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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

For the fiscal year ended December 31, 2002

or

Commission file number: 0-31271

REGENERATION TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

11621 Research Circle, Alachua, Florida 32615

(Address of Principal Executive Offices) (Zip Code)

(386) 418-8888

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:    None

Securities registered pursuant to Section 12(g) of the Act:    Common Stock, par value $0.001

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.    ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  x    No  ¨

The aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the last sale price of the Common Stock reported on the Nasdaq Stock Market as of the last business day of the registrant’s most recently completed second fiscal quarter (June 28, 2002), was approximately $132.9 million.

The number of shares of Common Stock outstanding as of March 7, 2003, was 26,112,414.

DOCUMENTS INCORPORATED BY REFERENCE

As stated in Part III of this Annual Report on Form 10-K, portions of the registrant’s definitive proxy statement for the registrant’s 2003 Annual Meeting of Stockholders are incorporated by reference in Part III of this Annual Report on Form 10-K.

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REGENERATION TECHNOLOGIES, INC.

FORM 10-K Annual Report

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PART I

This Annual Report on Form 10-K and the documents incorporated by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates and projections about our industry, our management’s beliefs and certain assumptions made by our management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the risk factors set forth below, as well as in other reports or documents the registrant files from time to time with the Securities and Exchange Commission.

All dollar amounts are stated in thousands, except for share and per share data.

Item 1.    BUSINESS.

Company Overview

We are a leader in the use of natural tissues and innovative technologies to repair and promote the natural healing of human bone and other human tissues. Using core human physiology—the basic biology of natural tissues as they function in the body—our human tissue implants are improving surgical outcomes. We are a comprehensive provider of natural tissue products in a broad range of markets. We are one of the largest processors and distributors of allografts in the United States. Our allografts are distributed in all 50 states and in eleven countries internationally.

We process human musculoskeletal and other tissue, including bone, cartilage, tendon, ligament, dermal and cardiovascular tissue in producing our allografts. Surgeons then use these tissues to repair and promote the healing of a wide variety of bone and other tissue defects, including spinal vertebrae repair, musculoskeletal reconstruction, fracture repair, repairs to the jaw and related tissues, urinary incontinence and heart valve disorders. Our current grafts range from conventional allografts to grafting material which is precisely tooled for specific surgical uses, including bone dowels, wedges, pastes and pins, urological allografts and heart valves.

The following table outlines the markets we serve and the amount and percentage of our revenues, net of management services fees, for the years ended December 31, 2002, 2001 and 2000:

We distribute our allografts both within and outside the United States. Foreign distribution, primarily in Europe, accounted for 6.5%, 4.8% and 5.9% of our net revenues during the years ended December 31, 2002, 2001 and 2000, respectively.

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We pursue a market-by-market approach to distribution of our allografts, including strategic arrangements in order to increase our penetration in selected markets. We have an alliance with Medtronic Sofamor Danek in the spinal market, with Exactech, Inc. in portions of the bone paste market and with C.R. Bard, Inc. in the urological market. In addition, in January 2003, we entered into a strategic distribution arrangement with Stryker Corporation to serve as our exclusive distributor of allograft tissue for use in sports medicine surgeries.

Our BioCleanse^™ process is a patented tissue sterilization process that is designed to add an extra measure of safety to our bone allografts by sterilizing the tissue, providing surgeons and patients an allograft free of any bacteria or virus. Before tissues are processed using the BioCleanse^™ process, tissue recovery agencies perform a risk assessment on every potential donor, interview family members and evaluate the donor’s medical records. All collected tissue is tested for the presence of viral or bacterial diseases. Bone tissue is sterilized through the BioCleanse^™ process only after it has passed this screening and testing. The BioCleanse^™ process is an automated multi-step cleansing process which first removes blood and fats, then chemically sterilizes the tissue.

We were incorporated in 1997 in Florida as a wholly owned subsidiary of Southeast Tissue Alliance, or SETA (formerly the University of Florida Tissue Bank, Inc.). We began operations on February 12, 1998 when SETA contributed to us its allograft manufacturing and processing operations, related equipment and technologies, distribution arrangements, research and development activities and certain other assets. At the time of our initial public offering in August 2000, we reincorporated in the State of Delaware. Our principal offices are located at 11621 Research Circle, Alachua, Florida, and our phone number is (386) 418-8888. Our Internet address is www.rtix.com. Our SEC filings are available through our website, which is linked to the SEC’s website, where you are able to obtain copies of our public filings free of charge. Our Common Stock trades on the Nasdaq National Market under the symbol “RTIX”.

Industry Overview

Defects in bone and other human tissue can be caused by a variety of sources including trauma, congenital defect, infectious disease, cancer and other disease conditions. The prevalent method used by surgeons to repair and promote the healing of defective tissue is surgery, principally through the use of surgical implants. When considering a surgical procedure for tissue repair, surgeons and patients face a number of treatment options including metals and synthetics, “autograft” tissue, “allograft” tissue and “xenograft” tissue. An autograft procedure is one in which the surgeon harvests tissue from one part of a patient’s body for transplant to another part of the body to make the needed repair. In contrast to autograft, allograft tissues are recovered from deceased human donors, processed for biologic safety and certain mechanical characteristics and then transplanted by a surgeon into the patient’s body to make the needed repair. Procedures using xenograft tissue, while not widely used in the United States other than for heart valves, involve recovering animal tissue, typically from cattle or pigs, and then transplanting that recovered tissue into the patient’s body.

Market Segments

We process human musculoskeletal and other tissue, including bone, cartilage, tendon, ligament, dermal and cardiovascular tissue, in producing our line of proprietary allografts. Our current tissues range from conventionally processed bone and soft tissue to bone implants that are precisely tooled for specific surgical uses, urological allografts and heart valves. The following table summarizes our allograft offerings in each of the market segments we serve and distribution of these allografts.

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Tissue Recovery

Tissue recovery is the actual removal of tissue from a donor. Tissue recovery personnel aseptically recover tissue within 24 hours following a donor’s death using surgical instruments and sterile techniques similar to those used in hospitals for routine surgery. Recovered tissue is placed on wet or dry ice and then transported by the recovery agency to the tissue bank.

Under U.S. law, human tissue cannot be sold. However, the law permits the recovery of some costs, such as those involved in recovering, processing and storing tissue and for the advancement of tissue processing technologies, the types of activities in which we are involved.

Our network of donor recovery groups recovers a variety of tissue types from donors including the fibula, femur, tibia, humerus, ilium, pericardium, fascia lata, dermis, hearts for valves and blood vessels. We screen recovered tissue in numerous ways to guard against transmittable diseases. This screening process includes evaluation of risk on the basis of donor medical history, lifestyle, interviews with the donor’s family and physical examination of the donor. We also perform biomedical testing and culturing at various stages during the processing of tissue, using U.S. Food and Drug Administration, or FDA, licensed tests and other tests for known viruses and pathogens.

The limited supply of human tissue has at times limited our growth, and may not be sufficient to meet our future needs. Other factors, some of which are unpredictable, such as negative publicity, regulatory actions or national events like those of September 11, also can unexpectedly reduce the available supply of tissue. Southeast Tissue Alliance, or SETA (formerly the University of Florida Tissue Bank, Inc.) our largest recovery group, supplied us with approximately 31% of our total tissue during 2002. Our three largest recovery groups together recovered approximately 65% of our total tissue. If we were to lose any one of these three sources of tissue, the impact on our results could be material.

Due to the limitations in the availability of human donor tissue, we continue to investigate methods of rendering xenograft tissue (tissue recovered from non-human sources) biocompatible for implant to humans while not adversely affecting tissue strength. Grafts processed from xenograft tissue would be regulated by the FDA as devices and we would be required to obtain approval or licenses from the FDA prior to marketing in the United States.

Marketing and Distribution

Our allografts are distributed in all 50 states and in eleven countries internationally. We pursue a market-by-market approach to distribution, including strategic relationships in selected markets, in order to increase our penetration of these markets.

Medtronic Sofamor Danek, or MSD, serves as our exclusive worldwide distributor for allograft tissue and bone paste for use in spinal surgery. On June 1, 2002, we entered into a new license and distribution agreement with MSD which replaced the two existing agreements between the two companies. As under the prior agreements, MSD remains our exclusive distributor in the spinal market and we remain responsible for processing allograft tissue for the spine and regulatory compliance related to screening, testing and processing of this tissue. Under the new agreement, however, MSD is now responsible for distribution of available tissue and regulatory compliance related to distribution, as well as developing techniques and instrumentation for implantation of human allograft tissue, and training and consultation with surgeons on custom implants. In addition, under the new agreement, MSD pays us license and service fees of approximately 40% to 50% of the listed average net distribution fee for specialty tissue allografts and bone paste for use in spinal surgery. As a result, effective November 1, 2002, we no longer pay management services fees to MSD with respect to distribution activities. Our new agreement with MSD also provides that we must offer MSD the right to become the exclusive distributor for new allografts we develop for use in the spine and negotiate in good faith with MSD for exclusive distribution rights with respect to any other allografts intended for use outside the spine. The new agreement is for an initial term expiring June 1, 2014, subject to earlier termination under certain limited circumstances.

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Effective July 1, 2002, we entered into a new license and distribution agreement with Exactech, Inc., which replaced the existing agreement between the two companies. The expanded agreement with Exactech is an exclusive worldwide distribution arrangement for both moldable and flowable bone paste products for non-spinal musculoskeletal orthopedic procedures. The original agreement was limited to moldable bone paste products. The new agreement resolved all outstanding issues related to the arbitration between the two companies. Under the new agreement, we remain responsible for processing bone paste allograft tissue for musculoskeletal indications exclusive of the spine and regulatory compliance related to screening, testing and processing of this tissue. Exactech will continue distribution of available bone paste products and regulatory compliance related to distribution. Under the new agreement, Exactech will pay us license and service fees based on a percentage of the listed average net distribution fee for bone paste used in non-spinal orthopedic procedures. We also are required to pay a small percentage of the fees we receive from others with respect to our moldable bone pastes distributed in the spinal market. Our new agreement with Exactech also provides that we must offer it the right to distribute new bone pastes for non-spinal uses. The new agreement is for an initial term expiring June 30, 2014, subject to earlier termination under certain limited circumstances.

Effective January 1, 2003, we entered into an exclusive License and Distribution Services Agreement with Stryker Endoscopy, a division of Stryker Corporation, to serve as the exclusive distributor of allografts we process for use in sports medicine surgeries, including reconstruction and repair of the knee, hip, shoulder, wrist, elbow, foot and ankle. Prior to this agreement, we distributed these allografts through a network of independent distributors. Under the new agreement, Stryker Endoscopy will pay us license and service fees based on a percentage of the listed average net distribution fee. Our line of sports medicine allograft products includes menisci, pre-shaped tendons, precision-tooled anchors, screws and pins, and fresh osteochondral allografts. Under the agreement, we remain responsible for processing and delivery of the relevant tissue and regulatory compliance related to screening, testing and processing of this tissue. Stryker Endoscopy will be responsible for developing techniques and instrumentation for implantation of human allograft tissue, customer education and certain marketing activities. The agreement is for an initial term ending December 31, 2004 and is automatically renewable for one year periods thereafter unless prior notice is given by either party.

In the United States, we have 17 independent distributors specializing in general orthopedics, which distribute our allografts through approximately 230 sales representatives, complemented by our internal sales and marketing staff of 24 people. Internationally, we have four distributors that distribute our allografts through approximately 320 sales representatives. This network distributes conventional tissue directly to hospitals and surgeons in their exclusive territory. Distributors and sales representatives receive compensation for the revenues they generate and have the right to maintain their status as the exclusive distributor in their territory if they reach a specified annual quota.

We use direct distribution for the oral-maxillofacial market, with an emphasis on the periodontal market. We use direct mail product information sheets and we attend trade shows to increase the exposure of our allografts. Our marketing staff supports these marketing efforts by speaking at various clinics and universities.

In the urological market, we have an exclusive distribution agreement with C.R. Bard providing for the marketing and distribution of our urological allografts. Under this agreement, we may ship our urological allografts directly to C.R. Bard’s customers or to C.R. Bard for their direct distribution. In return, we receive reimbursement for shipping charges and a transfer fee as a percentage of the amount charged to the customer. In order to remain our exclusive distributor of these allografts, C.R. Bard must meet a specific annual distribution quota. C.R. Bard has an exclusive 90-day right to negotiate an agreement for the distribution of any new technology, invention, process or application we may develop in the future for the treatment of “urinary voiding dysfunction or pelvic tissue defects.” This agreement expires in June 2008, subject to a provision providing for automatic renewal.

In the cardiovascular market, we distribute heart valve, blood vessel and bone paste allografts through 13 cardiovascular distributors, using approximately 40 sales representatives within the United States.

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We distribute our allografts both within and outside the United States. Foreign distribution, primarily in Europe, accounted for 6.5%, 4.8% and 5.9% of our net revenues during the years ended December 31, 2002, 2001 and 2000, respectively.

Research and Development

We plan to continue to develop new allografts and technologies within the spinal, sports medicine, urological and cardiovascular markets and to develop additional tissue-related technologies for other markets. As of December 31, 2002, our research and development staff consisted of 19 professional and technical personnel. Our research and development staff works closely with surgeons in the development of new techniques and procedures related to tissue healing.

Intellectual Property

Our business depends upon the significant know-how and proprietary technology we have developed. To protect this know-how and proprietary technology, we rely on a combination of trade secret laws, patents, trademarks and confidentiality agreements. The effect of these intellectual property rights is to define zones of exclusive use of the covered intellectual property.

We presently hold five patents covering our MD-Series cortical bone dowel, a patent on the use of the interference screw technology, a patent covering our segmentally demineralized graft, a patent with claims directed toward our demineralized stent or conduit technology and a patent on BioCleanse, our proprietary method of cleaning, sterilizing and virally inactivating donor tissue, in the United States. We also presently have one foreign patent covering our MD-Series cortical bone dowel technology and one foreign patent covering our demineralized stent technology. The duration of patent rights generally is 20 years from the date of filing of priority application, while trademarks, once registered, essentially are perpetual. We also have 40 patent applications pending in the U.S. (including continuation and divisional applications), and 40 corresponding foreign patent applications pending in various countries including, but not limited to, Canada, Mexico, Japan, Australia and the European Union. In addition, we rely on our substantial body of know-how, including proprietary techniques and processes in tissue recovery, research and development, tissue processing and quality assurance.

Competition

Competition in the bone and tissue healing industry is intense and subject to rapid technological change and evolving industry requirements and standards. Generally, competitors within the industry compete on the basis of design of related instrumentation, efficacy of products, relationships with the surgical community, depth of range of implants, scientific and clinical results, and pricing. Allograft implants compete with autograft, metals and synthetic tissues, as well as with alternative medical procedures. For the foreseeable future, we believe a significant number of surgeons will continue to choose to perform autograft procedures when feasible, despite the necessity of performing a second operation on the patient in order to obtain the autograft tissue. In addition, many members of the medical community will continue to prefer to use metals and synthetics due in part to their familiarity with the products and the procedures required for their use. While synthetics do not stimulate the growth of new tissue, we believe that researchers will eventually develop methods for permitting the combination of synthetic tissue with recombinant growth stimulating materials in order to create a synthetic tissue that stimulates bone growth. We and a number of other companies are conducting research intended to develop this technology.

Our principal competitors in the conventional allograft market include the Musculoskeletal Transplant Foundation, the American Red Cross Tissue Services, AlloSource and LifeNet. Among our competitors in precision tooled allograft are Osteotech, LifeNet, Musculoskeletal Transplant Foundation, and Tutogen. Other companies who process bone pastes include Osteotech, AlloSource, GenSci Regeneration Sciences, Wright

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Medical Technologies, and Musculoskeletal Transplant Foundation. Among the companies that market devices used for soft tissue anchoring in bladder neck suspensions are Mentor, Ethicon (a division of Johnson & Johnson), Boston Scientific, Smith & Nephew and C.R. Bard. In the cardiovascular tissue market, CryoLife is our principal competitor distributing human heart valves and blood vessels. LifeNet, American Red Cross and Northwest Tissue Service also compete in this market, but to a lesser degree.

We are currently seeking certification from the American Association of Tissue Banks, a nationally recognized association of the tissue banking industry.

Government Regulation

Government regulation plays a significant role in the processing and distribution of allografts. The production, testing, labeling, storage, record keeping, approval, advertising and promotion of allografts are governed or influenced by the Food, Drug, and Cosmetic Act, the Public Health Service Act, and/or other federal and state statutes and regulations. Failure to comply with applicable requirements could result in fines, injunctions, civil penalties, recall or seizure of products, suspension of production, inability to market current products, criminal prosecution, and/or refusal of the government to authorize the marketing of new products. In addition to being registered as a tissue bank with the FDA, we also are licensed by the states of New York, Florida, California and Maryland. These states have regulations similar to the FDA covering donor screening and tissue processing. We were inspected by State of New York, under Tissue Regulations in April 2002, by State of Florida under Tissue Regulations in September 2002, and by State of New York for Clinical Laboratory Accreditation in December 2002. All inspections resulted in favorable recommendations to continue/renew licensure or accreditation as applicable.

We currently market allografts that are subject to the FDA’s “Human Tissue Intended for Transplantation” and Subparts A and B of “Human Cells, Tissues, and Cellular and Tissue-Based Products” regulations. Under these regulations, we are required to perform donor screening and infectious disease testing and to document this screening and testing for each donor from whom we process tissue. The FDA has authority under the rules to inspect human tissue processing facilities, and to detain, recall, or destroy tissues for which appropriate documentation is not available. We are not required to obtain premarket approval or clearance from the FDA for allografts that meet the regulation’s definition of “human tissue.”

In January 2001, the FDA issued a final rule requiring tissue processors to register with the agency and list their tissue products. This is a preliminary step to the FDA issuing its proposed comprehensive tissue regulations titled “Current Good Tissue Practices for Manufacturers of Human Cellular and Tissue Based Products.” This proposed regulation is presently under review and finalization and is expected to be published in early 2004. We are currently an FDA registered tissue processor in compliance with this rule.

The FDA may regulate certain allografts as medical devices, drugs, or biologics, which would require that we obtain approval or product licensure from the FDA. This would occur in those cases where the allograft is deemed to have been “more than minimally manipulated or indicated for nonhomologous use.” In general, “homologous use” occurs when tissue is used for the same basic function that it fulfilled in the donor. Guidelines for making these determinations appear in the FDA’s rules. If the FDA decides that certain of our current or future allografts are more than minimally manipulated or indicated for nonhomologous use, it would require approval or clearances of those allografts. Allografts requiring such approval are subject to pervasive and continuing regulation by the FDA. We would be required to list these allografts as a drug, as a medical device, or as a biologic, and to manufacture them in specifically registered or licensed facilities in accordance with “Good Manufacturing Practices.” We would also be subject to post-marketing surveillance and reporting requirements. In addition, our manufacturing facilities and processes would be subject to periodic inspection to assess compliance with Good Manufacturing Practices. Depending on the nature and extent of any FDA decision applicable to our allografts, further distribution of the affected grafts could be interrupted for a substantial period of time, which would reduce our revenues and hurt our profitability. Our labeling and promotional activities

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would be subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. The export of drugs, devices and biologics is also subject to more intensive regulation than is the case for human tissue products.

On March 12, 2002 we and other tissue processors were advised by the FDA that our bone paste allografts would be subject to regulation as medical devices under the 510(k) premarketing process. We submitted the required documentation to the FDA in August 2002 and are awaiting approval. We and the other processors are permitted to continue distributing these allografts while going through this process.

Heart valve allografts are regulated by the FDA as medical devices. The FDA permits entities that processed and distributed heart valve allografts before June 26, 1991 to continue distributing heart valve allografts without obtaining 510(k) clearance or pre-market approval from the FDA. Our heart valve allografts are covered by this “grandfather” policy provided these heart valves are processed and labeled in the same manner as they were prior to June 26, 1991. Any changes to processes or labels would subject heart valves to the premarket approval process as a medical device.

Our tissue processing generates by-products classified as medical hazardous waste by the U.S. Environmental Protection Agency and the Florida Department of Environmental Protection. We segregate the material and properly dispose of it in compliance with applicable environmental regulations.

Employees

As of December 31, 2002, we had a total of 347 employees. The following chart shows the number of our employees involved in the various aspects of our business:

Risk Factors

An investment in our common stock involves a high degree of risk. You should consider each of the risks and uncertainties described in this section and all of the other information in this document before deciding to invest in our common stock. Any of the risk factors we describe below could severely harm our business, financial condition and results of operations. The market price of our common stock could decline if any of these risks or uncertainties develop into actual events. You may lose all or part of the money you paid to buy our common stock.

We have a limited operating history.

We incorporated in 1997 and commenced operations as an independent entity in 1998. Accordingly, we have a limited operating history on which to base an evaluation of our business and prospects.

Many of the risks inherent in the development of a new enterprise will affect our business, including:

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It is difficult for us to predict our future results of operations due to our limited operating history and the uncertain nature of our markets. As we increase our operating expenses to continue our research and development, expand processing capacity and add to our tissue recovery and distribution programs, these expenditures may not result in increased revenues and we may incur operating losses.

We may need to raise additional funds to operate and grow our business, and if we are unable to raise these funds, our ability to execute our business strategy could be disrupted.

As of December 31, 2002, we had $9,811 of cash and cash equivalents, and $18,510 of cash which is restricted as collateral under our new credit facility. Pursuing our business strategy may require us to raise additional funds. However, the extent of our future capital requirements and the adequacy of available funds will depend on numerous factors, including:

To the extent we are successful in raising additional funds, we likely would do so through equity or debt financings, strategic alliances or other sources. The terms of any future equity financings may be dilutive to our stockholders and the terms of any debt financings likely will contain restrictive covenants that limit our ability to pursue particular courses of action, including paying dividends. Our ability to obtain financing depends upon the status of our future business prospects, as well as conditions prevailing in the capital markets.

We may require additional funds to repay amounts due Medtronic Sofamor Danek.

During the third quarter of 2002, we entered into new distribution and license agreements with Medtronic Sofamor Danek, or MSD. The new agreements contain terms which are more favorable to us than those contained in our previous arrangements with MSD, and could further improve our liquidity situation. However, pursuant to our new agreements with MSD, we are required to pay a portion of the $19,931 amount payable as of December 31, 2002 that we owe MSD by March 31, 2003. Included in this amount due is $13,843 of management fees, which were withheld by us during 2002. We continue to work with MSD to resolve these issues in a manner that addresses the needs of the two companies. While there can be no assurance that we will be successful in doing so, we are confident that a satisfactory arrangement will be reached. Through March 7, 2003, we have repaid $2,500 of the amounts we owe MSD by using our excess working capital.

We recently have generated losses from our operations.

We generated a loss from operations of $2,144 during the first quarter of 2002 and $15,148 during the second quarter of 2002. These losses were primarily the result of a decrease in fees from tissue distribution due to a temporary shortage in inventory of certain allografts most often requested in spinal surgeries. The temporary shortage was caused in part by a shutdown of certain manufacturing facilities as part of a corporate restructuring and by our shift to a demand-based approach in which we focus our processing on these popular allografts. Our losses were also due in part to one-time charges including a $2,000 litigation settlement, $3,098 of asset

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abandonments and $1,352 of restructuring costs. While we did return to profitability during the third and fourth quarters of 2002, we recognized an operating loss of $13,965 for the year ended December 31, 2002 and it is possible that we could generate operating losses in the future. If this happens, it could make it difficult to fund our operations and achieve our business plan.

We depend heavily upon a limited number of sources of human tissue, and any failure to obtain tissue from these sources in a timely manner will interfere with our ability to process and distribute allografts.

The limited supply of human tissue has at times limited our growth, and may not be sufficient to meet our future needs. In addition, due to seasonal changes in mortality rates, some scarce tissues that we use for our allografts are at times in particularly short supply. Other factors, some of which are unpredictable, such as negative publicity, regulatory actions or national events like those of September 11, 2001 also can unexpectedly reduce the available supply of tissue.

Donor recovery groups are part of relatively complex relationships. They deal with donor families, are regulated by the FDA and are often affiliated with hospitals, universities or organ procurement groups. Our relationships with donor recovery groups, which are critical to our supply of tissue, can be affected by relationships they have with these other groups. Any negative impact of the regulatory and disease transmission issues facing the industry, as well as the negative publicity that these issues create, could have an impact on our ability to negotiate favorable contracts with recovery groups.

SETA, our largest recovery group, supplied us with approximately 31% of our total tissue for the year ended December 31, 2002. Our three largest recovery groups together supplied approximately 65% of our total tissue for the year ended December 31, 2002. If we were to lose any one of these three sources of tissue, the impact on our operating results could be material.

We cannot be sure that our supply of tissue will continue to be available at current levels or will be sufficient to meet our needs. If we are no longer able to obtain tissue from these sources sufficient to meet our needs, we may not be able to locate replacement sources of tissue on commercially reasonable terms, if at all. Any interruption of our business caused by the need to locate additional sources of tissue would significantly hurt our revenues. We expect our revenues would decline in proportion to any decline in tissue supply.

Our success will depend on the continued acceptance of our allografts and technologies by the medical community.

Our new allografts, technologies or enhancements to existing allografts may never achieve broad market acceptance, which can be affected by numerous factors, including:

Market acceptance will also depend on our ability to demonstrate that our existing and new allografts and technologies are an attractive alternative to existing tissue repair treatment options. Our ability to do so will depend on surgeons’ evaluations of the clinical safety, efficacy, ease of use, reliability and cost-effectiveness of these tissue repair options and technologies. For example, we believe that a small portion of the medical community has lingering concerns over the risk of disease transmission through the use of allografts.

Furthermore, we believe that even if the medical community generally accepts our allografts and technologies, recommendations and endorsements by influential surgeons will be important to the commercial

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success of our allografts and technologies. If our allografts and technologies are not broadly accepted in the marketplace, we may not achieve a competitive position in the market.

If we fail to achieve and maintain the high processing standards that our allografts require or if we are unable to develop processing capacity as required, our commercial opportunity will be reduced or eliminated.

Our allografts require careful calibration and precise, high-quality processing. Achieving precision and quality control requires skill and diligence by our personnel. If we fail to achieve and maintain these high processing standards, including avoiding processing errors, design defects or component failures:

Further, to be successful, we will need to manage our processing capacity related to tissue recovery and processing facilities in relation to demand. For example, our operating losses during the first half of 2002 were in part due to disruptions caused by our switch to a more demand-based approach to processing. It may be difficult for us to match our processing capacity to demand due to problems related to yields, quality control and assurance, tissue availability, adequacy of control policies and procedures, and lack of skilled personnel. If we are unable to process and produce our allografts on a timely basis, at acceptable quality and costs, and in sufficient quantities, or if we experience unanticipated technological problems or delays in processing, it will reduce our revenues and increase our cost per allograft processed.

If we do not manage the medical release of donor tissue into processing in an efficient manner, it could affect our profitability.

There are many factors which affect the level and timing of donor medical releases, such as effectiveness of donor screening performed by our recovery groups, the timely receipt, recording and review of required medical documentation, and employee loss and turnover in our medical records department. Some of our recovery groups are also processors who provide us with partially processed tissues which they have already determined to be medically suitable for processing. Therefore, these sources provide a higher level of documentation than those that perform recovery alone. Although we strive for the timely medical release of tissue, while at the same time maximizing safety for our employees and for tissue recipients, our internal policies may sacrifice timely release of tissue in favor of safety. We continue to review our internal policies in order to provide the best framework for medical releases, however we can provide no assurance that releases will occur at levels which maximize our processing efficiency and minimize our cost per allograft processed.

Inventory write-downs that we take against our supply of unprocessed and processed tissue may turn out to be inadequate, potentially resulting in inventory losses greater than estimated losses and requiring us to take larger inventory write-downs in the future, which would have a negative effect on our results of operations.

We classify our tissue inventory into three major categories: Unprocessed Donor Tissue, or UDT, Tissue in Process, or TIP, and Implantable Donor Tissue, or IDT. At each stage of storage and processing, for a variety of reasons, the tissue is at risk of not becoming distributed allograft, which is the source of our revenue.

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To estimate future write-offs of inventory, we rely primarily on our experience in operating the business and the data that we have accumulated since our inception. It is possible the amounts we write-off by these means may be inadequate and we could experience actual inventory loss greater than anticipated, and be required to take higher write-offs in the future based on additional experience gained. Since inventory write-offs have the effect of reducing our profitability during the period in which they are recorded, this could have a material adverse effect on our results of operations for the relevant period.

The value of our investment in Organ Recovery Systems, Inc. is dependent on the financial success of this new venture.

We own 1,285,347 shares of convertible preferred stock issued by Organ Recovery Systems, Inc., or ORS, a privately held company, for which the purchase price was $5,250. ORS is organized for the purpose of advancing organ transplantation technology. Realization of our investment in ORS is dependent upon ORS’s successful execution of its operational strategies and the continued industry acceptance of its current and future product developments. If ORS does not successfully execute its operational strategies and recognize long-term profitability, the value of our investment could be impaired.

Rapid technological change will affect us and our customers, which could result in reduced demand for our allografts.

Technologies change rapidly in our industry and there are frequent introductions of new technologies. For example, steady improvements have been made in synthetic human tissue substitutes which compete with allografts. Unlike allografts, synthetic tissue technologies are not dependent on the availability of human tissue. If one of our competitors successfully introduces synthetic technologies using recombinant technologies, which stimulate the growth of tissue surrounding an implant, it could result in a decline in demand for allografts. Although our growth strategy contemplates introducing new allografts and technologies, including the use of recombinant technologies, the development of these new allografts and technologies is a complex and uncertain process, requiring a high level of innovation, as well as the ability to accurately predict future technology and market trends. The allografts we currently have in development will require significant additional development, investment and testing. We may need to undertake costly and time-consuming efforts to achieve these objectives. We may not be able to respond effectively to technological changes and emerging industry standards, or to successfully identify, develop or support new technologies or enhancements to existing allografts in a timely and cost-effective manner, if at all. If we are unable to achieve the improvements in our allografts necessary for their successful commercialization, the demand for our allografts will suffer.

We face intense competition, which could result in reduced acceptance and demand for our allografts and technologies.

The medical technology/biotechnology industry is intensely competitive. We compete with companies in the United States and internationally that engage in the development and production of medical technologies and processes including:

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Many of our competitors have much greater financial, technical, research, marketing, sales, distribution, service and other resources than we have. Moreover, our competitors may offer a broader array of tissue repair treatment products and technologies or may have greater name recognition than we do in the marketplace. For example, we compete with a number of divisions of Johnson & Johnson, a company with significantly greater resources and brand recognition than we have. Our competitors, including several development stage companies, may develop or market technologies that are more effective or commercially attractive than ours, or that may render our technologies obsolete. For example, the successful development of a synthetic tissue product that permits remodeling of bones could result in a decline in the demand for allograft-based products and technologies.

If we fail to maintain our existing strategic relationships or are unable to identify additional distributors of our allografts, our revenues may decrease.

While we market a portion of our current technologies directly to our customers, we currently derive the majority of our revenues through our relationships with three companies, Medtronic Sofamor Danek, Exactech, Inc. and C.R. Bard. For the year ended December 31, 2002, we derived approximately 55% of our net revenues from distribution assisted by management services provided by Medtronic Sofamor Danek and less than 5% of net revenue from distribution assisted by management services provided by Exactech, Inc. and C.R. Bard.

Medtronic Sofamor Danek provides nearly all of the instrumentation, surgeon training, distribution assistance and marketing materials for our line of spinal allografts. If our relationship with this distributor were terminated for any reason and we were unable to replace the relationship with other means of distribution, our revenues could be negatively impacted.

We may need to obtain the assistance of additional distributors to market and distribute our new allografts and technologies, as well as to market and distribute our existing allografts and technologies to new market segments or geographical areas. We may not be able to find additional distributors who will agree to and successfully market and distribute our allografts and technologies on commercially reasonable terms, if at all. If we are unable to establish new distribution relationships on favorable terms, our revenues may decline, which could cause the market price of our shares to decline.

Our allografts and technologies could become subject to significantly greater regulation by the FDA, which could disrupt our business.

The U.S. Food and Drug Administration and several states have statutory authority to regulate allograft processing and allograft-based materials. The FDA could identify deficiencies in future inspections or future regulatory rulings that could potentially disrupt our business, hurting our profitability.

For example, in mid-2001, the FDA reviewed our BioCleanse system after the FDA raised concerns about the process in a letter to us dated May 3, 2001. While the FDA stated in January 2002 that it had concluded the compliance portion of its review of our BioCleanse process and determined we were in compliance with existing regulations and that no regulatory action was warranted, the possibility always exists that the FDA could raise concerns with other aspects of our business. Moreover, while the FDA’s review was made in the context of our current procedures, including the BioCleansing of tissue from multiple donors, its decision does not constitute a formal approval of our process and it is free to raise the same or similar concerns in the future.

If any of our allografts fall under the FDA’s definitions as “more than minimally manipulated or indicated for nonhomologous use,” we would be required to obtain medical device or biologics licenses, which could require clinical testing. Disapproval of our license applications and restricted distribution of any of our allografts, which may become subject to premarket approval, may result. The FDA may require post-market testing and

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surveillance to monitor the effects of such allografts, may restrict the commercial applications of these allografts, and may conduct periodic inspections of our facility and our suppliers’ facilities. Delays encountered during the FDA approval process may shorten the patent protection period during which we have the exclusive right to commercialize such technologies.

On March 12, 2002 we and other tissue processors were advised by the FDA that our bone paste allografts would be subject to regulation as medical devices under the 510(k) premarketing process. We submitted the required documentation to the FDA in August 2002 and are awaiting approval. We and the other processors are permitted to continue distributing these allografts while going through this process. While we are confident that we will obtain the necessary approval to continue marketing these allografts, if we do not, it could have a material and adverse effect on our revenues and our profitability.

Proposed FDA regulations of human cellular and tissue-based products, titled “Good Tissue Practices,” would regulate all stages of allograft processing, from procurement of tissue to distribution of final allografts. These proposed regulations will potentially increase regulatory scrutiny within our industry and this could lead to increased enforcement action affecting the conduct of our business. In addition, the effect of this regulation on recovery agencies, which supply us with tissue, may be significant, and lead to additional costs of recovery activities. These costs may translate into increased cost to us, as we compensate the recovery agencies based on their cost of recovery. Some of our proposed grafts will contain tissue derived from animals, commonly referred to as xenografts. Xenografts are medical devices that are subject to premarket review by the FDA.

Other regulatory entities include state agencies with statutes covering tissue banking. Of particular relevance to our business are regulations issued by Florida, New York, California, and Maryland. Most states do not currently have Tissue Banking regulations. However, recent incidence of allograft related infections in the industry may incite the development of regulation in other states. It is possible that others may make allegations against us or against donor recovery groups or tissue banks, including those with which we have a relationship, about non-compliance with applicable FDA regulations or other relevant statutes and regulations. Allegations like these could cause regulators or other authorities to take investigative or other action, or could cause negative publicity for our industry or us in general.

Our industry is subject to additional local, state, federal and international government regulations and any increased regulations of our current or future activities could significantly increase the cost of doing business, thereby reducing our profitability.

Some aspects of our business are subject to additional local, state, federal or international regulation. Changes in the laws or new interpretations of existing laws could negatively affect our business, revenues or prospects, and increase the costs associated with conducting our business. In particular, the procurement and transplantation of allograft tissue is subject to federal regulation under the National Organ Transplant Act, or NOTA, a criminal statute that prohibits the purchase and sale of human organs, including bone and other tissue. NOTA permits the payment of reasonable expenses associated with the transportation, processing, preservation, quality control and storage of human tissue, which are the types of services we perform. If in the future NOTA were amended or interpreted in a way that makes us unable to include some of these costs in the amounts we charge our customers, it could reduce our revenues and therefore hurt our business. It is possible that more restrictive interpretations or expansions of NOTA could be adopted in the future which could require us to change one or more aspects of our business, at a substantial cost, in order to continue to comply with this statute.

A variety of additional local, state, federal and international government laws and regulations govern our business, including those relating to the storage, handling, generation, manufacture and disposal of medical wastes from the processing of our allografts. While at present we believe that we comply with these laws and regulations, if we fail to conduct our business in compliance with these laws and regulations, it could subject us to significant liabilities. We carry insurance that would cover some liabilities arising from hazardous biological materials; however, liabilities could arise in the future for which our insurance will not be adequate. Moreover,

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such insurance may not always be available in the future on commercially reasonable terms, if at all. If our insurance proves to be inadequate to pay a damage award, we may not have sufficient funds to do so, which could harm our financial condition and liquidity.

Negative publicity concerning methods of tissue recovery and screening of donor tissue in our industry could reduce demand for our allografts and impact the supply of available donor tissue.

Media reports or other negative publicity concerning both improper methods of tissue recovery from donors and disease transmission from donated tissue could limit widespread acceptance of our allografts. Recent publicity concerning prions and the potential transmission of Transmissible Spongiform Encephalopathy, or TSE, through human musculoskeletal tissue and tissue-based products may adversely affect tissue recovery, as well as the demand for our allografts. Unfavorable reports of illegal tissue recovery practices, both in the United States and internationally, as well as incidents of improperly processed tissue leading to transmission of disease, may broadly affect the rate of future tissue donation and market acceptance of allograft technologies.

Potential patients may not distinguish our allografts, technologies and the tissue recovery and processing procedures we have in place, from those of our competitors or others engaged in tissue recovery. In addition, families of potential donors may become reluctant to agree to donate tissue to for-profit tissue processors.

Negative publicity could cause the market price of our shares to decline in value.

If our patents and the other means we use to protect our intellectual property prove to be inadequate, our competitors could exploit our intellectual property to compete more effectively against us.

The law of patents and trade secrets is constantly evolving and often involves complex legal and factual questions. The U.S. government may deny or significantly reduce the coverage we seek in our patent applications before or after a patent is issued. We therefore cannot be sure that any particular patent we apply for will be issued, that the scope of the patent protection will be comprehensive enough to provide adequate protection from similar technologies which may compete with ours, that interference proceedings regarding any of our patent applications will not be filed, or that we will achieve any other competitive advantage from a patent. In addition, it is possible that one or more of our patents will be held invalid if challenged or that others will claim rights in or ownership of our patents and other proprietary rights. If any of these events occur, our competitors may be able to use our intellectual property and compete more effectively against us.

Because patent applications are secret until patents are actually issued and the publication of discoveries in the scientific or patent literature lags behind actual discoveries, we cannot be certain that our patent application was the first application filed covering a particular invention. If another party’s rights to an invention are superior to ours, we may not be able to obtain a license to use that party’s invention on commercially reasonable terms, if at all. In addition, our competitors, many of which have greater resources than we do, could obtain patents that will prevent, limit or interfere with our ability to make use of our inventions either in the United States or in international markets. Further, the laws of some foreign countries do not always protect our intellectual property rights to the same extent as the laws of the United States. Litigation or regulatory proceedings in the United States or foreign countries also may be necessary to enforce our patent or other intellectual property rights or to determine the scope and validity of our competitors’ proprietary rights. These proceedings can be costly, result in development delays, and divert our management’s attention from our business.

We also rely upon unpatented proprietary techniques and processes in tissue recovery, research and development, tissue processing and quality assurance. It is possible that others will independently develop technology similar to ours or otherwise gain access to or disclose our proprietary technologies. We may not be able to meaningfully protect our rights in these proprietary technologies, which would reduce our ability to compete.

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In 1996, a law was passed in the United States that limits the enforcement of patents covering the performance of surgical or medical procedures on a human body. This law prevents medical practitioners and health care entities who practice these procedures from being sued for patent infringement. Therefore, depending upon how these limitations are interpreted by the courts, they could have a material adverse effect on our ability to enforce any of our proprietary methods or procedures deemed to be surgical or medical procedures.

Our success will depend in part on our ability to operate without infringing on or misappropriating the proprietary rights of others, and if we are unable to do so we may be liable for damages.

We cannot be certain that U.S. or foreign patents or patent applications of other companies do not exist or will not be issued that would prevent us from commercializing our allografts and technologies. Third parties may sue us for infringing or misappropriating their patent or other intellectual property rights. Intellectual property litigation is costly. If we do not prevail in litigation, in addition to any damages we might have to pay, we could be required to stop the infringing activity or obtain a license requiring us to make royalty payments. It is possible that a required license will not be available to us on commercially acceptable terms, if at all. In addition, a required license may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around another company’s patent, we may be unable to make use of some of our technologies or distribute our allografts which would negatively impact our revenues.

We or our competitors may be exposed to product liability claims which could cause us to be liable for damages or cause investors to think we will be liable for similar claims in the future.

The development of allografts and technologies for human tissue repair and treatment entails an inherent risk of product liability claims, and substantial product liability claims may be asserted against us. Although we have not received any material product liability claims to date, we have obtained insurance to cover these claims should they arise. Claims could arise in the future for which our insurance will not be adequate. Moreover, insurance covering our business may not always be available in the future on commercially reasonable terms, if at all. If our insurance proves to be inadequate to pay a damage award, we may not have sufficient funds to do so, which would harm our financial condition and liquidity. In addition, successful product liability claims made against one of our competitors could cause claims to be made against us or expose us to a perception that we are vulnerable to similar claims. In addition, claims against us, regardless of their merit or potential outcome, may also hurt our ability to obtain surgeon endorsement of our allografts or to expand our business.

If we are not successful in expanding our distribution activities into international markets, we will not be able to pursue one of our strategies for increasing our revenues.

Our current and planned international distribution strategies vary by market, as well as within each country in which we operate. For example, we distribute only a portion of our line of allografts within each country. Our international operations will be subject to a number of risks which may vary from the risks we face in the United States, including:

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If third party payors fail to provide appropriate levels of reimbursement for the use of our allografts, our revenues would be adversely affected.

Political, economic and regulatory influences are subjecting the healthcare industry in the United States to fundamental change. Any new federal or state legislation could result in significant changes in the availability, delivery, pricing or payment for healthcare services and products. While we cannot predict what form any new legislation will take, it is possible that any significant healthcare legislation, if adopted, could lower the amounts paid to us for our services, which would decrease our revenues.

Our revenues depend largely on the reimbursement of patients’ medical expenses by government health care programs and private health insurers. Governments and private insurers closely examine medical procedures incorporating new technologies to determine whether the procedures will be covered by payment, and if so, the level of payment which may apply. We cannot be sure that third party payors will continue to reimburse us or provide payment at levels which will be profitable to us.

Item 2.    PROPERTIES.

Our physical facilities, located in Alachua, Florida, include three new buildings on approximately 21 acres of property we own, including a 65,000 square foot manufacturing facility, a 50,000 square foot office building and a 20,000 square foot commons building. These facilities include 30 clean-rooms for tissue processing and packaging, freezers for storage of tissue and laboratory facilities. We currently have a BioCleanse^™ processing unit and laboratory operations in approximately 2,500 square feet of leased space related to xenograft research. The monthly rent is $4 per month and the lease expires on January 31, 2004. We also currently lease approximately 8,800 square feet of warehouse space at a rate of $5 per month under a lease expiring in June 2003. We currently plan to vacate this space upon the expiration of the lease and move our warehouse inventories to our new buildings.

We believe our new manufacturing facility will increase our capacity for tissue processing. We intend for this new facility to meet the FDA’s current Good Manufacturing Practices requirements and believe it will also allow us to be designated as an FDA approved medical device manufacturer if necessary.

Our wholly owned subsidiary, Alabama Tissue Center, operates from a leased space on the campus of the University of Alabama in Birmingham, Alabama comprising 3,200 square feet, with four clean-rooms for tissue processing and packaging, and freezers for tissue storage. We had a two-year term lease which expired in August 2002 and we are currently paying on a month to month basis of $4 per month.

Item 3.    LEGAL PROCEEDINGS.

We are, from time to time, involved in litigation relating to claims arising out of our operations in the ordinary course of business. We believe that none of these claims that were outstanding as of December 31, 2002 will have a material adverse impact on our financial position or results of operations.

Item 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

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PART II

Item 5.    MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Market Information and Holders

Our common stock is quoted on the Nasdaq Stock Market under the symbol “RTIX.” The following table sets forth the range of high and low sales prices for our common stock for each quarterly period in the last two fiscal years.

As of March 7, 2003, we had 185 stockholders of record of our common stock. The closing sale price of our common stock on March 7, 2003 was $8.60 per share.

Dividend Policy

We have never paid cash dividends. We do not expect to declare or pay any dividends on our common stock in the foreseeable future, but instead intend to retain all earnings, if any, to invest in our operations. In addition, our existing bank credit facility restricts our ability to pay dividends. The payment of future dividends is within the discretion of our board of directors and will depend upon our future earnings, if any, our capital requirements, financial condition, debt covenant terms, and other relevant factors.

Use of Proceeds

On August 9, 2000 the Securities and Exchange Commission declared effective our Registration Statement on Form S-1 (File No. 333-35756). The offering date was August 10, 2000. The offering has terminated and all of the securities registered have been sold. The managing underwriters were Bank of America Securities, LLC, Lehman Brothers, and Stephens, Inc. Our registration was for 5,700,000 shares of common stock, par value $.001 per share. We sold 3,800,000 shares and the selling stockholder in the offering sold 1,900,000 shares, in both cases for $14.00 per share, generating $53,200 in gross proceeds for us and $26,600 in gross proceeds for the selling stockholder. After deducting approximately $3,700 in underwriting discounts and commissions and $1,500 in other transaction expenses, our net proceeds were $48,025. None of the payments for underwriting discounts and commissions and other transaction expenses represented direct or indirect payment to any of our directors, officers, persons owning 10% or more of any class of our equity securities or other affiliates.

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From the effective date of the registration statement through December 31, 2002, the following table identifies the approximate amounts of the net proceeds paid directly or indirectly to others:

Recent Issuances of Unregistered Securities

On November 26, 2002, we completed a private placement of our common stock resulting in net proceeds to us of approximately $25,683. We sold 3.8 million shares of common stock at $7.25 per share pursuant to a purchase agreement between us and the investors party thereto, a copy of which was filed with the Securities and Exchange Commission. Based on representations contained in the purchase agreement, all of the investors were “accredited investors” within the meaning of the Securities Act of 1933. We sold these shares in reliance on the exemption provided by Section 4(d) of the Securities Act and Rule 506 promulgated thereunder. As part of this financing, we also entered into a registration rights agreement with the investors requiring us to file a registration statement covering the resale of the shares we sold, which we have filed and which has been declared effective by the SEC. We have agreed to prepare and file any amendments and supplements to the registration statement relating to these shares as may be necessary to keep the registration statement effective until the earlier of the date all of the shares have been sold or become saleable pursuant to Rule 144(k) under the Securities Act.

Item 6.    SELECTED FINANCIAL DATA.

The statement of operations data set forth below for the period from January 1, 1998 to February 11, 1998 for our predecessor business have been derived from our audited statements of revenues and direct costs and accompanying notes which are not included within this Form 10-K. In addition, the data set forth below for the period from February 12, 1998, when we began operations, to December 31, 1998, and for the year ended December 31, 1999, as well as the data as of December 31, 2000, have been derived from our audited consolidated financial statements and accompanying notes which are not included elsewhere in this Form 10-K.

The statement of operations data set forth below for the years ended December 31, 2000, 2001, and 2002, and selected balance sheet data as of December 31, 2001 and 2002 have been derived from our audited consolidated financial statements and accompanying notes which are included elsewhere in this Form 10-K. The following items should be considered when comparing the selected consolidated financial information from period to period: During the period from January 1, 1998 to February 11, 1998 and the period from February 12, 1998 to December 31, 1998, revenues and cost of processing and distribution consisted of revenues from and costs of conventional tissue processing and distribution of precision tooled allografts. Beginning in April 1999, revenues included revenues for direct distribution of conventional tissue into Florida and Georgia as well as revenues for distribution of allografts that are precisely tooled for specific surgical uses. The selected consolidated financial data set forth below should be read along with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and accompanying notes included elsewhere in this document.

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Item 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion of our financial condition and results of operations together with the financial statements and the notes to these statements included elsewhere in this filing. This discussion contains forward-looking statements based on our current expectations, assumptions, estimates and projections about us and our industry. Our actual results could differ materially from those anticipated in these forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Overview

As described in more detail below, effective November 1, 2002, we entered into a new distribution agreement with Medtronic Sofamor Danek, or MSD, our largest distributor. Under our prior agreement, MSD distributed our spinal allografts and we were responsible for the collection of all fees charged to the users of these grafts. We then paid MSD a management service fee based on a percentage of what we collected. The amount we collected was reflected in our total revenues and the amount we retained after payment of the management fees was reflected as our net revenues. Under our new agreement with MSD, we are no longer responsible for the collection of total distribution fees but instead receive a fee based on our listed average net distribution fee from MSD. Consequently, subsequent to November 1, 2002, our total revenues will be the same as our net revenues. Accordingly, we believe that analysis of our revenues on a net revenues basis is more meaningful than any comparison on a total revenues basis.

We were incorporated in 1997 as a wholly owned subsidiary of Southeast Tissue Alliance, or SETA (formerly the University of Florida Tissue Bank, Inc.). We began operations on February 12, 1998 when SETA contributed to us its allograft manufacturing and processing operations, related equipment and technologies, distribution arrangements, research and development activities and certain other assets in exchange for shares of preferred stock. We also assumed various liabilities of SETA that were related to the transferred business. At approximately the same time, we sold shares of our preferred stock to a number of unrelated investors.

At approximately the time of our separation from SETA, our former Chairman of the Board, Chief Executive Officer, and officer of SETA prior to our separation from that entity, contributed his royalty rights in certain intellectual property to us in exchange for shares of our preferred stock.

At the time of our separation, SETA assigned to us various agreements to which it was party at the time of the separation, including an agreement with Medtronic Sofamor Danek, or MSD, under which that company was given the right to be the exclusive provider of management services for our current line of precision tooled allografts for use in spinal and cranial medical procedures, including our bone dowels. Later, we entered into a second agreement with MSD under which it was given the right to be the exclusive provider of management services for our current line of bone paste allografts for use in spinal and cranial medical procedures. Under these agreements, we were required to pay MSD a percentage of the amount charged for the covered allografts, ranging from 50% to 70% depending up the nature of the graft.

On June 1, 2002, we entered into a new license and distribution agreement with MSD which replaced the two existing agreements between the two companies. As under the prior agreements, MSD remains our exclusive distributor in the covered markets and we remain responsible for processing allograft tissue for the spine and regulatory compliance related to screening, testing and processing of this tissue. Under the new agreement, however, MSD is now responsible for the distribution of available tissue and regulatory compliance related to distribution, as well as developing techniques and instrumentation for implantation of human allograft tissue, and training and consultation with surgeons on custom implants. In addition, under the new agreement, MSD pays us license and service fees of approximately 40% to 50% of the listed average net distribution fee for specialty tissue allografts and bone paste for use in spinal surgery. As a result, effective November 1, 2002, we no longer

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pay management services fees to MSD with respect to its distribution activities. Our new agreement with MSD also provides that we must offer MSD the right to become the exclusive distributor for new allografts we develop for use in the spine and negotiate in good faith with MSD for exclusive distribution rights with respect to any other allografts developed by us for use outside the spine. The new agreement is for an initial term expiring June 1, 2014, subject to earlier termination under certain limited circumstances.

On April 15, 1999, we changed our business strategy to distribute both conventional allografts and allografts that are precisely tooled for specific surgical uses. Prior to that time, we processed both conventional and precision tooled allografts, but we only directly distributed the precision tooled allograft, allowing SETA to distribute the conventional tissue processed by us. On April 15, 1999, as part of this change in business strategy, we entered into a Programs Transfer Agreement with SETA under which SETA transferred to us its recovery operations outside of Florida and Georgia, conventional allograft distribution services, and its interests in agreements with various tissue recovery programs in exchange for the offset of amounts owed to us by SETA. Also on that date, we entered into a Tissue Recovery Agreement with SETA under which SETA functions as one of our tissue recovery agencies, supplying us with the majority of the tissue it recovers.

On November 1, 1999, we acquired the net assets of Georgia Tissue Bank, Inc. along with certain equipment owned by a director of Georgia Tissue Bank.

On August 21, 2000, we acquired substantially all of the existing assets and liabilities of a division of the University of Alabama Health Services Foundation, which had been doing business as the Alabama Tissue Center in Birmingham, Alabama.

All of our processing operations are located in the United States, although we distribute our allografts to customers both within and outside the United States.

Critical Accounting Policies

Although our financial statements have been prepared in accordance with accounting principles generally accepted in the United States, we must often make estimates and judgments that affect reported amounts. These estimates and judgments are based on historical experience and assumptions that we believe to be reasonable under the circumstances. Assumptions and judgments based on historical experience may provide reported results which differ from actual results.

We often introduce new technologies and processes and therefore we may be at risk of using estimates based on assumptions that later become invalid.

The accounting policies which we feel are “critical,” or require the most use of estimates and judgment, relate to the following items presented in our financial statements: 1) Tissue Inventory Valuation; 2) Accounts Receivable Allowances; 3) Valuation of Long-Lived Assets; and 4) Revenue Recognition.

Tissue Inventory Valuation.    Accounting principles generally accepted in the United States require that inventory be stated at the lower of cost or market value. Due to various reasons, some tissue within our inventory will never become distributed allograft, the source of our revenue. Therefore we must make estimates of future distribution from existing inventory in order to writeoff inventory which will not be distributed and which therefore have reduced or no market value.

Our management reviews available information regarding processing costs, inventory distribution rates, industry supply and demand, medical releases and processed tissue rejections, in order to determine writeoffs of cost above market value. For a variety of reasons, we may from time to time be required to adjust our assumptions as processes change and as we gain better information. For example, during 2001, we determined that our inventory valuation requirement was higher than we had previously estimated, resulting in a $2.3 million reserve increase during that year. Although we continue to refine the information on which we base our estimates, we cannot be sure that our estimates are accurate indicators of future events.

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Accounts Receivable Allowances.    We maintain allowances for doubtful accounts based on our review and assessment of historical payment history and our estimate of the ability of each client to make payments on amounts invoiced. If the financial condition of any of our clients were to deteriorate, additional allowances might be required. From time to time we must adjust our estimates. For example, during 2001, we determined that our accounts receivable allowance was not sufficient and we therefore recorded an additional $5.8 million of bad debt allowance during that year. Changes in estimates of the collection risk related to accounts receivable can result in decreases and increases to current period net income.

Valuation of Long-Lived Assets and Investments.    Accounting principles generally accepted in the United States require that long-lived assets on our balance sheet be stated at the lower of cost, net of depreciation and amortization, or fair value. The factors in this valuation which require significant estimates and judgments are: 1) determination of the estimated useful life of each asset, which determines expense per period, number of periods of expense, and the carrying value of each asset at any time; and 2) determination of the fair value of assets, which may result in impairment charges when fair value is lower than the carrying value of assets, which we would recognize as a charge to earnings during the period we made the determination.

These determinations require complex calculations based on estimated future benefit and fair value. We have often made investments for which the expected future benefit has not been easily estimated. Examples of such investments include, but are not limited to, our acquisition of GTB; our acquisition of ATC; our investment in equipment; our investment in development of software; and our investment in obtaining patents.

If we overestimate the useful life of an asset, or overestimate the fair value of an asset, and at some time in the future we dispose of that asset for a lower amount than its carrying value, our reported total assets and net income will be higher than they would have been during periods prior to our recognition of the loss on disposal of assets, and lower during the period when we recognize the loss.

Long-lived assets include certain long-term investments, such as our investment in Organ Recovery Systems, Inc., or ORS. The fair value of this long-term investment is dependent on the performance of ORS, as well as volatility inherent in the external markets for this investment. In assessing potential impairment for this investment, we will consider these factors as well as forecasted financial performance of our investees. If these forecasts are not met, impairment charges may be required.

Revenue Recognition.    We recognize revenue at the time we ship processed tissue for implant, or when received by our customers based on our distribution agreements. For consignment inventory, revenue is recognized when the tissue is transferred from our consignment inventory locations for implant. Effective November 1, 2002, our revenues no longer reflect a management service fee as management service fees are no longer included in our distribution agreements. However, revenues will continue to be reported gross of any management services fees we incurred related to the distribution of our allografts. We recognize any other revenues when all significant contractual obligations have been satisfied.

We permit returns of tissue in accordance with the terms of contractual agreements with customers if the tissue is returned in a timely manner, in unopened packaging and from the normal channels of distribution. We provide allowances for returns based upon analysis of our historical patterns of returns, matched against the fees from which they originated. Historical returns have been within the amounts we reserved.

Recent Regulatory Actions

In a letter released January 25, 2002, the FDA stated that it had concluded the compliance portion of its review of our BioCleanse^™ process and determined that based on validation data submitted by us and under current FDA requirements, we were in compliance with existing regulations and that no regulatory action was warranted. The FDA’s letter was the result of its review of our BioCleanse^™ system undertaken during mid-2001 after the FDA raised concerns about the process in a letter to us dated May 3, 2001. The BioCleanse^™ validation studies submitted by us to the FDA represented a combination of previously conducted studies, modifications of previous studies and novel methodologies suggested by the FDA for demonstrating sterilization of tissue-based products with respect to conventional infectious disease agents. During the year ended December 31, 2001, we devoted considerable personnel and financial resources to addressing the FDA’s concerns.

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Index to Financial Statements

On June 21, 2001, in response to concerns raised by regulators in the State of Florida, we changed our BioCleanse^™ procedures to comply with that state’s regulation requiring donated tissue processed for transplantation to be traceable from individual donor to individual recipient.

On March 12, 2002 we and other tissue processors were advised by the FDA that our bone paste allografts would be subject to regulation as medical devices under the 510(k) premarketing process. We submitted the required documentation to the FDA in August of 2002 and are awaiting approval. We and the other processors are permitted to continue distributing these allografts while going through this process. While we are confident that we will obtain necessary approval to continue marketing these allografts, if we do not it would have a material and adverse effect on our revenues and our profitability.

Results of Operations

The following table sets forth, in both dollars and as a percentage of net revenues, the results of our operations for the years indicated: