UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Period Ended June 30, 2002
or
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period from ____________ to
____________
Commission File Number 0-19278
OSTEOTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3357370
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
51 James Way, Eatontown, New Jersey 07724
(Address of principal executive offices) (Zip Code)
(732) 542-2800
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
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 |_|
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
Common Stock, $.01 par value - 16,960,940 shares as of July 31, 2002.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
OSTEOTECH, INC. AND Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
June 30, December 31,
2002 2001
- ----------------------------------------------------------------------------------------------------------
ASSETS
- ----------------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 15,729 $ 5,192
Accounts receivable, net 15,273 15,093
Deferred processing costs 13,607 11,165
Inventories 9,038 8,803
Deferred income taxes 2,002 2,002
Prepaid expenses and other current assets 2,639 2,025
----------------------------
Total current assets 58,288 44,280
Property, plant and equipment, net 56,553 56,736
Goodwill, net of accumulated amortization of $404 in 2002 and 2001 1,669 2,910
Other assets 4,590 3,318
- ----------------------------------------------------------------------------------------------------------
Total assets $ 121,100 $ 107,244
==========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ----------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 14,604 $ 17,311
Current maturities of long-term debt 2,661 2,530
----------------------------
Total current liabilities 17,265 19,841
Long-term debt 17,253 18,683
Other liabilities 1,440 934
- ----------------------------------------------------------------------------------------------------------
Total liabilities 35,958 39,458
- ----------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized;
no shares issued or outstanding
Common stock, $.01 par value; 70,000,000 shares authorized; issued and
outstanding 16,957,690 shares in 2002
and 14,098,264 shares in 2001 170 140
Additional paid-in capital 63,239 47,076
Accumulated other comprehensive loss (196) (653)
Retained earnings 21,929 21,223
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity 85,142 67,786
- ----------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 121,100 $ 107,244
==========================================================================================================
See accompanying notes to condensed consolidated financial statements.
- 2 -
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(dollars in thousands, except per share data)
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Net revenues:
Service $ 21,102 $ 17,924 $ 41,688 $ 34,530
Product 1,907 1,048 3,406 1,885
------------ ------------ ------------ ------------
23,009 18,972 45,094 36,415
Cost of services 9,174 7,137 17,313 13,626
Cost of products 1,084 1,390 1,965 2,047
------------ ------------ ------------ ------------
10,258 8,527 19,278 15,673
------------ ------------ ------------ ------------
Gross profit 12,751 10,445 25,816 20,742
Marketing, selling, general and administrative 10,311 12,713 21,540 22,384
Research and development 1,085 1,117 1,988 2,172
------------ ------------ ------------ ------------
11,396 13,830 23,528 24,556
Litigation settlement charge (1,785) (1,785)
------------ ------------ ------------ ------------
Operating income (loss) (430) (3,385) 503 (3,814)
Interest income (expense), net (362) 79 (620) 262
Gain on sale of patents 950 950
------------ ------------ ------------ ------------
Income (loss) from continuing operations
before income taxes 158 (3,306) 833 (3,552)
Income tax provision (benefit) (76) (1,182) 220 (1,140)
------------ ------------ ------------ ------------
Income (loss) from continuing operations 234 (2,124) 613 (2,412)
Income (loss) from discontinued operations,
net of loss on disposal of $291 in 2002 86 (6) 93 (25)
- ------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 320 $ (2,130) $ 706 $ (2,437)
==================================================================================================================
Earnings (loss) per share:
Basic:
Income (loss) from continuing operations $ .01 $ (.15) $ .04 $ (.17)
Discontinued operations .01 .01
------------ ------------ ------------ ------------
Net income (loss) $ .02 $ (.15) $ .05 $ (.17)
============ ============ ============ ============
Diluted:
Income (loss) from continuing operations $ .01 $ (.15) $ .04 $ (.17)
Discontinued operations .01 .01
------------ ------------ ------------ ------------
Net income (loss) $ .02 $ (.15) $ .05 $ (.17)
============ ============ ============ ============
Shares used in computing earnings (loss) per share:
Basic 15,521,088 14,011,866 14,818,770 14,006,241
Diluted 15,864,341 14,011,866 15,200,592 14,006,241
See accompanying notes to condensed consolidated financial statements.
- 3 -
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
Six Months Ended June 30, 2002 2001
- --------------------------------------------------------------------------------------------------
Cash Flow From Operating Activities
Net income (loss) $ 706 $ (2,437)
Adjustments to reconcile income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 3,544 3,907
Provision for doubtful accounts 368 16
Litigation settlement charge 1,785
Gain on sale of patents (950)
Changes in current assets and liabilities:
Accounts receivable (1,167) (5,924)
Deferred processing costs (2,082) (2,029)
Inventories (82) (1,524)
Prepaid expenses and other current assets 201 930
Accounts payable and other liabilities (4,522) 7,852
- --------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (2,199) 791
Cash Flow From Investing Activities
Capital expenditures (3,472) (5,766)
Purchases of investments (1,951)
Proceeds from sale of investments 1,935
Proceeds from sale of patents 1,000
Other, net 160 (170)
- --------------------------------------------------------------------------------------------------
Net cash used in investing activities (2,312) (5,952)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 16,193 248
Proceeds from issuance of long-term debt 1,468
Principal payments on long-term debt (1,299) (88)
- --------------------------------------------------------------------------------------------------
Net cash provided by financing activities 14,894 1,628
Effect of exchange rate changes on cash 154 43
- --------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 10,537 (3,490)
Cash and cash equivalents at beginning of period 5,192 10,923
- --------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 15,729 $ 7,433
==================================================================================================
Supplementary cash flow data:
Cash paid during the period for interest, excluding amounts capitalized $ 623 $ 57
Cash paid during the period for taxes 287 945
See accompanying notes to condensed consolidated financial statements
- 4 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
reflect all adjustments (consisting only of normal recurring accruals and
certain non-cash charges in the three-month period ended June 30, 2001)
considered necessary by management to present fairly the consolidated
financial position as of June 30, 2002, the consolidated results of
operations for the three-month and six-month periods ended June 30, 2002
and 2001 and the consolidated cash flows for the six-month periods ended
June 30, 2002 and 2001. The results of operations for the respective
interim periods are not necessarily indicative of the results to be
expected for the full year. The December 31, 2001 financial information
has been derived from the audited financial statements for the year ended
December 31, 2001. The condensed consolidated financial statement should
be read in conjunction with the audited consolidated financial statements
for the year ended December 31, 2001, which were included as part of
Osteotech, Inc.'s (the "Company") Annual Report on Form 10-K.
2. Recent Accounting Pronouncements
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible
Assets". Pursuant to the provisions of SFAS No. 142, beginning in 2002 the
Company is no longer amortizing goodwill. Amortization of goodwill
included in continuing operations was $33,000 and $66,000 for the three
and six months ended June 30, 2001, respectively. Discontinued operations
included $63,000 and $126,000 of goodwill amortization for the three and
six months ended June 30, 2001, respectively. In addition, in accordance
with the transition provisions of SFAS No. 142, the Company completed an
evaluation of the carrying value of its goodwill as of January 1, 2002 and
determined that there was no impact on the Company's consolidated
financial statements as a result of such evaluation.
The Company's other intangibles, which have finite lives, have carrying
values of $2,004,000 and $1,854,000 as of June 30, 2002 and December 31,
2001, respectively, and are being amortized over their estimated useful
lives ranging from five to ten years.
The following table presents comparative data for the three and six months
ended June 30, 2002 and 2001 to reflect the adoption of SFAS No. 142 as of
January 1, 2002:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------
(in thousands) 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------
Net income (loss) - as reported $ 320 $ (2,130) $ 706 $ (2,437)
Add back goodwill amortization 96 192
----------------------------------------------
Net income (loss) - as adjusted $ 320 $ (2,034) $ 706 $ (2,245)
====================================================================================================
Basic earnings per share:
Net income (loss) - as reported $ .02 $ (.15) $ .05 $ (.17)
Goodwill amortization .01 .01
----------------------------------------------
Net income (loss) - as adjusted $ .02 $ (.14) $ .05 $ (.16)
====================================================================================================
Diluted earnings per share:
Net income (loss) - as reported $ .02 $ (.15) $ .05 $ (.17)
Goodwill amortization .01 .01
----------------------------------------------
Net income (loss) - as adjusted $ .02 $ (.14) $ .05 $ (.16)
====================================================================================================
- 5 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
3. Continuing Operations - Gains/Charges
2002 Second Quarter Gains/Charges
In May, 2002, the Company sold its PolyActive(TM) polymer biomaterials
technology and patents to IsoTis BV for $1,000,000. The Company recognized
a pretax gain of $950,000 on this transaction. (See Note 8 - "License and
Option Agreement").
In April, 2002, the Company settled the Medtronic Sofamor Danek, Inc.,
Sofamor Danek L.P. and Sofamor Holdings, Inc. v. Osteotech, Inc. lawsuit.
The Company recorded a pretax charge of $1,785,000 related to this
settlement. (See Note 8 - "Litigation").
2001 Second Quarter Charges
In June, 2001, the Company recorded pretax charges of $1,845,000 of which
$655,000 has been recorded as cost of product and $1,190,000 has been
recorded as marketing, selling, general and administrative expense. These
charges were primarily to establish reserves associated with excess
inventory and instrumentation associated with spinal implant systems.
There were no significant gains or charges recorded in the first quarter
of 2002 or 2001.
4. Discontinued Operations
On July 10, 2002, the Company completed the sale of the business and
substantially all of the assets, including the assumption of certain
liabilities, of its operations located in Leiden, The Netherlands for
$1,000,000 in cash and a non-interest bearing note with a face value of
$1,500,000, which the Company will discount based on the acquirer's
incremental borrowing rate of 5.75%. The note is payable in increasing
amounts on a quarterly basis beginning in March, 2003 through December,
2006. The Company has retained a security interest in all assets
transferred to the acquirer and received a second mortgage on the land and
building the acquirer will occupy to collateralize the note. The Company
has no on-going financial or operational responsibilities with respect to
the acquirer.
In addition to the net assets sold, which consist of accounts receivable,
inventories and prepaids and other current assets with an aggregate value
of $1,064,000, equipment with a net book value of $405,000 and current
liabilities of $146,000, the Company had goodwill of $1,241,000
attributable to these operations. The Company recorded a loss of $291,000
on the sale of this business in the second quarter of 2002. This loss
along with the net income (loss) of this operation prior to the sale is
reflected in the statements of operations as discontinued operations.
Prior period statements of operations have been reclassified to conform to
this presentation.
These operations represent the Company's ceramic and titanium plasma spray
coating services and products, which were previously reflected in the
Company's Other segment.
- 6 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
4. Discontinued Operations (continued)
Revenues and net income (loss) on the operations sold were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------
(in thousands) 2002 2001 2002 2001
- -------------------------------------------------------------------------------
Revenues $ 1,135 $ 609 $ 1,630 $ 1,119
===========================================
Net income (loss) from operations $ 377 $ (6) $ 384 $ (25)
Loss on disposal (291) (291)
-------------------------------------------
Net income (loss) $ 86 $ (6) $ 93 $ (25)
===========================================
5. Deferred Processing Costs
Deferred processing costs consist of the following:
June 30, December 31,
(in thousands) 2002 2001
- --------------------------------------------------------------------------------
Unprocessed donor tissue to be distributed
by the Company $ 1,240 $ 492
Tissue in process 3,919 2,936
Processed implantable donor tissue to be distributed
by the Company 6,009 5,359
Processed implantable donor tissue held for clients 2,439 2,378
- --------------------------------------------------------------------------------
$ 13,607 $ 11,165
================================================================================
6. Inventories
Inventories consist of the following:
June 30, December 31,
(in thousands) 2002 2001
- --------------------------------------------------------------------------------
Supplies $ 227 $ 245
Raw materials 557 784
Finished goods 8,254 7,774
- --------------------------------------------------------------------------------
$ 9,038 $ 8,803
================================================================================
- 7 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
7. Debt and Financing Arrangements
In June, 2002, the Company obtained an irrevocable standby letter of
credit from its lender with which it has a $5,000,000 revolving line of
credit to support the $1,900,000 due to Medtronic Sofamor Danek, Inc.
pursuant to the settlement agreement in connection with the Medtronic
Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings, Inc. v.
Osteotech, Inc. lawsuit. (See Note 8 - "Litigation"). The commitment under
the standby letter of credit is $1,900,000, but such commitment decreases
over time based on a predetermined schedule concurrent with the Company's
monthly payments under the settlement. As of June 30, 2002, the standby
letter of credit has been reduced to $1,824,000. The amount committed
under the standby letter of credit reduces the Company's availability
under its revolving line of credit. As of June 30, 2002, no amounts were
outstanding under the revolving line of credit and $3,176,000 was
available.
8. Commitments and Contingencies
Service Agreement
Effective June 1, 2002, the Company entered into a new Processing
Agreement with the Musculoskeletal Transplant Foundation ("MTF"), which
will continue through December 31, 2008. Under the terms of the Processing
Agreement, MTF will: (i) supply a certain increasing minimum annual amount
of donor tissue to the Company for processing into standard base tissue
forms, Grafton(R) DBM and Graftech(TM) Bio-implants, all of which will be
distributed to hospital end-users by MTF, under the MTF label, and (ii)
provide a certain increasing minimum annual amount of tissue from donors
that do not fall within MTF's current age criteria for the Company to
process into standard base tissue forms, Grafton(R) DBM and Graftech(TM)
Bio-implant tissue forms, all of which will be distributed to hospital
end-users by the Company under its own label. This new Processing
Agreement was entered into as part of the settlement of the Company's
litigation with MTF. (See Note 8 - "Litigation - Musculoskeletal
Transplant Foundation v. Osteotech, Inc.").
Loan Receivable
In November, 2000, the Company entered into a Loan Agreement with the
American Tissue Services Foundation ("ATSF"), a not-for-profit tissue
recovery organization. The Loan Agreement expires on December 31, 2010.
Through June, 2002, the Company had loaned ATSF an aggregate of $2,458,000
at an average interest rate of 5.59%. The Company has fully reserved all
amounts outstanding under the loans, of which $402,000 and $55,000 was
reserved in the first and second quarters of 2002, respectively, and the
balance was reserved in 2001. The Company reserved $298,000 and $564,000
in the first and second quarters of 2001, respectively. All charges
related to these reserves are included in marketing, selling, general and
administrative expenses in the statements of operations.
Through June 15, 2002, Michael J. Jeffries, the Company's Executive Vice
President and Chief Financial Officer, was one of the three members of
ATSF's Board of Directors. ATSF is a not-for-profit corporation, and
neither Mr. Jeffries nor the Company owns any equity or any other interest
in ATSF. Mr. Jeffries received no compensation from ATSF. On June 15,
2002, the existing ATSF management and ATSF's Board of Directors,
including Mr. Jeffries resigned and were replaced by a new management
- 8 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
group and a new Board of Directors. Concurrent with this change, the
Company and ATSF re-negotiated the existing Loan Agreement to convert it
to a non-interest bearing note and to provide for the forgiveness of
approximately 50% of the loan balance, which remains fully reserved. The
note requires minimum annual repayments of $150,000 beginning January 1,
2003.
In December, 2000, the Company entered into an exclusive fifteen-year
processing and distribution agreement with ATSF. Pursuant to the
agreement, the Company has the right to process and distribute all ATSF
recovered musculoskeletal tissue. In June, 2002, in conjunction with the
change in ATSF's management and Board of Directors, the Company waived the
exclusivity provisions of the agreement where ATSF's management believes
other processors have technology desired by surgeons in ATSF's service
areas. As of June 30, 2002, the Company owed ATSF $158,000 for tissue
recovery reimbursement fees. For the three and six months ended June 30,
2002, the Company incurred liabilities to ATSF of $452,000 and $691,000,
respectively, for tissue recovery reimbursement fees. No such liabilities
were incurred during the three or six months ended June 30, 2001.
License and Option Agreement
In June, 1997, the Company entered into an exclusive worldwide License and
Option Agreement for its proprietary PolyActive(TM) polymer biomaterial
technology and patents (collectively, the "PolyActive technology") with
IsoTis BV ("IsoTis"), The Netherlands. IsoTis had an option to acquire the
technology for approximately 1,815,000 euros (approximately $1,582,000 at
the March 31, 2002 exchange rate) expiring in June, 2003. On April 8,
2002, the Company amended the License and Option Agreement to reduce the
option price for IsoTis to acquire the PolyActive technology to
$1,000,000. In conjunction with the execution of the amendment, IsoTis
elected to exercise its option to acquire the PolyActive technology. The
Company has recognized a pretax gain of $950,000 upon closing this
transaction in May, 2002.
Litigation
The following is a description of material developments that occurred in
lawsuits reported in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001 and the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2002, and the disclosure of two lawsuits
which arose subsequent to the previous reports. Additionally, the Company
is party to other litigation incidental to its business, none of which,
individually or in the aggregate, are expected to have a material adverse
effect on the Company.
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings,
Inc. v. Osteotech, Inc.
In July, 1999, Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and
Sofamor Danek Holdings, Inc. (collectively, "Medtronic") sued the Company
in the United States District Court for the Western District of Tennessee
alleging that certain instruments and instrument sets relating to cortical
bone dowel products, including the bio-d(R) threaded cortical bone dowel
and endodowel, manufactured, sold and/or otherwise distributed by the
Company infringe on certain claims of U.S. Patent Nos. 5,741,253,
5,484,437 and 6,096,038 which are owned by Medtronic.
- 9 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
In April, 2002, Medtronic and the Company settled this lawsuit (the
"Medtronic Settlement"). The Company agreed to pay an aggregate of
$1,900,000 to Medtronic in 24 equal monthly installments, without
interest, and supported by an irrevocable standby letter of credit, and to
cease processing, marketing, distributing, advertising and promoting of
the bio-d(R) threaded cortical bone dowel by January 31, 2003. In
addition, Medtronic agreed to discontinue its participation in the lawsuit
brought by the University of Florida Tissue Bank, Inc., Regeneration
Technologies, Inc. ("RTI"), Sofamor Danek Group, Inc. and Sofamor Danek
L.P. (see "University of Florida Tissue Bank, Inc. v. Osteotech, Inc."),
neither fund nor voluntarily assist RTI or any other party to continue to
pursue this suit against the Company, and to contact RTI, inform it of the
terms of this settlement and recommend to RTI to accept the terms of this
settlement in complete resolution of its suit against the Company.
The Company recorded a charge of $1,785,000 in the second quarter of 2002
representing the present value of the amounts due to Medtronic under this
settlement. This charge is reflected as a litigation settlement charge in
the consolidated statements of operations.
University of Florida Tissue Bank, Inc. v. Osteotech, Inc.
In February, 1999, Southeast Tissue Alliance, formerly known as the
University of Florida Tissue Bank, Inc., ("Southeast"), Regeneration
Technologies, Inc. ("RTI"), Sofamor Danek Group, Inc. and Sofamor Danek
L.P. filed a complaint against the Company in the United States District
Court for the Northern District of Florida alleging that the Company's
bio-d(R) threaded cortical bone dowel and endodowel infringe on the claims
of U.S. Patents Nos. 5,814,084, 4,950,296 and 6,096,081.
In April, 2002 Medtronic settled its portion of this lawsuit with the
Company pursuant to the Medtronic Settlement discussed above. In June,
2002, Southeast and RTI settled their portions of this lawsuit with the
Company under the same terms as the Medtronic Settlement without any
additional monetary payments.
Musculoskeletal Transplant Foundation v. Osteotech, Inc.
In October, 2000, the Musculoskeletal Transplant Foundation ("MTF") and
Synthes Spine Company, L.P. ("Synthes") commenced an action against the
Company in the United States District Court for the District of New
Jersey. Plaintiffs sought a declaratory judgment that their manufacture,
use, sale and/or offer for sale of their demineralized bone matrix
products, known as DBX(R), do not infringe on the claims of the Company's
U.S. Patent Nos. 5,290,558 and 5,284,655, and that the Patents are invalid
and unenforceable.
By agreement dated June 1, 2002, the parties have settled this action.
Part of the settlement was the execution of a new processing agreement
between MTF and the Company. (See Note 8 - "Service Agreement")
- 10 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
Wright Medical Technology, Inc. v. Osteotech, Inc.
In June, 2001, Wright Medical Technology, Inc. ("Wright") filed a
complaint against the Company in the United States District Court for New
Jersey, which alleged claims for false advertising, and related causes of
action concerning certain statements allegedly made by the Company
regarding a FDA Warning Letter received by Wright with respect to a tissue
product marketed by Wright.
On June 14, 2002, the parties settled this action. The settlement of this
action did not have a material impact on the Company's results of
operations or financial condition.
Condos v. Musculoskeletal Transplant Foundation
In July, 2000, the Company was served with an action brought in the United
States District Court for the District of Utah against the Company and
MTF. The suit alleged causes of action for strict liability, breach of
implied warranty and negligence arising from allegedly defective allograft
bone tissue processed and/or provided by the Company and MTF and allegedly
implanted into plaintiff, Chris Condos during two spinal surgeries.
Plaintiffs, which include Mr. Condos's family members, demanded monetary
damages in an unspecified amount. In February, 2002, the Company moved for
summary judgment in its favor on all claims asserted against it. Defendant
MTF sought the same relief. On July 8, 2002, the Court entered an order
granting the summary judgment motions brought by the Company and MTF in
their entirety and dismissed all claims against the Company and MTF in
this action. On July 26, 2002, plaintiffs filed a notice of appeal with
the United States Tenth Circuit Court of Appeals.
Scroggins v. Zimmer Holdings, Inc.
On or about June 24, 2002, the Company received a complaint filed in the
United States District Court for the Eastern District of Louisiana against
numerous defendants, including the Company. The complaint alleges that
plaintiff received defective medical hardware in connection with a certain
hip replacement procedure in May, 1992, and that such hardware was
manufactured or distributed by certain of the defendants. The procedure
involved the use of allogaft bone tissue processed by the Company and
provided by one of our clients. The Company is assessing the claims
against it and has not yet responded to the complaint.
The Company maintains a general liability insurance policy and has
notified the insurance company of this action. The insurance company has
agreed to defend the action.
Younger v. Hayes Medical Center, Inc.
In April, 2001, the Company was served in an action brought in the
Twentieth Judicial District Court in Ellis County, Kansas against Hayes
Medical Center, Inc., MTF, Metropath, Inc. and the Company. With respect
to the Company, the suit alleges a cause of action for negligence in
connection with allegedly defective allograft bone tissue provided by
defendants and allegedly implanted in plaintiff during a surgical
procedure. In May, 2002, plaintiff voluntarily dismissed this action
without prejudice.
- 11 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
Regner v. Inland Eye & Tissue Bank of Redlands; Thacker v. Inland Eye &
Tissue Banks
The Company is a defendant with fifteen or more other defendants in two
actions pending in the Superior Court for the State of California, Los
Angeles County. The suits seek class action status and initially alleged
causes of action based on a violation of the California Business and
Professional Code, as well as a number of common law causes of action,
including negligence, deceit, and intentional and negligent infliction of
emotional distress. Through dismissals, either by the Court or voluntarily
by plaintiffs, only the California Business and Professional Code claims,
which are based on the allegation that defendants are engaging in the
activity of buying or selling organs or tissue for valuable consideration
or profit, and negligence claims remain with respect to both actions. It
appears that plaintiffs are seeking only injunctive relief against the
defendants, including the Company, with respect to their California
Business and Professional Code claims. To the extent any of the other
causes of action which have not been specifically alleged against the
Company but which may be interpreted as applying to the Company, do in
fact lie against the Company, plaintiffs are seeking damages in an
unspecified amount in addition to class certification.
Savitt v. Doheny Eye & Tissue Bank
In July, 2002, the Company was named in an action similar to the Regner
and Thacker lawsuits discussed above filed in Los Angeles County. The
Company is in the process of assessing the claims against it and has not
yet responded to the action.
Litigation is subject to many uncertainties and management is unable to
predict the outcome of the pending suits and claims. It is possible that
the results of operations or liquidity and capital resources of the
Company could be adversely affected by the ultimate outcome of the pending
litigation or as a result of the costs of contesting such lawsuits. The
Company is currently unable to estimate the ultimate liability, if any,
that may result from the pending litigation and, accordingly, no material
provision for any liability (except for accrued legal costs for services
previously rendered) has been made for such pending litigation in the
consolidated financial statements. When the Company is reasonably able to
determine the probable minimum or ultimate liability, if any, that may
result from any of the pending litigation, the Company will record a
provision for such liability to the extent not covered by insurance.
9. Stockholders' Equity
Common Stock
In May, 2002, the Company completed the sale of 2.8 million shares of its
common stock representing approximately 19.8% of the then outstanding
shares of common stock at $6.25 per share to a small group of investors in
a private placement transaction. The resale of these shares were
registered with the Securities and Exchange Commission in May, 2002. The
Company recognized net proceeds of $15,884,000 after deducting the fees
and expenses of the transaction.
- 12 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
9. Stockholders' Equity (continued)
Preferred Stock
On April 4, 2002, the Company reduced the number of authorized shares of
preferred stock to 5,000,000 shares from 5,675,595 shares. In accordance
with the Company's Restated Certificate of Incorporation, these 675,595
shares were previously converted to common stock, and therefore are no
longer available for issuance.
10. Foreign Net Operating Loss Carryforwards
In the second quarter of 2002, the Company utilized approximately
$2,000,000 of its historical net operating loss carryforwards relating to
its subsidiary in The Netherlands. Such net operating loss carryforwards
were utilized against the Company's tax gain on the foreign portion of the
gain on the sale of the PolyActive(TM) polymer biomaterial technology and
patents, the tax gain on the sale of the Company's operations in The
Netherlands and earnings from operations in 2002. Utilization of these net
operating loss carryforwards had no impact on the Company's operating
results, since the tax effect of approximately $680,000 of such
carryforwards had been fully reserved with an equal valuation allowance
because in prior periods realization of the future tax benefits was
uncertain.
11. Comprehensive Income
Comprehensive income for the three-month and six-month periods ended June
30, 2002 and 2001 were as follows:
Three months ended Six months ended
June 30, June 30,
------------------------------------------
(in thousands) 2002 2001 2002 2001
- -------------------------------------------------------------------------------
Net income (loss) $ 320 $ (2,130) $ 706 $ (2,437)
Currency translation adjustments 556 (26) 457 (434)
- -------------------------------------------------------------------------------
Comprehensive income (loss) $ 876 $ (2,156) $ 1,163 $ (2,871)
===============================================================================
- 13 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
12. Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted
earnings (loss) per share for the three-month and six-month periods ended
June 30, 2002 and 2001:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------
(dollars in thousands
except per share data) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations $ 234 $ (2,124) $ 613 $ (2,412)
Discontinued operations 86 (6) 93 (25)
----------------------------------------------------------
Net income (loss) available to
common shareholders $ 320 $ (2,130) $ 706 $ (2,437)
==========================================================
- ---------------------------------------------------------------------------------------------------------
Denominator for basic earnings (loss)
per share, weighted average common
shares outstanding 15,521,088 14,011,886 14,818,770 14,006,241
Effect of dilutive securities, stock options 343,253 381,822
----------------------------------------------------------
Denominator for diluted earnings (loss)
per share 15,864,341 14,011,886 15,200,592 14,006,241
==========================================================
- ---------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share:
Income (loss) from continuing operations $ .01 $ (.15) $ .04 $ (.17)
Discontinued operations .01 .01
----------------------------------------------------------
Net income (loss) $ .02 $ (.15) $ .05 $ (.17)
==========================================================
- ---------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ .01 $ (.15) $ .04 $ (.17)
Discontinued operations .01 .01
----------------------------------------------------------
Net income (loss) $ .02 $ (.15) $ .05 $ (.17)
==========================================================
- ---------------------------------------------------------------------------------------------------------
In 2001, common equivalent shares, consisting solely of stock options, are
excluded from the calculation of diluted loss per share as their effects
are antidilutive. Weighted average shares issuable upon the exercise of
stock options which were not included in the calculation of diluted
earnings (loss) per share were 1,182,188 and 1,053,188, and 1,839,161 and
1,774,973 for the three and six months ended June 30, 2002 and 2001,
respectively. Such shares were not included because they were
antidilutive.
- 14 -
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
13. Operating Segments
Summarized in the table below is financial information for our reportable
segments after giving effect to the divestiture of the Company's
operations in The Netherlands for the three-month and six-month periods
ending June 30, 2002 and 2001:
Three Months Ended Six Months Ended
June 30, June 20,
--------------------------------------------
(dollars in thousands) 2002 2001 2002 2001
- ------------------------------------------------------------------------
Revenues:
Grafton(R) DBM Segment $ 11,490 $ 9,926 $ 23,641 $ 20,946
Base Tissue Segment 9,612 7,998 18,047 13,584
Other 1,907 1,048 3,406 1,885
- ------------------------------------------------------------------------
Consolidated $ 23,009 $ 18,972 $ 45,094 $ 36,415
========================================================================
Operating income (loss):
Grafton(R) DBM Segment $ 2,851 $ 451 $ 4,516 $ 2,639
Base Tissue Segment (2,790) (1,586) (2,713) (3,042)
Other (491) (2,250) (1,300) (3,411)
- ------------------------------------------------------------------------
Consolidated $ (430) $ (3,385) $ 503 $ (3,814)
========================================================================
During the three months ended June 30, 2002 and 2001, two of our clients,
MTF and ARC, in the Grafton(R) DBM and Base Tissue Segments together
accounted for 61% and 76%, respectively, of consolidated net revenues. For
the six months ended June 30, 2002 and 2001, these same two clients
accounted for 62% and 83%, respectively, of consolidated net revenues.
14. Reclassifications
Certain prior year amounts have been reclassified to conform to the 2002
presentation.
- 15 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information contained herein contains "forward-looking statements" which can be
identified by the use of forward-looking terminology such as "believes",
"expects", "may", "will", "should", or "anticipates" or the negative thereof or
variations thereon or comparable terminology, or by discussions of strategy. No
assurance can be given that the future results covered by the forward-looking
statements will be achieved. Some of the matters set forth in the "Risk Factors"
section of our Annual Report on Form 10-K for the year ended December 31, 2001
constitute cautionary statements identifying factors with respect to such
forward-looking statements, including certain risks and uncertainties, that
could cause actual results to vary materially from the future results indicated
in such forward-looking statements. Other factors could also cause actual
results to vary materially from the future results indicated in such
forward-looking statements.
FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 2002 AND 2001
Results of Operations
Critical Accounting Policies and Estimates
In December, 2001, the Securities and Exchange Commission issued Release No.
33-8040, "Cautionary Advice Regarding Disclosure About Critical Accounting
Policies." Critical accounting policies are those that involve subjective or
complex judgments, often as a result of the need to make estimates. The
following areas all require the use of judgments and estimates: product returns,
bad debts, inventories, deferred processing costs, intangible assets, income
taxes and contingencies and litigation. Estimates in each of these areas are
based on historical experience and various assumptions that we believe are
appropriate. Actual results may differ from these estimates. Our accounting
practices are discussed in more detail in "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 2 of "Notes to
Consolidated Financial Statements" in our Annual Report on Form 10-K for the
year ended December 31, 2001.
Income from Continuing Operations
Consolidated income from continuing operations was $234,000 or $.01 diluted
earnings per share and $613,000 or $.04 diluted earnings per share for the three
and six months ended June 30, 2002, respectively, compared to a consolidated
loss from continuing operations of $2,124,000 or $.15 diluted loss per share and
$2,412,000 or $.17 diluted loss per share in the same respective periods last
year. Both the three and six months ended June 30, 2002 include an after tax
charge of $1,071,000 or $.07 diluted loss per share associated with the
Medtronic litigation settlement and an after tax gain of $830,000 or $.05
diluted earnings per share related to the sale of the PolyActive(TM) polymer
biomaterial technology and patents to IsoTis BV. Both the three and six months
ended June 30, 2001 included a charge of $1,107,000, net of tax, or $.08 diluted
net loss per share, primarily to establish reserves for excess inventory and
instrumentation associated with spinal implant systems.
Discontinued Operations
On July 10, 2002, we completed the sale of the business and substantially all of
the assets, including the assumption of certain liabilities, of our operations
in Leiden, The Netherlands for $1,000,000 in cash and a non-interest bearing
note with a face value of $1,500,000, which we will discount based on the
acquirer's incremental borrowing rate 5.75%. These operations represent our
ceramic and titanium plasma spray coating services and products. We recognized a
loss on the sale of this business of $291,000 in the second
- 16 -
quarter of 2002. Revenues from this business were $1,135,000 and $609,000 for
the three months ended June 30, 2002 and 2001, respectively, and $1,630,000 and
$1,119,000 for the six months ended June 30, 2002 and 2001, respectively. The
business had net income of $377,000 and $384,000 for the three and six months
ended June 30, 2002, respectively, compared to a net loss of $6,000 and $25,000
in the corresponding periods in 2001.
Net Income (Loss)
Consolidated net income in the second quarter of 2002 was $320,000 or $.02
diluted net income per share compared to a consolidated net loss of $2,130,000
or $.15 diluted net loss per share in the second quarter of 2001. Consolidated
net income for the six months ended June 30, 2002 was $706,000 or $.05 diluted
net income per share compared to a consolidated net loss of $2,437,000 or $.17
diluted net loss per share for the six months ended June 30, 2001.
The following is a discussion of factors affecting results of continuing
operations after giving effect to the divestiture of the operations of our
subsidiary in The Netherlands for the three-month and six-month periods ended
June 30, 2002 and 2001.
Net Revenues
Consolidated net revenues increased 21% in the second quarter of 2002 to
$23,009,000, compared to consolidated revenues of $18,972,000 in the
corresponding period in 2001. The increase in 2002 was principally due to higher
revenues in all segments primarily as a result of increased unit volume, and to
a lesser extent, as a result of price increases effective January 1, 2002.
Domestic net revenues increased 21% in the second quarter of 2002 to $21,836,000
from $18,063,000 in the corresponding period in 2001. The increase in domestic
revenues was due primarily to increased unit volume in Grafton(R) DBM,
bio-implants and spinal metal implants and increased pricing in Grafton(R) DBM
and bio-implants, partially offset by a 10% decrease in base allograft tissue
processing revenue due to a 4% decrease in the number of donors processed in the
second quarter of 2002 compared to the second quarter of 2001. Foreign-based
revenues increased 29% to $1,173,000 in the second quarter of 2002 from $909,000
in the same period in 2001. The increase in foreign-based revenues was primarily
as a result of increased unit sales volume in all product lines.
Consolidated net revenues increased 24% for the six months ended June 30, 2002
to $45,094,000, compared to consolidated revenues of $36,415,000 in the
corresponding period in 2001. The increase in 2002 was principally due to higher
revenues in all segments primarily as a result of increased unit volume, and to
a lesser extent, as a result of price increases effective January 1, 2002.
Domestic net revenues increased 24% in the six months ended June 30, 2002 to
$42,723,000 from $34,375,000 in the corresponding period in 2001. The increase
in domestic revenues was due primarily to increased unit volume in Grafton(R)
DBM, bio-implants and spinal metal implants and increased pricing in Grafton(R)
DBM and bio-implants, partially offset by an 11% decrease in base allograft
tissue processing revenue due to a 7% decrease in the number of donors processed
in 2002 compared to 2001. Foreign-based revenues increased 16% to $2,371,000 in
the six months ended June 30, 2002 from $2,040,000 in the same period in 2001.
The increase in foreign-based revenues was due to increased unit sales volume in
principally all product lines.
Grafton(R) Demineralized Bone Matrix ("DBM") Segment, or Grafton(R) DBM Segment,
revenues were $11,490,000 in the second quarter of 2002, an increase of 16% from
revenues of $9,926,000 in the same period in 2001. Grafton(R) DBM Segment
revenues increased $2,695,000 or 13% to $23,641,000 in the six months ended June
30, 2002 from $20,946,000 in the six months ended June 30, 2001. Domestic
Grafton(R)
- 17 -
DBM Segment revenues increased 16% to $11,133,000 in the second quarter of 2002
compared to the prior year period and increased 13% to $22,660,000 in the six
months ended June 30, 2002 compared to the same period in 2001. Domestic
Grafton(R) DBM revenues increased due to increased unit sales volume and the
effects of a January 1, 2002 price increase. Foreign-based Grafton(R) DBM
revenues were relatively flat in the second quarter of 2002 and in the six
months ended June 30, 2002 compared to the corresponding periods in the prior
year due to the restructuring of our distribution network in certain European
countries. The recent appointment of DePuy International, LTD as a sales agent
to represent Grafton(R) DBM in a number of key European markets represents an
important step toward completing this restructuring.
Base Tissue Segment revenues increased 20% to $9,612,000 in the second quarter
of 2002 from $7,998,000 in the corresponding period in 2001. The increase is
principally the result of a 58% increase in bio-implant revenues, partially
offset by a 10% decrease in base allograft tissue processing revenues resulting
from a 4% decline in donors processed for our clients. Base Tissue Segment
revenues increased 33% in the six months ended June 30, 2002 compared to the
same period in 2001, principally as a result of a 103% increase in bio-implant
revenues, partially offset by an 11% decrease in base allograft tissue
processing revenues resulting primarily from a 7% decline in donors processed
for our clients. The increase in bio-implant revenues is primarily due to
increased unit volume in 2002 compared to 2001 when several bio-implant tissue
forms were in a launch mode, the ability to charge higher unit sale prices as a
result of our direct distribution of the majority of those units to hospitals,
and the effects of a January 1, 2002 price increase.
Revenue from other product lines increased 82% in the second quarter of 2002 to
$1,907,000 from $1,048,000 in the same period in 2001. In the six months ended
June 30, 2002, revenues from other product lines increased $1,521,000 or 81% to
$3,406,000 from $1,885,000 in 2001. Metal spinal implant systems revenues
increased 119% and 113%, and bovine tissue product revenues increased 16% and
26%, in the three and six months ended June 30, 2002, respectively, compared to
the corresponding periods in 2001. The increases principally resulted from
improved unit sales volume in spinal metal implant systems and bovine tissue
products.
During the three months ended June 30, 2002 and 2001, two of our clients in the
Grafton(R) DBM and Base Tissue Segments, the Musculoskeletal Transplant
Foundation and the American Red Cross accounted for 61% and 76%, respectively,
of consolidated net revenues. In the six months ended June 30, 2002 and 2001
these same two clients accounted for 62% and 83%, respectively, of consolidated
net revenues. We have processing agreements with each of these clients, which
expire in December, 2008 and December, 2006, respectively.
Gross Profit
Gross profit as a percentage of net revenues was relatively flat at 55% in both
the second quarter of 2002 and the second quarter of 2001 and was relatively
flat at 57% for the six months ended June 30, 2002 and 2001. Gross profit as a
percentage of revenues in the second quarter of 2002 was positively impacted by
increased revenues in substantially all product lines resulting in improved
absorption of fixed costs in the processing of Grafton(R) DBM and bio-implants,
offset by the under-absorption of fixed costs in base allograft tissue
processing as a result of a decline in the number of donors processed, metal
spinal implant product lines that have not yet achieved revenue levels
sufficient to fully absorb related operational costs and expenses, and reserves
of $655,000 established in June, 2001 for excess metal spinal implant
inventories.
- 18 -
Marketing, Selling, General and Administrative Expenses
Marketing, selling, general and administrative expenses decreased 19% in the
second quarter 2002 to $10,311,000 from $12,713,000 in the corresponding period
in 2001 and decreased 4% in the six months ended June 30, 2002 compared to the
same period in 2001. The decrease in second quarter 2002 relates mainly to
decreased costs associated with our funding of the American Tissue Services
Foundation, decreased legal fees as a result of the settlement/resolution of a
number of our patent and other lawsuits, decreased marketing costs due to the
launch in 2001 of new bio-implant tissue forms, which increased 2001 marketing
costs, and in 2001 a provision of $1,190,000 for reserves primarily for excess
instrument sets associated with spinal implant systems. The decrease in
marketing, selling, general and administrative expenses in the six months ended
June 30, 2002 compared to the same period in 2001 is due mainly to decreased
costs associated with our funding of the American Tissue Services Foundation,
decreased marketing costs due to the launch in 2001 of new bio-implant tissue
forms, which increased 2001 marketing costs, and in 2001 a provision of
$1,190,000 for reserves primarily for excess instrument sets associated with
spinal implant systems, partially offset by increased legal fees.
Research and Development Expenses
Consolidated research and development expenses decreased 3% in the second
quarter of 2002 to $1,085,000 from $1,117,000 in the same period in 2001, and
decreased 8% in the six months ended June 30, 2002 to $1,988,000 from $2,172,000
in the six months ended June 30, 2001. The decreases in both periods were
primarily related to the completion of development of bio-implant tissue forms,
which were launched in 2001, and Grafton Plus(TM) DBM, which was launched in the
first quarter of 2002, as well as the completion of new processing technology
and packaging, which were implemented in 2001.
Litigation Settlement Charge
In April, 2002, we settled a patent lawsuit and agreed to pay an aggregate of
$1,900,000 in 24 equal monthly installments, without interest. We recorded a
charge of $1,785,000 related to this settlement representing the present value
of the amounts due. (See Note 8 of "Notes to Condensed Consolidated Financial
Statements").
Operating Income (Loss)
We incurred a consolidated operating loss in second quarter 2002 of $430,000
compared to a consolidated operating loss in second quarter 2001 of $3,385,000.
Operating income for the six months ended June 30, 2002 was $503,000 compared to
an operating loss of $3,814,000 in the six months ended June 30, 2001. Included
in 2002 is the aforementioned litigation settlement charge of $1,785,000, while
2001 included provisions of $1,845,000 for excess inventory and instrumentation.
Grafton(R) DBM Segment operating income increased $2,400,000 in the second
quarter of 2002 to $2,851,000 from $451,000 in the corresponding period in 2001.
The increase results principally from an increase in gross profit margins due to
increased revenue volume and improved absorption of fixed costs, decreased legal
fees, lower research and development costs associated with the development of
Grafton Plus(TM) DBM, which was launched in the first quarter of 2002, and
decreased marketing costs. Operating income for the six months ended June 30,
2002 was $4,516,000, an increase of $1,877,000 from operating income of
$2,639,000 in the six months ended June 30, 2001. The increase results
principally from an increase in gross profit margins due to increased revenue
volume and improved absorption of fixed costs,
- 19 -
lower research and development costs associated with the development of Grafton
Plus(TM) DBM, which was launched in the first quarter of 2002, and decreased
marketing costs, partially offset by increased legal fees.
We incurred an operating loss in the Base Tissue Segment in the second quarter
of 2002 of $2,790,000 compared to an operating loss of $1,586,000 in the same
period in 2001. In the six months ended June 30, 2002, we incurred an operating
loss of $2,713,000 compared to an operating loss of $3,042,000 in the same
period in 2001. The operating loss in the second quarter and in the year to date
period resulted primarily from the litigation settlement charge, increased legal
fees associated with the patent lawsuits that were settled in the second
quarter, and the decline in base allograft tissue processing revenue, partially
offset by increased bio-implant revenues and lower costs for marketing, selling
and promotional activities primarily due to incurring the costs to launch the
new bio-implant tissue forms in 2001.
Operating losses associated with other revenues were $491,000 and $2,250,000 in
the first quarter of 2002 and 2001, respectively. In the six months ended June
30, 2002, we incurred an operating loss of $1,300,000 compared to an operating
loss of $3,411,000 in the same period in 2001. The operating loss in both
periods of 2002 decreased over the operating loss in both periods of 2001
principally as a result of improved gross margins as a result of increased sales
volume and a reduction in our funding of the American Tissue Services
Foundation, and in 2001 reserves for excess inventory and instrumentation
associated with metal spinal implant systems.
Other Income (Expense)
Interest expense, net of interest income, was $362,000 and $620,000 in the
second quarter and six months ended June 30, 2002, respectively, compared to
interest income, net of interest expense, of $79,000 and $262,000 in the
corresponding periods in 2001. In 2002, interest expense on long-term debt, is
partially offset by interest income, which is lower than historical levels as a
result of a decline in interest rates and lower average cash balances available
for investment. In 2001, interest income exceeded interest expense due to higher
average cash balances available for investment and because the majority of our
interest costs were capitalized in connection with the construction of our new
allograft tissue processing facility. In late 2001, we began to charge such
interest costs to earnings since the facility was substantially complete.
In May, 2002, we completed the sale of the PolyActive(TM) polymer biomaterial
technology and patents to IsoTis BV for $1,000,000 in cash. We recognized a
$950,000 gain on this transaction after deduction costs and expenses.
Income Tax Provision
For the three months ended June 30, 2002, we recognized an income tax benefit
from continuing operations primarily due to losses incurred in our domestic
operation and our ability to utilize previously unrecognized net operating loss
carryforwards, which carry a full valuation allowance, to offset foreign income.
In addition, we did not record an income tax provision for discontinued
operations due to our ability to utilize the additional foreign net operating
loss carryforwards to offset taxable income.
For the six months ended June 30, 2002, our effective income tax rate from
continuing operations was 26%, as our tax provision on expected domestic income
was partially offset by the utilization of foreign net operating loss
carryforwards, which carry a full valuation allowance, to offset foreign income.
We did not recognize an income tax provision for discontinued operations due to
utilization of net operating loss carryforwards, which carry a full valuation
allowance, to offset income from operations and the tax gain on the sale of our
operations in The Netherlands. In the three and six month periods ended June 30,
2002, we
- 20 -
utilized approximately $2,000,000 (tax effect of approximately $680,000) of our
historical net operating loss carryforwards relating to our subsidiary in The
Netherlands.
In the second quarter and six months ended June 30, 2001, we recognized a
consolidated income tax benefit on our domestic losses due to our ability to
carryback and carryforward these losses. No income tax benefit was recognized in
2001 for our foreign losses, principally as a result of the uncertainty of
realization of such future tax benefits.
Liquidity and Capital Resources
At June 30, 2002 we had cash and cash equivalents of $15,729,000 compared to
$5,192,000 at December 31, 2001. We invest excess cash in U.S. Government-backed
securities and investment grade commercial paper of major U.S. corporations.
Working capital increased $16,584,000 to $41,023,000 at June 30, 2002 compared
to $24,439,000 at December 31, 2001. The increase resulted primarily from the
sale of 2.8 million shares of common stock and proceeds from the sale of the
PolyActive(TM) polymer biomaterial technology and patents.
Net cash used in operating activities was $2,199,000 in the six months ended
June 30, 2002 compared to net cash provided by operations of $791,000 in the
corresponding period in the prior year. The decrease resulted primarily from our
continued investments in accounts receivable and deferred processing costs as a
result of our direct distribution and donor recovery efforts and from reductions
in accounts payable and other liabilities, partially offset by improved
profitability compared to the prior year. Beginning in the second quarter of
2001, we began to distribute tissue forms directly to surgeons and hospitals.
This change in distribution methodology has impacted our liquidity and cash
flow. We have had to make additional investments in accounts receivables,
inventories and deferred processing costs to support our direct sales efforts,
and expect to make additional investments in inventory and deferred processing
costs, as necessary, to support our efforts to expand direct distribution.
Cash used in investing activities decreased to $2,312,000 in the six months
ended June 30, 2002 from $5,952,000 in the six months ended June 30, 2001. The
decrease is principally due to a decrease in capital expenditures to $3,472,000
in 2002 from $5,766,000 in 2001 as a result of reduced spending on the
construction of our new allograft tissue processing facility and due to proceeds
from the sale of the PolyActive(TM) polymer biomaterial technology and patents
of $1,000,000. Through June 30, 2002, we incurred $40,131,000 of capital
expenditures, including capitalized interest of $1,769,000, related to our new
allograft tissue processing facility, of which $19,352,000 has been funded
through bank financing.
Net cash provided by financing activities was $14,894,000 in the six months
ended June 30, 2002 compared to $1,628,000 in the same period in 2001. In May,
2002, we sold 2.8 million shares of common stock at a price of $6.25 and
received proceeds of $15,884,000, after deducting fees and expenses of the
offering. For the six months ended June 30, 2002, we made principal payments of
$1,299,000 under our equipment term loan and mortgage, while in 2001 we only
made principal payments under the mortgage of $88,000. Also, in the first
quarter of 2001, we borrowed the remaining funds of $1,468,000 available under
the equipment term loan.
We have a Credit Facility with a U.S. bank that includes: a $5,000,000 revolving
line of credit, a building mortgage loan and an equipment term loan. At June 30,
2002, there were no borrowings under the revolving line of credit, $4,331,000
was outstanding under the building mortgage loan and $15,583,000 was outstanding
under the equipment term loan. In June, 2002 to support the $1,900,000 due under
the settlement of certain patent litigation (See Note 8 of "Notes to Condensed
Consolidated Financial Statements" - "Litigation-Medtronic Sofamor Danek, Inc.,
Sofamor Danek L.P. and Sofamor Holdings, Inc. v. Ostectech, Inc."), we have
provided an irrevocable standby letter of credit in an original amount of
$1,900,000. As of June 30, 2002, the standby letter of credit has been reduced
to $1,824,000.
- 21 -
Amounts committed under this standby letter of credit decrease over time based
on a predetermined schedule concurrent with our monthly payments due under the
settlement and reduce the amounts available under the revolving line of credit.
As of June 30, 2002, no amounts were outstanding under the revolving line of
credit and $3,176,000 was available.
In February, 2001, we entered into a distribution agreement to market a pedicle
screw system and a cervical plating system. This agreement requires us to make
minimum purchase commitments of $6,000,000 over the two-year period beginning on
February 1, 2002. Through June 30, 2002, we purchased $3,612,000 of inventory
pursuant to the commitment. We expect to purchase the remaining balance of
$2,388,000 during the remainder of 2002 and in 2003.
As of June 30, 2002, there were no material changes in our contractual
obligations or long-term debt from that disclosed in our Annual Report on Form
10-K for the year ended December 31, 2001. See Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations, Liquidity and
Capital Resources" in our Annual Report on Form 10-K for the year ended December
31, 2001.
We believe that our cash and cash equivalents and available lines of credit,
together with anticipated future cash flows from operations, will be sufficient
to meet our forecasted cash needs for the next twelve months. However, we expect
to continue to make investments in our business during the remainder of the
fiscal year, which we expect will deplete a portion of our cash reserves. From
time to time we may seek additional funds through equity or debt financing.
However, there can be no assurance that such additional funds will be available,
or if available, that such funds will be available on favorable terms.
Impact of Inflation and Foreign Currency Exchange Fluctuations
Results of operations for the periods discussed above have not been materially
affected by inflation or foreign currency fluctuations.
Litigation
Osteotech, Inc. is involved in various legal proceedings involving product
liability and patent infringement claims. For a discussion of these matters see,
Note 8 of "Notes to Condensed Consolidated Financial Statements", PART II., ITEM
1. LEGAL PROCEEDINGS, our Annual Report on Form 10-K for the year ended December
31, 2001 and our Quarterly Report on Form 10-Q for the quarter ended March 31,
2002. It is possible that our results of operations or liquidity and capital
resources could be adversely affected by the ultimate outcome of the pending
litigation or as a result of the costs of contesting such lawsuits.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding our exposure to certain market risks, see Item 7A,
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, in our Annual Report
on Form 10-K for the year ended December 31, 2001. There have been no
significant changes in our market risk exposures from the fiscal 2001 year-end.
- 22 -
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following is a description of material developments that occurred in
lawsuits reported in our Annual Report on Form 10-K for the year ended December
31, 2001 and our Quarterly Report on Form 10-Q for the quarter ended March 31,
2002 and the disclosure of two lawsuits which arose subsequent to the previous
reports. Additionally, we are a party to other litigation incidental to our
business, none of which, individually or in the aggregate, are expected to have
a material adverse effect.
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings, Inc. v.
Osteotech, Inc.
In July, 1999, Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor
Danek Holdings, Inc. (collectively, "Medtronic") sued us in the United States
District Court for the Western District of Tennessee alleging that certain
instruments and instrument sets relating to cortical bone dowel products,
including the bio-d(R) threaded cortical bone dowel and endodowel, manufactured,
sold and/or otherwise distributed by us infringe on certain claims of U.S.
Patent Nos. 5,741,253, 5,484,437 and 6,096,038 which are owned by Medtronic.
In April, 2002, the parties settled this lawsuit (the "Medtronic Settlement").
We agreed to pay an aggregate of $1,900,000 to Medtronic in 24 equal monthly
installments, without interest, and supported by an irrevocable standby letter
of credit, and to cease processing, marketing, distributing, advertising and
promoting of the bio-d(R) threaded cortical bone dowel by January 31, 2003. In
addition, Medtronic agreed to discontinue its participation in the lawsuit
brought by the University of Florida Tissue Bank, Inc., Regeneration
Technologies, Inc. ("RTI"), Sofamor Danek Group, Inc. and Sofamor Danek L.P.
(see "University of Florida Tissue Bank, Inc. v. Osteotech, Inc."), neither fund
nor voluntarily assist RTI or any other party to continue to pursue this suit
against us, and to contact RTI, inform it of the terms of this settlement and
recommend to RTI to accept the terms of this settlement in complete resolution
of its suit against us.
University of Florida Tissue Bank, Inc. v. Osteotech, Inc.
In February, 1999, Southeast Tissue Alliance, formerly known as the University
of Florida Tissue Bank, Inc., ("Southeast"), Regeneration Technologies, Inc.
("RTI"), Sofamor Danek Group, Inc. and Sofamor Danek L.P. filed a complaint
against us in the United States District Court for the Northern District of
Florida alleging that our bio-d(R) threaded cortical bone dowel and endodowel
infringe on the claims of U.S. Patents Nos. 5,814,084, 4,950,296 and 6,096,081.
In April, 2002 Medtronic settled its portion of this lawsuit with us pursuant to
the Medtronic Settlement discussed above. In June, 2002, Southeast and RTI
settled their portions of this lawsuit with us under the same terms as the
Medtronic Settlement without any additional monetary payments.
Musculoskeletal Transplant Foundation v. Osteotech, Inc.
In October, 2000, the Musculoskeletal Transplant Foundation ("MTF") and Synthes
Spine Company, L.P. ("Synthes") commenced an action against us in the United
States District Court for the District of New Jersey. Plaintiffs sought a
declaratory judgment that their manufacture, use, sale and/or offer for sale of
their demineralized bone matrix products, known as DBX(R), do not infringe on
the claims of our U.S. Patent Nos. 5,290,558 and 5,284,655, and that the Patents
are invalid and unenforceable.
- 23 -
By agreement dated June 1, 2002, the parties have settled this action. Part of
the settlement was the execution of a new processing agreement between MTF and
us.
Wright Medical Technology, Inc. v. Osteotech, Inc.
In June, 2001, Wright Medical Technology, Inc. ("Wright") filed a complaint
against us in the United States District Court for New Jersey, which alleged
claims for false advertising, and related causes of action concerning certain
statements allegedly made by us regarding a FDA Warning Letter received by
Wright with respect to a tissue product marketed by Wright.
On June 14, 2002, the parties settled this action. The settlement of this action
did not have a material impact on our results of operations or financial
condition.
Condos v. Musculoskeletal Transplant Foundation
In July, 2000, we were served with an action brought in the United States
District Court for the District of Utah against us and MTF. The suit alleged
causes of action for strict liability, breach of implied warranty and negligence
arising from allegedly defective allograft bone tissue processed and/or provided
by us and MTF and allegedly implanted into plaintiff, Chris Condos during two
spinal surgeries. Plaintiffs, which include Mr. Condos's family members,
demanded monetary damages in an unspecified amount. In February, 2002, we moved
for summary judgment in our favor on all claims asserted against us. Defendant
MTF sought the same relief. On July 8, 2002, the Court entered an order granting
the summary judgment motions brought by us and MTF in their entirety and
dismissed all claims against us and MTF in this action. On July 26, 2002,
plaintiffs filed a notice of appeal with the United States Tenth Circuit Court
of Appeals.
Scroggins v. Zimmer Holdings, Inc.
On or about June 24, 2002, we received a complaint filed in the United States
District Court for the Eastern District of Louisiana against numerous
defendants. The complaint alleges that plaintiff received defective medical
hardware in connection with a certain hip replacement procedure in May, 1992,
and that such hardware was manufactured or distributed by certain of the
defendants. The procedure involved the use of allogaft bone tissue processed by
us and provided by one of our clients. We are assessing the claims against us
and have not yet responded to the complaint.
We maintain a general liability insurance policy and has notified the insurance
company of this action. The insurance company has agreed to defend the action.
Younger v. Hayes Medical Center, Inc.
In April, 2001, we were served in an action brought in the Twentieth Judicial
District Court in Ellis County, Kansas against Hayes Medical Center, Inc., MTF,
Metropath, Inc. and us. The suit alleges against us a cause of action for
negligence in connection with allegedly defective allograft bone tissue provided
by defendants and allegedly implanted in plaintiff during a surgical procedure.
In May, 2002, plaintiff voluntarily dismissed this action without prejudice.
- 24 -
Regner v. Inland Eye & Tissue Bank of Redlands; Thacker v. Inland Eye & Tissue
Banks
We are a defendant with fifteen or more other defendants in two actions pending
in the Superior Court for the State of California, Los Angeles County. The suits
seek class action status and initially alleged causes of action based on a
violation of the California Business and Professional Code, as well as a number
of common law causes of action, including negligence, deceit, and intentional
and negligent infliction of emotional distress. Through dismissals, either by
the Court or voluntarily by plaintiffs, only the California Business and
Professional Code claims, which are based on the allegation that defendants are
engaging in the activity of buying or selling organs or tissue for valuable
consideration or profit, and negligence claims remain with respect to both
actions. It appears that plaintiffs are seeking only injunctive relief against
the defendants, including us, with respect to their California Business and
Professional Code claims. To the extent any of the other causes of action which
have not been specifically alleged against us but which may be interpreted as
applying to us, do in fact lie against us, plaintiffs are seeking damages in an
unspecified amount in addition to class certification.
Savitt v. Doheny Eye & Tissue Bank
In July, 2002, we were named in an action similar to the Regner and Thacker
lawsuits discussed above filed in Los Angeles County. We are in the process of
assessing the claims against us and have not yet responded to the action.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
On May 17, 2002, we sold 2.8 million shares of our common stock to 14
"accredited investors" (as that term is defined in Rule 501(a) under the
Securities Act of 1933 (the "Securities Act")) in an unregistered private
placement. Such private placement was exempt from the registration requirements
of Section 5 of the Securities Act pursuant to the exemption contained in
Section 4(2) of the Securities Act and Rule 506 under the Securities Act. Bear
Stearns & Co. Inc. acted as placement agent for this private placement. The
aggregate offering price for the securities sold was $17.5 million, the
aggregate commissions paid to the placement agent were $1.225 million and the
aggregate expenses of the placement agent for which we reimbursed the placement
agent were $145,000. In claiming the exemption from registration provided by
Section 4(2) and Rule 506 described above, we relied on the following facts: (i)
the offering was made only to a select group of investors, (ii) all of the
purchasers were accredited investors, (iii) no general solicitation or general
advertising was conducted in connection with the offering, (iv) all of the
purchasers represented that they were purchasing the shares for their own
account and not with a view towards distribution and (iv) all of the purchasers
agreed that they cannot resell their shares without registration under the
Securities Act or an exemption therefrom.
On May 17, 2002 we obtained the effectiveness of a registration statement on
Form S-3, which registers the resale of the shares sold in this private
placement.
- 25 -
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An annual meeting of stockholders was held on June 13, 2002.
(b) The matters voted upon at the annual meeting and the results of the voting
are set forth below:
With respect to the election of Directors of Osteotech, the persons named
below were elected at the annual meeting to serve a term of one year or
until the next annual meeting of stockholders. They constitute the entire
board of directors of the Company. Each received the following number of
votes:
Director For Withheld
--------------------------------------------------------------------------
Richard W. Bauer 9,901,552 2,516,218
Kenneth P. Fallon, III 11,032,663 1,385,107
Michael J. Jeffries 9,899,884 2,517,886
Donald D. Johnston 11,035,906 1,381,864
John Phillip Kostuik, M.D. 11,037,213 1,380,557
Stephen J. Sogin, Ph.D. 12,309,938 107,832
ii) With respect to a proposal to increase the number of authorized
shares of Common Stock which may be issued under Osteotech's 1994
Employee Stock Purchase Plan by 200,000 shares to 575,000 shares,
the stockholders voted 11,707,057 shares in favor, 428,526 shares
against and 282,187 shares abstained. Broker non-votes were not
applicable. This proposal received the vote required by Delaware
General Corporation Law and the Company's by-laws for approval (i.e.
affirmative vote of a majority of the shares of common stock present
at the meeting and entitled to vote on the proposal).
iii) With respect to a proposal to ratify the appointment of
PricewaterhouseCoopers LLP as Osteotech's independent auditors for
the fiscal year ending December 31, 2002, the stockholders voted
12,347,697 shares in favor, 58,066 shares against and 12,007 shares
abstained. Broker non-votes were not applicable. This proposal
received the vote required by Delaware General Corporation Law and
the Company's by-laws for approval (i.e. affirmative vote of a
majority of the shares of common stock present at the meeting and
entitled to vote on the proposal).
- 26 -
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
Exhibit Page
Number Description Number
------ ----------- ------
3.4 Certificate of Retirement and Prohibition of Reissuance E-1
of Shares of Osteotech, Inc., dated April 4, 2002.
10.56 Settlement Agreement and Release by and among Osteotech, E-2
Inc. and Osteotech Investment Corporation, the
Musculoskeletal Transplant Foundation, and Synthes Spine
Company, L.P., dated as of June 1, 2002. []
10.57 Second Amended and Restated Processing Agreement by and E-9
among Musculoskeletal Transplant Foundation, Biocon,
Inc., and Osteotech, Inc. dated as of June 1, 2002. []
10.58 License Agreement by and among Osteotech, Inc., E-61
Osteotech Investment Corporation, Musculoskeletal
Transplant Foundation, Biocon, Inc., and Synthes Spine
Company, L.P., dated as of June 1, 2002. []
10.59 Asset Purchase Agreement between Cam Implants B.V. and E-85
Cam Acquisition B.V. dated July 10, 2002 []
10.60 Settlement Agreement between Medtronic, Inc., on behalf E-210
of itself and as owner, directly or indirectly, of
Medtronic Sofamor Danek, Inc. (formerly known as Sofamor
Danek Group, Inc.), Sofamor Danek Holdings, Inc.,
Medtronic Sofamor Danek USA, Inc., SDGI Holdings, Inc.,
and Sofamor Danek L.P. and Osteotech, Inc., effective
May 15, 2002.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as E-219
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as E-220
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
[] Copy omits information for which confidential treatment has been
requested.
(b) Reports on Form 8-K
On June 26, 2002, we filed with the Commission a Current Report on Form
8-K to announce that on June 25, 2002 we settled the patent lawsuit that
was brought by Regeneration Technologies, Inc. and Southeast Tissue
Alliance, Inc. (formerly known as University of Florida Tissue Bank). This
lawsuit is related to the bone dowel instrumentation patent lawsuit with
Medtronic, Inc., which lawsuit the Company announced on April 30, 2002 had
been settled.
On June 18, 2002, we filed with the Commission a Current Report on Form
8-K to announce that we settled a lawsuit brought against us by Wright
Medical Technology, Inc.
On June 12, 2002, we filed with the Commission a Current Report on Form
8-K to announce that effective June 1, 2002, we entered into (i) an
agreement to settle the lawsuit with MTF and Synthes, (ii) a Second
Amended and Restated Processing Agreement with Musculoskeletal Transplant
Foundation and its parent, Biocon Inc. (collectively "MTF"), and (iii) a
License Agreement (the "License Agreement") with MTF and Synthes Spine
Company, L.P. ("Synthes").
On May 20, 2002, we filed with the Commission a Current Report on Form 8-K
to announce that we completed the previously announced sale of 2.8 million
shares of our Common Stock at a price of $6.25 per share ($17.5 million in
the aggregate) in a private placement transaction.
- 27 -
On May 9, 2002, we filed with the Commission a Current Report on Form 8-K
to announce that we had entered into agreements to sell 2.8 million shares
of our Common Stock at a price of $6.25 per share ($17.5 million in the
aggregate) to a small group of institutional investors in a private
placement transaction.
On May 1, 2002, we filed with the Commission a Current Report on Form 8-K
to announce that we had settled the patent lawsuit with Medtronic Sofamor
Danek Inc., Sofamor Danek L.P. and Sofamor Danek Holdings, Inc, and have
separately agreed to sell our PolyActive(TM) patents to IsoTis BV for $1.0
million.
On April 9, 2002, we filed with the Commission a Current Report on Form
8-K to announce that on April 4, 2002, the court issued an order
construing disputed patent claims in the Medtronic Sofamor Danek Inc.,
Sofamor Danek L.P. and Sofamor Danek Holdings, Inc., or collectively,
Medtronic, v. Osteotech, Inc. lawsuit. We also announced that the
American National Red Cross, or ARC, recently notified us that a plaintiff
had brought an action against it for negligence relating to ARC's
distribution of certain Grafton(R)DBM putty that was allegedly implanted
in the plaintiff during a surgical procedure.
On April 2, 2002, we filed with the Commission a Current Report on Form
8-K to announce that our French subsidiary, OST Developpement SA, or OST,
has entered into a seven year exclusive contractual collaboration with the
federal agency of the Republic of Bulgaria responsible for transplant
recovery and management. Under this agreement, the Bulgarian Federal
Agency for Transplant Management, which is responsible for developing and
overseeing all activities related to the recovery, processing and
allocation of human organs, tissues, cells and biomaterials for
transplantation, will work exclusively with OST in this field. OST is
responsible for the recovery and processing of these tissues, cells and
biomaterials as well as the allocation and distribution of these
anatomical gifts throughout Europe and the rest of the world.
- 28 -
SIGNATURES
Pursuant to the requirements 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.
Osteotech, Inc.
----------------------------------------
(Registrant)
Date: August 8, 2002 By: /S/Richard W. Bauer
----------------------------------------
Richard W. Bauer
President, Chief Executive Officer
Date: August 8, 2002 By: /S/Michael J. Jeffries
----------------------------------------
Michael J. Jeffries
Executive Vice President,
Chief Financial Officer