Back to GetFilings.com
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, 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 July 30, 2004 was 17,154,119.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
June 30, December 31,
2004 2003
- ----------------------------------------------------------------------------------------------------
ASSETS
- --------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 15,715 $ 15,326
Accounts receivable, net of allowance of
$1,733 in 2004 and $1,487 in 2003 15,500 15,187
Deferred processing costs 31,778 29,013
Inventories 1,188 3,581
Prepaid expenses and other current assets 8,979 7,345
------------------------
Total current assets 73,160 70,452
Property, plant and equipment, net 43,925 47,107
Goodwill, net of accumulated amortization of $404 in 2004 and 2003 1,669 1,669
Other assets 7,246 7,985
- --------------------------------------------------------------------------------------------------
Total assets $126,000 $127,213
==================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 13,093 $ 11,407
Current maturities of long-term debt 2,661 2,661
------------------------
Total current liabilities 15,754 14,068
Long-term debt 11,932 13,262
Other liabilities 3,661 3,663
- --------------------------------------------------------------------------------------------------
Total liabilities 31,347 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 17,154,119
shares in 2004 and 17,117,720 shares in 2003 171 171
Additional paid-in capital 64,373 64,170
Accumulated other comprehensive income 517 605
Retained earnings 29,592 31,274
- --------------------------------------------------------------------------------------------------
Total stockholders' equity 94,653 96,220
- --------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $126,000 $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 June 30, Six Months Ended June 30,
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------
Net revenues:
Service $ 21,153 $ 23,222 $ 43,346 $ 44,544
Product 1,072 1,570 2,656 2,727
------------ ------------ ------------ ------------
22,225 24,792 46,002 47,271
Cost of services 11,800 8,320 22,697 17,045
Cost of products 468 1,144 3,710 2,205
------------ ------------ ------------ ------------
12,268 9,464 26,407 19,250
------------ ------------ ------------ ------------
Gross profit 9,957 15,328 19,595 28,021
Marketing, selling, general and administrative 9,678 9,735 20,184 19,067
Research and development 1,187 935 2,043 1,925
------------ ------------ ------------ ------------
10,865 10,670 22,227 20,992
------------ ------------ ------------ ------------
Operating income (loss) (908) 4,658 (2,632) 7,029
Interest expense and other, net (108) (169) (345) (464)
------------ ------------ ------------ ------------
Income (loss) before income provision (benefit) (1,016) 4,489 (2,977) 6,565
Income tax provision (benefit) (589) 1,747 (1,295) 2,642
------------ ------------ ------------ ------------
Net income (loss) $ (427) $ 2,742 $ (1,682) $ 3,923
==============================================================================================================================
Earnings (loss) per share:
Basic $ (.02) $ .16 $ (.10) $ .23
Diluted $ (.02) $ .15 $ (.10) $ .22
Shares used in computing earnings (loss) per share:
Basic 17,144,280 17,037,302 17,132,335 17,025,760
Diluted 17,144,280 17,736,448 17,132,335 17,468,168
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, 2004 2003
- ---------------------------------------------------------------------------------------------------------
Cash Flow From Operating Activities
Net income (loss) $ (1,682) $ 3,923
Adjustments to reconcile income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 4,078 4,272
Provision for metal spinal implant systems 1,998
Changes in current assets and liabilities:
Accounts receivable (527) (5,294)
Deferred processing costs (2,855) (7,436)
Inventories 502 496
Prepaid expenses and other current assets 356 1,555
Accounts payable and other liabilities 216 5,569
- ---------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 2,086 3,085
Cash Flow From Investing Activities
Capital expenditures (771) (991)
Proceeds from sale of investments 1,982
Other, net 67 (341)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (704) 650
Cash Flow From Financing Activities
Proceeds from issuance of common stock 202 404
Principal payments on long-term debt (1,331) (1,331)
- ---------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,129) (927)
Effect of exchange rate changes on cash 136 3
- ---------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 389 2,811
Cash and cash equivalents at beginning of period 15,326 10,040
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 15,715 $ 12,851
=========================================================================================================
Supplementary cash flow data:
Cash paid during the period for interest, excluding amounts capitalized $ 270 $ 506
Cash paid (refunded) during the period for taxes 1,413 (758)
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 for a fair presentation of the
consolidated financial position as of June 30, 2004, the consolidated
results of operations for the three months and six months ended June 30,
2004 and 2003 and the consolidated cash flows for the six months ended
June 30, 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
statements 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 accordance with the provisions of Statement of Financial Accounting
Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets", the
Company completed an evaluation of the carrying value of its goodwill as
of January 1, 2004 and determined that there was no impairment which would
need to be reflected in 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
$3,881,000 and $3,800,000 as of June 30, 2004 and December 31, 2003,
respectively. The carrying values of such intangibles are $2,322,000 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.
-5-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
3. Stock Options (continued)
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.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
(in thousands except per share data) 2004 2003 2004 2003
----------------------------------------------------------------------------------------------------
Net income (loss) - reported $ (427) $ 2,742 $ (1,682) $ 3,923
Impact on net income (loss) related to
stock-based employee compensation
expense, net of tax $ 227 $ 207 $ 454 $ 405
Net income (loss) - pro forma $ (654) $ 2,535 $ (2,136) $ 3,518
====================================================================================================
Earnings (loss) per share As reported:
Basic $ (.02) $ .16 $ (.10) $ .23
Diluted $ (.02) $ .15 $ (.10) $ .22
Pro forma:
Basic $ (.04) $ .15 $ (.12) $ .21
Diluted $ (.04) $ .14 $ (.12) $ .20
====================================================================================================
4. First Quarter 2004 Charges
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 expected to cease marketing and
distributing all metal spinal implant product lines by the end of the
second quarter of 2004. The Company 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. The
Company ceased distribution of all metal spinal implant product lines in
June, 2004.
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.
-6-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Deferred Processing Costs
Deferred processing costs consist of the following:
June 30, December 31,
(in thousands) 2004 2003
---------------------------------------------------------------------------------
Donor tissue to be processed $ 9,202 $ 6,758
Tissue in process 8,273 8,350
Processed implantable donor tissue to be distributed
by the Company 12,123 11,962
Processed implantable donor tissue held for clients 2,180 1,943
------------------------------------------------------------------------------
$31,778 $29,013
==============================================================================
6. Inventories
Inventories consist of the following:
June 30, December 31,
(in thousands) 2004 2003
-----------------------------------------------------------------------
Supplies $ 273 $ 287
Raw materials 722 765
Finished goods 193 2,529
--------------------------------------------------------------------
$1,188 $3,581
====================================================================
In first quarter 2004, the Company recorded a charge to reduce its metal
spinal implant inventory, which was 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 2002, the Company obtained an automatically declining irrevocable
standby letter of credit to support the $1,900,000 due to Medtronic
Sofamor Danek, Inc. pursuant to the settlement of certain patent
litigation. The final amounts due to Medtronic under the settlement were
paid in April, 2004. The commitment under the standby letter of credit
terminated in May, 2004.
On April 30, 2004, the Company amended its Credit Facility with its lender
to, among other items, extend the maturity date of its $5.0 million
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 ended 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 ended 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.
The Company's Credit Facility includes: a $5,000,000 revolving line of
credit, a building mortgage loan, and an equipment term loan. At June 30,
2004, there were no borrowings under the revolving line of credit and
$5,000,000 was available, $3,866,000 was outstanding under the building
mortgage loan and $10,727,000 was outstanding under the equipment term
loan. The Credit Facility, as amended, imposes certain operating and
financial restrictions and covenants. Based upon a review of the Company's
financial results for the first six months of 2004, its current operations
and future expected operational activities for the remainder of 2004, the
Company may, in certain circumstances, not comply with one of these
covenants in the fourth quarter of 2004. Should circumstances indicate
that the Company would in fact fail to comply with any covenant, the
Company believes there are options available to it to achieve compliance,
including, but not limited to, obtaining a waiver from the lender or
amending the covenant, or both, or adjusting operational activities. The
Company has begun discussions with its lender concerning the possibility
of non-compliance with one of the covenants, and will continue such
discussions over the next several months to explore its options. The
Company cannot provide assurance that it will be able to comply with all
of the covenants or institute activities to bring it into compliance, or,
in the event of non-compliance with a covenant, obtain a waiver to, or
amendment of, the covenant, in which case the bank could avail itself of
the remedies set forth in the risk factor entitled "Failure to comply with
covenants under our loan and security agreement could materially adversely
impact our business, financial condition and results of operations" set
forth in the Company's Annual Report on Form 10-K for the year ended
December 31, 2003.
-8-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
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 as of June 30, 2004, and based upon the Alphatec
litigation and other factors has 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. No trial date has been set, but the final
pre-trial conference is scheduled for November 1, 2004.
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 June 30, 2004 in lawsuits reported in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003
and the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004. Additionally, from time to time 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 our
results of operations or financial condition.
-9-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
8. Commitments and Contingencies (continued)
"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 alleged
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 plaintiff 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 did 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. On
May 17, 2004, the settlement agreement was finalized and plaintiff's
action against the Company was dismissed with prejudice.
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 and six months ended June 30,
2004 and 2003 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------
(in thousands) 2004 2003 2004 2003
------------------------------------------------------------------------------------
Net income $(427) $ 2,742 $(1,682) $3,923
Currency translation adjustments (96) 332 (88) 357
------------------------------------------------------------------------------------
Comprehensive income $(523) $ 3,074 $(1,770) $4,280
====================================================================================
-10-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
10. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three months and six months ended June 30, 2004
and 2003
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------------
(dollars in thousands except per share data) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------------------
Net income (loss) available to
common shareholders $ (427) $ 2,742 $ (1,682) $ 3,923
==================================================================
--------------------------------------------------------------------------------------------------------------------
Denominator for basic earnings
per share, weighted average common
shares outstanding 17,144,280 17,037,302 17,132,335 17,025,760
Effect of dilutive securities, stock options 699,146 442,408
------------------------------------------------------------------
Denominator for diluted earnings
per share 17,144,280 17,736,448 17,132,335 17,468,168
==================================================================
--------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic $ (.02) $ .16 $ (.10) $ .23
Diluted $ (.02) $ .15 $ (.10) $ .22
--------------------------------------------------------------------------------------------------------------------
Weighted average shares issuable upon the exercise of stock options which were
not included in the calculation of diluted earnings per share were 1,690,803 and
501,269, and 1,636,752 and 662,942 for the three months and six months ended
June 30, 2004 and 2003, respectively. Such shares were not included because they
were antidilutive.
-11-
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
11. Operating Segments
Summarized in the table below is financial information for our reportable
segments for the three months and six months ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
-----------------------------------------------------
(dollars in thousands) 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------
Revenues:
Demineralized Bone Matrix Segment $ 10,862 $ 12,263 $ 22,295 $ 23,632
Base Tissue Segment 10,291 10,959 21,051 20,912
Other, principally metal spinal
implants 1,072 1,570 2,656 2,727
-----------------------------------------------------------------------------------------------
Consolidated $ 22,225 $ 24,792 $ 46,002 $ 47,271
===============================================================================================
Operating income (loss):
Demineralized Bone Matrix Segment $ 121 $ 4,392 $ 1,241 $ 7,657
Base Tissue Segment (722) 1,703 (1,064) 1,882
Other, principally metal spinal
Implants (307) (1,437) (2,809) (2,510)
-----------------------------------------------------------------------------------------------
Consolidated $ (908) $ 4,658 $ (2,632) $ 7,029
===============================================================================================
During the three months ended June 30, 2004, two of our clients,
Musculoskeletal Transplant Foundation ("MTF") and the American Red Cross
Tissue Services ("ARC"), in the Demineralized Bone Matrix and Base Tissue
Segments each accounted for 21% and 22%, respectively, of consolidated net
revenues and accounted for 24% and 25%, respectively, of consolidated net
revenues for the three months ended June 30, 2003. For the six months
ended June 30, 2004, these same two clients accounted for 22% and 21%,
respectively, of consolidated net revenues, and 26% and 26%, respectively,
of consolidated net revenues for the six months ended June 30, 2003.
12. Reclassifications
Certain prior year amounts have been reclassified to conform to the 2004
presentation.
-12-
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 AND SIX MONTHS ENDED JUNE 30, 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.
Net Income (Loss)
We incurred a consolidated net loss for the three months ended June 30, 2004 of
$427,000 or $.02 diluted net loss per share compared to consolidated net income
of $2,742,000 or $.15 diluted net income per share for the three months ended
June 30, 2003. We incurred a consolidated net loss for the six months ended June
30, 2004 of $1,682,000 or $.10 net loss per share compared to consolidated net
income of $3,923,000 or $.22 diluted net income per share for the six months
ended June 30, 2003. The net loss in both periods of 2004 is primarily
attributable to a decline in gross profit margin impacted by lower net revenues
and increased per unit processing costs as a result of declining unit sales
volume and other inventory management initiatives, and for the six months ended
June 30, 2004, additionally by the reserves recorded in the first quarter of
2004 for costs associated with our exit from the spinal metal implant business
and the reorganization of our sales and marketing functions.
The following is a discussion of factors affecting results of operations for the
three months and six months ended June 30, 2004 and 2003.
Net Revenues
Consolidated net revenues declined to $22,225,000 in the second quarter of 2004
compared to consolidated net revenues of $24,792,000 in the corresponding period
in 2003. Domestic net revenues decreased to $19,446,000 for the three months
ended June 30, 2004 from $22,492,000 in the corresponding period in
-13-
2003. Foreign-based net revenues increased 21% to $2,779,000 in the second
quarter of 2004 from $2,300,000 in the same period in 2003. Consolidated net
revenues decreased to $46,002,000 for the six months ended June 30, 2004
compared to consolidated net revenues of $47,271,000 for the six months ended
June 30, 2003. Domestic net revenues declined for the six months ended June 30,
2004 to $40,365,000 from $43,183,000 in the corresponding period in 2003.
Foreign-based revenues increased 38% to $5,637,000 for the six months ended June
30, 2004 from $4,088,000 in the corresponding period in 2003. The decline in
revenues in both periods of 2004 is mainly attributable to lower unit volume in
our domestic Grafton(R) DBM and Graftech(R) Bio-implant product lines as a
result of aggressive marketing and sales programs by our competitors which our
marketing and sales initiative have, to date, been unable to neutralize and, in
second quarter 2004 from the decline in revenues from metal spinal implant
product lines, which is directly associated with our announcement in March, 2004
to exit the metal spinal implant business effective June 30, 2004. Such declines
in revenue were partially offset by increased revenues from private label DBM
product lines and increased unit volume internationally.
The Demineralized Bone Matrix ("DBM") Segment or DBM Segment, revenues declined
to $10,862,000 in the second quarter of 2004 from revenues of $12,263,000 in the
corresponding period in 2003. DBM Segment revenues for the six months ended June
30, 2004 of $22,295,000 decreased from DBM Segment revenues of $23,632,000 for
the six months ended June 30, 2003. Domestic DBM Segment revenues declined to
$9,174,000 in second quarter 2004 from revenues of $10,911,000 in second quarter
2003 and decreased to $18,883,000 for the six months ended June 30, 2004 from
$21,274,000 for the corresponding period in the prior year. The decline in
domestic DBM Segment revenues is primarily related to lower units sales volume
of Grafton(R) DBM due to the strong competitive pressures mentioned above,
partially offset by increased units sales volume for private label DBM product
lines. We announced the execution of a second private label DBM arrangement with
Smith & Nephew, Inc. in April, 2004 and expect to begin shipping product under
this new arrangement in the third quarter of 2004. Foreign-based Grafton(R) DBM
revenues increased 25% to $1,688,000 in the second quarter of 2004 from revenues
of $1,352,000 in the corresponding period in the prior year, and increased 45%
to $3,412,000 for the six months ended June 30, 2004 from $2,358,000 for the six
months ended June 30, 2003. The increase in foreign-based Grafton(R) DBM
revenues is primarily due to increased penetration in existing markets and the
expansion into additional international markets.
Base Allograft Tissue Segment, or Base Tissue Segment, revenues decreased to
$10,291,000 in the second quarter of 2004 from $10,959,000 in the corresponding
period in 2003. Base Tissue Segment revenues for the six months ended June 30,
2004 of $21,051,000 were essentially flat with revenues of $20,912,000 for the
six months ended June 30, 2003. The decline in Base Tissue Segment revenues in
the second quarter of 2004 is primarily attributable to a 17% decline in
Graftech(R) Bio-implant revenues, partially offset by a 105% increase in
revenues from the direct distribution of Osteotech labeled traditional tissue.
For the six months ended June 30, 2004, we realized a 282% increase in revenues
from the direct distribution of Osteotech labeled traditional tissue, which was
mostly offset by an 8% decline in Graftech(R) Bio-implant revenues. The decline
in Graftech(R) Bio-implant revenues is primarily due to the strong competitive
pressures mentioned above.
Revenue from other product lines, consisting primarily of metal spinal implants
and bovine tissue, declined in the second quarter of 2004 to $1,072,000 from
$1,570,000 in the same period in 2003 and declined for the six months ended June
30, 2004 to $2,656,000 from $2,727,000 in the corresponding period in 2003. The
decline in revenues is directly associated with our announcement in March, 2004
to exit the metal spinal implant business effective June 30, 2004.
During the three months ended June 30, 2004, two of our clients in the DBM and
Base Tissue Segments, the Musculoskeletal Transplant Foundation, or MTF, and the
American Red Cross Tissue Services, or ARC,
-14-
accounted for 21% and 22%, respectively, of consolidated net revenues. In the
three months ended June 30, 2003, MTF and ARC accounted for 24% and 25%,
respectively, of consolidated net revenues. For the six months ended June 30,
2004, these same clients accounted for 22% and 21%, respectively, of
consolidated net revenues, and accounted for 26% and 26%, respectively, of
consolidated net revenues for the six months ended June 30, 2003. We have
processing agreements with each of these clients. The MTF agreement expires in
December, 2008 and the ARC agreement expires in December, 2006.
Gross Profit
Consolidated gross profit as a percentage of consolidated net revenues was 45%
in the second quarter of 2004 compared to 62% in the second quarter of 2003.
Consolidated gross profit as a percentage of consolidated net revenues was 43%
for the six months ended June 30, 2004 compared to 59% for the six months ended
June 30, 2003. The decline in gross profit as a percentage of revenues was due
primarily to the negative impact of lower net revenues and higher per unit
processing costs as a result of declining unit sales volume and other inventory
management initiatives, and for the six months ended June 30, 2004, additionally
by the reserves recorded in the first quarter of 2004 for costs associated with
our exit from the metal spinal implant business 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 was
negatively impacted by the continuing shift in revenue mix to lower margin
products, including international Grafton(R) DBM, the direct distribution of
Osteotech labeled traditional tissue and private label DBM revenues, and 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 decreased
slightly in second quarter 2004 to $9,678,000 from $9,735,000 in the
corresponding period in 2003, primarily due to a decline in domestic commission
costs as a result of the lower domestic revenues. Consolidated marketing,
selling, general and administrative expenses increased 6% for the six months
ended June 30, 2004 to $20,184,000 from $19,067,000 for the six months ended
June 30, 2003, principally 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 the reorganization of the sales
and marketing departments. Through the six months ended June 30, 2004, we have
incurred approximately $250,000 in professional fees related to our efforts to
comply with Section 404 of the Sarbanes-Oxley Act of 2002 relating to our
internal controls over financial reporting.
Research and Development Expenses
Consolidated research and development expenses increased 27% in the second
quarter of 2004 to $1,187,000 from $935,000 in the corresponding period in 2003,
and increased 6% in the six months ended June 30, 2004 to $2,043,000 from
$1,925,000 in the six months ended June 30, 2003. The increase in consolidated
research and development expenses is primarily due to increased activity on
existing and new programs.
Operating Income (Loss)
We incurred a consolidated operating loss of $908,000 and $2,632,000 in the
three months and six months ended June, 30, 2004, respectively, compared to a
consolidated operating income of $4,658,000 and $7,029,000 in the same
respective periods in 2003. The operating losses in both periods in 2004 result
principally from a decline in gross profit margin impacted by lower net revenues
and increased per unit processing costs as discussed above, and for the six
months ended June 30, 2004, by the reserves recorded
-15-
in the first quarter of 2004 for costs associated with our exit from the spinal
metal implant business and the reorganization of our sales and marketing
functions.
DBM Segment operating income decreased to $121,000 in the three months ended
June 30, 2004 from $4,392,000 in the same period in 2003 and declined to
$1,241,000 for the six months ended June 30, 2004 from $7,657,000 in the
corresponding period in 2003. These declines are attributable to the decline in
domestic revenue, a corresponding decline in gross profit margin, an increase in
operating expenses associated with programs aimed at stabilizing and growing
revenues, including the shift of sales and marketing resources from marketing
metal spinal implant products to focus on our tissue businesses, and in the six
months ended June 30, 2004, a portion of the severance costs related to the
reorganization of the sales and marketing departments.
We incurred an operating loss in the Base Tissue Segment of $722,000 and
$1,064,000 in the three months and six months ended June 30, 2004, respectively,
compared to an operating income of $1,703,000 and $1,882,000 in the respective
corresponding periods in 2003. The operating losses in 2004 are primarily
attributable to the decline in revenues, lower gross profit margins, increased
operating expenses associated with programs to restore revenue growth, including
the shift of sales and marketing resources from marketing metal spinal implant
products to focus on our tissue businesses, and in the six months ended June 30,
2004, a portion of the severance costs related to the reorganization of the
sales and marketing departments.
Operating losses associated with other revenues were $307,000 and $2,809,000 for
the three months and six months ended June 30, 2004, respectively, and were
$1,437,000 and $2,510,000 for the three months and six months ended June 30,
2003. The operating loss for the six months ended June 30, 2004 includes a
charge of $1,998,000 to reduce metal spinal implant inventory and
instrumentation to estimated net realizable value because of the decision in the
first quarter of 2004 to exit from the metal spinal implant business.
Interest Expense and Other, Net
Interest expense and other, net, which primarily represents interest expense,
net of interest income, was $108,000 and $345,000 for the three months and six
months ended June 30, 2004, respectively, compared to interest expense, net of
interest income, of $169,000 and $464,000 in the corresponding periods in 2003,
respectively. In all periods in 2004 and 2003, interest expense on long-term
debt is partially offset by interest income.
Income Tax Provision (Benefit)
We recognized an income tax benefit for the three months and six months ended
June 30, 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 and six months ended June 30, 2003 were 39%
and 40%, respectively.
Liquidity and Capital Resources
At June 30, 2004 we had cash and cash equivalents of $15,715,000 compared to
$15,326,000 at December 31, 2003. We invest excess cash in U.S.
Government-backed securities and investment grade commercial paper of major U.S.
corporations. Working capital increased $1,022,000 to $57,406,000 at June 30,
2004 compared to $56,384,000 at December 31, 2003, principally due to continued
investment in unprocessed tissue inventories.
-16-
Net cash provided by operating activities was $2,086,000 and $3,085,000 in the
six months ended June 30, 2004 and 2003, respectively. The decline in net cash
provided by operating activities is primarily due to the net loss incurred in
2004, partially offset by the reserve recorded to reduce metal spinal implant
inventory and instrumentation to net realizable value.
Cash used in investing activities was $704,000 for the six months ended June 30,
2004 compared to cash provided by investing activities of $650,000 for the six
months ended June 30, 2003. Cash used in investing activities in 2004 primarily
results from capital expenditures of $771,000. Cash provided by investing
activities in 2003 was primarily generated from the sale of short-term
investments of $1,982,000, partially offset by capital expenditures of $991,000.
Net cash used in financing activities was $1,129,000 and $927,000 for the six
months ended June 30, 2004 and 2003, respectively. Net cash used in financing
activities in both periods principally results from the payments on long-term
debt, partially offset by proceeds from the sale of common stock associated with
employee stock option exercises and 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 June
30, 2004, there were no borrowings under the revolving line of credit and
$5,000,000 was available, $3,866,000 was outstanding under the building mortgage
loan and $10,727,000 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, which was terminated in May, 2004 after the last
payment was made under the litigation settlement in April, 2004. The Credit
Facility, as amended, imposes certain operating and financial restrictions and
covenants. Based upon a review of our financial results for the first six months
of 2004, our current operations and our future expected operational activities
for the remainder of 2004, we may, in certain circumstances, not comply with one
of these covenants in the fourth quarter of 2004. Should circumstances indicate
that we would in fact fail to comply with any covenant, we believe there are
options available to us to achieve compliance, including, but not limited to,
obtaining a waiver from our lender or amending the covenant, or both, or
adjusting our operational activities. We have begun discussions with our lender
concerning the possibility of our non-compliance with one of the covenants, and
will continue such discussions over the next several months to explore our
options. We cannot provide assurance that we will be able to comply with all of
the covenants or institute activities to bring us into compliance, or, in the
event of non-compliance with a covenant, obtain a waiver to, or amendment of,
the covenant, in which case the bank could avail itself of the remedies set
forth in the risk factor entitled "Failure to comply with covenants under our
loan and security agreement could materially adversely impact our business,
financial condition and results of operations" set forth 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.
As of June 30, 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.
-17-
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 and our
Quarterly Report on Form 10-Q for the three months ended March 31, 2004. 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 13a - 15(e) under the Exchange Act) as of June
30, 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. We have evaluated the additional procedures instituted in the first
quarter of 2004 discussed above and have found that such procedures are
operating effectively.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following is a description of material developments that occurred during the
three months ended June 30, 2004 in lawsuits reported in our Annual Report on
Form 10-K for the year ended December 31, 2003 and our Quarterly Report on Form
10-Q for the quarter ended March 31, 2004. Additionally, from time to time 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
on our results of operations or financial condition.
-18-
"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 alleged 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 plaintiff 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 did not obligate us to pay
monetary damages to the plaintiffs, but assigns certain of our rights under our
insurance policies to the plaintiff. On May 17, 2004, the settlement agreement
was finalized and plaintiff's action against us was dismissed with prejudice.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An annual meeting of stockholders of Osteotech, Inc. was held on June 10,
2004.
(c) The matters voted upon at the annual meeting and the results of the voting
are set forth below:
i) 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 Osteotech. Each received
the following number of votes:
Director For Withheld
-------------------------------------------------------------------
Richard W. Bauer 12,245,090 3,912,308
Kenneth P. Fallon, III 12,281,818 3,875,580
Stephen Galliker 16,004,144 153,254
Michael J. Jeffries 12,256,808 3,900,590
Donald D. Johnston 12,256,926 3,900,472
John Phillip Kostuik, M.D. 12,259,926 3,897,472
Stephen J. Sogin, Ph.D. 12,303,566 3,853,832
ii) With respect to a proposal to ratify the appointment of
PricewaterhouseCoopers LLP as Osteotech's independent auditors for
the fiscal year ending December 31, 2004, the stockholders voted
16,010,997 shares in favor, 135,947 shares against and 10,004 shares
abstained. Broker non-votes were not applicable. This proposal
received the vote required by Delaware General Corporation Law and
Osteotech's by-laws for approval (i.e. the affirmative vote of a
majority of the shares of common stock voted on the proposal).
-19-
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
10.47 Third Allonge to Loan and Security Agreement among Fleet National Bank, *
Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech B.V., H.C.
Implants, B.V., CAM Implants, B.V., Osteotech/CAM Services, B.V., Osteotech
Implants, B.V., Osteotech S.A. and OST Developpement dated April 30, 2004.
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 June 30, 2002 and incorporated herein by
reference thereto.
(b) Reports on Form 8-K
On June 15, 2004, we filed with the Commission a Current Report on Form
8-K to announce that Sam Owusu-Akyaw has been elected President and Chief
Operating Officer of the Company responsible for domestic operations. Mr.
Owusu-Akyaw has also been appointed to the Board of Directors.
On April 27, 2004, we filed with the Commission a Current Report on Form
8-K to announce our financial results for the three months ended March 31,
2004.
On April 5, 2004, we filed with the Commission a Current Report on Form
8-K to announce we had entered into a five-year agreement with Smith &
Nephew, Inc.'s Orthopaedic division for the processing and distribution of
a private label demineralized bone matrix to the U.S. hospital and
surgical center market.
-20-
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: August 4, 2004 Osteotech, Inc.
---------------------------------
(Registrant)
Date: August 4, 2004 By: /S/ Richard W. Bauer
---------------------------------
Richard W. Bauer
Chief Executive Officer
(Principal Executive Officer)
Date: August 4, 2004 By: /S/ Michael J. Jeffries
---------------------------------
Michael J. Jeffries
Executive Vice President,
Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
-21-