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 March 31, 2004
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
The number of shares of the registrant's common stock, $.01 par value,
outstanding as of May 5, 2004 was 17,144,796.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
March 31, December 31,
2004 2003
- ----------------------------------------------------------------------------------------------------
ASSETS
- ----------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 13,957 $ 15,326
Accounts receivable, net of allowance of
$1,621 in 2004 and $1,487 in 2003 17,507 15,187
Deferred processing costs 30,694 29,013
Inventories 1,383 3,581
Prepaid expenses and other current assets 7,619 7,345
--------------------------
Total current assets 71,160 70,452
Property, plant and equipment, net 45,415 47,107
Goodwill, net of accumulated amortization of $404 in 2004 and 2003 1,669 1,669
Other assets 7,633 7,985
- ----------------------------------------------------------------------------------------------------
Total assets $125,877 $127,213
====================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ----------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 11,875 $ 11,407
Current maturities of long-term debt 2,661 2,661
--------------------------
Total current liabilities 14,536 14,068
Long-term debt 12,597 13,262
Other liabilities 3,662 3,663
- ----------------------------------------------------------------------------------------------------
Total liabilities 30,795 30,993
- ----------------------------------------------------------------------------------------------------
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 17,136,296
shares in 2004 and 17,117,720 shares in 2003 171 171
Additional paid-in capital 64,279 64,170
Accumulated other comprehensive income 613 605
Retained earnings 30,019 31,274
- ----------------------------------------------------------------------------------------------------
Total stockholders' equity 95,082 96,220
- ----------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $125,877 $127,213
====================================================================================================
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 Ended March 31, 2004 2003
- ---------------------------------------------------------------------------------------------
Net revenues:
Service $ 22,193 $ 21,322
Product 1,584 1,157
----------------------------------
23,777 22,479
Cost of services 10,897 8,725
Cost of products 3,242 1,061
----------------------------------
14,139 9,786
----------------------------------
Gross profit 9,638 12,693
Marketing, selling, general and administrative 10,506 9,332
Research and development 856 990
----------------------------------
11,362 10,322
----------------------------------
Operating income (loss) (1,724) 2,371
Interest expense and other, net (237) (295)
----------------------------------
Income (loss) before income tax provision (benefit) (1,961) 2,076
Income tax provision (benefit) (706) 895
----------------------------------
Net income (loss) $ (1,255) $ 1,181
=============================================================================================
Earnings (loss) per share:
Basic $ (.07) $ .07
Diluted $ (.07) $ .07
Shares used in computing earnings per share:
Basic 17,120,390 17,002,455
Diluted 17,120,390 17,279,283
=============================================================================================
See accompanying notes to condensed consolidated financial statements.
-3-
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
Three Months Ended March 31, 2004 2003
- ----------------------------------------------------------------------------------------------------
Cash Flow From Operating Activities
Net income (loss) $ (1,255) $ 1,181
Adjustments to reconcile income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 2,043 2,150
Provision for metal spinal implant systems 1,998
Changes in current assets and liabilities:
Accounts receivable (2,550) (2,660)
Deferred processing costs (1,899) (2,477)
Inventories 486 291
Prepaid expenses and other current assets 52 1,012
Accounts payable and other liabilities 489 2,532
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (636) 2,029
Cash Flow From Investing Activities
Capital expenditures (381) (475)
Proceeds from sale of investments 1,982
Other, net 168 (275)
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (213) 1,232
Cash Flow From Financing Activities
Proceeds from issuance of common stock 109 114
Principal payments on long-term debt (665) (665)
- ----------------------------------------------------------------------------------------------------
Net cash used in financing activities (556) (551)
Effect of exchange rate changes on cash 36 70
- ----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (1,369) 2,780
Cash and cash equivalents at beginning of period 15,326 10,040
- ----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 13,957 $ 12,820
====================================================================================================
Supplementary cash flow data:
Cash paid during the period for interest $ 133 $ 260
Cash paid (refunded) during the period for taxes 1,398 (1,658)
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)
considered necessary by management to present fairly the consolidated
financial position as of March 31, 2004 and the consolidated results of
operations and the consolidated cash flows for the three months ended
March 31, 2004 and 2003. The results of operations and cash flows for the
respective interim periods are not necessarily indicative of the results
to be expected for the full year. The December 31, 2003 financial
information has been derived from the audited financial statements for the
year ended December 31, 2003. The condensed consolidated financial
statement should be read in conjunction with the audited consolidated
financial statements which were included as part of Osteotech, Inc.'s (the
"Company") Annual Report on Form 10-K for the year ended December 31,
2003.
2. Goodwill and Other Intangible Assets
In January, 2002, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets", and
accordingly, no longer amortizes goodwill. In accordance with the
provisions of SFAS No. 142, the Company completed an evaluation of the
carrying value of its goodwill as of January 1, 2004 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 principally represent patents,
patent applications and licenses, are recorded at an original cost of
$3,865,000 and $3,800,000 as of March 31, 2004 and December 31, 2003,
respectively. The carrying values of such intangibles are $2,375,000 and
$2,378,000 as of the same respective dates. Patents and licenses are
amortized over their estimated useful lives ranging from five to ten
years. Patent application costs are amortized upon grant of the patent or
expensed if the application is rejected or withdrawn.
3. Stock Options
The Company has adopted the "disclosure only" provisions of SFAS No. 123,
"Accounting for Stock Based Compensation", and accordingly, no
compensation cost has been recognized in the consolidated statements of
operations. Pro forma information regarding net income and earnings per
share is required by SFAS No. 123, and has been determined as if the
Company accounted for its stock options under the Fair Value Method of
that Statement. For purposes of the pro forma disclosures, the estimated
fair value of the options is amortized on a straight-line basis to expense
over the options' vesting period.
The following table shows the estimated effect on earnings and per share
data as if the Company had applied the fair value recognition provisions
of SFAS No. 123 to stock-based employee compensation.
-5-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
3. Stock Options (continued)
Three Months Ended
March 31,
--------------------------
(in thousands except per share data) 2004 2003
-----------------------------------------------------------------------------------
Net income (loss) - reported $ (1,255) $ 1,181
Impact on net income (loss) related to stock-based
employee compensation expense, net of tax $ 227 $ 192
Net income (loss) - pro forma $ (1,482) $ 989
===================================================================================
Earnings (loss) per share As reported:
Basic $ (.07) $ .07
Diluted $ (.07) $ .07
Pro forma:
Basic $ (.09) $ .06
Diluted $ (.09) $ .06
===================================================================================
4. First Quarter 2004 Charges
Severance - Sales and Marketing Reorganization
In first quarter 2004, the Company reorganized its sales and marketing
departments. As a result, the Company recorded a charge in marketing, selling,
general and administrative expenses of $650,000, principally for the severance
costs associated with the departure of the executive officer responsible for
these areas and two other employees.
Provision for Metal Spinal Implant Systems
As a result of an assessment of its metal spinal implant business in the first
quarter of 2004, the Company expects to cease marketing and distributing all
metal spinal implant product lines by the end of the second quarter of 2004. The
Company has recorded a charge to cost of sales in the first quarter of 2004 of
$1,998,000 to reduce metal spinal implant inventory and instrumentation to
estimated net realizable value.
-6-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Deferred Processing Costs
Deferred processing costs consist of the following:
(in thousands) March 31, 2004 December 31, 2003
------------------------------------------------------------------------------------------------------
Donor tissue to be processed $ 8,015 $ 6,758
Tissue in process 7,094 8,350
Processed implantable donor tissue to be distributed
By the Company 12,673 11,962
Processed implantable donor tissue held for clients 2,912 1,943
------------------------------------------------------------------------------------------------------
$30,694 $29,013
======================================================================================================
6 Inventories
Inventories consist of the following:
(in thousands) March 31, 2004 December 31, 2003
------------------------------------------------------------------------------------------------------
Supplies $ 232 $ 287
Raw materials 726 765
Finished goods 425 2,529
------------------------------------------------------------------------------------------------------
$ 1,383 $ 3,581
======================================================================================================
In first quarter 2004, the Company recorded a charge to reduce its metal
spinal implant inventory, which is included in finished goods, to
estimated net realizable value. See Note 4, "First Quarter 2004 Charges -
Provision for Metal Spinal Implant Systems".
7. Debt and Financing Arrangements
In June, 2002, the Company obtained an automatically declining irrevocable
standby letter of credit to support the $1,900,000 ($79,000 as of March
31, 2004) due to Medtronic Sofamor Danek, Inc. pursuant to the settlement
of certain patent litigation. The commitment under the standby letter of
credit decreases over time based on a predetermined schedule concurrent
with the Company's monthly payments under the settlement. As of March 31,
2004, the standby letter of credit has been reduced to $173,000. The
amount committed under the standby letter of credit reduces the Company's
availability under its $5,000,000 revolving line of credit. As of March
31, 2004, no amounts were outstanding under the revolving line of credit
and $4,827,000 was available.
On April 30, 2004, the Company amended its Credit Facility with its lender
to, among other items, extend the maturity date of its revolving line of
credit to April 30, 2006 from April 30, 2004. In addition, the amendment
revises the restriction on incurring or maintaining additional
indebtedness to allow the Company to incur up to $1.0 million of capital
leases and up to $2.5 million in lines of credit for its foreign
subsidiaries.
-7-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
7. Debt and Financing Arrangements (continued)
Prior to April 30, 2004, if the Company's cash, cash equivalents and
short-term investments decline below $10.0 million at the end of any
calendar month, the lender, at its option, has the right to obtain a
security interest in the Company's general intangibles, including, but not
limited to, the Company's patents and patent applications. Effective April
30, 2004 in conjunction with the amendment to the Credit Facility, the
$10.0 million limitation noted above was reduced to $5.0 million. In
addition, unless there exists or has existed an event of default prior to
December 31, 2004, the provisions of this covenant will terminate on that
date.
Through April 30, 2004, each tranche of the Company's Credit Facility, the
revolving line of credit, the mortgage loan and the term loan, bore
interest on the outstanding amounts at a variable rate ranging from prime
minus .25% to prime plus 1.5%, or from the London Interbank Offered Rate
("LIBOR") plus 2.25% to LIBOR plus 4.0%, based upon a leverage ratio as
defined in the Credit Facility. From May 1, 2004 through the date the
Company delivers to the lender its Quarterly Report on Form 10-Q for the
quarter ending June 30, 2004, each tranche bears interest at prime minus
.25% or LIBOR plus 2.25%. Upon delivery to the lender of the Company's
Quarterly Report on Form 10-Q for the quarter ending June 30, 2004, each
tranche will bear interest at a variable rate ranging from prime minus
1.1% to prime plus 1.25% or LIBOR plus 1.40% to LIBOR plus 3.75%, based
upon a leverage ratio as defined in the Credit Facility.
8. Commitments and Contingencies
Purchase Commitments
In February, 2001, the Company entered into an exclusive distribution
agreement with Alphatec Manufacturing, Inc. ("Alphatec") to market and
distribute two metal spinal implant products in the United States and
Canada. In September, 2003, the Company provided written notice to
Alphatec terminating the distribution agreement upon the completion of the
then current term, which expired on March 31, 2004.
The agreement included provisions for minimum purchases over the
contractual period, subject to penalty payments if the minimum purchases
were not achieved. The Company settled the provisions of the first year
purchase commitment with Alphatec in the fourth quarter of 2002, including
placing a deposit with Alphatec for future purchases in the amount of
$300,000, and recorded all appropriate charges at that time. Also, in the
fourth quarter of 2002, the Company recorded an estimated reserve of
$1,079,000 for the penalty that may be due for not achieving the minimum
purchase commitment in year two of the agreement. The Company has
re-assessed such reserve during first quarter 2004, and based upon the
Alphatec litigation and other factors have determined that the provision
is adequate.
In July, 2003, Alphatec filed an action against the Company for recovery
of contractual penalty, breach of contract, fraud and trade libel arising
out of the distribution agreement between the parties. In August, 2003,
the Company answered Alphatec's complaint and asserted counterclaims
setting forth causes of action for breach of contract, breach of implied
covenant of good faith and fair dealing, fraudulent misrepresentation,
fraudulent concealment, unjust enrichment, unfair competition,
cancellation or rescission of the contract and indemnification. Discovery
in this action is continuing.
-8-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
As a result of the Alphatec litigation and the Company's decision to exit
the metal spinal implant business by the end of the second quarter of
2004, all inventory and instrumentation owned by the Company related to
the two metal spinal implant product lines manufactured by Alphatec have
been reduced to estimated net realizable value.
Litigation
The following is a description of material developments that occurred
during the three months ended March 31, 2004 and since the filing of the
Company's Annual Report on Form 10-K for the year ended December 31, 2003.
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.
"O" Company, Inc. v. Osteotech, Inc.
In July, 1998, a complaint was filed against the Company in the Second
Judicial District Court, Bernallilo County, New Mexico, which alleges
negligence, strict liability, breach of warranties, negligent
misrepresentation, fraud, and violation of the New Mexico Unfair Trade
Practices Act arising from allegedly defective dental implant coating and
coating services provided to plaintiffs by the Company's subsidiary,
Osteotech Implants BV, formerly known as CAM Implants BV. On October 8,
2003, a settlement conference was conducted and the parties reached a
tentative settlement agreement, which does not obligate the Company to pay
monetary damages to the plaintiffs, but assigns certain of the Company's
rights under its insurance policies to the plaintiffs. The parties are now
in the process of negotiating and preparing mutually acceptable definitive
agreements. On October 10, 2003, the Court issued an order staying all
proceedings in the action and vacating case management deadlines. On
December 18, 2003, the Court extended the stay of all proceedings until
March 27, 2004.
Although an extension of the March 27, 2004 deadline has not been
requested, currently the parties continue to negotiate mutually acceptable
definitive agreements. In the event the parties are unable to consummate a
settlement, or the Court decides not to grant any further extension, the
Court will lift the stay of the proceedings and the parties will return to
active litigation. If the stay is lifted, further discovery on matters
relating to the merits of plaintiffs' claims and the scope of plaintiffs'
alleged damages would go forward.
Anthonsen v. Allosource, Inc.
In January, 2004, the Company was served with a complaint in an action
brought in the Lake Superior Court of Lake County, State of Indiana
against numerous defendants, including the Company. The complaint alleges
that plaintiff received defective implants and medical hardware in
connection with cervical surgery performed on plaintiff, and that such
implants and hardware were manufactured, processed or distributed by
defendants. Plaintiff alleges personal injuries and unspecified damages.
On or about February 11, 2004, the action was removed to the United States
District Court, Northern District of Indiana, Hammond Division.
-9-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
At a conference on April 7, 2004, plaintiff agreed to voluntarily dismiss
the above-referenced action in its entirety with prejudice. On April 20,
2004, an order dismissing this action with prejudice was approved by the
Court.
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. Comprehensive Income
Comprehensive income for the three months ended March 31, 2004 and 2003
was:
Three Months Ended March 31,
---------------------------------
(dollars in thousands) 2004 2003
-------------------------------------------------------------------------------------------------
Net income (loss) $ (1,255) $ 1,181
Currency translation adjustments 8 25
-------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ (1,247) $ 1,206
=================================================================================================
10. Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three months ended March 31, 2004 and 2003:
Three Months Ended March 31,
--------------------------------
(dollars in thousands, except per share data) 2004 2003
-------------------------------------------------------------------------------------------------
Net income (loss) available to common stockholders $ (1,255) $ 1,181
--------------------------------------------------------------------------------------------------
Denominator for basic earnings per share,
weighted average common shares outstanding 17,120,390 17,002,455
Effect of dilutive securities, stock options 276,828
--------------------------------
Denominator for diluted earnings per share 17,120,390 17,279,283
-------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic $ (.07) $ .07
Diluted $ (.07) $ .07
-------------------------------------------------------------------------------------------------
-10-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
10. Earnings (Loss) Per Share (continued)
Weighted average shares issuable upon the exercise of stock options which
were not included in the calculation of diluted earnings per share were
1,685,158 and 1,325,325 for the three months ended March 31, 2004 and
2003, respectively. Such shares were not included because they were
antidilutive.
11. Operating Segments
Summarized in the table below is financial information for the Company's
reportable segments for the three months ended March 31, 2004 and 2003:
Three Months Ended
March 31,
----------------------------
(dollars in thousands) 2004 2003
--------------------------------------------------------------------
Revenues:
DBM Segment $ 11,433 $ 11,369
Base Tissue Segment 10,760 9,953
Other 1,584 1,157
--------------------------------------------------------------------
Consolidated $ 23,777 $ 22,479
=====================================================================
Operating income (loss):
DBM Segment $ 1,120 $ 3,265
Base Tissue Segment (342) 179
Other (2,502) (1,073)
---------------------------------------------------------------------
Consolidated $ (1,724) $ 2,371
=====================================================================
Two of our clients, Musculoskeletal Transplant Foundation and American Red
Cross Tissue Services, in the DBM and Base Tissue Segments together
accounted for 43% and 56% of consolidated net revenues during the three
months ended March 31, 2004 and 2003, respectively.
12. Reclassifications
Certain prior year amounts within the consolidated financial statements
have been reclassified to conform to the 2004 presentation.
-11-
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, 2003
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 MONTHS ENDED MARCH 31, 2004 AND 2003
Results of Operations
Critical Accounting Policies and Estimates
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 including purchase commitments, deferred processing costs including
rework reserves, property, plant and equipment, intangible assets, current and
deferred income taxes, 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, 2003.
Cessation of Marketing and Distribution Efforts for Metal Spinal Implant
Products
In January, 2004, we provided written notice that we would terminate the
Distribution Agreement dated February 1, 2003 with SpineVision, S.A. and
SpineVision, Inc. in accordance with the provisions of the agreement effective
February 17, 2004. In addition, after an assessment of our metal spinal implant
business, we decided in March, 2004 that we would discontinue our marketing and
distribution efforts for all remaining metal spinal implant product lines.
Revenues generated from metal spinal implants were $1,092,000 and $650,000 for
the three months ended March 31, 2004 and 2003, respectively. We currently
expect to completely cease the marketing and distribution of metal spinal
implant by the end of the second quarter of 2004. In addition, we recorded a
charge of $1,998,000 in first quarter 2004 to reduce metal spinal implant
inventory and instrumentation to estimated net realizable value.
Net Income (Loss)
We incurred a consolidated net loss in the first quarter of 2004 of $1,255,000
or $.07 diluted net loss per share compared to consolidated net income of
$1,181,000 or $.07 diluted net income per share in the first quarter of 2003.
The net loss in the first quarter of 2004 primarily relates to the
aforementioned charge to reduce metal spinal implant inventory and
instrumentation to estimated net realizable value and severance charges for the
reorganization of our sales and marketing departments. Such charges aggregated
$2,648,000 on a pre-tax basis and were $1,589,000, or $.09 diluted net loss per
share, on an after-tax basis.
-12-
The following is a discussion of factors affecting results of operations for the
three months ended March 31, 2004 and 2003.
Net Revenues
Consolidated net revenues increased 6% to $23,777,000 in the first quarter of
2004 compared to consolidated revenues of $22,479,000 in the corresponding
period in 2003. Domestic net revenues of $20,919,000 in the first quarter of
2004 increased slightly from first quarter 2003 domestic net revenues of
$20,691,000. The increase in domestic revenues was due primarily to increased
unit sales volume in most product categories and the impact of our 2004 price
increases, mostly offset by a decline in unit sales volume of Grafton(R) DBM.
Foreign-based revenues increased 60% to $2,858,000 in the first quarter of 2004
from $1,788,000 in the same period in 2003. The increase in foreign-based
revenues was primarily a result of increased unit sales volume of Grafton(R) DBM
and the direct distribution of traditional tissue.
Demineralized Bone Matrix ("DBM") Segment, or the DBM Segment, revenues
increased to $11,433,000 in the first quarter of 2004 from $11,369,000 in the
first quarter of 2003. Domestic DBM Segment revenues declined 6% to $9,709,000
in first quarter 2004 from revenues of $10,363,000 in first quarter 2003,
primarily as a result of an 11% decline in domestic Grafton(R) DBM revenues due
to continuing strong competition, partially offset by a 273% increase in
revenues from the processing of private label DBM and the effects of the 2004
price increase. Foreign-based DBM Segment revenues increased 71% to $1,724,000
in the first quarter of 2004 from revenues of $1,006,000 in the same period in
the prior year, primarily as a result of increased unit sales volume and the
effects of the 2004 price increases.
Base Allograft Tissue Segment, or Base Tissue Segment, revenues increased 8% to
$10,760,000 in the first quarter of 2004 from $9,953,000 in the corresponding
period in 2003. The increase is principally the result of a 16% increase in base
tissue processing fees and revenue from the direct distribution of traditional
tissue, a 2% increase in bio-implant revenues and the impact of our 2004 price
increases.
Revenue from other product lines, consisting mainly of metal spinal implant
products and bovine tissue, increased 37% in the first quarter of 2004 to
$1,584,000 from $1,157,000 in the first quarter of 2003. Metal spinal implant
system revenues increased 68% in the first quarter of 2004 to $1,092,000 from
$650,000 in the comparable period in 2003, principally related to the
acceleration of metal spinal implant sales due to efforts to sell off remaining
metal spinal implant inventory as a result of our anticipated exit from that
business by the end of the second quarter of 2004.
Two of our clients in the DBM and Base Tissue Segments, the Musculoskeletal
Transplant Foundation, or MTF, and the American Red Cross, or ARC, accounted for
23% and 20%, respectively, of consolidated net revenues during the three months
ended March 31, 2004. In the three months ended March 31, 2003, MTF and ARC each
accounted for 28% of consolidated net revenues. We have processing agreements
with each of these clients. The MTF agreement expires in December, 2008 and the
ARC agreement expires in December, 2006.
In April, 2004, we entered into a five-year agreement with the Orthopaedic
Division of Smith & Nephew, Inc. for us to process and Smith & Nephew to
distribute a private label DBM to the domestic orthopaedic markets other than
spine. We anticipate that this private label DBM will be introduced into the
market in the third quarter of 2004 in gel, putty, paste, flex and demineralized
cancellous crunch forms. The agreement automatically renews for successive
five-year periods unless either party gives twelve months prior notice of
non-renewal.
-13-
We market Grafton(R) DBM as a human tissue-based product pursuant to an August,
1995 designation from the Food and Drug Administration, or FDA. In March, 2002,
the FDA informed us that they were changing the regulatory status of Grafton(R)
DBM and will henceforth regulate it as a medical device. We communicated to the
FDA that we believe its initial designation of Grafton(R) DBM as a human
tissue-based product was and still is correct. In this regard, we have and
continue to have dialogue with the FDA on this matter to present our point of
view. We have not submitted a 510(k) and we continue to disagree with the FDA's
opinion. If we are unsuccessful in our effort, we will be required to obtain a
medical device approval or clearance for Grafton(R) DBM, and to comply with
medical device postmarketing obligations. We believe that Grafton(R) DBM will be
eligible for 510(k) clearance, but we cannot be sure that we will not be
required to obtain premarket approval, or that the FDA will issue any clearance
or approval in a timely fashion, or at all.
We also market Grafton Plus(TM) DBM as a human tissue-based product. The FDA has
indicated in an October 30, 2003 letter that its determination regarding
Grafton(R) DBM is also to be applied to Grafton Plus(TM) DBM. We have requested
a pre-meeting with the FDA to discuss the requirements and criteria for filing a
510(k) for Grafton Plus(TM) DBM. If the FDA maintains its position that all
products consisting of demineralized bone with a carrier should be regulated as
a medical device, we would also be required to obtain FDA clearance or approval
for any other DBM carrier product we may process and to comply with other
medical device requirements for these products.
Gross Profit
Consolidated gross profit as a percentage of consolidated net revenues was 41%
in the first quarter of 2004 compared to 56% in the first quarter of 2003.
Consolidated gross profit as a percentage of consolidated net revenues in first
quarter 2004 was negatively impacted by the charge of $1,998,000 to reduce metal
spinal implant inventory and instrumentation to estimated net realizable value.
Additionally, gross profit as a percentage of consolidated net revenues in the
first quarter of 2004 was negatively impacted by the continuing shift in revenue
mix to lower margin product categories, including international Grafton(R) DBM,
direct distribution of traditional tissue and private label DBM revenues, all of
which are experiencing growth rates in excess of the overall revenue growth rate
of 6%, and due to the decline in domestic Grafton(R) DBM revenues, which
represent our highest gross profit margin product category.
Marketing, Selling, General and Administrative Expenses
Consolidated marketing, selling, general and administrative expenses increased
13% in the first quarter of 2004 to $10,506,000 from $9,332,000 in the
corresponding period in 2003. The increase is primarily due to increased selling
costs due to the hiring of additional direct sales personnel in the second and
third quarter of 2003, increased commission costs on domestic Grafton(R) DBM for
our agency sales force and the severance charge of $650,000 related to our
reorganization of the sales and marketing departments.
Research and Development Expenses
Consolidated research and development expenses declined in the first quarter of
2004 to $856,000 from $990,000 in the first quarter of 2003. The decline
principally results from the delayed start-up of several research and
development programs due to the availability of certain raw materials and
ongoing supply contract negotiations. We expect that research and development
expenditures will increase in future quarters.
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Operating Income
We incurred a consolidated operating loss of $1,724,000 in the first quarter of
2004 compared to consolidated operating income of $2,371,000 in the first
quarter of 2003. The operating loss in the first quarter of 2004 primarily
relates to the aforementioned charges to reduce metal spinal implant inventory
and instrumentation to estimated net realizable value and severance related to
the reorganization of our sales and marketing departments; increased sales and
commission costs; and lower gross profit margins resulting from the shift in
revenue towards lower margin product categories.
DBM Segment operating income decreased to $1,120,000 for the three months ended
March 31, 2004 from $3,265,000 in the same period in 2003. The decrease resulted
principally from a decline in gross profit margins resulting from the shift in
revenue towards lower margin products (international Grafton(R) DBM and private
label DBM revenues); increased sales and marketing costs primarily associated
with increased investment in our tissue businesses, including the shift of sales
and marketing resources from marketing metal spinal implant products to focus on
our tissue businesses; increased commission costs related to an increase in the
commission rate for our agency sales force; and a portion of the severance costs
related to the reorganization of the sales and marketing departments.
The Base Tissue Segment incurred an operating loss of $342,000 in the first
quarter of 2004 compared to operating income of $179,000 in the corresponding
period in 2003. The decline resulted primarily from lower gross profit margins
due to increased processing costs and the direct distribution of traditional
tissue, which has a lower gross profit margin; increased marketing, selling and
promotional activities related to our increased focus on our tissue businesses;
and a portion of the severance costs related to the reorganization of the sales
and marketing departments.
Operating losses associated with other revenues were $2,502,000 and $1,073,000
in the first quarter of 2004 and 2003, respectively. The operating loss, which
is generated substantially from our metal spinal implant product line, results
primarily from the charge of $1,998,000 to reduce metal spinal implant inventory
and instrumentation to estimated net realizable value and the underabsorption of
costs for which there is not sufficient revenue volume to offset the
infrastructure established to support the product line.
Income Tax Provision (Benefit)
We recognized an income tax benefit for the three months ended March 31, 2004
primarily due to losses incurred in our domestic operations and our ability to
utilize previously unrecognized net operating loss carryforwards, which carry a
full valuation allowance, to offset foreign income. The effective income tax
rate for the three months ended March 31, 2003 was 43%, which exceeded the
United States statutory rate principally due to state income taxes and
non-recognition of tax benefits related to foreign losses.
Liquidity and Capital Resources
At March 31, 2004 we had cash and cash equivalents of $13,957,000 compared to
$15,326,000 at December 31, 2003. The decline in cash and cash equivalents
primarily relates to Federal income tax payments on income earned in 2003 and
continued investments in our tissue inventories. Working capital increased to
$56,624,000 at March 31, 2004 compared to $56,384,000 at December 31, 2003,
principally due to continued investments in our business, mostly offset by the
decline in cash.
Net cash used in operating activities was $636,000 for the three months ended
March 31, 2004 compared to net cash provided by operating activities of
$2,029,000 for the three months ended March 31, 2003. The
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decline in net cash flow from operating activities is primarily due to our
continued investments in our business, including the continued expansion of
tissue available for processing.
Cash used in investing activities was $213,000 for the three months ended March
31, 2004 compared to cash provided by investing activities of $1,232,000 for the
three months ended March 31, 2003. Cash used in investing activities in 2004
primarily represented spending for capital expenditures. Cash provided by
investing activities in 2003 included proceeds from the sale of investments of
$1,982,000, partially offset by capital expenditures.
Net cash used in financing activities was $556,000 and $551,000 for the three
months ended March 31, 2004 and 2003, respectively. Cash used in financing
activities in both periods primarily relates to principal payments on long-term
debt, partially offset by the exercise of stock options and the sales of stock
pursuant to our employee stock purchase plan.
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 March
31, 2004, there were no borrowings under the revolving line of credit,
$3,924,000 was outstanding under the building mortgage loan and $11,334,000 was
outstanding under the equipment term loan. In support of the amounts due under
the settlement of certain patent litigation, we provided an automatically
declining irrevocable standby letter of credit in an original amount of
$1,900,000. As of March 31, 2004, the standby letter of credit has been reduced
to $173,000. Amounts committed under this standby letter of credit decrease over
time based on a predetermined schedule concurrent with our monthly payments
under the settlement and reduce the amounts available under the revolving line
of credit. As of March 31, 2004, no amounts were outstanding under the revolving
line of credit and $4,827,000 was available.
On April 30, 2004, we amended our Credit Facility to, among other items, extend
the maturity date of our revolving line of credit to April 30, 2006 from April
30, 2004. In addition, the amendment revises the restriction on incurring or
maintaining additional indebtedness to allow us to incur up to $1.0 million of
capital leases and up to $2.5 million in lines of credit for our foreign
subsidiaries.
Prior to April 30, 2004, if our cash, cash equivalents and short-term
investments decline below $10.0 million at the end of any calendar month, the
lender, at its option, has the right to obtain a security interest in our
general intangibles, including, but not limited to, our patents and patent
applications. Effective April 30, 2004 in conjunction with the amendment to the
Credit Facility, the $10.0 million limitation noted above was reduced to $5.0
million. In addition, unless there exists or has existed an event of default
prior to December 31, 2004, the provisions of this covenant will terminate on
that date.
Through April 30, 2004, each tranche of our Credit Facility bore interest on the
outstanding amounts at a variable rate ranging from prime minus .25% to prime
plus 1.5%, or from the London Interbank Offered Rate ("LIBOR") plus 2.25% to
LIBOR plus 4.0%, based upon a leverage ratio as defined in the Credit Facility.
From May 1, 2004 through the date the we deliver to the lender our Quarterly
Report on Form 10-Q for the quarter ending June 30, 2004, each tranche bears
interest at prime minus .25% or LIBOR plus 2.25%. Upon delivery to the lender of
our Quarterly Report on Form 10-Q for the quarter ending June 30, 2004, each
tranche will bear interest at a variable rate ranging from prime minus 1.1% to
prime plus 1.25% or LIBOR plus 1.40% to LIBOR plus 3.75%, based upon a leverage
ratio as defined in the Credit Facility.
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As of March 31, 2004, there were no material changes in our contractual
obligations or long-term debt from that disclosed in 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, 2003.
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. 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. For a discussion of
these matters see, Note 8 of "Notes to Condensed Consolidated Financial
Statements" included elsewhere herein and PART II. ITEM 1. LEGAL PROCEEDINGS,
and our Annual Report on Form 10-K for the year ended December 31, 2003. It is
possible that our results of operations or liquidity and capital resources could
be adversely affected by the ultimate outcome of 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, 2003. There have been no
significant changes in our market risk exposures from the fiscal 2003 year-end.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13(a)-15(e) under the Exchange Act) as of March
31, 2004 (the "Evaluation Date"). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that, as of the
Evaluation Date, our disclosure controls and procedures were effective in timely
alerting them to the material information relating to us required to be included
in our periodic SEC filings.
Changes in internal controls
There were no changes made in our internal controls during the period covered by
this report or, to our knowledge, in other factors that could affect these
controls subsequent to the date of their last evaluation, except for the
procedures instituted in the first quarter of 2004 related to the timely review
and monitoring of certain account analyses, including the account impacted by
the flaw in our computer software detected during year-end 2003 closing
procedures.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following is a description of material developments that occurred during the
quarter ended March 31, 2004 in lawsuits reported in the Company's Annual Report
on Form 10-K for the year ended December 31, 2003. 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.
"O" Company, Inc. v. Osteotech, Inc.
In July, 1998, a complaint was filed against us in the Second Judicial District
Court, Bernallilo County, New Mexico, which alleges negligence, strict
liability, breach of warranties, negligent misrepresentation, fraud, and
violation of the New Mexico Unfair Trade Practices Act arising from allegedly
defective dental implant coating and coating services provided to plaintiffs by
our subsidiary, Osteotech Implants BV, formerly known as CAM Implants BV. On
October 8, 2003, a settlement conference was conducted and the parties reached a
tentative settlement agreement, which does not obligate us to pay monetary
damages to the plaintiffs, but assigns certain of our rights under our insurance
policies to the plaintiffs. The parties are now in the process of negotiating
and preparing mutually acceptable definitive agreements. On October 10, 2003,
the Court issued an order staying all proceedings in the action and vacating
case management deadlines. On December 18, 2003, the Court extended the stay of
all proceedings until March 27, 2004.
Although an extension of the March 27, 2004 deadline has not been requested,
currently the parties continue to negotiate mutually acceptable definitive
agreements. In the event the parties are unable to consummate a settlement, or
the Court decides not to grant any further extension, the Court will lift the
stay of the proceedings and the parties will return to active litigation. If the
stay is lifted, further discovery on matters relating to the merits of
plaintiffs' claims and the scope of plaintiffs' alleged damages would go
forward.
Anthonsen v. Allosource, Inc.
In January, 2004, we were served with a complaint in an action brought in the
Lake Superior Court of Lake County, State of Indiana against numerous
defendants, including us. The complaint alleges that plaintiff received
defective implants and medical hardware in connection with cervical surgery
performed on plaintiff, and that such implants and hardware were manufactured,
processed or distributed by defendants. Plaintiff alleges personal injuries and
unspecified damages. On or about February 11, 2004, the action was removed to
the United States District Court, Northern District of Indiana, Hammond
Division.
At a conference on April 7, 2004, plaintiff agreed to voluntarily dismiss the
above-referenced action in its entirety with prejudice. On April 20, 2004, an
order dismissing this action with prejudice was approved by the Court.
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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
------ ----------- ------
3.1 Restated Certificate of Incorporation of Osteotech, as amended ^
3.2 Third Amended and Restated Bylaws of Osteotech ^
3.4 Certificate of Retirement and Prohibition of Reissuance of Shares of
Osteotech, Inc., dated April 4, 2002 ^^
4.1 Rights Agreement dated as of February 1, 1996 between Osteotech,
Inc. and Registrar and Transfer Co., as amended ^
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 *
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 *
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 *
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 *
* Filed herewith.
^ Previously filed as an exhibit to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 and incorporated herein by
reference thereto.
^^ Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2002 and incorporated herein by
reference thereto.
(b) Reports on Form 8-K
On January 6, 2004, we filed with the Commission a Current Report on Form
8-K to announce that the March 15, 2004 issue of "Spine", a prestigious
medical journal, will publish a study sponsored by us describing the first
prospective randomized clinical trial ever conducted with a demineralized
bone matrix in a carrier, Grafton(R) DBM Gel.
On January 16, 2004, we filed with the Commission a Current Report on Form
8-K to announce we have provided notice to SpineVision in accordance with
the terms of the Distribution Agreement dated February 1, 2003 that
effective February 17, 2004 we would no longer distribute SpineVision
products.
On February 9, 2004, we filed with the Commission a Current Report on Form
8-K to announce we had reorganized our sales and marketing functions.
On March 2, 2004, we filed with the Commission a Current Report on Form
8-K to announce our financial results for the fourth quarter and year
ended December 31, 2003.
On March 29, 2004, we filed with the Commission a Current Report on Form
8-K to announce our Board of Directors elected Stephen S. Galliker to the
Board at its meeting on March 25, 2004.
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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.
Date: May 7, 2004 Osteotech, Inc.
----------------------------------------
(Registrant)
Date: May 7, 2004 By: /S/Richard W. Bauer
----------------------------------------
Richard W. Bauer
President, Chief Executive Officer
(Principal Executive Officer)
Date: May 7, 2004 By: /S/Michael J. Jeffries
----------------------------------------
Michael J. Jeffries
Executive Vice President,
Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
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