Back to GetFilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2004

OR

For the transition period from                      to                     

Commission file number 0-31271

REGENERATION TECHNOLOGIES, INC.

11621 Research Circle

Alachua, Florida 32615

(386) 418-8888

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes x No ¨

Shares of common stock, $0.001 par value, outstanding on July 30, 2004: 26,604,607

REGENERATION TECHNOLOGIES, INC.

FORM 10-Q For the Quarter Ended June 30, 2004

Index

PART I. FINANCIAL INFORMATION

REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except share data)

See notes to unaudited condensed consolidated financial statements.

1

REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Unaudited)

(In thousands, except share and per share data)

See notes to unaudited condensed consolidated financial statements.

2

REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

See notes to unaudited condensed consolidated financial statements.

3

REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Three Months and Six Months Ended June 30, 2004 and 2003

(Unaudited)

(In thousands, except share and per share data)

The accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring accruals, which the Company considers necessary for a fair presentation of the results of operations for the periods shown. The condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. All intercompany balances and transactions have been eliminated in consolidation. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

The condensed consolidated financial statements include the accounts of Regeneration Technologies, Inc. and its wholly owned subsidiaries, Alabama Tissue Center, Biological Recovery Group (inactive) and RTI Services, Inc. (collectively, the “Company”). The condensed consolidated financial statements also include the accounts of RTI Donor Services, Inc., which is a controlled entity.

Restricted Deposits— At June 30, 2004, the Company no longer has any restricted deposits. At December 31, 2003, the Company had $14,757 on deposit with a commercial bank in satisfaction of a collateral requirement contained in a credit agreement, which was fully repaid and terminated on February 20, 2004.

Deferred Financing Costs— Deferred financing costs include costs incurred to obtain financing. Upon funding of debt offerings, deferred financing costs are capitalized as debt issuance costs and amortized using the straight-line method, which approximates the effective interest method, over the life of the related debt. At June 30, 2004, deferred financing costs approximated $832 net of accumulated amortization of $50, which are included in other assets—net in the accompanying condensed consolidated balance sheets.

Reclassifications— Certain amounts in the condensed consolidated financial statements for the three and six months ended June 30, 2003, as previously reported, have been reclassified to conform to the 2004 presentation.

Options to purchase approximately 3,352,189 shares of common stock at prices ranging from $1.30 to $14.95 per share were outstanding as of June 30, 2004.

4

Had compensation cost for grants of options after March 31, 2000, the date with which all options granted to employees thereafter were issued with an exercise price equal to the fair market value on the date of the grant, been determined on the basis of fair value pursuant to SFAS No. 123, net income and net income per common share would have been affected as follows:

The Company recorded deferred compensation expense for certain stock options granted to employees and non-employees prior to April 1, 2000 of $48 and $102 for the three months ended June 30, 2004 and 2003, respectively, and $110 and $219 for the six months ended June 30, 2004 and 2003, respectively.

A reconciliation of the weighted average number of shares of common stock used in the calculation of basic and diluted earnings per share is presented below:

For the three months ended June 30, 2004 and 2003, approximately 1,645,000 and 1,895,000, respectively, and for the six months ended June 30, 2004 and 2003, approximately 1,868,000 and 1,828,000, respectively, of issued stock options were not included in the computation of diluted earnings per share because they were anti-dilutive.

5

The carrying value of goodwill was $2,863 at June 30, 2004 and December 31, 2003. The following table reflects the components of other intangible assets which are recorded as a component of noncurrent other assets – net in the condensed consolidated balance sheets:

Amortization expense for the six months ended June 30, 2004 and 2003 was $9 and $20, respectively. Management estimates amortization expense of $20 for each of the next five years.

Inventories by stage of completion are as follows:

During the six month periods ended June 30, 2004 and 2003, the Company had inventory write-downs of $0 and $699, respectively, due to estimated obsolescence.

On November 2, 2001 the Company purchased 1,285,347 shares of convertible preferred stock issued by Organ Recovery Systems, Inc. (“ORS”), a privately held company, at a price of $3.89 per share. ORS is organized for the purpose of advancing organ transplantation technology. The Company invested in ORS to continue its commitment to the promotion of effective use and distribution of human tissue. The purchase was paid for in cash and recorded at a total cost of $5,250.

Realization of the Company’s investment in ORS is dependent upon ORS’s successful execution of its operational strategies and the continued industry acceptance of its current and future product developments. Management monitors progress towards these success factors on a continual basis and has concluded that its investment in ORS has not been negatively impacted by operational matters. Additionally, in late 2003, ORS raised additional equity at a price equal to what the Company paid for its shares of preferred stock. Accordingly, management of the Company believes there has been no impairment of the Company’s investment.

6

The following table summarizes the notional transaction amount and fair value for the outstanding derivative at December 31, 2003:

On February 20, 2004, the Company terminated the interest rate swap agreement by paying off the fair value of the swap, or $1,613. The net increase in fair value for the derivative liability of the interest rate swap for the period from December 31, 2003 to the termination date was $61.

The Company uses the asset and liability method of accounting for income taxes. Deferred income taxes are recorded to reflect the tax consequences in future years for differences between the tax basis of assets and liabilities and their financial reporting amounts at each period-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized.

At June 30, 2004, net deferred tax assets were approximately $6,351. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. The Company expects the deferred tax assets, net of the valuation allowance at June 30, 2004 of $500, to be realized through the generation of future taxable income and the reversal of existing taxable temporary differences.

Selected cash payments, receipts, and noncash activities are as follows:

7

The Company processes human tissue received from various tissue recovery agencies and distributes the tissue through various channels. This one line of business represents 100% of consolidated fees from tissue distribution and is comprised of four primary product lines: spinal, sports medicine, cardiovascular and general orthopedic. The following table presents net revenues from tissue distribution and for other non-tissue revenues:

Note payable is as follows:

On February 20, 2004, the Company, with proceeds from a new long-term financing agreement, fully repaid the outstanding balance on the term loan. The previously restricted deposits were applied to the outstanding balance and the remaining amount of the restricted deposits, or $1,200, no longer serves as collateral under the new agreement.

Long-term debt is as follows:

On February 20, 2004, the Company entered into a new long-term financing agreement with a major financial institution. The new agreement consists of a $9,000 five-year term loan and a five-year $16,000 revolving line of credit. The $9,000 term loan calls for monthly principal payments of $125. Interest on the new loan agreement is paid monthly at LIBOR plus 4.25% (5.61% at June 30, 2004). Under the $16,000 revolving line of credit, the Company can borrow up to the maximum eligible amount, based on certain outstanding receivables and inventories, of which $9,167 is available at June 30, 2004. Interest on outstanding amounts under the revolving line of credit is payable at LIBOR plus 3.75%. Principal and interest on the revolving line of credit are payable upon maturity,

8

unless otherwise called for in the agreement. There is a .5% fee payable on any unused portion of the revolving credit facility. No amounts were outstanding under the revolving line of credit at June 30, 2004. The term loan and revolving line of credit are fully collateralized by substantially all of the assets of the Company, including accounts receivable, inventories and certain property and equipment.

The credit agreement also contains various restrictive covenants which limit, among other things, indebtedness, liens and business combination transactions. In addition, the Company must maintain certain financial covenant ratios, including operating cash flows to fixed charges, senior debt to EBITDA, and total debt to EBITDA, as defined in the agreement. The Company is in compliance with the financial covenant ratios at June 30, 2004.

During the three months ended June 30, 2004, the Company paid $10,202 to Medtronic Sofamor Danek (MSD) for management service fee obligations which were recognized under the terms of the prior distribution agreement.

The Company is in settlement discussions with MSD regarding their performance under the prior agreement based on the contractual terms including, among other things, responsibilities of the parties relative to losses on consignment inventories and uncollected accounts receivable. The current distribution agreement calls for the Company and MSD to enter into arbitration to settle disputes if a settlement cannot otherwise be reached. The Company cannot predict whether it will be successful in pursuit of their claims; however, they believe that these matters will be resolved without going to arbitration. The Company further believes that the ultimate settlement of all outstanding claims will not exceed liabilities provided for in the accompanying condensed consolidated financial statements.

The Company is, from time to time, involved in litigation relating to claims arising out of its operations in the ordinary course of business. The Company believes that none of the claims that were outstanding as of June 30, 2004 will have a material adverse impact on its financial position or results of operations.

9

Cautionary Statement Relating to Forward Looking Statements

Information contained in this filing contains “forward-looking statements” which can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “anticipates” or comparable terminology, or by discussions of strategy. We cannot assure that the future results covered by these forward-looking statements will be achieved. Some of the matters described in the “Risk Factors” section of our Form 10-K constitute cautionary statements which identify factors regarding these forward-looking statements, including certain risks and uncertainties, that could cause actual results to vary materially from the future results indicated in these forward-looking statements. Other factors could also cause actual results to vary materially from the future results indicated in such forward-looking statements.

Three Months Ended June 30, 2004 Compared With Three Months Ended June 30, 2003

Net Revenues. Our net revenues were $23.1 million for both the three months ended June 30, 2004 and the three months ended June 30, 2003. Net revenues from spinal allografts decreased $666,000 which was offset by a $354,000 increase in our sports medicine allografts and a $287,000 increase in net revenues from our cardiovascular distributions. Net revenues from spinal allografts decreased 4.3% while unit volume increased 4.0% for the three months ended June 30, 2004 when compared to the three months ended June 30, 2003. The increase in unit volume compared to the decrease in revenues reflects a greater proportion of our spinal unit volume coming from our cervical line during the three months ended June 30, 2004 as compared to the three months ended June 30, 2003. During the three months ended June 30, 2004, approximately half of our spinal unit volume was from our cervical line of products, which made up only one third of our spinal unit volume during the same period in 2003. Cervical products are lower revenue grafts than lumbar spine products on a per unit basis.

Costs of Processing and Distribution. Costs of processing and distribution increased by $761,000, or 6.0%, to $13.4 million for the three months ended June 30, 2004 from $12.6 million for the three months ended June 30, 2003. Our costs of processing and distribution were primarily impacted by the increase in the mix of new cervical units produced, which on a per unit basis are more costly to produce than our lumbar spinal products. During the three months ended June 30, 2004, the cost per unit was impacted by the start up costs associated with producing new cervical products, which are being distributed by MSD. As a percentage of net revenues, costs of processing and distribution increased from 54.7% for the three months ended June 30, 2003 to 58.0% for the three months ended June 30, 2004.

Marketing, General and Administrative Expenses. Marketing, general and administrative expenses decreased by $225,000, or 3.6%, to $6.1 million for the three months ended June 30, 2004 from $6.3 million for the three months ended June 30, 2003. These expenses decreased as a percentage of net revenues from 27.2% for the three months ended June 30, 2003 to 26.3% for the three months ended June 30, 2004. The decrease primarily was due to a $243,000 decrease in consulting expense related to the cost of marketing our patented BioCleanse tissue sterilization process in 2003.

10

Research and Development Expenses. Research and development expenses increased by $539,000, or 86.9%, to $1.2 million for the three months ended June 30, 2004 from $620,000 for the three months ended June 30, 2003. As a percentage of net revenues, research and development expenses increased from 2.7% for the three months ended June 30, 2003 to 5.0% for the three months ended June 30, 2004, as we increased our spending on payroll and studies associated with new product development initiatives.

Net Interest Expense. Net interest expense was $162,000 for the three months ended June 30, 2004 compared to $516,000 for the three months ended June 30, 2003. This decrease was primarily the result of lower outstanding debt and no longer having the interest expense associated with our previously outstanding interest rate swap agreement in the three months ended June 30, 2004. The swap agreement was terminated on February 20, 2004.

Income Tax Expense. Income tax expense for the three months ended June 30, 2004 was $810,000 compared to $1.2 million for the three months ended June 30, 2003. Our effective tax rate for the three months ended June 30, 2004 was 35%, which was lower than the 38% effective tax rate for the three months ended June 30, 2003, due to a tax credit we recognized for qualified research and development expenses incurred.

Six Months Ended June 30, 2004 Compared With Six Months Ended June 30, 2003

Net Revenues. Our net revenues increased by $3.8 million, or 8.9%, to $46.7 million for the six months ended June 30, 2004 from $42.9 million for the six months ended June 30, 2003. Spinal allografts increased $3.1 million, sports medicine allografts increased $642,000, and cardiovascular distributions increased $613,000, offset partially by a $681,000 decrease in our general orthopedic allografts. Spinal revenues increased as a result of a 17.4% increase in units distributed to our distributor, Medtronic Sofamor Danek, which is attributable to increased demand for these allografts along with new product introductions. In addition, sports medicine revenues increased 14.6% as a result of a volume increase and a price increase associated with the introduction of soft tissue BioCleanse. Cardiovascular revenues increased 24.4% as a result of volume increases, change in product mix, and a price increase instituted at the beginning of 2004. General orthopedic revenues decreased 9.6% as a result of our allocation of tissue to support the increasing demand for our spinal allograft products.

Costs of Processing and Distribution. Costs of processing and distribution increased by $4.8 million, or 20.2%, to $28.3 million for the six months ended June 30, 2004 from $23.6 million for the six months ended June 30, 2003. Our costs of processing and distribution were primarily impacted by an increase in the proportion of new cervical units produced as compared to our lumbar spinal line and processing inefficiencies resulting from reduced production levels as we addressed the inventory buildup that occurred during the second half of 2003. Our cervical product line is more costly to produce than our lumbar spinal product line, on a per unit basis. During the six months ended June 30, 2004, the cost per unit was impacted by the start up costs associated with producing new cervical products, which are being distributed by MSD. As a percentage of net revenues, costs of processing and distribution increased from 54.9% for the six months ended June 30, 2003 to 60.6% for the six months ended June 30, 2004.

Marketing, General and Administrative Expenses. Marketing, general and administrative expenses decreased by $600,000, or 4.9%, to $11.6 million for the six months ended June 30, 2004 from $12.2 million for the six months ended June 30, 2003. These expenses decreased as a percentage of net revenues from 28.5% for the six months ended June 30, 2003 to 24.9% for the six months ended June 30, 2004. The decrease primarily was due to a $222,000 decrease in commission expense, a reversal of $200,000 in our allowance for bad debts, and a $243,000 decrease in consulting expense related to the costs of marketing our patented BioCleanse tissue sterilization process in 2003.

Research and Development Expenses. Research and development expenses increased by $1.0 million, or 97.5%, to $2.0 million for the six months ended June 30, 2004 from $1.0 million for the six months ended June 30, 2003. As a percentage of net revenues, research and development expenses increased from 2.4% for the six months ended June 30, 2003 to 4.3% for the six months ended June 30, 2004, as we increased our spending on payroll and studies associated with new product development initiatives.

11

Net Interest Expense. Net interest expense was $412,000 for the six months ended June 30, 2004 compared to $747,000 for the six months ended June 30, 2003. This decrease was primarily the result of our lower outstanding debt balance and no longer having interest expense associated with an outstanding interest rate swap agreement for the six months ended June 30, 2004 compared to the six months ended June 30, 2003. The swap agreement was terminated on February 20, 2004.

Income Tax Expense. Income tax expense for the six months ended June 30, 2004 was $1.5 million compared to $2.1 million for the six months ended June 30, 2003. Our effective tax rate for the six months ended June 30, 2004 was 34%, which was lower than our 39% effective tax rate for the six months ended June 30, 2003, due to a tax credit we recognized for qualified research and development expenses incurred.

12

Liquidity and Capital Resources

Cash Flows.

Our net cash used in operating activities was $6.5 million for the six months ended June 30, 2004, compared to $2.1 million of net cash provided by operating activities for the six months ended June 30, 2003. During the six months ended June 30, 2004, cash was provided by net income of $2.9 million and a decrease in inventories of $383,000. During the six months ended June 30, 2004, primary uses of cash were a reduction in accounts payable of $11.4 million, which included a $10.2 million payment to Medtronic Sofamor Danek for management service fee obligations which were recognized under the terms of the prior distribution agreement, an increase in accounts receivable of $1.6 million due to higher revenues and a decrease in accrued expenses of $419,000. Significant non-cash adjustments to operating activities for the six months ended June 30, 2004 included depreciation and amortization expense of $2.2 million and a deferred income tax provision of $1.4 million. Our accounts receivable days sales outstanding were 29 for both the six months ended June 30, 2004 and year ended December 31, 2003. Our inventory days outstanding were 259 annualized for the six months ended June 30, 2004, compared to 289 for year ended December 31, 2003. The reduced inventory days were the result of maintaining inventories at similar levels to the end of 2003 while increasing annualized revenues.

Our cash used in investing activities was $1.1 million for the six months ended June 30, 2004 compared to $1.5 million for the six months ended June 30, 2003. Our investing activities consisted of purchases of property, plant, and equipment.

Our net cash provided by financing activities was $8.3 million for the six months ended June 30, 2004 compared to net cash used in financing activities of $1.1 million for the six months ended June 30, 2003. Cash provided by financing activities for the six months ended June 30, 2004 consisted of a $14.8 million decrease in restricted deposits and proceeds of $9.0 million from issuance of our new term loan. Cash used in financing activities for the six months ended June 30, 2004 consisted of the repayment of our previous term loan of $12.1 million, a $1.6 million payment made to terminate a swap agreement, an $832,000 payment associated with deferred borrowing costs, and payments on capital lease and note obligations of $1.1 million.

Liquidity.

As of June 30, 2004, we had $10.8 million of cash and cash equivalents. We believe that our working capital as of June 30, 2004, together with our borrowing ability under the $16.0 million revolving line of credit, will be adequate to fund our operations for at least the next 12 months.

Certain Commitments.

We are in discussions with MSD regarding their performance under the prior agreement based on the contractual terms including, among other things, responsibilities of the parties relative to losses on consignment inventories and uncollected accounts receivable. The current distribution agreement calls for us and MSD to enter into arbitration to settle disputes if we cannot otherwise reach a settlement. We cannot predict whether we will be successful in pursuit of our claims; however, we believe that these matters will be resolved without going to arbitration. We further believe that the ultimate settlement of all outstanding claims will not exceed liabilities provided for in the accompanying condensed consolidated financial statements.

On February 20, 2004, we entered into a new long-term financing agreement with a major financial institution. The new agreement consists of a $9.0 million five-year term loan and a five-year $16.0 million revolving line of credit. The $9.0 million term loan calls for monthly principal payments of $125,000. Interest on the new loan agreement is paid monthly at LIBOR plus 4.25% (5.61% at June 30, 2004). Under the $16.0 million revolving line of credit, we can borrow up to the maximum eligible amount, based on certain outstanding receivables and inventories, of which $9,167 is available at June 30, 2004. Interest on outstanding amounts under the revolving credit loan is payable at LIBOR plus 3.75%. Principal and interest on the revolving credit loan are payable upon maturity, unless otherwise called for in the agreement. There is a .5% fee payable on any unused portion of the

13

revolving credit facility. No amounts were outstanding under the revolving line of credit June 30, 2004. The term loan and revolving line of credit are collateralized by substantially all of our assets, including accounts receivable, inventories and certain property and equipment.

The credit agreement also contains various restrictive covenants, which limit, among other things, indebtedness, liens and business combination transactions. In addition, we must maintain certain financial covenant ratios, including operating cash flows to fixed charges, senior debt to EBITDA, and total debt to EBITDA, as defined in the agreement. We were in compliance with the financial covenants at June 30, 2004.

14

We are subject to market risk from exposure to changes in interest rates based upon our financing, investing and cash management activities. We use a mix of debt maturities along with variable-rate debt to manage our exposure to changes in interest rates. We do not expect changes in interest rates to have a material adverse effect on our income or our cash flows in 2004. However, we cannot assure that interest rates will not significantly change in 2004. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

15

We carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Exchange Act Rule 13a-15 and 15d-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that material information is recorded, processed, summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the Securities Exchange Act of 1934 and the SEC rules thereunder. There have not been any changes in our internal controls over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

16

PART II. OTHER INFORMATION

We refer you to Item 1, note 14 entitled “Legal Actions.”

None.

Not applicable.

On April 26, 2004, we held our Annual Meeting of Stockholders. The matters voted on at the meeting and the result of the vote are as follows:

Election of two directors for a three year term expiring 2007:

Proposal to approve the Regeneration Technologies, Inc. 2004 Equity Incentive Plan:

In addition, there were 6,824,595 “broker non votes” with respect to the proposal to approve the Regeneration Technologies, Inc. 2004 Equity Incentive Plan.

Not applicable.

17

None.

18

SIGNATURE PAGE

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 6, 2004