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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
================================================================================
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997 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
of incorporation or organization) Identification No.)
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.
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 2, 1998 was approximately $212,262,361.
As of March 2, 1998, there were 8,848,755 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 1998 Proxy Statement which will be filed
pursuant to Regulation 14A is incorporated by reference into Part III of this
Annual Report on Form 10-K.
OSTEOTECH, INC.
1997 Form 10-K Annual Report
TABLE OF CONTENTS
Section Page
- ------- ----
PART I
Item 1. Business ......................................................... 1
Company Overview ............................................... 1
Company Strategy ............................................... 3
Business Summary ............................................... 4
Allograft Bone Tissue Processing ............................... 7
Ceramic and Titanium Plasma Spray Coating Services
and Products ................................................. 8
Implants and Instruments ....................................... 9
Quality Assurance .............................................. 9
Clients ........................................................ 10
Education and Marketing ........................................ 11
Government Regulations ......................................... 11
Research and Development ....................................... 13
Competition .................................................... 13
Environmental Matters .......................................... 19
Patents and Proprietary Rights ................................. 19
Product Liability and Insurance ................................ 19
Employees ...................................................... 20
Item 2. Properties ....................................................... 20
Item 3. Legal Proceedings ................................................ 21
Item 4. Submissions of Matters to a Vote
of Security Holders .............................................. 23
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters .................................. 24
Item 6. Selected Financial Data .......................................... 24
i
Item 7. Management's Discussion And Analysis Of Financial
Condition And Results Of Operations .............................. 26
Results of Operations .......................................... 26
Liquidity and Capital Resources ................................ 29
Year 2000 ...................................................... 31
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk ...................................................... 31
Item 8. Financial Statements and Supplementary Data ...................... 31
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure .............................. 31
PART III
Item 10. Directors and Executive Officers of the Registrant ............... 31
Item 11. Executive Compensation ........................................... 31
Item 12. Security Ownership of Certain Beneficial
Owners and Management ............................................ 32
Item 13. Certain Relationships and Related Transactions ................... 32
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K .......................................... 32
- ---------------
The following trademarks and service marks appear in this Annual Report:
PolyActive(TM) and OsteoActive Bone Substitute(TM) are trademarks and
Osteotech(R), Alloprep System(R), Allograft Tissue Reconstitution Solution(R),
Grafton(R) Demineralized Bone Matrix and Allogard(R) Packaging are registered
trademarks of Osteotech, Inc.; D-Min(R) Aseptic Tissue Demineralization is a
registered service mark of Osteotech, Inc.; and USIS(R) is a registered
trademark of Heinrich C. Ulrich, KG.
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PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
Osteotech, Inc. ("Osteotech" or the "Company") is the world's largest
processor of human bone and bone connective tissue ("allograft bone tissue")
which is procured by independent tissue banks primarily through the donation of
tissue from deceased human donors and used for transplantation. Since commencing
its processing operations in 1987, the Company has leveraged its 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. The
Company is also a leader in biomaterials, providing ceramic and titanium plasma
spray coating services to orthopaedic and dental implant manufacturers through
operations based in Leiden, The Netherlands, and is the exclusive U.S.
distributor of spinal implant products developed and manufactured by Heinrich C.
Ulrich, K.G., ("Ulrich"), a medical devices company based in Germany.
The total bone graft market in the U.S. was estimated by the Company at
$459 million for 1997 and includes allograft bone tissue procedures, synthetic
graft substitutes and autograft bone tissue procedures (transplant tissue
harvested from the patient). The Company estimates that the allograft bone
tissue portion of the total bone graft market in the U.S. grew 19% in 1997, to
approximately $145 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 an accepted surgical alternative to
autograft procedures. Autograft bone tissue often requires a second surgical
procedure to harvest bone from the patient's own body and, therefore, exposes
the patient to increased risk associated with blood loss, infection and chronic
pain. Increased use of allograft bone tissue is expected to continue as
physicians become increasingly educated about the benefits of allograft bone
tissue and concerns over disease transmission are diminished. Moreover,
allograft bone tissue is increasingly preferred in elderly patients, who often
lack sufficient harvestable bone.
Based upon management's knowledge of the allograft bone tissue industry,
management believes that Osteotech processes more allograft bone tissue than any
other processor in the world and estimates that it represents an approximately
40% share of the domestic allograft bone tissue market. The Company believes
that its strong market position is attributable to its proprietary product line,
its large national sales and marketing organization and the substantial
investment it has made in processing technology to ensure stringent standards
and high quality control which combined with extensive donor screening and
testing performed by its clients, has virtually eliminated the risk of
transmission of infectious agents.
Osteotech processes allograft bone tissue for its clients which pay the
Company fees for processing, finishing and packaging their base allograft
(non-proprietary forms of tissue, including Grafton(R) Demineralized Bone Matrix
("Grafton(R) DBM")) bone tissue, on a per donor basis, or for proprietary
products, on a per unit basis. Osteotech processes allograft bone tissue
pursuant to long term contracts with large not-for-profit organizations which
are responsible for donor procurement and distribution of processed bone tissue.
The renewals in December 1996 and April 1997 of the Company's longstanding
relationships with its clients, American Red Cross Tissue Services ("ARC") and
the Musculoskeletal Transplant Foundation ("MTF"), respectively, through new
long term, exclusive contracts, has solidified key donor availability for
Osteotech processed allograft bone tissue. The Company's clients also include
Bioimplant Services in The Netherlands, which distributes tissue in several
European markets.
In addition to its leadership position in traditional allograft bone tissue
processing, Osteotech has leveraged its expertise in musculoskeletal science and
allograft bone tissue processing to develop proprietary forms of allograft bone
tissue products which have a broader range of applications in musculoskeletal
surgery and increase the potential tissue yield from a single donor. Grafton(R)
DBM was developed utilizing an advanced proprietary demineralization process
which, when applied to cortical bone, results in allograft bone tissue having
osteoinductive (the process by which bone is induced to grow) and
osteoconductive (the matrix provided by allograft bone tissue into which the
host bone can grow) capabilities greater than other currently available forms of
mineralized allograft bone tissue. The Company markets its proprietary bone
graft materials through independent agents and direct field sales personnel. Due
to their flexibility, unique handling characteristics and ability to enhance
bone growth, these products are gaining wide acceptance among surgeons in a
broad spectrum of orthopaedic procedures.
With the introduction of two new forms of Grafton(R) DBM during the first
and fourth quarters of 1996, respectively, and a significant expansion of the
Company's independent agent network to 57 agencies with over 220 sales
representatives as of December 31, 1997, sales of Grafton(R) DBM have been
growing rapidly, increasing by 74% during 1997. During 1997, sales of Grafton(R)
DBM to end users (hospitals and professionals) were approximately $34.9 million.
Grafton(R) DBM is expected to continue to drive Company revenue growth and, due
to its margins, which are generally greater than those for the Company's other
products and services, increase Company profitability, as these products
continue to gain increased acceptance, particularly by surgeons who utilize the
product in spinal fusion procedures.
In 1996, Osteotech restructured its non-allograft bone tissue operations
located in Leiden, The Netherlands in order to allow greater management focus on
the revenue and profit generating activities of providing ceramic and titanium
plasma spray coating services and ceramic products to the orthopaedic and dental
markets. In connection with the restructuring, the Company discontinued its
PolyActive(TM)
2
polymer research and development program. Prior to the restructuring, the
Company's non-allograft bone tissue European operations had experienced
significant operating losses (approximately $1.3 million and $1.6 million in
1995 and 1996, respectively, excluding a one-time restructuring charge of $1.35
million in 1996) which were non-deductible for tax purposes due to the
cumulative loss position of the non-allograft bone tissue European operations.
In June 1997, the Company entered into a license agreement for its
PolyActive(TM) polymer technology with IsoTis BV (formerly known as Matrix
Medical BV). As a result of the elimination of significant research and
development costs and increased management focus on the remaining business, the
non-allograft bone tissue European operations reported operating profits of
$330,000 in 1997. The Company expects the restructuring of its non-allograft
bone tissue European operations to contribute to continued increased operating
profits as well as an improved overall tax rate.
COMPANY STRATEGY
The Company's strategy is to use its position as the leader in allograft
bone tissue processing to continue to educate the medical community and the
general public as to the benefits of allograft bone tissue and to use its strong
research and development capabilities and expertise in musculoskeletal science
to enhance the performance of its existing allograft bone tissues, expand the
safety claims of such tissues using proprietary processes and continue to
introduce new tissue forms with enhanced performance profiles.
In the near term, the Company will continue to focus on marketing
Grafton(R) DBM through its expanded national agent network and medical education
programs and to support these programs through prospective clinical and outcome
studies to further validate the performance, utility and safety of Osteotech
processed tissue.
Specifically, the achievement of the Company's business objectives and
financial goals will be built on the following corporate strategies:
o continued expansion of sales of Grafton(R) DBM through (i) surgeon
identified new procedures, (ii) surgeon oriented medical education
programs, (iii) in-depth sales agent training programs, (iv) published
clinical support, (v) product line extensions, (vi) global expansion
with a European focus and (vii) the pursuit of opportunities created
by the expected high growth in spinal, trauma and total joint
revisions;
o acceleration of growth in base allograft bone tissue (non-Grafton(R)
DBM tissue) processing through introduction of new packaging and a new
validated viral inactivation claim;
o global expansion of allograft bone tissue grafts and tissue processing
business in selected countries in Europe (primarily), South America,
and Asia;
3
o development of proprietary tissue processing technology through
internal research to yield new allograft bone tissue products with
enhanced performance profiles;
o refocusing of non-allograft bone tissue European operations to capture
available opportunities for ceramic coating services and powder
manufacture;
o capitalize on high-growth opportunities in the U.S. spinal products
market with innovative products developed and supplied by Ulrich;
o enter into agreements with other health care products companies to
utilize the Company's technology and expertise in allograft bone
tissue and ceramics for the development and manufacture of proprietary
product components;
o implement the Company's spinal product strategy.
The Company's spinal product strategy consists of three primary components.
The Company is developing and intends to introduce by the end of 1998 an
allograft-based threaded cortical bone dowel and instrumentation as an
alternative to metal threaded fusion cages and pedicle screw fixation for
certain spinal procedures. The Company intends to begin to roll out the
Segmented Spinal Correction System ("SSCS"), a load sharing, low profile
posterior lumbar and thoracic rod and hinged screw system, in the U.S. in the
second half of 1998. Osteotech believes that these new spinal lines are
synergistic with its Grafton(R) DBM and intends to aggressively market them in
combination with Grafton(R) DBM through its extensive sales agency network.
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 this Annual Report and in Exhibit
99.1 to 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.
BUSINESS SUMMARY
Bone and related tissue transplants are often necessary to correct
deformities and repair and reconstruct defects caused by congenital
malformations, trauma,
4
infections, cancer and other disease conditions. For certain procedures,
autograft bone 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 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 ("OPO") and/or directly by tissue banks.
Osteotech processes allograft bone tissue for its clients which pay the
Company fees for processing, finishing and packaging their base allograft
(non-proprietary forms of tissue, including Grafton(R) DBM) bone tissue, on a
per donor basis, or for proprietary products, on a per unit basis. Once
processed, the allograft bone tissue is returned to these clients for
distribution to surgeons and medical institutions. The surgeons and medical
institutions pay the fees charged by the Company's clients which are established
by such clients. The surgeons and medical institutions in turn charge their
patients for the various aspects of transplant surgery performed by them,
including standard charges established by the surgeon or institution for each
unit of processed allograft bone tissue used. The cost to the patient for the
processed allograft bone tissue is generally reimbursable by medical insurance
carriers as part of the overall cost of the procedure.
Processing by the Company yields a wide array of freeze-dried, frozen and
demineralized allograft bone tissue that is used by orthopaedic, neurological,
plastic, dental, periodontal 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. Osteotech believes its processing methods, its clients'
tissue recovery techniques and the multiple screening and testing procedures
employed, virtually eliminate the risk of transmission of infectious agents.
The Company has a validated viral inactivation process for its demineralized
bone tissue (consisting of all forms of demineralized tissue processed by the
Company, including Grafton(R) DBM), which accounted for 58% of all of the
allograft bone tissue units processed by the Company in 1997. Studies completed
by an independent testing laboratory specializing in viral inactivation studies
demonstrated that this proprietary demineralization process of the Company can
virtually inactivate and eliminate the HIV virus (the process reduces the
probability of transmission of the HIV virus to one in 2.8 billion), as well as
the hepatitis B, hepatitis C, cytomeglia and polio viruses. In addition to its
proprietary demineralization process, Osteotech expects to begin to implement
additional processing technologies in 1998 that, once fully implemented, will
enable the Company to expand its viral inactivation claims to include virtually
all of the allograft bone tissue it processes.
The Company believes that allograft bone tissue transplantation is one of
the fastest growing areas of transplant medicine. The Company estimates that in
1997 there were approximately 466,000 grafting procedures in the U.S. for which
allograft bone tissue could be utilized, representing an estimated available
allograft bone
5
tissue market of approximately $459 million. The Company estimates that the
allograft bone tissue portion of the total bone graft market in the U.S.
increased 19% in 1997 to $145 million. Industry data indicates that the
musculoskeletal surgical market is growing, expanding the potential market for
allograft bone tissue, 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 operative 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 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;
o an increase in the availability of allograft bone tissue due to
improved recovery and processing techniques and an increase in bone
tissue donations.
Allograft bone tissue is 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 to
the extremities and in other procedures requiring strong transplant material.
Cancellous bone, the spongy portion of bone tissue, is preferable for surgical
procedures, or aspects thereof, in which rapid penetration of new bone into the
pores of the transplant (a process known as osteoconduction) is desirable but
where weight-bearing strength is not paramount. Therefore, cancellous bone is
often used to fill smaller areas of bone loss and to augment more extensive
reconstructive procedures including knee and hip replacements. Most procedures
using allograft bone tissue, however, employ a combination of cortical and
cancellous bone in a variety of forms, shapes and sizes.
6
ALLOGRAFT BONE TISSUE PROCESSING
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. Osteotech processes its clients' tissue
utilizing technology it has 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. Demineralized bone
tissue includes cortical powders, segments and struts.
The suitability of an allograft bone tissue is partly dependent on the
methods and conditions 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, techniques have been developed by the Company that
minimize the use of chemicals and procedures that might render the allograft
bone tissue less suitable for use as a graft. The Company processes 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. The Company believes that its use of such clean room
techniques, a controlled environment, in-line disinfection and other
technologies preserves the properties of the tissues that make them suitable as
grafts and address the medical community's and the general public's perceptions
and concerns regarding the possible transmission of infectious disease and
toxicity. Once processed using Osteotech's current methods, freeze-dried bone
tissues may be stored for up to three years and frozen bone tissues may be
stored for up to five years before they must be used or discarded.
The Company has developed an advanced proprietary demineralization process
for cortical bone which yields a form of allograft bone tissue which can be used
to aid in the formation of new bone through the processes of osteoconduction and
osteoinduction. Osteoconduction is the process of providing the matrix into
which bone will grow and osteoinduction is the process by which bone is induced
to grow. Cortical bone is the principal reservoir for various factors which are
instrumental in osteoinduction. These biological properties of cortical bone,
however, are inhibited by the bone's structure and various minerals, lipids and
other substances comprising the bone. The Company's process removes these
inhibiting factors.
7
Grafton(R) DBM Gel, the Company's first Grafton(R) DBM form, was introduced
in 1991. Grafton(R) DBM Gel utilizes the Company's proprietary demineralization
process and offers surgeons unique handling characteristics when performing bone
graft procedures as part of spinal fusions, joint replacements and repairs of
osseous defects.
In January 1996, Osteotech introduced Grafton(R) DBM Flex. Grafton(R) DBM
Flex is a flexible "pressed fiber" form of demineralized bone which for the
first time gives surgeons a pliable form of bone graft. Grafton(R) DBM Flex is
available in square or strip forms and conforms to the body's natural anatomy
and can be easily cut for precise adaptation to host bone.
Additionally, in November 1996, Osteotech introduced Grafton(R) DBM Putty,
a moldable, putty--like graft of entangled fibers of demineralized bone, which
is easily mixed with marrow and other grafts. Grafton(R) DBM Putty minimizes
migration and can be molded and retains its shape even in larger defects.
Grafton(R) DBM Putty has received quick acceptance in the marketplace and
represented 37% of the Company's Grafton(R) DBM revenue in 1997.
With the introductions of the two new innovative forms of Grafton(R) DBM in
1996, Grafton(R) DBM Flex and Grafton(R) DBM Putty, plus wider distribution and
deeper market penetration utilizing the national network of independent agents
in combination with the Company's direct marketing force, the Company
anticipates further growth in the use of Grafton(R) DBM processed allograft bone
tissue. Through December 31, 1997, the Company's Grafton(R) DBM forms have been
utilized in over 150,000 procedures. The Grafton(R) DBM line of products
produced revenues at the end user level of approximately $34.9 million in 1997.
CERAMIC AND TITANIUM PLASMA SPRAY COATING SERVICES AND PRODUCTS
The Company is providing ceramic hydroxyapatite ("HA") plasma spray coating
services to orthopaedic and dental implant companies in Europe. The primary
advantage of coating orthopaedic and dental prosthetic devices with HA is that
it enables bone to grow onto the implanted device, thus enhancing the stability
of the device, and therefore, lowering the amount of bone loss and reducing pain
caused by micro motion. The Company manufactures the HA powder which it uses in
its plasma spray coating operations from raw materials which are readily
available from several sources. The Company also supplies HA powder to various
companies for use in their in-house plasma spray coating operations.
Additionally, the Company produces HA products which are used to replace middle
ear bones and for the repair of bone defects in dental applications.
In September 1993, the Company entered into a joint venture agreement with
APS Materials, Inc. ("APS"), a U.S. based supplier of titanium and HA plasma
spray coating services, pursuant to which the Company began offering titanium
plasma spray coating and combination titanium-HA plasma spray coating services
in
8
Europe. Titanium, like HA coating, is applied to prosthetic devices to
facilitate attachment of bone to the prosthesis. Under the agreement, the
Company makes all decisions regarding the joint venture business and manages its
daily operations, and the Company's personnel perform the spray coating
services. The parties share equally in the joint venture's income and losses.
The joint venture absorbs certain of the Company's facility and personnel costs
because it utilizes the Company's facility and personnel in The Netherlands.
In November 1997, the Company signed a long-term agreement to be the
exclusive supplier to ConvaTec, a Bristol Meyers Squibb division, of calcium
hydroxyapatite medical grade granules utilizing the Company's patented
technology. The granules are to be a key component in ConvaTec's urethral
sphincter augmentation device which is currently in clinical trials in Europe
and the United States. ConvaTec has stated that it intends to begin marketing
its product by the year 2000.
IMPLANTS AND INSTRUMENTS
In the U.S., Osteotech markets implants and instrumentation for spinal
surgery through an exclusive distribution agreement with Ulrich. Osteotech
markets Ulrich's VDS Zielke System, an implant system used by orthopaedic,
spinal and neurological surgeons worldwide - often in combination with banked
bone grafts - for the anterior correction of spinal deformities caused by
disease, trauma and degeneration. The Company also markets an extensive line of
more than 250 high quality, specialty surgical instruments manufactured by
Ulrich. Osteotech plans to continue expanding its line of spinal implant devices
and instrumentation through its relationship with Ulrich. One of Ulrich's spinal
fixation systems, the SSCS, features a proprietary hinged screw design that
allows for load sharing and provides improved results in spinal fusion
procedures. Currently, the product is being sold in Germany, the U.K., and South
Africa. The SSCS system received 510(k) clearance in the U.S. in June 1997.
Osteotech plans to first introduce the SSCS system to U.S. preceptors (a limited
number of well-respected spinal surgeons) for clinical evaluation during the
first half of 1998 and anticipates initiating full-scale product rollout in the
U.S. in the second half of 1998.
QUALITY ASSURANCE
The Company has a stringent quality assurance program in place covering all
lines of business, including allograft bone tissue, HA-titanium plasma spray
coating services, and implants and instruments. In Europe, the Company's
facility in Leiden, The Netherlands has received International Standardization
Organization ("ISO") certification for its quality systems used in the
development and manufacture of ceramic products and ceramic and titanium spray
coatings.
The Company's allograft bone tissue quality assurance program commences
with the recovery of allograft bone tissue which is procured under strict
aseptic
9
conditions. The tissue is primarily recovered in hospitals and, to a lesser
extent, coroners' facilities which have been prepared for recovery. Recovered
allograft bone tissue is also required to be sterilely wrapped and shipped in
special containers. Upon receipt of this tissue, a quarantine period is imposed
to permit serologic and microbiologic testing prior to release of allograft bone
tissue for processing. Upon satisfactory completion of all testing, the
allograft bone tissue is processed in a microbially-controlled environment.
Under constant monitoring, the allograft bone tissue is cleaned, soaked in
antibiotics and then cut and shaped in accordance with client specifications.
Before being released to clients, all processed allograft bone tissue is
inspected and again tested for microbiological contaminants by the Company's
quality assurance team.
The Company believes that the serologic screening of donors, the extensive
screening of donor profiles and medical histories performed by its clients and
its processing technologies virtually eliminate the likelihood of the presence
of infectious agents, including the HIV and hepatitis viruses, in processed
allograft bone tissue. Studies completed by an independent testing laboratory
specializing in viral inactivation studies demonstrated that the Company's
proprietary demineralization process can virtually inactivate and eliminate the
HIV virus (the process reduces the probability of transmission of the HIV virus
to one in 2.8 billion) as well as the hepatitis B, hepatitis C, cytomeglia and
polio viruses. To the Company's knowledge, none of the approximately 1.5 million
transplanted grafts it has processed since it commenced processing allograft
bone tissue in 1987 have resulted in a confirmed transmission of infectious
diseases. This record is due to the rigorous donor screening and tissue recovery
techniques used by the Company's clients, extensive donor testing, as well as
Osteotech's demanding quality assurance and processing protocols. In addition to
its proprietary demineralization process, Osteotech expects to begin to
implement additional processing technologies in 1998 that once fully implemented
will enable the Company to expand its viral inactivation claims to include
virtually all of the allograft bone tissue it processes. These proprietary,
tissue-specific technologies are expected to further enhance graft safety while
maintaining the tissue's biologic and physical properties. The Company believes
that its processing procedures and quality control measures complied with the
interim rule for banked human tissue instituted by the FDA on December 14, 1993
and effective until January 26, 1998, and comply with the final rule, Human
Tissue Intended for Transplantation, issued by the FDA on July 29, 1997, and
effective on January 26, 1998.
CLIENTS
Osteotech is the exclusive processor of allograft bone tissue for large
national and international clients which pay the Company fees for processing,
finishing and packaging their base allograft (non-propriertary forms of tissue,
including Grafton(R) DBM) bone tissue, on a per donor basis, or for proprietary
products, on a per unit basis. During 1997, MTF and ARC accounted for
approximately 57% and 34%, respectively, of the Company's revenues. The Company
has entered into new processing
10
agreements with MTF and ARC which run through March 31, 2002 and December 31,
2006, respectively.
Osteotech does not engage in donor procurement or tissue distribution and,
therefore, relies on its clients to obtain donor allograft bone tissue for
processing by the Company, and to distribute the processed allograft bone tissue
to hospitals and physicians for transplantation. However, the Company performs
marketing services which generate demand for its products. See "Education and
Marketing."
Customers of the Company's plasma spray coating services generally purchase
such services pursuant to purchase orders or non-exclusive supply agreements
which are cancelable at any time by either party.
EDUCATION AND MARKETING
Osteotech believes the markets for processed allograft bone tissue will
continue to be orthopaedic, neurological, plastic and oral/maxillofacial
surgical specialties. The Company's future growth in these areas will depend
upon a wider acceptance by these specialties of the use of allograft bone tissue
as an alternative to autograft bone tissue and other available materials and
treatments. As of December 31, 1997, there were 21 persons directly employed by
the Company to engage in efforts to educate surgeons as to the benefits and
applications of processed allograft bone tissue. To complement the Company's
direct sales organization, the Company commenced in mid-1995 to develop a
national network of independent sales agents who assist in the Company's
marketing of Grafton(R) DBM and further educate the medical community about
processed allograft bone tissue. At December 31, 1997, the Company had appointed
57 agencies with over 220 sales representatives.
A small in-house marketing staff located at the Company's Leiden facility
markets the plasma spray coating services of the Company and the Company's joint
venture with APS. These marketing activities consist primarily of attendance at
trade shows, placement of advertisements in trade journals and direct mailings
to orthopaedic and dental implant companies. The Company markets its HA powders
and ceramic products directly and through independent contract representatives
in Europe.
GOVERNMENT REGULATIONS
The procurement and transplantation of allograft bone tissue is subject to
federal law pursuant to the National Organ Transplant Act ("NOTA"), a criminal
statute which prohibits the purchase and sale of human organs, including bone
and related tissue, for "valuable consideration." NOTA permits the payment of
reasonable expenses associated with the removal, transportation, processing,
preservation, quality control, implantation and storage of human bone tissue.
The Company provides services in all of these areas, with the exception of
removal and implantation. Osteotech and other allograft bone tissue processors
are engaged in
11
ongoing efforts aimed at educating the medical community as to the benefits of
processed allograft bone tissue.
On July 29, 1997, the FDA issued a final rule, Human Tissue Intended for
Transplantation (21 CFR ss. 1270), codifying the regulatory requirements that it
had previously established in the interim rule issued on December 14, 1993. This
final rule became effective on January 26, 1998. Though a number of the
definitions and specific provisions in the interim rule were modified in the
final rule, the scope and requirements of the final rule are not substantially
different from those originally contained in the interim rule. Products
regulated under these requirements are not regulated as drugs, devices or
standard biologics, but are regulated as "human tissue for transplantation."
These products do not require a premarket clearance as do many other medical
products, but are subject to testing, screening, processing and other controls
designated as "Good Tissue Practices." These latter regulations are, in the
main, analogous to Good Manufacturing Practices applicable to medical products.
Tissue-based and cellular products that are not classified as human tissue
intended for transplantation will be regulated under different authorities as
either drugs, devices or biologics.
In August 1995, the FDA designated Grafton(R) DBM as within the scope of
the definition of banked human tissue under the interim rule on human tissue
intended for transplantation. Banked human tissue such as demineralized bone
matrix has been considered, and still is considered, exempt from FDA
premarketing clearance requirements imposed upon medical products such as drugs,
devices and biologics. Grafton(R) DBM is a demineralized bone matrix that is
mixed with glycerol, a basically inactive substance, to provide desirable
physical handling characteristics to the demineralized bone matrix.
The Company maintains a master file for its HA plasma spray coating
processes with the FDA. The Company's customers are required to obtain FDA
clearance for the marketing in the United States of their implants which are
coated by the Company. These customers refer to the Company's master file in
their application for clearance by the FDA of their implants as medical devices.
The Company's European HA plasma spray coating services meet existing regulatory
requirements in the specific countries where they are marketed. The Company's
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. ISO certification for production facilities
will be mandatory in 1998 for companies that market or distribute products
within the European Union. The certification was awarded by Tuv Product Service,
GmbH of Munich Germany, a leading Notified Body in medical devices, following a
series of audits. Notified Bodies are independent organizations authorized by
the European Union member countries to administer the ISO certification process.
Ceramic (HA) products which are produced by the Company are currently
distributed only in Europe. These products meet existing regulatory requirements
in
12
the specific countries where they are produced and marketed. The Company does
not intend currently to market these products in the United States; however, if
it does decide to do so, these products would require premarketing clearance by
the FDA as medical devices.
HA powder produced and sold in bulk by the Company in the United States and
Europe is considered to be a component product and, as such, is not currently
subject to regulation by the FDA and similar agencies in Europe.
RESEARCH AND DEVELOPMENT
During 1997, 1996 and 1995, the Company spent approximately $3.7 million,
$4.4 million and $3.7 million, respectively, on research and development
activities. The Company is engaged in continuing research and development
efforts in the allograft bone tissue processing field which include the
Company's 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. The Company's research and development expenditures in 1997 decreased
from those in 1996 due to the termination of the Company's PolyActiveTM polymer
research and development program in the fourth quarter of 1996. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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 segments
of the primary 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 -autograft bone tissue, allograft bone tissue
and synthetic bone void fillers. A potential fourth product category, growth
factor products, is still investigational.
The Company estimates that total domestic allograft bone tissue sales
increased 19% in 1997 to $145 million, comprising approximately 32% of the U.S.
bone graft market.
13
U.S. Bone Graft Market
1997
Specialty Graft Procedures(1) Allograft Market Size(2)
- --------- ------------------- ------------------------
Spinal Fusions 224,800
General Orthopaedics 162,400
Craniomaxillofacial 78,900
--------
Total 466,100
Average Selling Price(2) 985
Market Size (000) $459,109 $145,000 (32%)
1. Source: Company estimates based on Orthopaedic News Network, Medical Data
International and MarketLine Data
2. Source: Company estimate
The number of bone graft procedures is forecasted 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 pedical screw implants and spinal cages recently approved by
the FDA.
Factors producing the continued growth in the number of reconstructive
orthopaedic surgical procedures that incorporate a bone graft include the
following:
o the aging of the U.S. population;
o improving success rates for surgical procedures that involve a bone
graft procedure;
o development of less invasive reconstructive orthopaedic surgical
procedures that will be used in a wider patient population; and
o the increasing number of revision, spinal fusion and joint
arthroplasty procedures.
While the general bone graft market has experienced low-single-digit growth
in recent years, the Company estimates that allograft bone tissue sales have
increased at an average annual rate of approximately 16% since 1994 (19% in
1997). 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:
14
o the desire by surgeons to avoid the additional procedure needed to
acquire autograft bone tissue, which often increases (i) costs due to
additional operating time, medical supplies and extended hospital stay
and (ii) 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
improved recovery and processing techniques and an increase in bone
tissue donations.
Competitive Overview
Allograft bone tissue processed by Osteotech competes in the bone graft
market with autograft bone tissue, synthetic bone void fillers and allograft
bone tissue processed by others, primarily, bone tissue banks. Autograft bone
tissue has traditionally been the primary choice for surgeons and the Company
believes it still maintains an approximate 63% share of the U.S. bone graft
market. Due to factors including 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.
Osteotech has been successful in persuading surgeons to switch to Osteotech
processed allograft bone tissue through the introduction of its proprietary
tissue processing technology. The Company has 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 three forms - gel,
flex and putty - and packaged in sterile, single-patient delivery systems. With
the varying textural and handling characteristics of its three forms, Grafton(R)
DBM can be used in virtually all non-weight-bearing bone graft procedures and
has been used in over 150,000 procedures through December 31, 1997. Given its
osteoinductive and osteoconductive properties, Grafton(R) DBM has a distinct
advantage over synthetic bone void fillers, all of which are exclusively
osteoconductive.
15
Grafton(R) DBM vs. Synthetics
Mechanism(s) of Published Available
Bone Healing Applications Safety Data Forms
------------ ------------ ----------- -----
Grafton(R) DBM Osteoinduction & All non-weight- Yes Gel
Osteoconduction bearing bone Flex
graft procedures Putty
ProOsteon Osteoconduction Acute metaphyseal Yes Blocks
(Interpore) fracture defects Granules
less than or equal
to 30 cc with
internal fixation
Collagraft Osteoconduction Long bone defects Yes Paste
(Zimmer) & fractures less than Strips
or equal to 30ml
with fixation
Osteo Set Osteoconduction Non weight- Yes Pellets
(Wright bearing defects
Medical) in long bones and
spine
Grafton(R) DBM's advantages over other competitors in the market for
non-weight-bearing grafting materials include (i) superior handling and
performance qualities, (ii) the support of the Company's national network of 57
independent sales agencies with over 220 representatives as well as the
Company's direct 21 person field marketing organization and (iii) the
suitability of Grafton(R) DBM for all non-weight-bearing bone graft procedures
vs. the limited applications of other competitors. Grafton(R) DBM when compared
to competitive synthetic products, accounts for over 56% of the U.S. Market for
non-weight-bearing grafting materials.
16
Non-Weight-Bearing Grafting Materials
1996(1) 1997(2)
----------------- -----------------
Sales Share Sales Share
Product/Company ($000) % ($000) %
- ------------------ ------ ----- ------ -----
Grafton(R)
DBM/Osteotech 21,900(3) 53.2 30,000(3) 56.6
Pro Osteon/Interpore 21,500 30.3 15,000 28.3
Collagraft/Zimmer 6,500 15.8 5,000 9.4
Osteo Set/Wright 300 .7 3,000 5.7
------- ----- ------- -----
$41,200 100.0% $53,000 100.0%
- --------------
1. Source: Medical Data International
2. Source: Corbin & Company, orthopaedic Network News
3. Actual Grafton(R)DBM End-User Sales: 1996 $22,500,000; 1997 $34,900,000
Although it already occupies a dominant position in the U.S. market for
non-weight-bearing grafting materials, Grafton(R) DBM has significant
opportunities for growth. Currently, Grafton(R) DBM sales are almost exclusively
domestic. The Company estimates the potential non-domestic bone graft market to
be at least as large as that of the U.S. market. The European market, in
particular, provides Osteotech with an opportunity in an area where it already
has a sales presence with its profitable coatings and ceramics business. In
addition, the Company estimates that Grafton(R) DBM was used in only 11% of the
total bone graft procedures performed in the U.S. during 1997.
17
Grafton(R) DBM Procedure Penetration
1997
------------------------------------------------
Grafton
------------------------
Potential(1) Actual(2) Percent Penetration
------------ --------- -------------------
Specialty
Spinal Fusions 224,800 31,408 14.0%
General Orthopaedics 162,400 16,347 10.1%
Craniomaxillofacial 78,900 3,329 4.2%
------- ------ ----
Total 466,100 51,084 11.0%
1. Source: Company Estimates Based on Orthopaedic News Network, Medical Data
International and MarketLine Data
2. Source: Company Estimate
Allograft bone tissue is still the only alternative to autograft bone
tissue for bone grafting procedures which require weight-bearing tissue. The
Company plans to continue to differentiate its base allograft bone tissue
processing business from other allograft bone tissue processors by expanding the
Company's viral inactivation claim to include Osteotech's non-demineralized
weight-bearing tissue beginning in the fourth quarter of 1998. The Company will
also introduce in 1998 its Allogard(R) package plastic tray packaging for most
of its non-Grafton(R) DBM processed allograft bone tissue which will be easier
for operating room nurses to work with. In addition, this will allow the Company
to differentiate its "Osteotech processed bone" from most competitive allograft
processed bone that is usually packaged in glass bottles.
In order to maintain its leading position in the allograft bone tissue
processing market and to encourage more surgeons to switch from autograft bone
tissue to Osteotech processed allograft bone tissue, the Company plans to (i)
leverage its knowledge of bone tissue processing to expand Osteotech's
proprietary tissue safety claims, (ii) expand Osteotech's external scientific
presence to proactively support current and new product entries and (iii) expand
Osteotech's market differentiation through tissue performance improvements
including line extensions of existing Grafton(R) DBM and base allograft bone
tissue products and new product introductions such as new allograft bone tissue
forms, osteoinductive weight-bearing allografts, enhanced performance of
demineralized bone and use as a growth factor carrier.
Ceramic and Titanium Plasma Spray Coating Services and Products
The Company's 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, the Company also faces
competition from medical implant companies which have in-house plasma spray
coating operations. The Company competes primarily on the quality of its
coatings and price. Osteotech believes that the spraying technology it uses,
which is computer controlled and utilizes robotics, enables it to provide high
quality coatings at competitive prices. It should be noted, however, that the
ceramic and titanium coating industry is highly competitive, certain of the
Company's competitors have greater resources than the Company and there can be
no assurance the Company will be able to compete successfully.
18
ENVIRONMENTAL MATTERS
The Company's allograft bone tissue processing generates waste which is
classified as medical hazardous waste by the United States Environmental
Protection Agency and the New Jersey Department of Environmental Protection.
Such waste is segregated by the Company and disposed of through a licensed
hazardous waste transporter in compliance with applicable regulations. The
production of HA powder at the Company's facility in The Netherlands generates
small amounts of hazardous waste, which is segregated by the Company and
disposed of through a licensed hazardous waste transporter. Although the Company
believes it is in compliance with applicable environmental regulations, the
failure by the Company to fully comply with any such regulations could result in
the imposition of penalties, fines and/or sanctions which could have a material
adverse effect on the Company's business.
PATENTS AND PROPRIETARY RIGHTS
Osteotech considers its processing technology and procedures proprietary
and relies primarily on trade secrets to protect its technology and innovations.
Significant research and development activities have been conducted by
consultants employed by third parties or in conjunction with unaffiliated
medical institutions. Accordingly, disputes could arise in the future concerning
the proprietary rights to information applied to Company projects which have
been independently developed by the consultants or researchers at the medical
institutions.
At February 28, 1998, the Company held (i) twenty-nine patents in the
United States and foreign countries relating to its aseptic processing
technology and its transplant support products, including eight Grafton(R) DBM
patents, (ii) four United States and three foreign patents relating to its
biomaterial technology, (iii) five United States and three foreign patent
applications relating to aspects of its processing technology and its osteogenic
and other products under development and (iv) four United States patent
applications relating to its biomaterial technology. The Company believes that
its Grafton(R) DBM patents are significant in maintaining the Company's
competitive position. These patents expire on various dates ranging from 2009 to
2015. The Company's other patents expire at various dates ranging from 2007 to
2016. There can be no assurance that any pending patent applications will result
in issued patents or that any currently issued patents, or patents which may be
issued, will provide Osteotech with sufficient protection in the case of an
infringement of its technology or that others will not independently develop
technology comparable or superior to the Company's. See "Legal Proceedings."
PRODUCT LIABILITY AND INSURANCE
The testing and use of allograft bone tissue and the implantation of
medical devices coated with the Company's HA powder, medical devices
developed
19
with the Company's biomaterial technology and medical devices manufactured by
others and distributed by the Company entail inherent risks of medical
complications for patients and therefore, may result in product liability claims
against the Company. Further, Osteotech's agreements with its bone tissue
processing clients provide for indemnification by the Company for liabilities
arising out of defects in allograft bone tissue caused as a result of processing
by the Company.
As a distributor of implants and instruments for spinal surgery, including
bone screws, manufactured by Ulrich, the Company has been named as a defendant
in a number of lawsuits in which plaintiffs claim that they have suffered
damages from the implantation of allegedly defective spinal fixation devices.
See "Legal Proceedings."
Pursuant to its distribution agreement with the Company, Ulrich has agreed
to indemnify the Company for all costs, and damages incurred by the Company in
connection with its distribution of products manufactured by Ulrich, except such
costs and damages which are caused by the Company's gross negligence or willful
misconduct or unauthorized claims made by the Company in marketing the products.
Ulrich maintains its own product liability insurance coverage. To date, Ulrich
has made indemnity payments to the Company for a portion of the costs incurred
by the Company in defending the lawsuits involving the Ulrich products
distributed by the Company. There can be no assurance that the Company will in
fact be indemnified by Ulrich for all such costs. See Note 9 of "Notes to
Consolidated Financial Statements."
The Company presently maintains product liability insurance in the amount
of $37 million per occurrence and per year in the aggregate. There can be no
assurance that the Company will be able to maintain such insurance in the future
or that such insurance will be sufficient to cover all liabilities.
EMPLOYEES
At December 31, 1997, Osteotech had 231 employees, of whom 137 were engaged
in allograft bone tissue processing, ceramic plasma spray coating and the
manufacture of products; 25 in research and development; 35 in education and
marketing and 34 in regulatory, finance and administration. The Company's
employees are not covered by any collective bargaining agreement. The Company
considers relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in approximately
38,000 square feet in Eatontown, New Jersey which is occupied pursuant to a
lease which expires in December 2004 and provides for a base annual rental of
approximately $264,000. This facility is occupied by the Company's
corporate,
20
financial, administration, marketing, research and development, regulatory and
clinical affairs staff.
The Company's processing facility is located in approximately 30,000 square
feet of space in Shrewsbury, New Jersey which is occupied pursuant to a lease
which expires in February 2007 and provides for a base annual rental of
approximately $239,000 for the first five years of the lease and $261,000 for
the remaining term of the lease. The lease is renewable at the Company's option
for an additional five year term.
The Company's European subsidiaries occupy a 21,000 square foot facility in
Leiden, The Netherlands. The lease for this facility expires in May 2008 and the
annual rent is dfl 626,000 (approximately $309,000 at the December 31, 1997
exchange rate).
In 1997, the Company purchased approximately 13 acres of land surrounding
its Eatontown, New Jersey facility. The Company plans to utilize this land for
the future expansion of facilities to meet the Company's anticipated facilities
requirements. In connection with the first stage of this expansion, the Company
currently intends to sell a portion of this land to a developer who will build a
50,000 square foot processing facility to the Company's specifications. The
Company expects to occupy this facility pursuant to a lease by the end of 1999.
ITEM 3. LEGAL PROCEEDINGS
Orthopaedic Bone Screw Products Liability Litigation
As of February 13, 1998, the Company had been dismissed from all previously
reported bone screw products liability cases, with the exception of two state
court cases, Abercrombie v. Acromed, Case No. CV-28393 (Cuyahoga County Ct. of
Common Pleas, Ohio), and Ponder v. Synthes, Case No. 2729 (Court of Common
Pleas, Philadelphia County, Pa.), both of which have been stayed with respect to
the Company. The Company believes that the claims made in these actions are
without merit and, accordingly, both such cases are and will continue to be
vigorously defended.
Both of the actions seek monetary damages of no less than $50,000 per
plaintiff. The aggregate monetary damages eventually sought by all of the
plaintiffs and the related costs to defend such action may be substantial.
Pursuant to the Company's distribution agreement with Ulrich, the manufacturer
of the spinal system distributed by the Company, Ulrich has agreed to indemnify
the Company for liabilities incurred in connection with the distribution of
Ulrich's products. However, there can be no assurance that Ulrich will have the
financial resources necessary to comply with its indemnification obligations to
the Company.
21
Additionally, the Company maintains its own products liability insurance
coverage from Lexington Insurance Company ("Lexington"). However, Lexington has
denied coverage with respect to both of these cases.
Personal Injury Litigation
On July 11, 1994, a former employee of the Company and his spouse commenced
a personal injury action under the caption Fey v. Int'l Sheet Metal & Plate
Mfg., Case No. L-3837-94 (Superior Ct., Monmouth County, N.J.) for injuries
plaintiff Gerald Fey allegedly suffered during the course of his employment with
the Company. As a result of the New Jersey Workers' Compensation Act, the
plaintiffs are barred from asserting any actions resulting from the alleged
workplace injuries. The Company, therefore, was named a defendant for discovery
purposes only.
Plaintiffs, on or about June 24, 1997, however, moved the Court for an
order granting them leave to amend their complaint in this action to assert
against the Company a claim for spoliation of evidence. On July 15, 1997, the
Company filed its opposition to the motion. The motion has not yet been decided.
Patent Litigation
On January 16, 1998, the Company filed suit in the United States District
Court for the District of New Jersey for patent infringement against GenSci
Regeneration Sciences, Inc. and GenSci Laboratories, Inc. (collectively
"GenSci"). In the lawsuit, Osteotech accuses GenSci of violating claims of at
least one patent issued to Osteotech involving the Company's Grafton(R) DBM
process, by making, using, and/or selling the invention claimed in the patent
without permission or license from Osteotech. The Company's patent, U.S. Patent
No. 5,290,558 is directed to flowable demineralized bone powder composition and
its use in bone repair. The GenSci products which are the subject of this
lawsuit are marketed under the names DynaGraft Gel and DynaGraft Putty.
On January 28, 1998, GenSci Regeneration Laboratories, Inc. filed suit in
the United States District Court for the Central District of California against
Osteotech accusing Osteotech of violating certain claims of two patents held by
GenSci by the processing of Grafton(R) DBM Flex. Osteotech's Grafton(R) DBM Gel
and Grafton(R) DBM Putty products which represent more than 90% of the Company's
Grafton(R) DBM revenues are not involved in the lawsuit. This suit also contains
claims against Osteotech for tortious interference with a business expectancy,
negligent interference with prospective economic advantage, inducing breach of
contract and a declaratory judgment of the invalidity of the Company's U.S.
Patent Nos. 5,284,655 and 5,290,558. An amended complaint was filed by GenSci
Regeneration Laboratories, Inc. on February 18, 1998 alleging essentially the
same causes of action but adding a third GenSci patent to the allegation of
patent infringement.
22
The Company is moving to dismiss, transfer or stay the California action
while going forward with the first-filed suit in the United States District
Court for the District of New Jersey. GenSci has filed a similar motion with
respect to the New Jersey action. The Company intends to vigorously pursue its
claims against GenSci and believes GenSci's subsequently filed claims are
without merit.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been traded on the Nasdaq Stock MarketSM
under the trading symbol "OSTE" since the Company's initial public offering in
July 1991.
The following table sets forth the high and low sale prices for the Common
Stock for each of the fiscal quarters during the years ended December 31, 1997
and 1996 based on transaction data as reported by the Nasdaq Stock MarketSM .
Year Ended December 31, 1997 High Low
- ---------------------------- ---- ---
First Quarter 8 - 5/16 6 - 7/8
Second Quarter 10 - 3/4 7 - 1/8
Third Quarter 22 - 3/8 9 - 1/2
Fourth Quarter 32 - 3/4 17
Year Ended December 31, 1996 High Low
- ---------------------------- ---- ---
First Quarter 8 6 - 13/16
Second Quarter 8 - 3/8 6
Third Quarter 7 - 7/8 5 - 1/2
Fourth Quarter 7 - 1/8 5 - 29/64
As of March 3, 1998 there were 214 holders of record of the Company's
Common Stock. The Company believes that there are approximately 4,700 beneficial
owners of its Common Stock.
The Company has never paid a cash dividend and does not anticipate the
payment of cash dividends in the foreseeable future as earnings are expected to
be retained to finance the Company's growth. Declaration of dividends in the
future will remain within the discretion of the Company's Board of Directors,
which will review the Company's dividend policy from time to time.
Recent Sales of Unregistered Securities
During the quarter ended December 31, 1997, shares of the Company's Common
Stock were issued in connection with warrant exercises. The aggregate exercise
price of $138,091 was paid through the delivery of Common Stock with an
aggregate fair market value equal to the aggregate exercise price. These
transactions were consummated as private sales pursuant to Section 4(2) of the
Securities Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is the selected financial data for the Company for the five
fiscal years ended December 31, 1997. The following data should be read in
conjunction with the Company's consolidated financial statements and related
notes thereto contained elsewhere herein and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
24
============================================================================================================
Selected Financial Data
(dollars in thousands except
per share data)
For the Year ended
December 31 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------
Net revenues $ 44,931 $ 34,895 $ 27,934 $ 24,570 $ 19,124
- ------------------------------------------------------------------------------------------------------------
Costs and expenses (a) 35,944 33,146 27,696 23,935 20,817
- ------------------------------------------------------------------------------------------------------------
Other income, net (b) 585 271 4,582 577 2,926
- ------------------------------------------------------------------------------------------------------------
Income (loss) before income
taxes and unusual items (c) 9,572 3,370 1,653 1,212 (1,242)
- ------------------------------------------------------------------------------------------------------------
Income before income taxes 9,572 2,020 4,820 1,212 1,233
- ------------------------------------------------------------------------------------------------------------
Net income (loss) 5,686 (324) 4,582 1,747 1,107
- ------------------------------------------------------------------------------------------------------------
Net income (loss) per share
(i) basic .69 (.04) .58 .22 .15
(ii) diluted .65 (.04) .57 .22 .14
- ------------------------------------------------------------------------------------------------------------
Dividends per share 0 0 0 0 0
- ------------------------------------------------------------------------------------------------------------
Year End Financial
Position
- ------------------------------------------------------------------------------------------------------------
Working capital $ 19,922 $ 12,273 $ 12,135 $ 9,010 $ 7,239
- ------------------------------------------------------------------------------------------------------------
Total assets 43,052 31,483 30,170 22,594 19,706
- ------------------------------------------------------------------------------------------------------------
Long-term obligations 203 840 1,598 1,027 375
- ------------------------------------------------------------------------------------------------------------
Stockholders' equity 34,292 22,717 22,594 17,096 15,362
============================================================================================================
(a) Costs and expenses include: (i) a charge to earnings in 1996 of $1,350,000
related to the restructuring of the Company's non-allograft bone tissue
operations located in Leiden, The Netherlands and (ii) a charge to earnings
in 1995 of $980,000 resulting from the termination of a distribution
agreement.
(b) Other income includes principal payments on a fully reserved note from a
major client of $4,147,000 in 1995 and $2,475,000 in 1993;
(c) Excludes items of income and expense discussed in (a) and (b). The Company
provides information concerning income before income taxes and unusual
items because it enhances an investor's understanding of the Company's
operating performance and cash flows. Income before income taxes and
unusual items excludes significant components of income and expense which
impact Company financial performance, and should not be considered an
alternative to income before income taxes, net income (loss), or any other
measure of financial performance required by generally accepted accounting
principles ("GAAP"), and should be read in conjunction with the
consolidated financial statements of the Company included elsewhere herein.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
RESULTS OF OPERATIONS
Net Income (Loss)
Net income in 1997 increased to $5,686,000 compared to a net loss of
$324,000 in 1996 and net income of $4,582,000 in 1995.
Income before income taxes and unusual items increased to $9,572,000 in
1997 compared to $3,370,000 in 1996 and $1,653,000 in 1995. Including unusual
items, income before income taxes was $9,572,000 in 1997 compared to $2,020,000
in 1996 and $4,820,000 in 1995. Income before income taxes in 1996 includes a
charge to earnings of $1,350,000 related to the restructuring of the Company's
non-allograft bone tissue operations located in Leiden, The Netherlands. Income
before income taxes in 1995 includes the receipt of note repayments on a fully
reserved note from a major client of $4,147,000 and a charge to earnings of
$980,000 resulting from the termination of a distribution agreement for trauma
implant products. See "Provision for Restructuring" and "Provision for
Termination of a Distribution Agreement" included elsewhere in Item 7.
In 1995, income tax expense was reduced by the recognition of net deferred
tax assets resulting primarily from temporary differences which reversed during
the year and the realization of tax benefits associated with Federal and state
tax net operating loss carryforwards and tax credits. See "Income Tax Provision"
included elsewhere in Item 7.
The table below shows the impact of these items:
1997 1996 1995
---- ---- ----
Income before income taxes and unusual Items $ 9,572,000 $ 3,370,000 $ 1,653,000
Unusual Items:
Provision for restructuring (1,350,000)
Note repayments from major clients 4,147,000
Provision for termination of distribution agreement (980,000)
------------ ------------ ------------
Income before income taxes 9,572,000 2,020,000 4,820,000
Recognition of net deferred tax assets 2,551,000
Income tax provision (3,886,000) (2,344,000) (2,789,000)
------------ ------------ ------------
Net income (loss) $ 5,686,000 $ (324,000) $ 4,582,000
============ ============ ============
26
The Company provides information concerning income before taxes and unusual
items because it enhances an investor's understanding of the Company's operating
performance and cash flows. Income before taxes and unusual items excludes
significant components of income and expense which impact Company financial
performance, and should not be considered an alternative to income before income
taxes, net income (loss), or any other measure of financial performance required
by GAAP, and should be read in conjunction with the consolidated financial
statements of the Company included in a separate section of this Annual Report
commencing on page F-1.
The following is a discussion of factors which affected results of
operations for the years ended December 31, 1997, 1996 and 1995.
Net Revenues
Net revenues in 1997 increased 29% to $44,931,000 from $34,895,000 in 1996.
Net revenues in 1996 were 25% higher than 1995 revenues of $27,934,000.
Domestic revenues increased 33% to $41,887,000 in 1997 compared to
$31,582,000 in 1996. Domestic revenues in 1996 were 30% higher than 1995
revenues of $24,293,000. The increase in domestic revenues resulted principally
from increased demand for the Company's proprietary Grafton(R) DBM
allograft-processing services, which increased 74% in 1997 and 67% in 1996,
compared to the respective prior years.
Non-allograft bone tissue foreign revenues decreased 8% to $3,044,000 in
1997 compared to $3,313,000 in 1996. Non-allograft bone tissue foreign revenues
in 1996 were 9% lower than 1995 revenues of $3,641,000. The decline in 1997 is
attributable to the loss of grant revenues from the Dutch government, which were
$697,000 in 1996, as a result of the discontinuance of the Company's
PolyActive(TM) polymer research and development program. During 1997, the
Company licensed out the patents and technology related to PolyActive(TM) and
received an upfront payment of $257,000, which partially offset the decline in
grant revenues. Additionally, non-allograft bone tissue foreign revenues in 1997
were unfavorably impacted 14% as a result of the strength of the U.S. dollar
compared to the Dutch Guilder. However, the impact on consolidated net revenues
was approximately 1%. The decline in 1996 resulted from decreases in ceramic
spray coating services, ceramic products and grant revenues.
During 1997, 1996 and 1995, two of the Company's allograft bone tissue
clients, MTF and ARC, accounted for 57% and 34%, 64% and 25% and 65% and 20%,
respectively, of revenues. Effective in 1997, the Company entered into new
long-term exclusive processing agreements with MTF and ARC.
27
Costs of Services and Products
Costs of services as a percentage of service revenues was 34% in 1997, 39%
in 1996 and 43% in 1995. The decline in costs as a percentage of revenues
results from ashift in revenue mix toward services with higher gross margins,
operating efficiencies resulting from increased volume and an increase in fees
charged to the Company's customers for certain allograft processing services.
Cost of products as a percentage of product revenues was 75% in 1997, 97%
in 1996 and 77% in 1995. The decline in costs as a percentage of revenue in 1997
results primarily from a shift in product mix toward products with higher gross
margins. The increase in costs in 1996 as a percentage of revenues resulted
principally from an increase in product liability insurance premiums associated
with spinal implant products distributed by the Company.
Marketing, General and Administrative Expenses
Marketing, general and administrative expenses increased $3,762,000 or 30%
in 1997 and $2,211,000 or 21% in 1996. The increases are primarily attributable
to expanded marketing and promotional activities associated with the continued
expansion of the business, increased agent commissions directly related to the
increase in Grafton(R) DBM revenues and increased administrative costs,
principally outside professional services.
Research and Development Expenses
Research and development expenses in 1997 decreased $629,000, or 14%, to
$3,728,000 from $4,357,000 in 1996. The decline results principally from the
discontinuance of the Company's PolyActive(TM) polymer research and development
program in the fourth quarter of 1996 (see "Provision for Restructuring").
Research and development expenses in 1996 increased $608,000 or 16% to
$4,357,000 from $3,749,000 in 1995. The increase was primarily attributable to
increased spending associated with the development of additional allograft bone
tissue forms which were introduced into the market during 1996, expansion of the
Company's viral inactivation process to a broader range of allograft bone tissue
and the development of PolyActive(TM) products.
Provision for Restructuring
In October 1996, the Company announced a plan to restructure its
non-allograft bone tissue operations located in Leiden, The Netherlands in order
to focus those operations on: (i) the revenue and profit generating activities
of providing ceramic and titanium spray coating services and ceramic products to
the orthopaedic and dental markets and (ii) to pursue OEM business opportunities
for those
28
technologies. In connection with the restructuring, the Company discontinued its
PolyActive(TM) polymer research and development program. As a result of the
restructuring, the Company recorded a pre-tax restructuring charge of $1,350,000
which included $425,000 for employee termination costs, $541,000 for write-off
ofequipment, intangible assets and inventory, $234,000 for costs associated with
the planned sub-leasing of office space in Leiden on which the Company has a
long-term lease and $150,000 for other contractual obligations. See Note 4 of
"Notes to Consolidated Financial Statements."
Provision for Termination of Distribution Agreement
In June 1995, the Company terminated its distribution agreement for trauma
implant products with its supplier, aap, GmbH, of Berlin, Germany. As a result
of this termination the Company recorded a pre-tax charge to earnings of
$980,000 which included $840,000 for inventory write-offs, $85,000 for employee
termination costs and $55,000 for legal fees. Revenues from marketing trauma
products were not material in 1995. See Note 5 of "Notes to Consolidated
Financial Statements."
Other Income (Expense)
In 1997, other income increased by $314,000 compared to 1996 due to higher
invested cash and lower outstanding debt balances. In 1996, other income
decreased by $4,311,000 compared to 1995. Other income in 1995 included the
receipt of $4,147,000 of note repayments on a fully reserved note from a major
client. See Note 6 of "Notes to Consolidated Financial Statements."
Income Tax Provision
The Company's effective income tax rate declined to 41% in 1997 from 116%
in 1996. The high effective income tax rate in 1996 was principally due to
foreign losses for which no current tax benefits were available. The effective
income tax rate was 5% in 1995 due to the Company's recognition of net deferred
tax assets of $2,551,000 related to: (i) the realization of $1,335,000 of tax
benefits from temporary differences which reversed during the year, and (ii) the
Company's assessment that it would generate sufficient future U.S. taxable
income to realize $1,216,000 of deferred tax benefits associated with certain
federal and state net operating loss carryforwards and tax credits. See Note 14
of "Notes to Consolidated Financial Statements."
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had cash and short-term investments of
$15,357,000 compared to $9,277,000 at December 31, 1996. Working capital
increased $7,649,000 to $19,922,000 at December 31, 1997 compared to $12,273,000
at December 31, 1996. Accounts receivable at December 31, 1997 increased by
$1,267,000 from $6,280,000 due to the strong fourth quarter revenue increase.
29
Net cash provided by operations was $9,367,000 in 1997, compared to
$4,048,000 in 1996. The increase resulted primarily from the Company's improved
earnings in 1997. Cash used for capital expenditures increased to $5,385,000 in
1997from $2,152,000 in 1996 as the Company continues to invest in facilities and
equipment needed for current and future business requirements. The Company
expects 1998 capital expenditures to be approximately equivalent to 1997 capital
expenditures. The Company has not yet determined the amount of any capital
expenditures to be incurred in connection with the proposed processing facility
described in "Item 2. Properties" or whether such capital expenditures will be
financed through a lease, the Company's current credit facilities or its cash
reserves. Net cash provided by financing activities was $2,307,000 in 1997
compared to net cash used in financing activities of $360,000 in 1996. The
increase results principally from cash proceeds received from stock option
exercises.
The Company has a loan and security agreement with a U.S. bank which
provides for borrowings of up to $3,000,000 under a revolving line of credit and
$4,000,000 under an equipment line of credit. At December 31, 1997, $709,000 was
outstanding under the equipment line of credit and there were no borrowings
outstanding under the revolving line of credit. The Company also has a line of
credit with a Dutch bank which provides for borrowings of up to dfl 5,000,000,
or approximately $2,467,000 at the December 31, 1997 exchange rate. Analysis of
the Company's cash position and anticipated cash flow indicated that it most
likely would not be necessary to utilize a significant portion of this line of
credit in 1997 and, therefore, the Company agreed with the bank to limit its
borrowings in 1997, if any, to no more than dfl 3,000,000, or approximately
$1,480,000 at the December 31, 1997 exchange rate. Additionally, in connection
with the Leiden facility lease, the Company is required to maintain a declining
bank guarantee which reduced the current amount available for borrowings to dfl
2,810,000, or approximately $1,387,000 at the December 31, 1997 exchange rate.
At December 31, 1997, there were no borrowings outstanding under this credit
line. See Note 12 of "Notes to Consolidated Financial Statements."
At December 31, 1997 certain of the Company's foreign subsidiaries have net
operating loss carryforwards aggregating $9,700,000 at the December 31, 1997
exchange rate ($300,000 with no expiration date; $9,400,000 expiring 1999
through 2004). See Note 14 of "Notes to Consolidated Financial Statements."
The Company believes that its cash and cash equivalents, short-term
investments and available lines of credit, together with anticipated future cash
flow from operations will be sufficient to meet its near-term requirements, but
may not be adequate to fully develop and commercialize all products currently
under development by the Company. Further, from time to time, the Company may
seek additional funds through equity or debt financing. However, there can be no
assurance that such additional funds will be available to the Company, or if
available, that such funds will be available on terms favorable to the Company.
30
Impact of Inflation and Foreign Currency Exchange Fluctuations
The results of the Company's operations for the periods discussed have not
been significantly affected by inflation or foreign currency fluctuations.
YEAR 2000
The Company regularly evaluates its computer hardware and software
applications to determine the adequacy of such systems to support the Company's
business operations. As a result of such evaluation, the Company identified
changes that were required, and commenced implementation of a new fully
integrated computerized Management Information Systems, which is expected to be
fully operational in 1998. The new system is Year 2000 compliant, and
accordingly, the Company does not anticipate a disruption to its business
operations or those of its clients.
Since the new software is being implemented to support the Company's
business operations, there is no incremental cost associated with Year 2000
compliance.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this Annual
Report commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The section of the Company's 1998 Proxy Statement entitled "Election of
Directors" is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section of the 1998 Proxy Statement entitled "Executive Compensation"
is incorporated herein by reference.
31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section of the 1998 Proxy Statement entitled "Security Ownership of
Certain Beneficial Owners and Management" is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section of the 1998 Proxy Statement entitled "Certain Relationships and
Related Transactions" is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2). The response to this portion of Item 14 is submitted as a
separate section of this report commencing on page F-1.
(a)(3) and (c). Exhibits (numbered in accordance with Item 601 of
Regulation S-K).
Exhibit Page
Number Description Number
- ------ ----------- ------
3.1 Restated Certificate of Incorporation of the Company *
3.2 Amended and Restated Bylaws of the Company #
3.3 Form of Stock Certificate **
4.1 Stock and Warrants Purchase Agreement, as amended **
4.2 Amended Security Holders Agreement **
4.3 Rights Agreement dated as of February 1, 1996 between Osteotech, Inc. #
and Registrar and Transfer Co.
10.1 1991 Stock Option Plan, as amended^ *****
10.2 1991 Independent Directors Stock Option Plan, as amended^ *****
10.3 Various Written Option Agreements between the Company and ***
certain employees, officers, directors and consultants or
advisors of the Company A^
10.4 Senior Management Bonus Programs^ ****
10.5 Senior Management Loan Program^ ****
32
Exhibit Page
Number Description Number
- ------ ----------- ------
10.6 Lease for the Company's Leiden, The Netherlands facility dated May 28, +
1993
10.7 Service Agreement between the Company and the **
Musculoskeletal Transplant Foundation, dated March 1,
1987
10.8 Processing Agreement between the Company and Stichting **
Eurotransplant Nederland, dated September 26, 1988-
10.9 Stock Purchase Agreement by and among Osteotech, Inc., Osteotech BV ++
and C.A. van Blitterswijk, C.A. van Blitterswijk Holding BV,
K. de Groot, K. de Groot Holding BV, R. G. van der Scheer and
HOM Consultancy BV
10.10 Loan and Security Agreement between the Company and United Jersey +
Bank/Central, N.A. dated May 27, 1993
10.11 First Amendment to Loan and Security +++
Agreement between the Company and United
Jersey Bank/Central, N.A. dated July 14, 1994
10.12 Sublicense Agreement by and between CAM *****
Implants, Inc. and APS-Materials, Inc.
dated September 20, 1993
10.13 Partnership Agreement by and between *****
Osteotech/CAM Services BV and APS-
Materials, Inc. dated September 20, 1993
10.14 Employment Agreement with Michael J. Jeffries dated January 1, 1996^ *******
10.15 Employment Agreement with Roger C. Stikeleather *******
dated January 1, 1996^
10.16 Lease for the Company's Eatontown facility ******
dated October 20, 1994
10.17 Employment Agreement with James L. Russell, *******
Ph.D. dated December 18 , 1995^
10.18 Confidentiality Agreement and Non-Competition *******
Agreement with James L. Russell, Ph.D. dated
November 15, 1995
33
Exhibit Page
Number Description Number
- ------ ----------- ------
10.19 Second Amendment to Loan and Security Agreement ++++
between the Company and United Jersey Bank/Central,
N.A. dated June 30, 1995
10.20 Amendment to the lease for the Company's Leiden, the ++++
Netherlands facility dated June 27, 1995
10.21 Agreement dated December 10, 1996 between ********
American Red Cross Tissue Services and the Company-
10.22 Lease for the Company's Shrewsbury, New Jersey ********
processing facility
10.23 Employment Agreement between the Company ********
and Richard W. Bauer dated December 5, 1996^
10.24 Agreement dated April 1, 1997 between Muscoloskeletal ++++++
Transplant Foundation and the Company
10.25 Credit Agreement between Osteotech b.v. and ING +++++
Bank N.V. dated March 14, 1996
10.26 Third Amendment to Loan and Security Agreement +++++
between the Company and United Jersey Bank/Central,
N.A. dated May 31, 1996
10.27 Fourth Amendment to Loan and Security Agreement ++++++
between the Company and Summit Bank dated July 28,
1997
10.28 Third Restated Equipment Promissory Note between ++++++
the Company and Summit Bank dated July 28, 1997
10.29 Second Restated Revolving Loan Promissory Note between ++++++
the Company and Summit Bank dated July 28, 1997
10.30 License & Option Agreement between HC Implants BV and Matrix ++++++
Medical Holding BV dated June 6, 1997
10.31 Change in Control Agreement by and between the Company and Richard W. +++++++
Bauer^
10.32 Change in Control Agreement by and between the Company and Michael J. +++++++
Jeffries^
34
Exhibit Page
Number Description Number
- ------ ----------- ------
10.33 Change in Control Agreement by and between the +++++++
Company and James L. Russell^
10.34 Change in Control Agreement by and between the +++++++
Company and Roger Stikeleather^
10.35 Employment Agreement with Michael J. Jeffries
dated January 1, 1998^ E-2
10.36 Employment Agreement with Roger C. Stikeleather
dated January 1, 1998^ E-11
10.37 Employment Agreement with James L. Russell dated
December 18, 1997^ E-20
21.1 Subsidiaries of the Registrant E-29
23.1 Consent of Coopers & Lybrand LLP E-30
27.0 Financial Data Schedule E-32
99.1 Risk Factors E-33
* Previously filed as exhibits to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1991 and incorporated
herein by reference thereto.
** Previously filed as exhibits to the Company's Registration Statement
on Form S-1 (File No. 33-40463) and incorporated herein by reference
thereto.
*** Previously filed as exhibits to the Company's Registration Statement
on Form S-8 (File No. 33-44547) and incorporated herein by reference
thereto.
**** Previously filed as exhibits to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1992 and incorporated
herein by reference thereto.
***** Previously filed as exhibits to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1993 and incorporated
herein by reference thereto.
****** Previously filed as exhibits to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1994 and incorporated
herein by reference thereto.
******* Previously filed as exhibits to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1995 and incorporated
herein by reference thereto.
******** Previously filed as exhibits to the Company's 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 the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1993 and incorporated herein by
reference thereto.
35
Exhibit
Number Description
- ------ -----------
++ Previously filed as exhibits to the Company's Current Report on Form
8-K filed with the Commission on May 26, 1992.
+++ Previously filed as exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994 and incorporated herein by
reference thereto.
++++ Previously filed as exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1994 and incorporated herein by
reference thereto.
+++++ Previously filed as exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996 and incorporated herein by
reference thereto.
++++++ Previously filed as exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997 and incorporated herein by
reference thereto.
+++++++ Previously filed as exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997 and incorporated herein
by reference thereto.
# Previously filed as exhibits to the Company's Report on Form 8-A dated
February 2, 1996 and incorporated herein by reference thereto.
- - Copy omits information which is subject to confidential treatment.
^ Management contracts or compensatory plans and arrangements required
to be filed pursuant to Item 14(c).
(b) Reports on Form 8-K
None.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 1998 OSTEOTECH, INC.
By: /s/Richard W. Bauer
-------------------------------
Richard W. Bauer
President, Chief Executive
Officer (Principal Executive
Officer) and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated:
Signature Title Date
- --------- ----- ----
/s/DONALD D. JOHNSTON Chairman of the Board March 30, 1998
- --------------------------------- of Directors
Donald D. Johnston
/s/RICHARD W. BAUER President, Chief March 30, 1998
- --------------------------------- Executive Officer
Richard W. Bauer (Principal Executive
Officer) and Director
/s/MICHAEL J. JEFFRIES Executive Vice March 30, 1998
- --------------------------------- President, Chief
Michael J. Jeffries Operating Officer,
Chief Financial Officer
(Principal Financial
Accounting Officer),
Secretary and Director
/s/STEPHEN J. SOGIN Director March 30, 1998
- ---------------------------------
Stephen J. Sogin
/s/KENNETH P. FALLON III Director March 30, 1998
- ---------------------------------
Kenneth P. Fallon III
/s/JOHN P. KOSTUIK Director March 30, 1998
- ---------------------------------
John P. Kostuik
37
OSTEOTECH, INC. AND SUBSIDIARIES
-------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Page
----
1. FINANCIAL STATEMENTS
Report of Independent Accountants .................................. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 ....... F-3
Consolidated Statements of Operations
for the years ended December 31, 1997, 1996 and 1995 ............ F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1997, 1996 and 1995 ............ F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 1997, 1996 and 1995 ............ F-6
Notes to Consolidated Financial Statements ......................... F-7
2. SCHEDULES
II. Valuation and Qualifying Accounts
for the years ended December 31, 1997, 1996 and 1995 ..... S-1
Report of Independent Accountants .................................. S-2
All schedules, except for those set forth above, have been omitted since the
information required is included in the financial statements or accompanying
notes or have been omitted as not applicable or not required.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and
Stockholders of Osteotech, Inc.:
We have audited the accompanying consolidated balance sheets of Osteotech, Inc.
and Subsidiaries as of December 31, 1997 and 1996 and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Osteotech, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Princeton, New Jersey
February 27, 1998
F-2
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
December 31, 1997 1996
- -----------------------------------------------------------------------------------------
ASSETS
- -----------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 13,884 $ 7,290
Short-term investments 1,473 1,987
Accounts receivable, less allowance of
$147 in 1997 and $163 in 1996 7,547 6,280
Deferred processing costs 1,070 1,222
Inventories 792 729
Deferred income taxes 457 590
Prepaid expenses and other current assets 2,860 1,833
--------------------
Total current assets 28,083 19,931
Property, plant and equipment, net 11,650 8,170
Excess of cost over net assets of business acquired, less
accumulated amortization of $1,449 in 1997 and $1,197 in 1996 2,249 2,501
Other assets 1,070 881
- -----------------------------------------------------------------------------------------
Total assets $ 43,052 $ 31,483
=========================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 6,919 $ 6,247
Notes payable 608 655
Current maturities of long-term debt and
obligations under capital leases 634 756
--------------------
Total current liabilities 8,161 7,658
Long-term debt and obligations under capital leases 203 840
Other liabilities 396 268
- -----------------------------------------------------------------------------------------
Total liabilities 8,760 8,766
- -----------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,676,595 shares
authorized; no shares issued or outstanding
Common stock, $.01 par value; 20,000,000 shares
authorized; issued and outstanding 8,686,346
shares in 1997 and 7,826,779 shares in 1996 87 78
Additional paid-in capital 36,130 30,288
Currency translation adjustments (75) (113)
Accumulated deficit (1,850) (7,536)
- -----------------------------------------------------------------------------------------
Total stockholders' equity 34,292 22,717
- -----------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 43,052 $ 31,483
=========================================================================================
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, 1997 1996 1995
- ----------------------------------------------------------------------------------------------------
Net revenues:
Service $ 42,861 $ 31,717 $ 24,451
Product 1,800 2,481 2,682
Licensing fee 257
Grant 13 697 801
-----------------------------------------
44,931 34,895 27,934
Costs and expenses:
Cost of services 14,487 12,406 10,481
Cost of products 1,348 2,414 2,078
Marketing, general and administrative 16,381 12,619 10,408
Research and development 3,728 4,357 3,749
Provision for restructuring 1,350
Provision for termination of distribution agreement 980
-----------------------------------------
35,944 33,146 27,696
Operating income 8,987 1,749 238
Other income (expense):
Recovery of principal on note
from a major client 4,147
Interest income 673 448 605
Interest expense (140) (232) (252)
Other 52 55 82
-----------------------------------------
585 271 4,582
Income before income taxes 9,572 2,020 4,820
Income tax provision 3,886 2,344 238
- ----------------------------------------------------------------------------------------------------
Net income (loss) $ 5,686 $ (3.04) $ 4,582
====================================================================================================
Net income (loss) per share:
Basic $ .69 $ (.04) $ .82
Diluted $ .65 $ (.04) $ .57
- ----------------------------------------------------------------------------------------------------
Shares used in computing net income (loss) per share:
Basic 8,259,416 7,921,158 7,836,938
Diluted 8,792,515 7,921,158 8,018,500
- ----------------------------------------------------------------------------------------------------
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, 1997, 1996 and 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Common Stock Additional Currency Total
----------------------- Paid-In Translation Accumulated Stockholders'
Shares Amount Capital Adjustments Deficit Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 7,089,876 $ 71 $ 28,918 $ (99) $ (11,794) $ 17,096
Exercise of stock options 30,571 111 111
Exercise of stock warrants 55,616 1 (1)
Common stock issued pursuant to
employee stock purchase plan 22,116 136 136
Tax benefits related to stock options 618 618
Currency translation adjustments 51 51
Net income 4,582 4,582
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 7,198,179 72 29,782 (48) (7,212) 22,594
Exercise of stock options 85,866 1 317 318
Exercise of stock warrants 525,204 5 (5)
Common stock issued pursuant to
employee stock purchase plan 17,530 120 120
Tax benefits related to stock options 74 74
Currency translation adjustments (65) (65)
Net loss (324) (324)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 7,826,779 78 30,288 (113) (7,536) 22,717
Exercise of stock options 572,098 6 2,952 2,958
Exercise of stock warrants 276,576 3 (3)
Common stock issued pursuant to
employee stock purchase plan 10,893 152 152
Tax benefits related to stock options 2,741 2,741
Currency translation adjustments 38 38
Net income 5,686 5,686
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 8,686,346 $ 87 $ 36,130 $ (75) $ (1,850) $ 34,292
===================================================================================================================================
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, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------
Cash Flow From Operating Activities
Net income (loss) $ 5,686 $ (324) $ 4,582
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,065 2,679 1,718
Deferred income taxes 268 804 (582)
Income tax benefit related to stock options 2,741 74 618
Provision for doubtful accounts 17 15
Provision for restructuring 1,350
Provision for termination of distribution agreement 980
Changes in assets and liabilities:
Accounts receivable (1,329) (1,738) 30
Inventories (84) 197 (594)
Deferred processing costs 152 (245) (207)
Prepaid expenses and other current assets (1,133) 7 (452)
Accounts payable and other liabilities 1,001 1,307 29
- --------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 9,367 4,128 6,137
Cash Flow From Investing Activities
Capital expenditures (5,385) (2,152) (4,071)
Proceeds from sale of investments 6,418 10,867 5,913
Purchases of investments (5,904) (7,935) (9,860)
Increase in other assets (231) (300) (484)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (5,102) 480 (8,502)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 3,110 432 246
Proceeds from issuance of notes payable 871 829 820
Proceeds from issuance of long-term debt 1,227
Principal payments on notes payable (918) (821) (495)
Principal payments on long-term debt
and obligations under capital leases (756) (800) (596)
Increase in other liabilities 150
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 2,307 (360) 1,352
Effect of exchange rate changes on cash 22 254 16
- --------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 6,594 4,502 (997)
Cash and cash equivalents at beginning of year 7,290 2,788 3,785
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 13,884 $ 7,290 $ 2,788
========================================================================================================
The accompanying notes are an integral part
of these consolidated financial statements.
F-6
1. DESCRIPTION OF BUSINESS
Osteotech, Inc. (the "Company"), formed in 1986, provides services and
develops and markets products to the orthopaedic, neurological,
oral/maxillofacial, dental and general surgery markets in the United States
and Europe. The Company's current technology, products and services, and
those under development, are focused primarily on the repair and healing of
the musculoskeletal system. Osteotech is engaged in: (i) the processing of
human bone, ligaments and tendons (collectively, "allograft bone tissue")
for transplantation; (ii) providing ceramic (hydroxyapatite) and titanium
plasma spray coating services and ceramic based products to the
orthopaedic, dental and ear, nose and throat implant markets; and (iii)
distributing implant devices and specialized instruments for spinal
surgery.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidated Financial Statements
The consolidated financial statements include the accounts of Osteotech,
Inc., its majority-owned subsidiaries and joint ventures controlled by the
Company. All intercompany transactions and balances are eliminated in
consolidation.
Revenue Recognition
Revenue is recognized at the time the Company ships processed allograft
bone tissue or products to its clients.
License fee revenues is recognized when all significant contractual
obligations have been satisfied.
Grant revenues are recognized when earned. Grant revenues are considered to
be earned in the period that qualifying research and development
expenditures are incurred and reflected in the Consolidated Statements of
Operations.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. Investments with
maturities in excess of three months but less than one year are classified
as short-term investments and are stated at cost, net of any unamortized
premiums or discounts, which approximates fair value.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
under the first-in, first-out method.
Deferred Processing Costs
Costs related to allograft bone tissue processing in progress are deferred
until processed allograft bone tissue is released from final quality
assurance testing and shipped to clients.
F-7
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated
depreciation and amortization. Major renewals and betterments are
capitalized while maintenance and repairs are expensed as incurred. The
cost of equipment under capital lease and leasehold improvements is
amortized on the straight-line method over the shorter of the lease term or
the estimated useful life of the asset. Depreciation is computed on the
straight-line method over the following estimated useful lives of the
assets:
Building 15 years
Production and laboratory equipment 5 to 10 years
Computer hardware and software 5 years
Office equipment, furniture and fixtures 5 years
Vehicles 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 operations.
Excess of Cost Over Net Assets of Business Acquired
The excess of cost over the net assets of business acquired ("goodwill") is
being amortized on a straight-line basis over 15 years. It is the Company's
policy to periodically review and evaluate whether there has been an
impairment in the value of goodwill. Factors considered in the valuation
include current operating results, trends, prospects and anticipated
undiscounted future cash flows.
Translation of Foreign Currency
Assets and liabilities of foreign subsidiaries are translated at rates of
exchange in effect at the close of the year. Revenues and expenses are
translated at the weighted average exchange rates during the year.
Translation gains and losses are accumulated as a separate component of
stockholders' equity. Foreign currency transaction gains and losses are
included in other income.
Concentrations of Credit Risk
The Company provides credit, in the normal course of business, to tissue
banks and hospitals. The Company maintains an allowance for doubtful
accounts and charges actual losses to the allowance when incurred.
The Company 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.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results may differ from such estimates.
3. CHANGES IN ACCOUNTING POLICIES
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("SFAS 128"). SFAS 128 establishes standards for computing and presenting
earnings per share ("EPS") and supersedes APB Opinion No. 15, "Earnings Per
Share." SFAS 128 replaces the presentation of primary EPS
F-8
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. CHANGES IN ACCOUNTING POLICIES (continued)
with a presentation of basic EPS which excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average
number of common shares and nominal warrants (warrants with an exercise
price of $.03) outstanding during the period. Diluted EPS reflects the
potential dilution that could occur if outstanding options and warrants
were exercised. The Company has adopted SFAS 128 and has restated all
prior-period EPS data presented.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes standards for reporting and display of comprehensive income and
its components in the financial statements. SFAS 130 is effective for
fiscal years beginning after December 15, 1997. Reclassification of
financial statements for earlier periods provided for comparative purposes
is required. The adoption of SFAS 130 will have no impact on the Company's
consolidated results of operations, financial position or cash flows.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 131 establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards or related
disclosures about products and services, geographic areas, and major
customers. SFAS 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. Financial statement disclosures for
prior periods are required to be restated. The adoption of SFAS 131 will
have no impact on the Company's consolidated results of operations,
financial position or cash flows.
4. RESTRUCTURING OF THE NETHERLANDS OPERATIONS
In October 1996, the Company announced a plan to restructure its
non-allograft bone tissue operations located in Leiden, The Netherlands. In
connection with the restructuring, the Company discontinued its
PolyActive(TM) polymer research and development program, and recorded a
pre-tax charge to earnings of $1,350,000 which included $425,000 for
employee termination costs, $541,000 for write-off of equipment, intangible
assets and inventory, $234,000 for costs associated with the planned
sub-leasing of office space in Leiden on which the Company has a long-term
lease and $150,000 for other contractual obligations.
5. TERMINATION OF DISTRIBUTION AGREEMENT
In June 1995, the Company terminated its distribution agreement for trauma
implant products with its supplier, aap, GmbH of Berlin, Germany. As a
result of this termination, the Company recorded a pre-tax charge to
earnings of $980,000 which included $840,000 for inventory write-offs,
$85,000 for employee termination costs and $55,000 for legal fees.
6. NOTE RECEIVABLE FROM A MAJOR CLIENT
The Company is the exclusive processor of allograft bone tissue procured
and distributed by the Musculoskeletal Transplant Foundation ("MTF"). (See
Note 9 and Note 18.) From MTF's inception in February 1987 through May
1989, the Company supplemented MTF's working capital requirements through a
series of cash advances and unpaid processing and service fees. In June
1990, the principal and interest on these advances at December 31, 1989
were converted into two notes which were fully reserved by the Company.
F-9
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. NOTE RECEIVABLE FROM A MAJOR CLIENT (continued)
The first note had an original face value of $7,216,000. During 1995 the
Company received $4,147,000 of principal payments on this note reducing the
outstanding balance to $0. During 1995 the Company also received interest
payments from MTF on this note of $330,000.
The second note, with an original face value of $2,621,000, was
non-interest bearing and was subject to cancellation by the Company at the
rate of $524,000 per year on the anniversary of the note (June 30th),
provided MTF met certain annual requirements as defined in the note. During
1995, the Company canceled $524,000 of the note thereby reducing the
remaining amount outstanding to $0. The cancellation of the note had no
impact on the Company's results of operations since the note was fully
reserved.
7. INVENTORIES
Inventories consist of the following at December 31:
(in thousands) 1997 1996
--------------------------------------------------------------------
Raw materials $ 475 $ 379
Finished goods 317 350
--------------------------------------------------------------------
$ 792 $ 729
====================================================================
8. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at December 31:
(in thousands) 1997 1996
--------------------------------------------------------------------
Land $ 1,961 $ 0
Building 201 0
Production and laboratory equipment 9,357 8,273
Computer hardware and software 1,504 1,328
Office equipment, furniture and fixtures 1,696 1,450
Vehicles 74 74
Equipment under capital lease 635 391
Leasehold improvements 4,784 3,870
------- -------
20,212 15,386
Less accumulated depreciation
and amortization 8,562 7,216
--------------------------------------------------------------------
$11,650 $ 8,170
====================================================================
Accumulated depreciation and amortization above includes amortization on
equipment under capital lease of $234,000 and $152,000 in 1997 and 1996,
respectively.
F-10
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES
Service Agreements
Osteotech is the exclusive processor of allograft bone tissue for large
national and international clients. The Company provides these processing
services pursuant to long-term service agreements. Clients are charged fees
on a per donor basis for processing, finishing and packaging each unit of
allograft bone tissue, and for proprietary products on a per unit basis.
Osteotech's agreements with its clients generally provide for the Company
to indemnify its clients against liability arising out of defects in
allograft bone tissue caused as a result of processing by the Company.
Effective January 1, 1997 the Company entered into a new ten-year
processing agreement with one of its major allograft processing clients,
the American Red Cross Tissue Services ("ARC"). Effective April 1, 1997 the
Company entered into a new five-year processing agreement with its other
major client, MTF.
Customers of the Company's plasma spray coating services generally purchase
such services pursuant to purchase orders or non-exclusive supply
agreements which are cancelable at any time by either party.
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 (formerly Matrix Medical BV), The Netherlands.
Pursuant to the terms of the agreement, the Company received an up front
license payment of 500,000 Dutch Guilders ("dfl" or approximately $257,000)
which was recognized as license fee revenue. IsoTis BV is required to make
two additional license payments of dfl 250,000 (approximately $123,000 at
the December 31, 1997 exchange rate) each on the first and second
anniversary of the effective date of the agreement. Additionally, IsoTis BV
has an option to acquire the technology for dfl 4 million (approximately $2
million at the December 31, 1997 exchange rate) commencing in the third
year of the agreement and extending through the sixth year of the
agreement.
Throughout the term of the agreement, which is the longer of ten years from
the first commercial sale of product or the life of the patents, the
Company will receive a royalty of 5% of net sales, declining to 2% of net
sales if the option to purchase the technology is exercised. Further, the
agreement requires IsoTis BV to achieve certain milestones during the first
three years of the agreement. Failure to do so will result in its loss of
exclusive rights to the patents and technology.
Products Liability Litigation
The Company has been named as a defendant in two lawsuits in which patients
claim that they have suffered damages from the implantation of allegedly
defective spinal fixation devices allegedly distributed by the Company.
Management believes that the suits and claims are without merit and intends
to defend such actions vigorously. It is the Company's position that either
a device distributed by the Company was not implanted in the patient, or
that if the allegations in the complaints regarding the use of the device
are assumed to be true, the device was used in a manner which was contrary
to the use approved by the FDA and the Company's written warnings
concerning use. Pursuant to its distribution agreement with the Company,
the manufacturer of the spinal fixation devices, Heinrich C. Ulrich, KG
("Ulrich") has agreed to indemnify the Company for all costs, and damages
incurred by the Company in connection with its distribution of products
manufactured by Ulrich, except such costs and damages which are caused by
the Company's gross negligence, willful misconduct or unauthorized claim
made by the Company in marketing the products. In connection with this
indemnification, the Company received $16,000 from Ulrich in 1997 and
$59,000 in 1996 as reimbursement for legal costs incurred by the Company.
F-11
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES (continued)
The Company maintains products liability insurance coverage, however, the
Company's insurance provider has denied coverage with respect to both
claims. 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
if the ultimate liability materially exceeds the amount that the Company
recovers from Ulrich. The Company is unable to estimate the potential
liability, if any, that may result from the pending litigation and,
accordingly, no provision for any liability (except for accrued legal
costs) has been made in the consolidated financial statements.
Patent Litigation
On January 16, 1998, the Company filed suit in the United States District
Court for the District of New Jersey for patent infringement against GenSci
Laboratories, Inc. and GenSci Regeneration Sciences, Inc. (collectively
"GenSci"). In the suit, the Company accuses GenSci of violating claims of
at least one of the patents involving the Company's Grafton(R) DBM process.
On January 28, 1998, GenSci filed suit in the United States District Court
for the Central District of California against the Company for (i) patent
infringement of two patents assigned to GenSci; (ii) tortious interference
with a business expectancy; (iii) negligent interference with prospective
economic advantage; and (iv) inducing breach of contract. The suit also
seeks a declaratory judgement of the invalidity of the Company's U.S.
Patent Nos. 5,284,655 and 5,290,558. An amended complaint was filed by
GenSci on February 18, 1998 alleging essentially the same causes of action,
but adding a third GenSci patent to the allegation of patent infringement.
The Company is moving to dismiss, transfer or stay the California action
while going forward with the first-filed suit in the United States District
Court for the District of New Jersey. The Company intends to vigorously
pursue its claims against GenSci, and also believes that GenSci's
subsequently filed claims are without merit.
10. LEASING TRANSACTIONS
The Company leases office and production facilities and equipment under
various capital and operating lease agreements which have non-cancelable
terms through May 2008. The leases for office and production facilities
include renewal provisions at the Company's option. Additionally, certain
of the leases contain purchase options.
Future minimum lease commitments as of December 31, 1997 are as follows:
Capital Operating
Year Leases Leases
--------------------------------------------------------------------------
(in thousands)
1998 $ 106 $ 905
1999 35 869
2000 836
2001 819
2002 and thereafter 4,131
-----------------
Total minimum lease payments 141 $7,560
======
Less amount representing interest 12
---------------------------------------------------------
Present value of minimum lease payments $ 129
=========================================================
Rental expense was $1,013,000, $1,045,000 and $956,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
F-12
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. 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,
1997 and 1996.
Stock Options
The Company has two stock option plans under which stock options may be
granted: the 1991 Stock Option Plan (the "1991 Plan") and the 1991
Independent Directors Stock Option Plan (the "Directors Plan"). Prior to
the adoption of these plans, the Company granted stock options pursuant to
written stock option agreements, which were not subject to a formal plan.
Such options were granted at prices equal to fair market value on the date
of grant and generally became exercisable in ratable installments over a
four-year period. Since 1991, all stock options are granted under the 1991
Plan or the Directors Plan.
The 1991 Plan, as amended, authorizes the grant of up to 1,813,765 shares
of the Company's common stock in the form of incentive stock options or
non-qualified stock options to employees and consultants. In July 1997, the
Board of Directors increased the number of shares of common stock reserved
for issuance under the 1991 Plan to 2,813,765, of which 818,624 shares are
subject to stockholder approval. Stock options may be granted at prices not
less than 100% of the fair market value at the date of option grant.
Options generally become exercisable in ratable installments over a
four-year period, with unexercised options expiring no later than ten years
from the date of grant.
The Directors Plan, as amended, authorizes the grant of up to 500,000
shares of the Company's common stock to members of the Board of Directors
who are not officers or employees of the Company. Option exercise prices
equal 100% of the fair market value on the date of grant. Options issued
prior to July 1, 1997 become exercisable in ratable installments over four
years with unexercised options expiring five years from the vesting date.
Effective July 1, 1997, the Directors Plan was amended to provide for
options issued to become 100% exercisable on the first anniversary of the
date of grant with unexercised options expiring ten years from the date of
grant.
Stock option activity for the years 1997, 1996 and 1995 is as follows:
1997 1996 1995
----------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 1,752,543 $ 5.82 1,582,162 $5.41 1,710,292 $6.07
Granted 551,125 12.18 303,500 7.44 533,177 5.97
Exercised 572,098 5.17 85,866 3.71 30,571 3.64
Canceled or expired 48,896 6.19 47,253 6.33 630,736 7.75
--------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1,682,674 $ 8.12 1,752,543 $5.82 1,582,162 $5.41
--------------------------------------------------------------------------------------------------------------------
Exercisable at December 31, 1,119,015 $ 8.64 1,009,545 $5.55 841,318 $5.36
--------------------------------------------------------------------------------------------------------------------
Available for grant at
December 31, 1,004,988(1) 507,745 514,904
--------------------------------------------------------------------------------------------------------------------
Weighted average fair value of
options granted during the period $ 7.36 $ 3.52 $ 2.95
--------------------------------------------------------------------------------------------------------------------
(1) includes 818,624 shares which are subject to stockholder approval.
F-13
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. STOCKHOLDERS' EQUITY (continued)
In April 1995, the Company instituted a stock option exchange program
whereby optionees with options having an exercise price of $6.00 or more
were offered repriced options on the basis of a 65% exchange ratio. The
exercise price of the new options was the then current fair market value of
the Common Stock which was $5.25 per share. As a result of the exchange
program, options for 327,458 shares were canceled and options for 213,477
shares were issued.
The following table summarizes the information about stock options
outstanding at December 31, 1997:
Options Outstanding Options Exercisable
--------------------------------------------- --------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding at Remaining Average Exercisable at Average
Range of December 31, Contractual Exercise December 31, Exercise
Exercise Prices 1997 Life (Years) Price 1997 Price
----------------------------------------------------------------------------------------------------------
$ .66 to $ 3.94 13,549 4 $ 2.54 6,999 $ 1.57
4.00 to 6.94 827,758 6 5.33 493,024 5.26
7.00 to 10.00 391,962 8 8.70 179,587 8.14
12.75 to 19.50 449,405 8 12.91 439,405 12.76
----------------------------------------------------------------------------------------------------------
$ .66 to $ 19.50 1,682,674 6 $ 8.12 1,119,015 $ 8.64
==========================================================================================================
The Company has adopted the "disclosure only" provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock Based
Compensation ("SFAS 123") and, accordingly, no compensation cost has been
recognized in the Statements of Operations. Pro forma information regarding
net income (loss) and net income (loss) per share is required by SFAS 123,
and has been determined as if the Company accounted for its stock options
under the Fair Value Method of that Statement. For purposes of the pro
forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period. Pro forma information follows:
(dollars in thousands except per share data) 1997 1996 1995
-----------------------------------------------------------------------------------------------------
Net income (loss)
As reported $ 5,686 $ (324) $ 4,582
Pro forma 1,726 (865) 4,054
Net income (loss) per share
As reported
Basic $ .69 $ (.04) $ .58
Diluted .65 (.04) .57
Pro forma
Basic $ .21 $ (.11) $ .52
Diluted .18 (.11) .52
-----------------------------------------------------------------------------------------------------
F-14
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. STOCKHOLDERS' EQUITY (continued)
The pro forma effect on net income (loss) for 1997, 1996 and 1995 is not
representative of the pro forma effect on net income in future years
because, in accordance with FAS 123, it does not take into consideration
pro forma compensation expense related to grants made prior to 1995.
The fair value for the option grants was estimated at the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions:
1997 1996 1995
--------------------------------------------------------------
Expected life (years) 7 6 1-5
Risk free interest rate 5.8%-6.6% 6.6% 6.9%
Volatility factor 50.0% 50.0% 50.0%
Dividend yield 0.0% 0.0% 0.0%
--------------------------------------------------------------
Stock Warrants
As part of financing and contract arrangements, the Company has, at certain
times, issued warrants to purchase the Company's Convertible Preferred
Stock and Common Stock. Warrant activity for the years ended December 31,
1995, 1996 and 1997 is summarized as follows:
Convertible Preferred
Stock Warrants
--------------------- Common
Series Series Stock
A D Warrants
-------------------------------------------------------------------------
Outstanding at December 31, 1994 96,343 248,061 620,326
Exercised 16,637 52,488
-------------------------------------------------------------------------
Outstanding at December 31, 1995 96,343 231,424 567,838
Exercised 85,190 15,709 437,474
-------------------------------------------------------------------------
Outstanding at December 31, 1996 11,153 215,715 130,364
Exercised 11,153 215,409 130,364
-------------------------------------------------------------------------
Outstanding at December 31, 1997 0 306 0
-------------------------------------------------------------------------
Exercise price $ 0.03 $ 5.58 $ 0.03
Expiration date 2000
-------------------------------------------------------------------------
Convertible Preferred Stock warrants are immediately convertible into
Common Stock upon exercise on a share for share basis. In January 1994, the
Board of Directors approved amending all outstanding warrants to allow for
cashless exercise of such warrants. Under the cashless exercise method, the
number of shares issued upon exercise of such warrant is determined by
calculating the aggregate number of shares represented by the warrants
using the closing price of the Company's Common Stock on the exercise date,
deducting the aggregate exercise cost and dividing the net remaining amount
by the market value per share on the exercise date.
F-15
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. STOCKHOLDERS' EQUITY (continued)
Stock Purchase Plan
The 1994 Employee Stock Purchase Plan provides for the issuance of up to
250,000 shares of Common Stock. Eligible employees may purchase shares of
the Company's Common Stock through payroll deductions of 1% to 7 1/2% of
annual compensation. The purchase price for the stock is 85% of the fair
market value of the stock on the last day of each calendar quarter. At
December 31,1997, 187,545 shares were available for future offerings under
this plan.
Stockholder Rights Agreement
In January 1996, the Board of Directors of the Company unanimously adopted
a stockholder rights agreement (the "Rights Agreement") declaring a
dividend of one preferred stock purchase right (the "Right") for each
outstanding share of common stock as of February 12, 1996. Each Right
entitles the stockholder to purchase from the Company one one-hundredth of
a preferred share at a price of $35.00 per share, subject to adjustment.
The Rights will not be exercisable or separable from the common shares
until ten business days after a person or group acquires or tenders for 20%
or more of the Company's outstanding common shares ("triggering event").
The Rights Agreement also provides that, after a triggering event occurs,
the Rights convert into a Right to buy common stock and entitle its holder
to receive upon exercise that number of common shares having a market value
of two times the exercise price of the Right. In the event the Company is
acquired in a merger or other business combination transaction, each Right
will entitle its holder to receive upon exercise of the Right, at the
Right's then current exercise price, that number of the acquiring company's
common shares having a market value of two times the exercise price of the
Right. The Company is entitled to redeem the Rights at a price of $.01 per
Right at any time prior to their becoming exercisable, and the Rights
expire on February 12, 2006. The Rights Agreement was adopted to maximize
the value of all stockholders' ownership interest in the Company by
establishing a deterrent to abusive takeover tactics sometimes used in
challenges for corporate control.
12. DEBT AND FINANCING ARRANGEMENTS
The Company has a loan and security agreement with a U.S. bank which
provides for borrowing up to $3,000,000 under a revolving line of credit
and $4,000,000 under an equipment line of credit. The annual interest rate
on revolving loan advances is based upon the bank's prime rate whereas the
annual rate of interest on equipment advances is based upon the bank's
prime rate plus a margin of .25%. Borrowings under the equipment line of
credit are repayable over a 48 month term and are collateralized by
equipment purchased with such borrowings. The Company is required under the
agreement to maintain certain financial ratios and meet certain net worth
and indebtedness tests. An annual commitment fee of .25% is payable on the
unused portion of the revolving line of credit. At December 31, 1997 and
1996, $709,000 and $1,377,000, respectively, was outstanding under the
equipment line of credit and there were no borrowings under the revolving
line of credit.
F-16
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. DEBT AND FINANCING ARRANGEMENTS (continued)
The Company has a line of credit with a Dutch bank which provides for
borrowing up to dfl 5,000,000, or approximately $2,467,000 at the December
31, 1997 exchange rate. Borrowings under this credit line bear interest at
the bank's prime rate plus a margin of 2.25%. Under certain circumstances
the Company may elect to utilize a rate based on the Amsterdam Interbank
Offered Rate (AIBOR) plus a margin of .75%. Analysis of the Company's
financial position and anticipated cash flow indicated that it most likely
would not be necessary to utilize a significant portion of this line of
credit in 1997 and, therefore, the Company agreed with the bank to limit
its borrowings, if any, to be no more than dfl 3,000,000, or approximately
$1,480,000 at the December 31, 1997 exchange rate. Additionally, in
connection with the Leiden facility lease, the Company is required to
maintain a declining bank guarantee which reduced the current amount
available for borrowings to dfl 2,810,000 or approximately $1,387,000 at
the December 31, 1997 exchange rate. At December 31, 1997 and 1996, there
were no borrowings under this line of credit.
The weighted average interest rate on short-term notes payable outstanding
was 5.75% in 1997 and 5.87% in 1996.
Long-term debt consists of the following at December 31:
(in thousands) 1997 1996
--------------------------------------------------------------------
Term loan payable to a bank, collateralized
by equipment and repayable in monthly
installments of $49,000 plus accrued
interest at the bank prime rate plus .25%
(8.50% at December 31, 1997) $ 709 $ 1,377
Less current portion 537 668
--------------------------------------------------------------------
$ 172 $ 709
====================================================================
Aggregate long-term debt maturities are $172,000 in 1999.
13. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
December 31:
(in thousands) 1997 1996
--------------------------------------------------------------------
Trade accounts payable $ 1,410 $ 1,391
Accrued compensation 819 1,051
Accrued research and development 1,046 1,264
Accrued taxes payable 1,465 565
Other accrued liabilities 2,179 1,976
--------------------------------------------------------------------
$ 6,919 $ 6,247
====================================================================
F-17
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. INCOME TAXES
The income tax provision is summarized as follows at December 31:
(in thousands) 1997 1996 1995
-------------------------------------------------------------------
Current:
Federal $ 2,958 $ 1,338 $ 294
State 660 470 152
-------------------------------------------------------------------
3,618 1,808 446
----------------------------------
Deferred:
Federal 217 508 (124)
State 51 28 (84)
-------------------------------------------------------------------
268 536 (208)
----------------------------------
Income tax provision $ 3,886 $ 2,344 $ 238
===================================================================
The difference between income tax expense and the expected tax which would
result from the use of the Federal statutory income tax rate is as follows:
(in thousands) 1997 1996 1995
--------------------------------------------------------------------------
Computed tax at statutory Federal rate $ 3,254 $ 687 $ 1,639
State income taxes 522 352 416
Amortization of excess of cost over
fair value of assets acquired 86 86 86
Net operating losses for which no tax
benefit is currently available 101 1,184 601
Change in valuation allowance allocated to
income tax expense (2,551)
Other (77) 35 47
--------------------------------------------------------------------------
Income tax provision $ 3,886 $ 2,344 $ 238
==========================================================================
F-18
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. INCOME TAXES (continued)
Loss before income taxes from foreign operations was $3,652,000 in 1996 and
$1,910,000 in 1995 respectively. The components of the deferred tax assets
and deferred tax liabilities are as follows at December 31:
(in thousands) 1997 1996
--------------------------------------------------------------------
Deferred Tax Assets:
Net operating loss carryforwards
Federal $ 277 $ 374
Foreign 3,896 4,016
State 42 57
Tax credits 11
Other 559 637
--------------------------------------------------------------------
Total gross deferred tax assets 4,774 5,095
Less valuation allowance 4,325 4,530
--------------------------------------------------------------------
Deferred tax assets 449 565
--------------------------------------------------------------------
Deferred Tax Liabilities:
Other 305 153
--------------------------------------------------------------------
Total gross deferred tax 305 153
--------------------------------------------------------------------
Net deferred tax asset $ 144 $ 412
====================================================================
In 1996, the Company increased its valuation allowance as a result of
foreign losses for which the realization of future tax benefits is
uncertain. In 1995 the Company reduced its valuation allowance resulting in
the recognition of net deferred tax assets of $2,551,000, resulting from
(i) the realization of $1,335,000 of tax benefits of temporary differences
which reversed during the year; and (ii) the Company's assessment that it
would generate sufficient future U.S. taxable income to realize deferred
tax benefits of $1,216,000 associated with certain Federal and state net
operating loss carryforwards and tax credits.
Certain of the Company's subsidiaries have foreign net operating loss
carryforwards aggregating $9,741,000 ($300,000 with no expiration date;
$9,441,000 expiring 1999 through 2005), of which approximately $214,000
were acquired in connection with an acquisition. Subsequently recognized
tax benefits which result from the utilization of these acquired net
operating loss carryforwards will be applied to reduce the excess of cost
over net assets of business acquired.
F-19
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(in thousands) 1997 1996 1995
-----------------------------------------------------------------------------------------------------------
Cash paid during the year for taxes $ 1,071 $ 1,120 $ 101
Cash paid during the year for interest 101 188 240
Capital lease obligations entered into during the year 309
-----------------------------------------------------------------------------------------------------------
16. SUPPLEMENTARY STATEMENT OF OPERATIONS INFORMATION
Maintenance and repairs expense for the years ended December 31, 1997, 1996
and 1995 was $1,164,000, $981,000 and $773,000 respectively. Depreciation
and amortization expense related to equipment and leasehold improvements
for the years ended December 31, 1997, 1996 and 1995 was $1,699,000,
$2,020,000 and $1,374,000 respectively.
17. EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
Year Ended
-----------------------------------------------
(dollars in thousands except per share data) 1997 1996 1995
-----------------------------------------------------------------------------------------------------------
Net income (loss) available to common
Shareholders $ 5,686 $ (324) $ 4,582
===========================================================================================================
Denominator for basic earnings (loss) per share:
Weighted average Common shares and
nominal warrants outstanding 8,259,416 7,921,158 7,836,938
Effect of dilutive securities:
Stock options 488,623 158,110
Warrants 44,476 23,452
-----------------------------------------------
Denominator for diluted earnings (loss) per share 8,792,515 7,921,158 8,018,500
===========================================================================================================
Basic earnings (loss) per share $ .69 $ (.04) $ .58
===========================================================================================================
Diluted earnings (loss) per share $ .65 $ (.04) $ .57
===========================================================================================================
F-20
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. SEGMENT AND MAJOR CUSTOMER DATA
The Company operates principally in one business segment - the repair and
healing of the musculoskeletal system. Financial information by geographic
area is summarized as follows:
(in thousands) United States Europe Consolidated
-----------------------------------------------------------------------------------------------------------
Revenues
1997 $ 41,887 $ 3,044 $ 44,931
1996 31,582 3,313 34,895
1995 24,293 3,641 27,934
Operating income (loss)
1997 $ 8,731 $ 256 $ 8,987
1996 (1) 4,732 (2,983) 1,749
1995 (2) 1,588 (1,350) 238
Identifiable Assets
1997 $ 37,656 $ 4,436 $ 42,092
1996 26,768 4,715 31,483
1995 24,929 5,241 30,170
Customers comprising 10% or greater of the Company's consolidated net
revenues are summarized as follows:
(in thousands) 1997 1996 1995
-----------------------------------------------------------------------------------------------------------
Revenues
MTF $ 25,731 $22,224 $ 18,009
ARC 15,442 8,735 5,544
-----------------------------------------------------------------------------------------------------------
$ 41,173 $30,959 $ 23,553
===========================================================================================================
(1) Europe's operating loss includes a charge to earnings of $1,350,000
related to the restructuring of the company's non-allograft bone
tissue operations located in Leiden.
(2) US operating income includes a charge to earnings of $980,000
resulting from the termination of a distribution agreement.
19. RETIREMENT BENEFITS
The Company has a 401(k) plan which covers substantially all full time U.S.
employees. The Company has agreed to contribute an amount equal to 25% of
each participant's contribution. A participant's contribution may not
exceed 15% of annual compensation, or the maximum allowed by the Internal
Revenue Code, if less than 15% of compensation. Provisions of the plan
include graduated vesting over five years of service. Total Company
contributions for the years ended December 31, 1997, 1996 and 1995 were
$161,000, $133,000 and $105,000 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 $56,000, $31,000 and
$44,000 for the years ended December 31, 1997, 1996 and 1995.
The Company does not maintain any other pension or post retirement plans.
F-21
OSTEOTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the 1997
presentation.
21. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of the unaudited quarterly results for the years
ended December 31, 1997 and 1996:
Quarter Ended
--------------------------------------------------------------
(dollars in thousands except per share data) March 31 June 30 Sept. 30 Dec. 31
-----------------------------------------------------------------------------------------------------------
1997
Net revenues $ 10,084 $ 10,703 $ 11,933 $ 12,211
Cost of services
and products 3,872 3,936 4,217 3,810
Net income 832 1,403 1,608 1,843
Net income per share
Basic $ .10 $ .17 $ .19 $ .21
Diluted .10 .17 .18 .20
-----------------------------------------------------------------------------------------------------------
1996
Net revenues $ 8,409 $ 8,375 $ 9,010 $ 9,101
Cost of services
and products 3,597 3,615 3,849 3,759
Net income (loss) 171 202 251 (948)
Net income (loss) per share
Basic $ .02 $ .03 $ .03 $ (.12)
Diluted .02 .02 .03 (.12)
The quarter ended December 31, 1996 includes a pre-tax charge of $1,350,000
related to the restructuring of the Company's non-allograft bone tissue
operations in Leiden, The Netherlands (See Note 4).
F-22
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, 1997:
Allowance for doubtful accounts $ 163 $ (11)(a) $ (5)(b) $ 147
Valuation allowance for deferred
tax asset 4,530 (205)(d) 4,325
For the year ended December 31, 1996:
Allowance for doubtful accounts 179 17 (10)(a) (23)(b) 163
Valuation allowance for deferred
tax asset 3,134 1,396(d) 4,530
For the year ended December 31, 1995:
Allowance for doubtful accounts 158 18 (3)(a) 179
Allowance for loss on notes receivable
from a significant customer 4,672 (1) (4,671)(c) 0
Valuation allowance for deferred
tax asset 5,665 604(d) (3,135)(e) 3,134
(a) Represents foreign currency translation adjustments.
(b) Represents the write-off of accounts receivable.
(c) Represents forgiveness of $524,000 on a non-interest bearing note
which was fully reserved and loan principal repayments of $4,147,000
on a note which was fully reserved.
(d) Represents the tax effect of temporary differences.
(e) Represents recognition of a deferred tax asset.
S-1
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and
Stockholders of Osteotech, Inc.:
Our report on the consolidated financial statements of Osteotech, Inc. and
Subsidiaries is included on page F-2 of this 1997 Form 10-K. In connection with
our audits of such consolidated financial statements, we have also audited the
related financial statement schedule listed in the index on page F-1 of this
Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
Princeton, New Jersey
February 27, 1998
S-2
EXHIBIT INDEX
Exhibit Page
Number Description Number
- ------ ----------- ------
10.35 Employment Agreement with Michael J. Jeffries
dated January 1, 1998 E-2
10.36 Employment Agreement with Roger C. Stikeleather
dated January 1, 1998 E-11
10.37 Employment Agreement with James L. Russell dated
December 18, 1997 E-20
21.1 Subsidiaries of the Registrant E-29
23.1 Consent of Coopers & Lybrand LLP E-30
27.0 Financial Data Schedule E-32
99.1 Risk Factors E-33