liquidity and cash flow. The Company has had to make additional investments
in inventories and deferred processing costs to support the direct
distribution efforts, and expects to make additional investments in
inventory and deferred processing costs, as necessary, to support the
efforts to expand direct distribution. For the year ended December 31,
2001, the Company experienced a substantial decrease in available cash and
cash equivalents due to continued investments in the business. The Company
expects to continue to make investments in the business to support the
direct distribution efforts and future programs and initiatives, which may
further deplete available cash balances. The Company believes that
available cash and cash equivalents, available lines of credit and
anticipated future cash flow from operations will be sufficient to meet
forecasted cash needs in 2002. The Company's future liquidity and capital
requirements will depend upon numerous factors, including:
o additional investments in inventories and deferred processing costs to
support direct distribution efforts;
o the progress of product development programs and the need and
associated costs relating to regulatory approvals which may be needed
to commercialize some of the products under development;
o the resources to be devoted to the development, manufacture and
marketing of services and products; and
o the defense and outcome of pending litigation, including any outcomes
which are adverse to the Company, to the extent not covered by product
liability or other insurance. In this regard there are two patent
lawsuits that are scheduled for trial in 2002 and in which any damages
that may be awarded against the Company are not covered by insurance.
The Company intends to seek additional funding to meet the needs of the
long-term strategic plan and to re-build cash reserves. The Company can
provide no assurance that such additional funds will be available, or if
available, that such funds will be available on favorable terms.
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.
F-7
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Critical Accounting Policies and Estimates
The preparation of these financial statements requires the Company to make
estimates and judgements that effect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, the Company evaluates the
estimates and may adjust them based upon the latest information available.
These estimates generally include those related to product returns, bad
debts, inventories, deferred processing costs, intangible assets, income
taxes and contingencies and litigation. The Company bases the estimates on
historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis
for making judgements about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from these estimates.
The Company believes the following critical accounting policies affect the
more significant judgements and estimates used in the preparation of the
consolidated financial statements.
o The Company maintains allowances for doubtful accounts primarily for
its direct distribution accounts for estimated losses resulting from
the inability of these customers to make required payments. If the
financial condition of these customers were to deteriorate, resulting
in an impairment of their ability to make payments, additional
allowances may be required.
o The Company records reductions to revenue for estimated product and
allograft tissue forms returns based upon historical experience. If
future returns are less than historical experience, reduction in
estimated reserves would increase revenue. Alternatively, should
returns exceed historical experience, additional allowances would be
required, which would reduce revenue.
o The Company writes down inventory and deferred processing costs for
estimated obsolescence, or unmarketable products and allograft tissue
forms equal to the difference between cost and the estimated market
value based upon assumptions about future demand and market
conditions. Obsolescence could occur from numerous factors, including,
but not limited to, the competitive nature of the market,
technological change and changes in surgeon preference. If actual
market conditions are less favorable than those projected by
management, additional write-downs may be required.
o The Company depreciates/amortizes its property, plant and equipment
based upon the Company's estimate of the respective asset's useful
life. In addition, the Company evaluates impairments of its property,
plant and equipment based upon an analysis of estimated undiscounted
future cash flows. If the Company determines that a change is required
in the useful life of an asset, future depreciation/amortization is
adjusted accordingly. Alternatively, should the Company determine that
an asset has been impaired, an adjustment would be charged to income
based on its fair market value, or discounted cash flows if the fair
market value is not readily determinable, reducing income in that
period.
F-8
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
o The Company records a valuation allowance to reduce deferred tax
assets to the amount that is more likely than not to be realized.
While the Company has considered future taxable income, in the event
that the Company would be able to realize the deferred tax assets in
the future in excess of the net recorded amount, an adjustment to the
deferred tax asset would increase income in the period such
determination was made. Likewise, should the Company determine that
the Company would not be able to realize all or part of the net
deferred tax asset in the future, an adjustment to the deferred tax
asset would be charged to income in the period such determination was
made.
o The Company accrues current and future tax liabilities based upon
levels of taxable income, tax planning strategies and assessments of
the timing of taxability of tax attributes. While the Company has
considered current tax laws in establishing tax liabilities, in the
event the Company was to settle the tax liabilities for less than
amounts accrued the Company would increase income in the period such
determination was made. Should the Company determine it would cost
more to settle the tax liabilities, an adjustment would be charged to
income thus reducing income in that period.
Consolidated Financial Statements
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. All intercompany transactions and
balances are eliminated in consolidation.
Revenue Recognition
The Company principally derives revenue from allograft bone tissue
processing services and other non-allograft tissue products and services.
Revenues for products and services, net of trade discounts and allowances,
are recognized once delivery has occurred provided that persuasive evidence
of an arrangement exists, the price is fixed or determinable, and
collectibility is reasonably assured. For allograft tissue, delivery is
considered to have occurred when risk of loss has transferred to the
Company's clients or customers, primarily upon shipment of such allograft
tissue to customers or clients, except for consigned inventory, when
delivery is considered to have occurred when the allograft tissue is
consumed by the customer. For non-allograft tissue products and services,
delivery is considered to have occurred when title and risk of loss have
transferred to the Company's customers primarily upon shipment of
non-allograft products to customers or clients.
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
Deferred processing costs are stated at the lower of cost or market, with
cost determined under the first-in, first-out method. 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 or customers.
F-9
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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
product lines included in Other.
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 and improvements 10 to 20 years
Machinery and equipment 5 to 10 years
Computer hardware and software 5 years
Office equipment, furniture and fixtures 5 years
Spinal 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 consolidated
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 on an analysis of undiscounted cash flows. If an
impairment is determined, the assets carrying value is written down to fair
market value, or discounted cash flows if fair market value is not readily
determinable.
Goodwill
Goodwill is being amortized on a straight-line basis over 15 years. It is
the Company's policy to periodically review and evaluate whether there has
been an impairment in the value of goodwill. Factors considered in the
valuation include current operating results, trends, prospects and
anticipated undiscounted future cash flows.
Beginning in 2002, pursuant to the provisions of SFAS No. 142, the Company
will no longer amortize goodwill. See Note 3, "Recent Accounting
Pronouncements".
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 accumulated other
comprehensive income (loss), which is a separate component of stockholders'
equity. Foreign currency transaction gains and losses are included in other
income (expense).
F-10
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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 its
clients and customers. In addition, the Company performs on-going credit
evaluations of its clients' and customers' financial condition, but
generally does not require collateral in support of available credit. The
Company maintains an allowance for doubtful accounts and charges actual
losses to the allowance when incurred. The Company has two customers who
together account for 75%, 90% and 94% of revenues in 2001, 2000, and 1999,
respectively. As of December 31, 2001 and 2000, these two customers
together accounted for 66% and 78%, respectively, of outstanding accounts
receivable.
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.
Reclassifications
Certain prior year amounts within the financial statements have been
reclassified to conform to the 2001 presentation.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In June, 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". As
a result of SFAS No. 141, all acquisitions completed after June 30, 2001
are to be accounted for using the purchase method of accounting. The
Company has had no such transactions in 2001. SFAS No. 142 primarily
addresses the accounting of goodwill and intangible assets subsequent to
their initial recognition. SFAS No. 142 requires that goodwill and
indefinite life intangible assets no longer be amortized but rather be
tested for impairment annually. Intangible assets with a finite life shall
continue to be amortized over their estimated useful life. SFAS No. 141 is
effective for business combinations initiated after June 30, 2001. SFAS No.
142 is effective for fiscal years beginning after December 15, 2001. SFAS
No. 142 requires that the elimination of amortization is to be applied on a
prospective basis and prior periods are not to be restated. SFAS No. 142
requires that goodwill be tested annually for impairment using a two-step
process. The first step is to identify a potential impairment and, in
transition, this step is to be measured as of the beginning of the fiscal
year and must be completed within six months of adoption. The second step,
which must be completed by the end of the Company's fiscal year, measures
the amount of the impairment loss, if any, as of the beginning of the year
of adoption.
F-11
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. RECENT ACCOUNTING PRONOUNCEMENTS (continued)
In June, 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 establishes accounting standards for
the recognition and measurement of a liability associated with the
retirement of a tangible long-lived asset that results from the
acquisition, construction, or development and/or normal operations of a
long-lived asset. SFAS No. 143 is effective for fiscal years beginning
after June 15, 2002.
In August, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long Lived Assets" which addresses financial
accounting and reporting for the impairment or disposal of long-lived
assets and discontinued operations. SFAS No. 144 is effective for fiscal
years beginning after December 15, 2001.
The Company is currently evaluating the impact of these pronouncements to
determine the effect they may have on its consolidated financial position
and results of operations. Under the provisions of SFAS No. 142, beginning
in 2002 the Company will no longer amortize goodwill. Amortization of
goodwill in 2001 was $384,000.
4. DEFERRED PROCESSING COSTS
Deferred processing costs consist of the following at December 31:
(in thousands) 2001 2000
---------------------------------------------------------------------------
Unprocessed donor tissue to be distributed by the
Company $ 492 $ 3
Tissue in process 2,936 2,646
Implantable donor tissue to be distributed
by the Company 5,359 424
Implantable donor tissue held for clients 2,378 2,841
---------------------------------------------------------------------------
$11,165 $ 5,914
===========================================================================
5. INVENTORIES
Inventories consist of the following at December 31:
(in thousands) 2001 2000
---------------------------------------------------------------------------
Supplies $ 245 $ 202
Raw materials 784 891
Finished goods 7,774 2,491
---------------------------------------------------------------------------
$8,803 $3,584
===========================================================================
F-12
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) 2001 2000
----------------------------------------------------------------------------
Land $ 811 $2,262
Building and improvements 13,821 279
Machinery and equipment 24,695 22,139
Computer hardware and software 4,264 4,165
Office equipment, furniture and fixtures 5,839 3,483
Spinal instruments 3,563 2,710
Leasehold improvements 7,850 6,741
Construction in progress 20,957 33,199
----------- -----------
81,800 74,978
Less accumulated depreciation
and amortization 25,064 16,688
----------------------------------------------------------------------------
$56,736 $58,290
============================================================================
During the fourth quarter 1998, the Company commenced construction of a new
processing facility in Eatontown, New Jersey. At December 31, 2001 and
2000, approximately $37,922,000 and $32,197,000, respectively, had been
incurred, primarily for construction of the facility, production equipment
and furniture and fixtures, of which approximately $1,769,000 and $761,000,
respectively, represents capitalized interest.
In 2001, the Company recorded additional provisions of $2,287,000 for
machinery and equipment that will no longer be utilized in the processing
of allograft tissue and $1,190,000 primarily for excess spinal instruments.
7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31:
(in thousands) 2001 2000
--------------------------------------------------------------------------
Trade accounts payable $ 8,802 $ 3,315
Accrued compensation 878 566
Accrued professional fees 1,333 409
Accrued taxes payable 3,100 3,110
Other accrued liabilities 3,198 3,945
--------------------------------------------------------------------------
$ 17,311 $11,345
==========================================================================
F-13
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, 2001 are as follows:
Operating
Year Leases
----------------------------------------------------------------
(in thousands)
2002 $ 996
2003 925
2004 907
2005 592
2006 and thereafter 1,652
------------------
Total minimum lease payments $ 5,072
==================
Rental expense was $1,186,000, $1,147,000, and $1,157,000 for the years
ended December 31, 2001, 2000, and 1999, respectively.
9. DEBT AND FINANCING ARRANGEMENTS
The Company has a Credit Facility which includes: a $5,000,000 revolving
line of credit, a building mortgage loan and an equipment line of credit,
the terms of which have been amended in March, 2002. See the last paragraph
of this Note 9.
Prior to March, 2002, the revolving line of credit was committed through
May 31, 2002. Interest was payable monthly on the outstanding amount. In
the absence of default, the Company had the option to convert the revolving
line of credit to a term loan and the outstanding unpaid balance would have
been repayable in forty-eight equal monthly installments of principal
together with accrued interest. Prior to conversion, the revolving line of
credit bore interest at the prime rate (5.00% at December 31, 2001) minus
.75% or the London Interbank Offered Rate ("LIBOR") plus 1.75%. After
conversion, interest accrued at the four year United States Treasury Note
Rate prior to conversion plus 1.75%. A facility fee of .25% was payable on
the unused portion of the revolving loan. As of December 31, 2001, no
amounts were outstanding under this facility and the full amount of the
revolving line of credit is available to the Company.
The mortgage loan was drawn in December, 2000 and is collateralized by the
building which houses 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. Interest is payable at a fixed rate of 7.38%.
F-14
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. DEBT AND FINANCING ARRANGEMENTS (continued)
The equipment line of credit is collateralized by equipment and other
capital expenditures purchased using the proceeds of such line. The
equipment line of credit converted to a term loan on September 10, 2001.
The equipment term loan is repayable in equal monthly installments of
principal plus interest based on a seven-year amortization schedule. Prior
to conversion, interest only was payable monthly under the equipment line
of credit at the prime rate minus .50% or LIBOR plus 1.75%. Upon
conversion, interest on the term loan changed to the prime rate or LIBOR
plus 2.25%.
Pursuant to the terms of the Credit Facility, the Company is required to
meet certain financial covenants regarding minimum working capital,
tangible net worth and interest coverage. In addition, the Credit Facility
contains limitations on sales of assets other than in the ordinary course
of business and additional indebtedness. The Company either complied with
or obtained the necessary waivers from its lender regarding these
covenants.
The effective weighted average interest rate for borrowings under the
Credit Facility was 6.60% in 2001 and 8.20% in 2000.
Long-term debt consists of the following at December 31:
(in thousands) 2001 2000
---------------------------------------------------------------------------
Domestic revolving line of credit
Domestic bank equipment term loan,
repayable in monthly principal payments of $202
plus interest through November, 2008 $16,798 $15,531
Domestic building mortgage loan, repayable in monthly
installments of $37, including interest through
December 2010 with a balloon payment
of $3,087 due December, 2010 4,415 4,500
---------------------------------------------------------------------------
21,213 20,031
Less current portion 2,530 101
---------------------------------------------------------------------------
$18,683 $19,930
===========================================================================
Aggregate maturities of long-term debt for the next five years are as
follows: 2002, $2,530; 2003, $2,540; 2004, $2,550; 2005, $2,560; 2006,
$2,571; thereafter, $8,462.
In March, 2002, the Company amended its domestic Credit Facility to extend
the maturity date of the revolving line of credit to April 30, 2004. The
amendment to the Credit Facility establishes a variable interest rate on
all three parts of the Credit Facility that changes the interest rate to
range from prime minus .25% to prime plus 1.50%, or from LIBOR plus 2.25%
to LIBOR plus 4.0% based upon a leverage ratio as defined. Under the terms
of the amendment, the new initial interest rate, which initially is
retroactive to January 1, 2002 and is effective through November 14, 2002
is prime plus 1.50% or LIBOR plus 4.0%, whichever is chosen by the Company.
Thereafter, the interest rate will be in the range described above. In
certain circumstances, as defined in the amendment, the interest rate on
the Credit Facility may increase up to an additional .35%.
F-15
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. DEBT AND FINANCING ARRANGEMENTS (continued)
The Credit Facility, as detailed in the amendment, will be collateralized
by domestic accounts receivable, domestic inventories, the new allograft
tissue processing facility, including all equipment and improvements
therein and a pledge of 65% of the Company's ownership in its foreign
subsidiaries. The amendment imposes certain restrictive operating and
financial covenants on the Company. The amendment established additional
covenants including a restriction on the payment of cash dividends, a
restriction on incurring or maintaining additional indebtedness, a
restriction on selling assets or engaging in mergers or acquisitions and
limitations on cash advances to the Company's foreign operations and
investments. The amendment also resets the interest coverage ratio, which
the Company did not comply with for the year ended December 31, 2001, but
the bank permanently waived such non-compliance. The amendment also
includes subjective acceleration provisions. Such provisions are based
upon, in the reasonable opinion of the bank, the occurrence of any adverse
or material change in the condition or affairs, financial or otherwise, of
the Company which impairs the interests of the bank. The bank also has the
right to approve, in advance, the form and substance of any equity capital
transaction, except for a common stock transaction resulting in the
issuance of less than 20% of the total issued and outstanding capital stock
of the Company as of the date of such transaction.
Failure to comply with any of these restrictions could result in a default
under this loan facility. Following a default, the bank may determine not
to make any additional financing available under the revolving line of
credit, could accelerate the indebtedness under the revolving credit
facility, the equipment loan and/or the mortgage, and could foreclose on
the real and personal property securing the loans.
10. INCOME TAXES
The income tax provision (benefit) at December 31 is summarized as follows:
(in thousands) 2001 2000 1999
---------------------------------------------------------------------------
Current:
Federal $ 265 $2,897 $7,307
State 574 402 1,347
---------------------------------------------------------------------------
839 3,299 8,654
------------------------------------------
Deferred:
Federal (1,921) 551 (148)
State (1,016) 224 27
---------------------------------------------------------------------------
(2,937) 775 (121)
------------------------------------------
Income tax provision (benefit) $ (2,098) $4,074 $8,533
===========================================================================
The difference between income tax provision (benefit) and the expected tax
which would result from the use of the Federal statutory income tax rate is
as follows:
(in thousands) 2001 2000 1999
----------------------------------------------------------------------------
Computed tax at statutory Federal rate $(2,213) $ 3,027 $ 7,309
State income taxes, net of Federal benefit (292) 413 1,129
Foreign losses for which no tax benefit is
currently available 606 660 456
Other (199) (26) (361)
----------------------------------------------------------------------------
Income tax provision (benefit) $(2,098) $ 4,074 $ 8,533
============================================================================
F-16
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES (continued)
Loss before income taxes from foreign operations was $882,000 in 2001,
$1,151,000 in 2000, and $591,000 in 1999. 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) 2001 2000
---------------------------------------------------------------------------
Deferred Tax Assets:
Net operating loss carryforwards
Federal $ 281 $ 275
Foreign 2,286 1,736
State 235 24
Tax credits 1,059 62
Other, principally reserves 2,207 674
---------------------------------------------------------------------------
6,068 2,771
Less valuation allowance 2,614 2,058
---------------------------------------------------------------------------
Deferred tax assets 3,454 713
---------------------------------------------------------------------------
Deferred Tax Liabilities:
Other 678 951
---------------------------------------------------------------------------
Deferred tax liabilities 678 951
---------------------------------------------------------------------------
Net deferred tax asset (liability) $ 2,776 $ (238)
===========================================================================
The Company's valuation allowance results principally from foreign losses
and related net operating loss carryforwards for which the realization of
future tax benefits is uncertain. Foreign net operating loss carryforwards
aggregate $5,818,000 ($525,000 with no expiration date; $5,293,000 expiring
2004 through 2009). Although realization is not assured, the Company has
concluded that it is more likely than not that the remaining deferred tax
assets will be realized based on the scheduling of deferred tax liabilities
and projected taxable income.
At December 31, the Company had prepaid Federal and state taxes of
approximately $1,331,000 in 2001 and $1,552,000 in 2000.
11. COMMITMENTS AND CONTINGENCIES
Service Agreements
The Company is the processor of allograft bone tissue for national and
international clients. The Company provides these processing services
pursuant to long-term service agreements. The Company's agreements with its
clients generally provide for cross-indemnification against liability
arising out of performance of the agreements.
The Company entered into an exclusive ten-year processing agreement with
one of its major allograft bone tissue processing clients, the American Red
Cross Tissue Services ("ARC"). The agreement was effective January 1, 1997.
F-17
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
In September, 2000, the Company entered into a five-year agreement with the
Musculoskeletal Transplant Foundation ("MTF"). The agreement expires on
August 31, 2005, and provides that either party has the right at any time
to terminate the agreement upon six months prior written notice. Neither
party has exercised their rights under such provision. Under the agreement,
MTF is not required to exclusively provide all donor tissue it recovers to
the Company for processing. The Company is currently in litigation with
MTF. (See "Litigation" - "Musculoskeletal Transplant Foundation v.
Osteotech, Inc.").
Effective January 4, 2002, the Company entered into a five-year agreement
with LifeNet. Under the terms of the agreement, the Company will process
allograft bone tissue provided by LifeNet into the Company's broad line of
Bio-d(R) and Graftech(R) Bio-implants. The agreement also provides the
future opportunity for the Company to process LifeNet labeled tissue
carrier products. Such tissue carrier products would be marketed through a
mutually agreed upon third party.
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 $2,117,000 and $878,000 under
the agreement in 2001 and 2000, respectively.
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 was in February, 2002. 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. The Company has purchased $3,046,000 of inventory under the
agreement in 2001 in advance of the beginning of the two-year commitment,
and must purchase an additional $2,954,000 in 2002 and 2003 to meet the
obligation under the first two-year commitment.
Loan Receivable
In February, 2001, the Company entered into a Loan Agreement with the
American Tissue Services Foundation ("ATSF"), a not-for-profit tissue
recovery organization. The Loan Agreement expires on December 31, 2010.
Pursuant to the Loan Agreement, loans made by the Company mature five (5)
years from the date each loan is made and bear interest at a rate per annum
equal to the five year United States Treasury Bill Rate plus one percent
(1%).
F-18
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Interest is payable on a quarterly basis. In February, 2002, the Company
and ATSF amended the Loan Agreement to allow ATSF to borrow an aggregate of
$2,750,000 from the Company. As of December 31, 2001, the Company had
loaned ATSF an aggregate of $2,208,000 at an average interest rate of
5.57%.
The funds loaned to ATSF are being utilized by ATSF to fund its operations.
The Company is providing a reserve against these loans equivalent to the
accumulated operating losses of ATSF until such time that ATSF is able to
generate positive cash flow from operations. For the year ended December
31, 2001, the Company has provided reserves totaling $2,001,000 against
these loans, which charge is included in marketing, selling, general and
administrative expenses. The Company expects that it will loan $250,000 to
ATSF in 2002 and expects to record additional reserves against these loans.
Michael J. Jeffries, the Company's Executive Vice President and Chief
Financial Officer, is one of the three members of ATSF's Board of
Directors. ATSF is a not-for-profit corporation, and neither Mr. Jeffries
nor the Company owns any equity or any other interest in ATSF. Mr. Jeffries
receives no compensation from ATSF.
The Company has entered into an exclusive fifteen-year processing and
distribution agreement with ATSF effective December 7, 2000. Pursuant to
the agreement, the Company has the right to process and distribute all ATSF
recovered tissue. As of December 31, 2001, the Company owed ATSF $378,000
for tissue recovery reimbursement fees, which represented the sum total of
all tissue recovery reimbursement fees for 2001.
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 ("IsoTis"), The Netherlands. IsoTis has an
option to acquire the technology for approximately 1,815,000 euros
(approximately $1,618,000 at the December 31, 2001 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 2001 and 2000 and license fee revenue of DFL
250,000, or approximately $118,000, was received in 1999.
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 subsequent to the time the option to purchase the technology is
exercised. Further, the agreement requires IsoTis 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, 2001, IsoTis has achieved all milestones associated
with the agreement. The Company has not earned any royalties under this
agreement in 2001, 2000 or 1999.
F-19
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
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 (the "655 Patent") and
5,290,558 (the "558 Patent") 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
April, 2000, GenSci Labs and GenSci Sciences agreed to dismiss with
prejudice all of GenSci's patent infringement claims against the Company.
Between September, 1998 and September, 2001, there were numerous amendments
to the complaints of both parties and both parties filed numerous motions
with the Court.
On October 31, 2001, the trial commenced in the United States District
Court for the Central District of California. In November, 2001, the jury
returned a verdict that the 558 Patent and the 655 Patent are valid and
that GenSci infringed on both patents through their sales of DynaGraft(TM)
Gel and Putty products. In arriving at its verdict, the jury rejected all
of GenSci's defenses.
In December 2001, the Company was awarded damages in the amount of
$17,533,634 for GenSci's infringement of its patents. This damage award
will be reduced by the $3.0 million previously paid by DePuy in 2000 and
1999 in settlement of the Company's claims against DePuy in this lawsuit.
The Company has not recognized any portion of the net award of $14,533,634
in its financial statements. On December 21, 2001, GenSci filed for
bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.
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.
F-20
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
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 pending completion of the
Company's patent infringement case against GenSci. This case has remained
stayed.
The Company believes the claims made in this lawsuit are without merit and
intends 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 re-examined 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.
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. As a result, the motion remains pending.
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-21
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
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, 4,950,296 and 6,096,081. The plaintiffs have sought injunctive
relief and monetary damages of approximately $1.5 million. 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.
Trial in this action is currently scheduled for September, 2002.
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.
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
certain 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, 5,484,437 and
6,096,038 which are owned by Danek. In addition to injunctive relief, the
plaintiffs seek monetary damages of $2.5 million. 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.
Currently pending before the Court are both parties' motions for summary
judgement. Trial in this matter has been scheduled for April, 2002.
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; Thacker 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. Through dismissals, either by the Court or voluntarily by
plaintiffs, only the California Business and Professional Code claims,
which are based on allegations that defendants are engaging in the activity
of buying or selling organs or tissue for valuable consideration or profit,
and negligence claims remain. It appears that the plaintiff is seeking only
injunctive relief with respect to their California Business and
Professional Code claims. 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.
F-22
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Defendants', including the Company, have filed demurrers seeking dismissal
of the negligence claims. A hearing on those demurrers was held on February
21, 2002. The Court granted the demurrer with respect to the negligence
claim asserted in the Thacker action. Additionally, the Court indicated
that the actions will be combined and treated as a single 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.
Condos v. Musculoskeletal Transplant Foundation
In July, 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.
In January, 2002, plaintiffs amended their complaint, but no new claims
were asserted. In February, 2002, the Company moved for summary judgement
in its favor on all claims asserted against it. MTF has sought the same
relief. Both motions remain pending.
The Company maintains a general liability insurance policy and has notified
the insurance company of this action. The insurance company has agreed to
defend the action. The Company believes the claims made against it in this
action are without merit and will vigorously defend against the claims.
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, known as DBX(R), 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 MTF's DBX(R) products and/or its
underlying technology.
In June, 2001, the Company made a motion for an order preliminarily
enjoining MTF and Synthes from selling or offering to sell their DBX(R)
products. A hearing was held on that motion on July 23, 2001. On September
18, 2001, the Court denied that motion. Discovery is otherwise continuing
in this case.
F-23
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
The Company seeks injunctive relief and monetary damages in an amount to be
determined. MTF and Synthes have denied any liability. The Company believes
that the claims made against it in this action are without merit and will
vigorously defend against the claims, and will vigorously pursue its claims
against MTF and Synthes.
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. In January, 2002, the
plaintiffs and the Company settled all claims pending against the Company
in this case for an insignificant amount. The Court dismissed the Company
from this case in February, 2002.
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.
In March, 2001, the Company answered the complaint, denying any and all
liability. In January, 2002, the Court dismissed plaintiff's claim for
misappropriation of trade secrets. In February, 2002, the parties agreed to
submit this matter to mediation, which proved to be unsuccessful.
The Company answered the complaint denying any and all liability and
intends to vigorously defend against all claims.
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 plaintiff sought to enjoin Mr. Miller, whom
the Company 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.
On April 25, 2001, the Court lifted a temporary restraining order
preventing Mr. Miller from working with the Company and entered an order
preliminarily enjoining Mr. Miller from working with the Company in the
area of spine surgery products. In November, 2001, the parties settled this
matter and the Court dismissed this action.
F-24
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Younger v. Hayes Medical Center, Inc.
In April, 2001, the Company was served in an action brought in the
Twentieth Judicial District Court in Ellis County, Kansas, against Hayes
Medical Center, Inc., the Musculoskeletal Transplant Foundation, Metropath,
Inc. and the Company. With respect to the Company, the suit alleges a cause
of action for negligence in connection with allegedly defective allograft
bone tissue provided by the defendants and allegedly implanted in the
plaintiff during a surgical procedure. The plaintiff seeks monetary damages
in excess of $75,000.
In May, 2001, the Company answered the complaint denying any and all
liability. Discovery in this action has commenced.
The Company maintains a general liability insurance policy and has notified
the insurance company of this action. The insurance company has agreed to
defend this action. The Company believes the claims made against it in this
action are without merit and will vigorously defend against the claims.
Wright Medical Technology, Inc. v. Osteotech, Inc.
In June, 2001, the Company received a complaint filed by Wright Medical
Technologies, Inc. in an action in the United States District Court for New
Jersey, which alleges against the Company claims for false advertising, and
tortious interference with business relations and prospective business
advantage relating to certain statements allegedly made by the Company
regarding a FDA Warning Letter received by the plaintiff with respect to a
tissue product marketed by the plaintiff. In addition to injunctive relief,
plaintiff seeks monetary damages in an unspecified amount. On June 15,
2001, the Court granted plaintiffs a temporary restraining order against
the Company. On June 20, 2001, the Company obtained a stay of that order
from the United States Court of Appeals for the Third Circuit, pending an
appeal of that order. On June 29, 2001, the District Court issued an order
granting plaintiffs' motion for a preliminary injunction, and amended the
order on July 2, 2001, enjoining the Company from making the accused
statements and requiring the Company to issue a clarification of such
statements. The Company issued a corrective statement in a timely fashion
and has appealed the District Court's order to the Third Circuit Court of
Appeals. That appeal is pending.
On October 22, 2001, the Company received an amended complaint in this
action, wherein plaintiffs named as additional defendants unidentified
"Roe" parties and alleged further misconduct on the part of the Company
giving rise to the claims described therein. The Company denies any and all
liability. Discovery in this action has commenced.
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 currently 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. When the Company is reasonably able to
determine the potential liability, if any, that may result from any of the
pending litigation, the Company will record a provision for such liability
to the extent not covered by insurance.
F-25
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY
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,
2001 or 2000.
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. No shares were repurchased in
2001.
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.
Stock Options
The Company's 2000 Stock 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. Options issued in 2001
and 2000 pursuant to the 2000 Plan typically have terms requiring ratably
vesting over four years.
The 1991 Stock Option Plan (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. In June, 2000, the 1991 Plan was replaced by the 2000 Plan,
and therefore, options will no longer be issued under the 1991 Plan.
The 1991 Independent Directors Stock Option Plan (the "Directors Plan"), as
amended, authorizes the grant of options to purchase 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,
provided that the holder of such option is on the Company's Board of
Directors during such year, with unexercised options expiring ten years
from the date of grant. Commensurate with the expiration of the Directors
Plan in September, 2001, available options under the plan will no longer be
issued.
F-26
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Stock option activity for the years 2001, 2000, and 1999 is as follows:
2001 2000 1999
---------------------------- -------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
----------------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 2,319,325 $ 9.98 1,866,522 $ 11.93 2,280,732 $ 9.35
Granted 238,000 5.37 686,000 5.76 404,500 18.17
Exercised 10,138 4.10 74,261 4.14 791,566 5.76
Cancelled or expired 36,488 14.29 158,936 17.45 27,144 16.40
----------------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2,510,699 $ 9.50 2,319,325 $ 9.98 1,866,522 $ 11.93
----------------------------------------------------------------------------------------------------------------------------
Exercisable at December 31, 1,544,076 $10.48 1,236,336 $ 10.36 995,529 $ 8.35
----------------------------------------------------------------------------------------------------------------------------
Available for grant at
December 31, 494,500 714,750 669,644
----------------------------------------------------------------------------------------------------------------------------
Weighted average fair value per share
Of options granted during the period $ 3.30 $ 3.28 $ 10.35
----------------------------------------------------------------------------------------------------------------------------
The following table summarizes the information about stock options
outstanding at December 31, 2001:
Options Outstanding Options Exercisable
----------------------------------------------------- -------------------------------------
Weighted
Number Average Number
Outstanding at Remaining Weighted Exercisable at Weighted
Range of December 31, Contractual Life Average December 31, Average
Exercise Prices 2001 (Years) Exercise Price 2001 Exercise Price
----------------------------------------------------------------------------------------------------------------------------
$ 2.33 To $ 3.78 402,825 8.5 $ 3.47 109,197 $ 3.41
3.79 To 7.58 846,249 6.9 5.64 474,499 5.40
7.59 To 11.36 545,250 6.1 8.79 501,000 8.75
11.37 To 15.15 266,000 7.4 12.59 161,500 12.54
15.16 To 18.94 176,375 7.2 16.22 107,875 16.29
18.95 To 22.73 214,500 6.9 20.68 162,755 20.68
34.09 To 37.88 59,500 7.4 37.74 52,250 37.80
----------------------------------------------------------------------------------------------------------------------------
$2.33 To $37.88 2,510,699 7.1 $ 9.50 1,569,076 $10.48
============================================================================================================================
The Company has adopted the "disclosure only" provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation", ("SFAS No. 123") and, accordingly, no compensation cost has
been recognized in the consolidated statements of operations. Pro forma
information regarding net income and net income per share is required by
SFAS No. 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.
F-27
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Pro forma information follows:
(in thousands except per share data) 2001 2000 1999
---------------------------------------------------------------------------
Net income (loss)
As reported $ (4,410) $ 4,828 $ 12,351
Pro forma (5,964) 3,699 10,927
Net income (loss) per share
As reported
Basic $ (.31) $ .34 $ .88
Diluted (.31) .34 .84
Pro forma
Basic $ (.43) $ .26 $ .78
Diluted (.43) .26 .75
---------------------------------------------------------------------------
The pro forma effect on net income (loss) for 2001, 2000, and 1999 is not
representative of the pro forma effect on net income (loss) in future years
because, in accordance with SFAS No. 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:
2001 2000 1999
---------------------------------------------------------------------------
Expected life (years) 5 5 5
Risk free interest rate 4.62% 5.70% 6.10%
Volatility factor 70.00% 60.00% 60.00%
Dividend yield 0.00% 0.00% 0.00%
---------------------------------------------------------------------------
Stock Warrants
As part of financing and contract arrangements, the Company has, at certain
times, issued warrants to purchase its Convertible Preferred Stock. As of
December 31, 1999 there were Convertible Preferred Stock warrants to
purchase 458 shares of Common Stock at an exercise price of $3.72. During
2000, all outstanding Convertible Preferred Stock warrants expired.
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, 2001, 94,321 shares were available for future offerings under
this plan.
F-28
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
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. 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, 2001,
2000, and 1999 was $2,498,000, $2,551,000, and $2,240,000, respectively.
Depreciation and amortization expense related to property, plant and
equipment for the years ended December 31, 2001, 2000, and 1999 was
$7,985,000, $3,956,000, and $2,745,000, respectively.
14. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(in thousands) 2001 2000 1999
-----------------------------------------------------------------------------------------------
Cash paid during the year for taxes $ 1,170 $ 1,895 $ 4,476
Cash paid during the year for interest, excluding
amounts capitalized 379 11 33
Acquisition of business:
Fair value of assets acquired 2,563
Liabilities assumed 2,669
F-29
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. NET INCOME (LOSS) 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) 2001 2000 1999
-----------------------------------------------
Net income (loss) $ (4,410) $ 4,828 $ 12,351
============================================================================ =============================
Denominator for basic net income (loss) per share:
Weighted average common shares outstanding 14,030,623 14,057,931 14,024,468
Effect of dilutive securities:
Stock options 277,601 593,933
Warrants 109 385
-----------------------------------------------
Denominator for diluted net income (loss) per share 14,030,623 14,335,641 14,618,786
===========================================================================================================
Basic net income (loss) per share $ (.31) $ .34 $ .88
===========================================================================================================
Diluted net income (loss) per share $ (.31) $ .34 $ .84
===========================================================================================================
For the year ended 2001, common equivalent shares, consisting solely of
stock options, are excluded from the calculation of diluted net loss per
share as their effects are antidilutive.
Weighted average shares issuable upon the exercise of stock options which
were not included in the calculation of diluted net income (loss) per share
were 1,744,518 in 2001, 771,498 in 2000, and 48,419 in 1999. Such shares
were not included because they were antidilutive.
16. OPERATING SEGMENTS
The Company has two primary 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. 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.
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 generate
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. These
expenses are allocated to the segments and geographic areas based on
allocations that the Company considers to be a reasonable reflection of the
utilization of services provided or the benefits received.
F-30
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. OPERATING SEGMENTS (continued)
Summarized financial information concerning the Company's segments is shown
in the following table.
Grafton(R)DBM Base Tissue
(in thousands) Segment Segment Other Consolidated
-----------------------------------------------------------------------------------------------------
Revenues:
2001 $ 43,637 $ 27,692 $ 6,517 $ 77,846
2000 45,226 26,204 4,253 75,683
1999 45,136 25,751 4,723 75,610
-----------------------------------------------------------------------------------------------------
Operating income (loss):
2001 $ 7,014 $ (7,979) $ (5,671) $ (6,636)
2000 11,389 694 (4,228) 7,855
1999 17,063 6,434 (3,645) 19,852
-----------------------------------------------------------------------------------------------------
Depreciation and amortization:
2001 $ 1,962 $ 5,413 $ 1,223 $ 8,598
2000 2,198 1,376 1,023 4,597
1999 1,203 1,153 942 3,298
-----------------------------------------------------------------------------------------------------
Financial information by geographic area is summarized as follows:
(in thousands) United States Europe Consolidated
--------------------------------------------------------- -----------------
Revenues
2001 $71,776 $ 6,070 $77,846
2000 71,468 4,215 75,683
1999 71,517 4,093 75,610
Long-lived Assets
2001 $55,261 $ 1,475 $56,736
2000 56,618 1,672 58,290
1999 32,068 1,927 33,995
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) 2001 2000 1999
-----------------------------------------------------------------------
Revenues
MTF $28,971 $37,743 $42,095
ARC 29,100 30,469 28,436
-----------------------------------------------------------------------
$58,071 $68,212 $70,531
=======================================================================
F-31
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 from date of employment. Total Company
contributions for the years ended December 31, 2001, 2000, and 1999 were
$393,000, $285,000, and $287,000, 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 $42,000, $70,000, and
$53,000 for the years ended December 31, 2001, 2000, and 1999,
respectively.
The Company does not maintain any other pension or post retirement plans.
18. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of the unaudited quarterly results for the years
ended December 31, 2001 and 2000:
Quarter Ended
----------------------------------------------------
(in thousands except per share data) March 31 June 30 Sept. 30 Dec. 31
----------------------------------------------------------------------------------------------------
2001
Net revenues $ 17,953 $ 19,581 $ 19,627 $ 20,685
Cost of services and products(a) 7,364 8,805 8,051 10,128
Net income (loss)(a) (307) (2,130) 232 (2,205)
Net income (loss) per share
Basic $ (.02) $ (.15) $ .02 $ (.16)
Diluted (.02) (.15) .02 (.16)
----------------------------------------------------------------------------------------------------
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(b) 1,969 2,524 231 104
Net income per share (b)
Basic $ .14 $ .18 $ .02 $ .01
Diluted .13 .18 .02 .01
----------------------------------------------------------------------------------------------------
(a) In June, 2001, the Company recorded charges of $1,845,000 ($1,107,000, net
of tax, or $.08 diluted net loss per share) of which $655,000 has been
recorded as cost of product and $1,190,000 has been recorded as marketing,
selling, general and administrative expense. Such charges were primarily to
establish reserves associated with excess inventory and instrumentation
associated with spinal implant systems.
In December, 2001, the Company recorded a charge of $2,287,000 ($1,372,000
net of tax, or $.10 diluted net loss per share) related to equipment which
will no longer be utilized in the processing of allograft tissue. Such
charge was recorded in cost of sales. In November, 2001, the Company
recorded a charge primarily for the severance costs associated with the
departure of an executive officer in the amount of $700,000 ($420,000, net
of tax, or $.03 diluted net loss per share). Such severance charge was
recorded in marketing, selling, general and administrative expenses.
(b) Net income in 2000 included approximately $150,000, or $.01 net income per
share, per quarter from a litigation settlement.
F-32
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, 2001:
Allowance for doubtful accounts $ 123 $ 296 $ (10)(a) $ (106)(b) $ 303
Valuation allowance for deferred
tax asset 2,058 607(c) (58)(a) 7 (d) 2,614
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
(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 March 13, 2002, appearing on page F-2 of this Form 10-K also included an
audit of the Financial Statement Schedule listed in Item 14(a)(2) of this 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
March 13, 2002
S-2
EXHIBIT INDEX
Exhibit Page
Number Description Number
- ------ ----------- ------
3.1 Restated Certificate of Incorporation of Osteotech, as amended E-2
3.2 Third Amended and Restated Bylaws of Osteotech E-14
4.3 Rights Agreement dated as of February 1, 1996 between Osteotech, Inc. E-41
and Registrar and Transfer Co., as amended
10.1 1991 Stock Option Plan, as amended E-110
10.4 Senior Management Loan Program E-118
10.10 Form of Confidentiality Agreement and Non-Competition Agreement with
executive officers E-119
10.45 2000 Stock Plan dated Feburary 9, 2000 E-126
10.46 Loan Agreement between American Tissue Services Foundation and E-137
Osteotech, Inc. dated November 27, 2000, as amended
10.47 Third Allonge to Loan and Security Agreement among Fleet National E-143
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 September 10, 2001
10.48 Third Allonge to Equipment Loan Note among Fleet National Bank, E-152
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 September 10, 2001
10.49 Second Allonge to Convertible Revolving Note among Fleet National E-155
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 September 10, 2001
10.50 Separation Agreement and General Release between Arthur A. Alfaro and E-157
Osteotech, Inc.
10.51 Agreement of Amendment to Loan and Security Agreement, Mortgage, E-170
Assignment of Leases and Other Documents among Fleet 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 13, 2002
21.1 Subsidiaries of Registrant E-212
23.1 Consent of PricewaterhouseCoopers LLP E-213
E-1