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 September 30, 1998
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
incorporation or organization) Identification No.)
51 James Way, Eatontown, New Jersey 07724
(Address of principal executive offices) (Zip Code)
(732)542-2800
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 par value - 8,896,911 shares as of October 31, 1998.
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
ASSETS
- -----------------------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 16,434 $ 13,884
Short-term investments 2,919 1,473
Accounts receivable, net 8,205 7,547
Deferred processing costs 1,935 1,070
Inventories 1,243 792
Deferred income taxes 3,327 457
Prepaid expenses and other current assets 787 2,860
------------------------------
Total current assets 34,850 28,083
Property, plant and equipment, net 14,261 11,650
Excess of cost over net assets of business acquired,
less accumulated amortization of $1,638 in 1998 and
$1,449 in 1997 2,060 2,249
Other assets 1,758 1,070
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 52,929 $ 43,052
=================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 9,946 $ 6,919
Notes payable 26 608
Current maturities of long-term debt and
Obligations under capital leases 352 634
------------------------------
Total current liabilities 10,324 8,161
Long-term debt and obligations under capital leases 0 203
Other liabilities 408 396
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 10,732 8,760
- -----------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,676,595 shares
Authorized; no shares issued or outstanding
Common stock, $.01 par value; 20,000,000 shares
Authorized; issued and outstanding 8,895,461
shares in 1998 and 8,686,346 shares in 1997 89 87
Additional paid-in capital 36,796 36,130
Accumulated other comprehensive income(loss) 9 (75)
Retained earnings(deficit) 5,303 (1,850)
- -----------------------------------------------------------------------------------------------------------------
Total stockholders' equity 42,197 34,292
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 52,929 $ 43,052
=================================================================================================================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------------- ----------------------------
1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues:
Service $ 14,001 $ 11,551 $ 42,085 $ 30,916
Product 282 382 803 1,547
Licensing fee 0 0 124 257
-------- -------- -------- --------
14,283 11,933 43,012 32,720
Costs and expenses:
Cost of services 3,910 3,971 12,424 10,917
Cost of products 232 246 584 1,108
Marketing, general and administrative 4,851 4,317 15,432 11,946
Research and development 1,079 861 3,285 2,687
-------- -------- -------- --------
10,072 9,395 31,725 26,658
Operating income 4,211 2,538 11,287 6,062
Other income (expense):
Interest income 257 189 768 458
Interest expense (14) (30) (64) (109)
Other 42 15 182 59
-------- -------- -------- --------
285 174 886 408
-------- -------- -------- --------
Income before income taxes 4,496 2,712 12,173 6,470
Income tax provision 1,878 1,104 5,020 2,627
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 2,618 $ 1,608 $ 7,153 $ 3,843
====================================================================================================================================
Net income per share:
Basic $ .30 $ .19 $ .81 $ .47
Diluted $ .28 $ .18 $ .76 $ .45
- ------------------------------------------------------------------------------------------------------------------------------------
Shares used in computing net income per share:
Basic 8,779,253 8,309,783 8,817,209 8,144,737
Diluted 9,305,756 8,961,404 9,378,624 8,604,910
====================================================================================================================================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1998 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flow From Operating Activities
Net income $ 7,153 $ 3,843
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,042 1,721
Deferred income taxes (2,870) (50)
Income tax benefit related to stock options 2,870
Changes in assets and liabilities:
Accounts receivable (624) (829)
Deferred processing costs (865) 314
Inventories (467) (18)
Prepaid expenses and other current assets 2,083 598
Accounts payable and other liabilities 2,938 1,952
- ----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 12,260 7,531
Cash Flow From Investing Activities
Capital expenditures (4,326) (2,443)
Purchases of investments (7,387) (4,431)
Proceeds from sale of investments 5,941 5,445
Increase in other assets (746) (98)
- ----------------------------------------------------------------------------------------------------------
Net cash used in investing activities (6,518) (1,527)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 2,756 1,747
Repurchase of common stock (4,958)
Proceeds from issuance of notes payable 93
Principal payments on notes payable (582) (722)
Principal payments on long-term debt
and obligations under capital leases (482) (594)
- ----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (3,266) 524
Effect of exchange rate changes on cash 74 33
- ----------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 2,550 6,561
Cash and cash equivalents at beginning of period 13,884 7,290
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 16,434 $ 13,851
==========================================================================================================
Supplementary cash flow data:
Cash paid during the period for taxes $ 1,065 $ 1,071
Cash paid during the period for interest 63 110
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
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 Company's
consolidated financial position as of September 30, 1998 and December 31,
1997, and the consolidated results of operations for the three-month and
nine-month periods ended September 30, 1998 and 1997, and the consolidated
cash flows for the nine-month periods then ended. The results of operations
for the respective interim periods are not necessarily indicative of the
results to be expected for the full year. The condensed consolidated
financial statements should be read in conjunction with the audited
financial statements for the year ended December 31, 1997 which were
included as part of the Company's Report on Form 10-K.
2. Changes in Accounting Policies
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 established standards for reporting and display of comprehensive
income and its components in financial statements.
Comprehensive income was $2,701,000 and $7,237,000 in the three months and
nine months ended September 30, 1998, respectively, compared to $1,608,000
and $3,891,000 in the same periods last year. Other comprehensive income
consists solely of foreign currency translation adjustments.
3. Financing Arrangements
The Company has a Loan and Security agreement with a US bank which provides
for borrowings of up to $3,000,000 under a revolving line of credit and
$4,000,000 under an equipment line of credit. In July 1998, the Company
received a commitment from the same bank for a new credit facility which
will replace the current facilities which expire in December 1998. The new
credit facility will include a $5,000,000 revolving line of credit and a
$21,500,000 building mortgage loan and equipment line of credit which the
Company will use to fund the planned construction of a new processing
facility. Consummation of the new credit facility is subject to negotiation
and execution of a definitive agreement.
5
<PAGE>
4. Commitments and Contingencies
Acquisition
In June 1998, the Company acquired a 5% interest in OST Developpement S.A.
("OST"), a subsidiary of Transphyto S.A. of Clermont-Ferrand, France for an
aggregate purchase price of 496,662 French Francs ("FRF"), or approximately
$84,400. OST is a processor of bovine bone grafts for orthopaedic and
dental use. The Company will acquire an additional 85% interest no later
than March 1999, provided that certain milestones are achieved by OST. The
purchase price for the additional interest will be FRF 8,503,338, or
approximately $1,519,000 at the September 30, 1998 exchange rate. The
Company also has the option to purchase the remaining 10% of OST at a price
to be determined at the time of purchase.
In addition, the Company has agreed to provide interest-bearing loans to
OST of up to FRF 10,000,000, or approximately $1,787,000 at the September
30, 1998 exchange rate, to support its capital expenditure and working
capital requirements. In July and August 1998, the Company made advances to
OST aggregating FRF 1,600,000 or $268,000.
Litigation
The Company remains a defendant in two lawsuits in which patients claim
that they have suffered damages from the implantation of allegedly
defective spinal fixation devices allegedly distributed by the Company.
Both cases have been stayed with respect to the Company. Management
believes that the claims made in these suits are without merit and,
accordingly, both such cases are and will continue to be vigorously
defended.
In January 1998, the Company filed a patent infringement action against
GenSci Regeneration Laboratories, Inc. ("GenSci Labs") and GenSci
Regeneration Sciences, Inc. ("GenSci Sciences") alleging that GenSci
parties has violated claims of one of the patents involving the Company's
Grafton(R) Demineralized Bone Matrix (DBM) process. Approximately two weeks
after Osteotech's filing, GenSci Labs filed a suit against the Company
alleging patent infringement of two patents assigned to GenSci Labs in
addition to tortious interference with a business expectancy, negligent
interference with a prospective economic advantage and inducing breach of
contract and seeking a declaratory judgment of the invalidity of two of the
Company's patents covering Grafton(R) DBM. In February 1998, GenSci Labs
amended its complaint alleging essentially the same causes of action but
adding a third patent to the allegation of patent infringement. The actions
have been consolidated into one lawsuit. In September 1998, GenSci Labs
served an amended complaint, which asserted, in addition to the previously
asserted claims, claims of false advertising under Federal law. In
September 1998, the Company served its answer to this amended complaint,
asserted counterclaims against GenSci Labs and served a third-party
complaint against GenSci Sciences, DePuy, Inc. and DePuy Motech, Inc. The
Company's counterclaims and third party complaint accuses the GenSci
parties of infringing a second Company patent, in addition to the patent
referred to above, and accuses the DePuy and GenSci parties of acting
jointly and severally in infringing the claims of both such patents.
Discovery has commenced and is ongoing. The Company has and will continue
to vigorously defend any claims against it and prosecute the claims it has
asserted against the GenSci and DePuy parties.
6
<PAGE>
4. Commitments and Contingencies (Continued)
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 warranty, 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 a subsidiary of the Company, Cam
Implants BV. Plaintiffs have demanded monetary damages. On August 14, 1998,
the Company removed this action to the United States District Court for the
District of New Mexico. On August 24, 1998, the Company filed and served
its answer, denying any and all liability in this action, and moved to
dismiss five of the seven claims alleged against it in this action -
negligence, strict liability, negligent misrepresentation, fraud, and
violation of the New Mexico Unfair Trade Practices Act. On November 5,
1998, the Company moved for summary judgment in its favor on all of the
claims alleged in this action, on the ground that all of plaintiffs' claims
are barred by their applicable statutes of limitations. The Company
believes that the claims against it are without merit and will continue to
vigorously defend against such claims.
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 suits. The
Company is unable to estimate the potential liability, if any, that may
result from any of the pending litigation and, accordingly, no provision
for any liability has been made in the consolidated financial statements.
5. Stock Repurchase Program
In June 1998, the Board of Directors of the Company authorized the
repurchase and retirement of up to $5,000,000 of the Company's common stock
through open market purchases. As of September 30, 1998, the Company
completed this program and had repurchased and retired 245,000 shares of
common stock at a cost of $4,958,000.
7
<PAGE>
6. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
(dollars in thousands
except per share data) 1998 1997 1998 1997
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income available to Common
Shareholders $ 2,618 $ 1,608 $ 7,153 $ 3,843
-------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares 8,779,253 8,196,979 8,817,209 8,016,508
Nominal warrants outstanding (a) 112,804 128,229
-------------------------------------------------------------
Denominator for basic earnings per share 8,779,253 8,309,783 8,817,209 8,144,737
Effect of dilutive securities:
Stock options 526,270 611,093 561,337 446,664
Warrants 233 40,528 78 13,509
-------------------------------------------------------------
Denominator for diluted earnings per share 9,305,756 8,961,404 9,378,624 8,604,910
-------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $ .30 $ .19 $ .81 $ .47
-------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ .28 $ .18 $ .76 $ .45
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Nominal warrants are warrants with an exercise price of $.03.
7. Reclassifications
Certain prior year amounts have been reclassified to conform with the 1998
presentation.
8
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information contained herein contains "forward-looking statements" (as such term
is defined in the Private Securities Litigation Reform Act of 1995) 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
other variations thereon or comparable terminology. Certain statements contained
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other sections herein, including without limitation, statements
regarding the Company's liquidity and capital resources and other statements
contained herein regarding matters that are not historical facts, are
forward-looking statements. No assurance can be given that the future results
covered by the forward-looking statements will be achieved. The matters set
forth in Exhibit 99.0 to the Company's Form 10-K for the year ended December 31,
1997, constitute cautionary statements identifying important 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.
FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
Results of Operations
Net Income
Net income in the third quarter of 1998 increased to $2,618,000 or $.30 basic
earnings per share and $.28 diluted earnings per share compared to net income of
$1,608,000 or $.19 basic and $.18 diluted earnings per share in the third
quarter of 1997. Net income in the first nine months of 1998 was $7,153,000 or
$.81 basic earnings per share and $.76 diluted earnings per share compared to
net income of $3,843,000 or $.47 basic earnings per share and $.45 diluted
earnings per share in the first nine months of 1997.
Following is a discussion of factors which affected results of operations for
the three-month and nine-month periods ended September 30, 1998 and 1997.
Revenues
Consolidated revenues in the third quarter of 1998 increased 20% to $14,283,000
from $11,933,000 in the third quarter of 1997. Revenues in the first nine months
of 1998 increased 31% to $43,012,000 from $32,720,000 in the first nine months
of 1997. During the third quarter and first nine months of 1998, two of the
Company's major customers accounted for 58% and 38% and 56% and 39%,
respectively, of revenues.
9
<PAGE>
Results of Operations (continued)
Domestic revenues increased 22% to $13,738,000 in the third quarter of 1998 from
$11,274,000 in the third quarter of 1997 and increased 35% to $41,177,000 in the
first nine months of 1998 from $30,403,000 in the first nine months of 1997.
Revenue growth was slower in the third quarter of 1998 as compared with the two
preceding quarters of 1998 due to: (i) the Company's decision to perform the
annual shutdown of its allograft tissue processing facility in the quarter,
which lasted for approximately two weeks and impacted the Company's ability to
ship base allograft tissue products to its clients and (ii) the traditional
slowdown in surgical procedures in July and August which impacted demand for the
Company's proprietary Grafton(R) (DBM) in the quarter. In 1997, the facility
shutdown occurred during the second quarter. The net increase in domestic
revenues resulted principally from increased demand for the Company's
proprietary Grafton(R) (DBM) allograft processing services which increased 32%
in the third quarter of 1998 and 50% in the first nine months of 1998 as
compared to the same periods in 1997.
Foreign non-allograft revenues decreased 17% in the third quarter of 1998 to
$545,000 from $659,000 in the third quarter of 1997 and decreased 21% in the
nine months ended September 30, 1998 to $1,835,000 from $2,317,000 in the nine
months ended September 30, 1997. The decrease in foreign revenues resulted
principally from lower ceramic product revenues and, in accordance with a
license agreement entered into in 1997 related to the Company's PolyActive
patents and technology, lower licensing fee revenues. Additionally, orthopaedic
coating revenues decreased due to European summer slowdown in surgical
procedures, and in the nine months, the temporary closing of one of the
Company's major coating customer's facility in conjunction with the relocation
of such facility.
Cost of Services and Products
Cost of services as a percentage of service revenues was 28% and 30% in the
third quarter and first nine months of 1998, respectively, compared to 34% and
35% in the same periods last year. The decline in costs as a percentage of
revenues as compared with the same periods last year results from an increased
percentage of revenue coming from services with higher gross margins, operating
efficiencies resulting from increased volume and an increase in fees charged to
the Company's customers for certain allograft processing services.
Cost of products as a percentage of product revenues was 82% and 73% in the
third quarter and first nine months of 1998, respectively, compared to 64% and
72% in the same periods last year. The changes in costs as a percentage of
product revenues during the third quarter and first nine months of 1998 results
primarily from a shift in product mix.
Marketing, General and Administrative
Marketing, general and administrative expenses increased $534,000 or 12% in the
third quarter and $3,486,000 or 29% in the first nine months of 1998, compared
to the same periods last year. The increases were primarily attributable to
expanded marketing and promotional activities, increased agent commissions
directly related to the increase in Grafton(R) DBM revenues and increased
administrative costs, principally outside professional services.
10
<PAGE>
Research and Development
Research and development expenses increased $218,000 or 25% and $598,000 or 22%
in the third quarter and first nine months of 1998, respectively, compared to
the same periods last year. The increases result principally from increased
spending associated with the future expansion of the Company's viral
inactivation process to a broader range of allograft bone tissue and the
development of new allograft bone tissue products, certain of which are expected
to be introduced into the market before the end of 1998.
Other Income (expense)
In the third quarter and first nine months of 1998, other income increased by
$111,000 and $478,000, respectively, compared to the same periods last year due
to higher invested cash and lower outstanding debt balances.
Income Tax Provision
The Company's effective income tax rate was 42% and 41%, respectively, in the
third quarter and first nine months of 1998 compared to 41% in both periods last
year. The effective income tax rate in the third quarter of 1998 was impacted by
foreign losses for which no current tax benefit was available.
Liquidity and Capital Resources
At September 30, 1998, the Company had cash and short-term investments of
$19,353,000 compared to $15,357,000 at December 31, 1997. Working capital
increased $4,604,000 to $24,526,000 at September 30, 1998 from $19,922,000 at
December 31, 1997.
Net cash provided by operations was $12,260,000 in the first nine months of
1998, compared to $7,531,000 in the first nine months of 1997. The increase
resulted primarily from improved earnings in 1998 and a reduction in prepaid
income taxes.
Cash used in investing activities increased to $6,518,000 in the first nine
months of 1998 from $1,527,000 in the first nine months of 1997. The increase
results principally from capital expenditures that increased to $4,326,000 from
$2,443,000 as the Company continues to invest in facilities and equipment needed
for current and future business requirements and a net increase in short-term
investments of $1,446,000. The Company plans to commence construction of a new
processing facility which it expects to occupy by the end of 1999 at an
aggregate anticipated cost of approximately $25 million. The Company plans to
fund the construction of this facility primarily from the new credit facility
described below.
Net cash used in financing activities increased by $3,790,000 in the first nine
months of 1998, principally as a result of cash used to repurchase and retire
245,000 shares of common stock at a cost of $4,958,000.
11
<PAGE>
Liquidity and Capital Resources (continued)
The Company has a loan and security agreement with a US bank which provides for
borrowings of up to $3,000,000 under a revolving line of credit and $4,000,000
under an equipment line of credit. At September 30, 1998, $294,000 was
outstanding under the equipment line of credit and there were no borrowings
outstanding under the revolving line of credit. In July 1998, the Company
received a commitment from the same bank for a new credit facility which will
replace the current facilities which expire in December 1998. The new credit
facility will include a $5,000,000 revolving line of credit and a $21,500,000
building mortgage loan and equipment line of credit which the Company will use
to fund the planned construction of a new processing facility. Consummation of
the new credit facility is subject to negotiation and execution of a definitive
agreement. The Company also has a line of credit with a Dutch bank which
provides for borrowings of up to 5,000,000 Dutch Guilders ("dfl"), or
approximately $2,657,000 at the September 30, 1998 exchange rate. Analysis of
the Company's cash position and anticipated cash flow indicated that it most
likely would not be necessary to utilize a significant portion of the line of
credit and, therefore, the Company agreed with the bank to limit its borrowings,
if any, to no more than dfl 3,000,000, or approximately $1,594,000 at the
September 30, 1998 exchange rate. There were no borrowings under this credit
line as of September 30, 1998.
The Company believes that its cash and cash equivalents, short-term investments
and available lines of credit, together with anticipated future cash flow from
operations, will be sufficient to meet its near-term requirements. From time to
time the Company may seek additional funds through equity or debt financing.
However, there can be no assurances that such additional funds will be available
to the Company, or if available, that such funds will be available on terms
favorable to the Company.
Impact of Inflation and Foreign Currency Exchange Fluctuations
The results of the Company's operations for the periods discussed above have not
been significantly affected by inflation or foreign currency fluctuations.
Year 2000
The Company recognizes the need to ensure that Year 2000 issues will not
adversely impact its operations and has identified its potential Year 2000 risk
in three categories: internal business software and hardware; internal
non-financial software and hardware; and external noncompliance by suppliers and
customers.
INTERNAL BUSINESS SOFTWARE AND HARDWARE. During 1994, the Company determined
that its existing business systems were not adequate to support the anticipated
growth in the Company's business operations and purchased a fully integrated
management information system, which is Year 2000 compliant. Implementation of
the new system commenced in 1995 and most of the system is operational at this
time. Full implementation of the remainder of the system is scheduled for June
30, 1999. The completion cost for implementation of the remaining software is
not expected to be material. All related hardware used to support internal
business software is currently Year 2000 compliant. As a result, the Company
does not believe that it requires a contingency plan with respect to its
internal business systems, and therefore has not developed one, however, if
significant risks are identified or progress deviates from the anticipated
timeline, the Company will develop contingency plans as deemed necessary at that
time.
12
<PAGE>
INTERNAL NON-FINANCIAL SOFTWARE. The Company is currently assessing the
potential effect of, and cost of remediating internal non-financial software and
hardware such as fax machines, photocopiers, telephone systems, security systems
and other business equipment and believes that minimal changes will be required
for Year 2000 compliance. The Company expects to be in full compliance with its
internal non-financial systems before the year 2000 and further anticipates that
the cost to achieve such compliance is not expected to be material.
SUPPLIERS AND CUSTOMERS. The Company has initiated written communications with
all of its significant suppliers and customers to determine the extent to which
the Company is vulnerable to those third parties' failure to remediate their own
Year 2000 issues. To the extent that the Company does not receive adequate
responses by December 31, 1998, it will develop contingency plans with respect
to the affected suppliers and, or customers. At this time the Company cannot
estimate the additional cost, if any, that may result from such contingency
plans.
Based on the progress the Company has made in addressing its Year 2000 issues,
it does not foresee significant risks associated with its year 2000 compliance
program at this time. Although the Company expects to be compliant before the
year 2000, there is no guarantee that these results will be achieved. Partial or
total business systems interruption or the inability of a significant supplier
or customer to achieve Year 2000 compliance could have a material adverse effect
on the Company's business operations, financial condition, results of operations
and business prospects.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
13
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
"O" Company, Inc. v. Osteotech, Inc., Case No. Civ. 98-981 BB/LFG (United
States District Court for the District of New Mexico)
On July 16, 1998, the Company received a complaint that was filed against
it in the Second Judicial District Court, Bernallilo County, New Mexico.
The complaint alleges negligence, strict liability, breach of warranty,
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 a subsidiary of the Company,
Cam Implants BV. Plaintiffs have demanded monetary damages. On August 14,
1998, the Company removed this action to the United States District Court
for the District of New Mexico. On August 24, 1998, the Company filed and
served its answer, denying any and all liability in this action, and moved
to dismiss five of the seven claims alleged against it in this action -
negligence, strict liability, negligent misrepresentation, fraud, and
violation of the New Mexico Unfair Trade Practices Act. The motion remains
sub judice. On November 5, 1998, the Company moved for summary judgment in
its favor on all of the claims alleged in this action, on the ground that
all of plaintiffs' claims are barred by their applicable statutes of
limitations. The Company believes that the claims against it are without
merit and will continue to vigorously defend against such claims.
Patent Infringement Litigation
The following development occured in the previously reported patent
infringement litigation between the Company and GenSci Regeneration
Laboratories, Inc. and GenSci Regeneration Sciences, Inc. during the
quarter ended September 30, 1998. In September 1998, GenSci Regeneration
Laboratories, Inc. served an amended complaint against the Company which
asserted, in addition to the previously asserted claims, claims of false
advertising under Federal law. In September 1998, the Company served its
answer to this amended complaint, asserted counterclaims against GenSci
Regeneration Laboratories, Inc. and served a third-party complaint against
GenSci Regeneration Sciences, Inc. DePuy, Inc. and DePuy Motech, Inc. The
Company's counterclaims and third party complaint accuses the GenSci
parties of infringing a second Company patent and accuses the DePuy and
GenSci parties of acting jointly and severally in infringing the claims of
both such patents.
14
<PAGE>
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
------ ----------- ------
10.22 Lease for the Company's
Shrewsbury, New Jersey Facility E-1
27.0 Financial Data Schedule E-11
(b) Reports on Form 8-K
On July 15, 1998, the Company filed with the Commission a current
report on Form 8-K to announce that on June 26, 1998 the Company's
Board of Directors had authorized the repurchase and retirement of up
to $5 million of the Company's common stock through open market
purchases which will be made from time to time as market conditions
allow. There were approximately 8,860,832 shares of common stock
issued and outstanding as of May 31, 1998. Additionally, Osteotech
announced on July 2, 1998 that it will acquire a majority interest in
OST Developpement SA, ("OST") a subsidiary of Transphyto SA of
Clermont-Ferrand, France, in a two step transaction. On June 25, 1998,
Osteotech acquired a 5% interest in OST, and will acquire an
additional 85% interest no later than March 1999, provided that
certain milestones are achieved by OST. The aggregate cost of the
transaction will be FF 9,000,000 (about $1.5 million at current
exchange rates). The acquisition will not be dilutive to Osteotech in
1998, and is expected to contribute about $4 million in revenues and
be accretive to net income in 1999. The agreement also provides for
the future purchase by Osteotech of the remaining 10% of OST at a
price to be determined at the time of the acquisition of the remaining
shares.
On September 21, 1998, the Company filed with the Commission a current
report on Form 8-K to announce that the Company amended its patent
infringement lawsuit against GenSci Regeneration Laboratories, Inc.
and its parent GenSci Regeneration Sciences, Inc. ("GenSci"), to
include as defendants DePuy Inc. and DePuy Motech, Inc. ("DePuy"). In
its amendment to the lawsuit, the Company accuses GenSci of infringing
the claims of a second patent and states that DePuy is infringing the
claims of the two patents as a result of DePuy offering for sale
products made and distributed by GenSci marketed under the names
DynaGraft Gel and DynaGraft Putty. DePuy is the North American
marketing and sales agent for GenSci's DynaGraft products.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Osteotech, Inc.
-------------------------------------
(Registrant)
Date: November 12, 1998 By: /s/ RICHARD W. BAUER
-------------------------------------
Richard W. Bauer
President, Chief
Executive Officer
Date: November 12, 1998 By: /s/ MICHAEL J. JEFFRIES
-------------------------------------
Michael J. Jeffries
Executive Vice President
Chief Operating Officer
Chief Financial Officer
SIXTH MODIFICATION OF LEASE
AGREEMENT (herein this "Sixth Lease Modification"), made this 11th day of
August, 1998, by and between SBC HOLDINGS L.P., having their office and Post
Office Address c/o National Realty & Development Corp., 3 Manhattanville Road,
Purchase, New York 10577 (hereinafter referred to as "Landlord") and OSTEOTECH,
INC., a Delaware corporation, having an office at 51 James Way, Eatontown, New
Jersey 07724 (hereinafter referred to as "Tenant").
W I T N E S S E T H:
WHEREAS, Landlord (as successor-in-interest to Robert C. Baker, et al.)
and Tenant are parties to that certain Lease dated August 18, 1986 as modified
by First Modification of Lease dated May 31, 1989, Second Modification of Lease
dated December 22, 1989, Third Modification of Lease dated June 21, 1991, Fourth
Modification of Lease dated January 30, 1992 and Fifth Modification of Lease
dated October 16, 1996 between Landlord and Tenant (said lease as modified is
hereinafter referred to as the "Lease") respecting certain premises (hereinafter
referred to as the "DEMISED PREMISES") within the buildings commonly known as
1151 Shrewsbury Avenue and 1163 Shrewsbury Avenue (the "Buildings") in the
BOROUGH OF SHREWSBURY, COUNTY OF MONMOUTH and STATE OF NEW JERSEY which premises
are more particularly described in the Lease; and
WHEREAS, the parties hereto desire to further modify the Lease in certain
respects as hereafter provided.
NOW, THEREFORE, in consideration of ONE AND 00/100 ($1.00) DOLLAR and other
good and valuable consideration, each to the other in hand duly paid, the
receipt and sufficiency whereof is hereby acknowledged, it is mutually agreed as
follows:
1. The Plot Plan of 1163 Shrewsbury Avenue presently annexed to the Lease
as Exhibit "A-1" is hereby deleted therefrom and the Plot Plan of 1163
Shrewsbury Avenue annexed hereto as Exhibit "A-1" is hereby substituted in lieu
thereof. The attached Exhibit "A-1" shows an area consisting of approximately
7,750 square feet located in the building known as 1163 Shrewsbury Avenue
situated within Lot No. 3/1, which area is cross-hatched on Exhibit "A-1" and is
hereinafter referred to as the "Additional Premises". Upon the Effective Date
(as hereinafter defined), the Additional Premises shall be deemed to be part of
the Demised Premises, as if originally included
E-1
<PAGE>
within the Demised Premises, as the same is defined by the Lease. The overall
square footage of the Demised Premises shall be increased to approximately
36,710 square feet. Tenant has examined the Additional Premises and has made a
complete inspection of the same and is familiar with the physical condition
thereof as of this date. Landlord has not made and does not make any
representation as to the physical condition or any other matter affecting or
relating to the Additional Premises except as provided below. Tenant agrees to
accept the Additional Premises "as-is".
2. The Effective Date shall be the date upon which Landlord delivers
possession of the Additional Premises to Tenant .
3. The Term of the Lease is hereby extended to that date which is the tenth
(10th) anniversary of the last day of the calendar month in which the Effective
Date shall occur (the "Expiration Date").
4. From and after the Effective Date, the annual minimum rental payable
pursuant to Article 3 of the Lease, and in accordance with and subject to the
provisions of the Lease, shall be as follows (subject to the provisions of
Paragraph 7 hereof):
(A) From the Effective Date through the day before the Fifth (5th)
anniversary of the Effective Date: THREE HUNDRED EIGHT THOUSAND SIX
HUNDRED SEVENTY AND 00/100 ($308,670.00) DOLLARS per annum - TWENTY
FIVE THOUSAND SEVEN HUNDRED TWENTY TWO AND 50/100 ($25,722.50) DOLLARS
per month. Notwithstanding the foregoing, in consideration for the
performance of Tenant's Work (as hereinafter defined), Tenant shall
receive a rent credit of $15,000.00 against the rentals payable during
the month next following the date upon which Tenant shall have
completed the Tenant's Work and shall have delivered to Landlord the
documentation required pursuant to Paragraph 5 below:
(B) From the Fifth (5th) anniversary of the Effective Date through the
Expiration Date: THREE HUNDRED FORTY FOUR THOUSAND THREE HUNDRED FORTY
AND 00/100 ($344,340.00) DOLLARS per annum - TWENTY EIGHT THOUSAND SIX
HUNDRED NINETY FIVE AND 00/100 ($28,695.00) DOLLARS per month.
E-2
<PAGE>
5. Following written notice given by Landlord to Tenant after the Effective
Date (such notice is hereinafter called the "Landlord's Work Notice"), Tenant
shall perform, in the Additional Premises and the premises adjacent to the
Additional Premises (which adjacent premises are designated on Exhibit A-1 as
the "Remaining Programmer's Paradise Space") the work described in Exhibit B
annexed hereto. Within thirty (30) days from the date of execution and delivery
of this Sixth Lease Modification, Tenant shall prepare and submit plans for the
Tenant's Work to Landlord for Landlord's approval. Tenant covenants and agrees
that Tenant shall commence the performance of the Tenant's Work within ten (10)
days following Tenant's receipt of notice from Landlord that Landlord has
approved the plans and specifications for the performance of the Tenant's Work,
and thereafter Tenant shall diligently prosecute such Tenant's Work and complete
same as soon as possible, but in no event more than thirty (30) days from and
after the date of the Landlord's Work Notice. Tenant's Work shall be effected
solely in accordance with the plans and specifications approved by Landlord.
Tenant's Work shall be performed in accordance with all of the provisions of the
Lease, including, without limitation, the provisions of Articles 6, 7 and 19
thereof. During the progress of Tenant's Work, Tenant's Work shall be subject to
inspection by representatives of Landlord, who shall be permitted access and the
opportunity to inspect at all reasonable times, but this provision shall not in
any way whatsoever create any obligation on Landlord to conduct an inspection or
impose any liability on Landlord for the failure of any such Tenant's Work. Upon
completion of Tenant's Work, Tenant shall submit to Landlord in form and
substance satisfactory to Landlord and counsel for Landlord the following:
(a) A Certificate of Completion by a licensed architect or engineer,
which Certificate shall certify that all Tenant's Work has been completed
in accordance with the approved plans and specifications;
(b) A certificate by Tenant that the entire cost of Tenant's Work has
been paid and the amount thereof, that all those who furnished work or
materials have been paid in full, and that no party has filed any lien or
possesses any claim which is unpaid or remains undischarged;
(c) A Certificate of Occupancy, or an equivalent permit or
certificate, required by any governmental authorities for the occupancy of
the Additional Premises and the Remaining Programmer's Paradise Space;
E-3
<PAGE>
(d) A final release and lien waiver signed by Tenant's general
contractor and all subcontractors and materialmen, together with a
certificate by the general contractor to the effect that all those who
furnished work or materials to the Additional Premises and the Remaining
Programmer's Paradise Space have been paid in full and that the release and
waiver has been signed by all those who furnished work or materials to the
Additional Premises and the Remaining Programmer's Paradise Space; and
(e) Final and complete "as-built" plans (architectural and mechanical)
evidencing the Tenant's Work.
In the event that Landlord shall determine, in its sole and absolute
discretion, that Tenant is not proceeding diligently with the performance of
Tenant's Work or has otherwise defaulted in its obligations under this Paragraph
4 or under the Lease, in addition to any other remedies that Landlord may have
under the Lease as a result of Tenant's default, Landlord shall have the right,
but shall not be obligated to, perform the Tenant's Work on Tenant's behalf and
at Tenant's sole cost and expense. Tenant shall reimburse Landlord, within five
(5) days following billing therefor, for any and all costs and expenses incurred
by Landlord (including administrative and overhead charges) in the performance
of Tenant's Work.
6. Notwithstanding anything to the contrary contained therein, Section
31.01 of the Lease is hereby modified to provide that for the purposes of this
Lease, as of the Effective Date, 15,197 square feet is deemed to be leased as
office space and 21,513 square feet is deemed to be leased as non-office or
processing space.
7. Landlord and Tenant acknowledge that, pursuant to letter dated May 6,
1998, Tenant has exercised its option under paragraph 3 of the Fifth
Modification of Lease dated October 16, 1996 between Landlord and Tenant, to
lease the approximate 7,040 square foot premises presently occupied by Asbury
Park Press at 1151 Shrewsbury Avenue, which leasing shall commence, and the
annual minimum rental payable under the Lease shall increase, from and after the
date that Landlord delivers possession of such premises to Tenant.
Notwithstanding anything to the contrary set forth in paragraph 3 of said Fifth
Modification of Lease, in the event that the lease of the Asbury Park Press
premises commences following the Effective Date of this Sixth Lease Modification
(as defined herein), the annual minimum rental amount set forth in Paragraph 3
(b) (ii) (A) of said Fifth Modification of Lease shall be changed to $366,750.00
per annum ($30,562.50 per month), and the
E-4
<PAGE>
annual minimum rental amount set forth in 3(b)(ii)(B) shall be changed to
$409,950.00 per annum ($34,162.50 per month). Similarly, notwithstanding
anything to the contrary set forth in this Sixth Lease Modification, if the
Effective Date (as defined herein) occurs following the commencement date of the
leasing of the Asbury Park Press premises (as determined by paragraph 3 of said
Fifth Modification of Lease), the annual minimum rental amount set forth in
Paragraph 4(A) of this Sixth Lease Modification shall be changed to $366,750.00
per annum ($34,162.50 per month), and the annual minimum rental set forth in
4(B) of this Sixth Lease Modification shall be changed to $409,950.00
($34,162.50 per month). Upon the commencement date of the leasing of the Asbury
Park Press premises following the Effective Date, the overall square footage of
the Demised Premises shall be increased to 43,750 square feet, and Section 31.01
of the Lease shall be modified to provide that for the purposes of this Lease,
17,504 square feet is deemed to be leased as office space, and 26,246 square
feet is deemed to be leased as non-office space or processing space.
8. Tenant acknowledges that, as of the Effective Date, Tenant's
proportionate share of additional rent payable under the Lease shall be
adjusted, pursuant to the terms of the Lease, to reflect the increase in the
square footage of the Demised Premises.
9. In the event that the Effective Date has not occurred within one (1)
year from the date hereof, thereafter Landlord or Tenant shall have the right,
upon notice given by the other prior to the Effective Date, to terminate this
Sixth Lease Modification. Notwithstanding anything to the contrary set forth
herein, upon termination of this Sixth Lease Modification, Landlord and Tenant
shall be released from all obligations under this Sixth Lease Modification and
the Lease shall remain in full force and effect as if this Sixth Lease
Modification had not been entered into between Landlord and Tenant.
E-5
<PAGE>
10. Except as expressly modified herein, all of the provisions, covenants,
conditions and agreements set forth in the Lease shall continue in full force
and effect.
IN WITNESS WHEREOF, the parties have caused this Sixth Modification of
Lease to be executed as of the day and year first above written.
ATTEST: SBC HOLDINGS L.P.,
a Delaware limited partnership
By: SBC BUILDING CORP.,
a Delaware corporation, General Partner
/s/ Ava Saltis By: /s/ Robert C. Baker
- ---------------------------- --------------------------------
Title: President
--------------------------------
ATTEST: OSTEOTECH, INC.
/s/ Steven T. Sobieski By: /s/ Michael Jeffries
- ---------------------------- --------------------------------
Treasurer Exec. Vice President
E-6
<PAGE>
STATE OF NEW YORK )
SS:
COUNTY OF WESTCHESTER )
BE IT REMEMBERED, that on this 11th day of August, 1998, before me, the
subscriber, A Notary Public of the State of New York, personally appeared Robert
C. Baker, President of SBC BUILDING CORP., general partner of SBC HOLDINGS L.P.,
who, I am satisfied, is the person who signed the within instrument; and I
having first made known to him the contents thereof, he thereupon acknowledged
that he signed, sealed with the corporate seal, and delivered the said
instrument as such officer aforesaid, and that the within instrument is the
voluntary act and deed of said corporation as general partner of SBC HOLDINGS
L.P., made by virtue of the authority of its board of directors.
/s/ Richard A. Kaufman
-----------------------------------------
NOTARY PUBLIC
Stamp: RICHARD A. KAUFMAN
Notary Public, State of New York
No. 4875196
Qualified in Westchester County
Commission Expires October 6, 1998
STATE OF NEW JERSEY )
SS:
COUNTY OF MONMOUTH )
BE IT REMEMBERED, that on this 14th day of July, 1998, before me, the
subscriber, personally appeared Michael J. Jeffries, EVP of OSTEOTECH, INC.,
who, I am satisfied, is the person who signed the within instrument; and I
having first made known to him the contents thereof, he thereupon acknowledged
that he signed, sealed with the corporate seal, and delivered the said
instrument as such officer aforesaid, and that the within instrument is the
voluntary act and deed of said corporation, made by virtue of the authority of
its board of directors.
/s/ Linda Manning Savoca
-----------------------------------------
NOTARY PUBLIC
Stamp: LINDA MANNING SAVOCA
Notary Public of New Jersey
No. 2102832, Ocean County
Commission Expires July 27, 2002
E-7
<PAGE>
EXHIBIT A-1
Diagram/Map of the Plot Plan of 1163 Shrewsbury Avenue
E-8
<PAGE>
Map of Existing Osteotech
<PAGE>
EXHIBIT B
TENANT'S WORK
Tenant agrees to perform the work set forth below in accordance with the
provisions of the Lease and the attached Sixth Modification of Lease.
1. Construct or restore fire wall to separate the Additional Premises from the
Remaining Programmer's Paradise Space.
2. Re-paint office portion of the Remaining Programmer's Paradise Space (two
coats - choice of color by Programmer's Paradise).
3. Tenant will include in its building plans for the Tenant's Work a new 8' x
8' (or smaller, at the option of Programmer's Paradise) UPS door, at the
rear of the warehouse, it being understood, however, that the construction
of such door is not part of Tenant's Work.
4. Tenant shall separate and provide for separate metering of the utilities
for the Additional Premises and the Remaining Programmer's Paradise Space,
inclusive of the HVAC system which shall be divided in a proportionate
manner between the two premises.
5. Tenant shall remove mezzanine shelving platforms used by Programmer's
Paradise in the Additional Premises, and reinstall same in the Remaining
Programmer's Paradise Space.
6. The doors which will be removed by Tenant to restore the fire wall shall be
delivered to Programmer's Paradise immediately upon their removal.
7. Tenant will remove and replace carpeting (selection by Programmer's
Paradise - comparable to existing) in the office area of the Remaining
Programmer's Paradise Space.
8. Tenant shall coordinate the performance of Tenant's Work with Programmer's
Paradise, as needed, including scheduling and performing Tenant's Work in a
manner that will minimize any disruption in the conduct of business by
Programmer's Paradise in the Remaining Programmer's Paradise Space.
E-9
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Osteotech, Inc. and Subsidiaries Consolidated Balance Sheet as of September 30,
1998 and the Condensed Consolidated Statement of Operations for the nine months
ended September 30, 1998 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 16,434,000
<SECURITIES> 2,919,000
<RECEIVABLES> 8,355,000
<ALLOWANCES> 150,000
<INVENTORY> 1,243,000
<CURRENT-ASSETS> 34,850,000
<PP&E> 24,749,000
<DEPRECIATION> 10,488,000
<TOTAL-ASSETS> 52,929,000
<CURRENT-LIABILITIES> 10,324,000
<BONDS> 0
0
0
<COMMON> 89,000
<OTHER-SE> 42,108,000
<TOTAL-LIABILITY-AND-EQUITY> 52,929,000
<SALES> 803,000
<TOTAL-REVENUES> 43,012,000
<CGS> 584,000
<TOTAL-COSTS> 31,725,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 64,000
<INCOME-PRETAX> 12,173,000
<INCOME-TAX> 5,020,000
<INCOME-CONTINUING> 7,153,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,153,000
<EPS-PRIMARY> .81
<EPS-DILUTED> .76
</TABLE>
