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, 2000
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 - 13,963,480 shares as of October 31, 2000.
<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,
2000 1999
--------------------------------------
ASSETS
---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 12,857 $ 16,770
Short-term investments 1,935 3,946
Accounts receivable, net 12,575 15,095
Inventories 2,801 3,405
Deferred processing costs 5,725 5,310
Prepaid expenses and other current assets 3,060 5,787
--------------------------------------
Total current assets 38,953 50,313
Property, plant and equipment, net 51,623 33,995
Excess of cost over net assets of business
acquired, less accumulated amortization
of $2,379 in 2000 and $2,089 in 1999 3,392 3,682
Other assets 2,172 1,740
---------------------------------------------------------------------------------------------------------
Total assets $ 96,140 $ 89,730
=========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
---------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable and accrued liabilities $ 8,933 $ 13,231
--------------------------------------
Total current liabilities 8,933 13,231
Long-term debt 15,019 6,359
Other liabilities 742 734
---------------------------------------------------------------------------------------------------------
Total liabilities 24,694 20,324
---------------------------------------------------------------------------------------------------------
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; 70,000,000 shares
authorized; issued and outstanding 13,963,480
shares in 2000 and 14,194,126 shares in 1999 138 140
Additional paid-in capital 46,358 48,837
Accumulated other comprehensive loss (579) (376)
Retained earnings 25,529 20,805
---------------------------------------------------------------------------------------------------------
Total stockholders' equity 71,446 69,406
---------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 96,140 $ 89,730
=========================================================================================================
</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,
------------------------------ ------------------------------
2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues:
Service $ 17,268 $ 16,770 $ 54,799 $ 53,596
Product 648 699 2,382 2,163
License fee 118
----------- ----------- ----------- -----------
17,916 17,469 57,181 55,877
Cost of services 6,132 5,204 17,934 16,330
Cost of products 864 439 2,015 1,285
----------- ----------- ----------- -----------
6,996 5,643 19,949 17,615
----------- ----------- ----------- -----------
Gross Profit 10,920 11,826 37,232 38,262
Marketing, general and administrative 9,228 6,956 25,960 20,019
Research and development 1,427 1,310 4,474 4,248
----------- ----------- ----------- -----------
10,655 8,266 30,434 24,267
Income from litigation settlement 250 1,750 750 1,750
----------- ----------- ----------- -----------
Operating income 515 5,310 7,548 15,745
Interest and other income, net 290 208 875 636
----------- ----------- ----------- -----------
Income before income taxes 805 5,518 8,423 16,381
Income tax provision 574 2,270 3,699 6,631
------------------------------------------------------------------------------------------------------------------------------------
Net income $ 231 $ 3,248 $ 4,724 $ 9,750
====================================================================================================================================
Net income per share:
Basic $ .02 $ .23 $ .34 $ .70
Diluted $ .02 $ .22 $ .33 $ .67
------------------------------------------------------------------------------------------------------------------------------------
Shares used in computing net income per share:
Basic 13,960,228 14,174,402 14,085,310 13,969,901
Diluted 14,249,133 14,641,259 14,403,949 14,639,183
</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, 2000 1999
------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flow From Operating Activities
Net income $ 4,724 $ 9,750
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization 3,137 2,201
Loss on disposal of fixed assets 11
Provision for doubtful accounts 3
Income tax benefit related to stock options 32 3,365
Changes in current assets and liabilities:
Accounts receivable 2,388 1,403
Inventories 528 (1,451)
Deferred processing costs (415) (2,104)
Prepaid expenses and other current assets 2,650 396
Litigation settlement receivable (2,000)
Accounts payable and other liabilities (3,981) 913
------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 9,077 12,473
Cash Flow From Investing Activities
Capital expenditures (20,509) (13,537)
Purchases of investments (3,877) (11,634)
Proceeds from sale of investments 5,888 10,610
Acquisition of business (1,526)
Increase in other assets (540) (859)
------------------------------------------------------------------------------------------------------
Net cash used in investing activities (19,038) (16,946)
Cash Flow From Financing Activities
Proceeds from issuance of common stock 608 4,854
Repurchase of common stock (3,121)
Proceeds from issuance of notes payable 116
Principal payments on notes payable (693)
Proceeds from long-term debt 8,660 3,000
Principal payments on long-term debt (758)
(Decrease)increase in other liabilities (100) 171
------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 6,047 6,690
Effect of exchange rate changes on cash 1 (78)
------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (3,913) 2,139
Cash and cash equivalents at beginning of period 16,770 15,119
------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 12,857 $ 17,258
======================================================================================================
Supplementary cash flow data:
Cash paid during the period for interest $ 494 $ 29
Cash paid during the period for taxes 1,882 2,114
Acquisition of business:
Fair value of assets acquired 2,563
Liabilities assumed 2,669
</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, 2000 and December 31,
1999, the consolidated results of operations for the three-month and
nine-month periods ended September 30, 2000 and 1999, 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, 1999 which were
included as part of the Company's Annual Report on Form 10-K.
2. Inventories
Inventories consist of the following:
September 30, December 31,
(dollars in thousands) 2000 1999
--------------------------------------------------------------------------
Raw Materials and Supplies $ 1,184 $ 912
Finished Goods 1,617 2,493
--------------------------------------------------------------------------
$ 2,801 $ 3,405
--------------------------------------------------------------------------
3. Comprehensive Income
Comprehensive income for the three-month and nine-month periods ended
September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
--------------------------------------------------
(dollars in thousands) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $231 $3,248 $4,724 $9,750
Currency translation adjustments (77) 189 (203) (93)
-------------------------------------------------------------------------------------------
Comprehensive Income $154 $3,437 $4,521 $9,657
============================================================================================
</TABLE>
4. Stock Repurchase Program
In May 2000, the Board of Directors of the Company authorized the
repurchase and retirement of up to 1,000,000 shares of the Company's common
stock through open market purchases, or block purchases. As of September
30, 2000, the Company had repurchased and retired 330,500 shares of common
stock at a cost of approximately $3,121,000.
5
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies
Service Contracts
In September 2000, the Company entered into a new five-year agreement with
the Musculoskeletal Transplant Foundation ("MTF"). This new agreement
replaces the current agreement which would have expired March 31, 2002.
Under the new agreement MTF will no longer be required to exclusively
provide all donor tissue it recovers to Osteotech for processing. The new
agreement expires on August 31, 2005, and provides that either party has
the right to terminate the agreement commencing March 31, 2002 upon six
months prior written notice. Also, under the terms of the new agreement,
Osteotech will have the ability to directly contract with tissue recovery
organizations for the processing of tissue recovered by those
organizations.
In June 2000, the Company entered into an exclusive five-year processing
agreement with Bone Bank Allografts ("BBA") of San Antonio, Texas. BBA,
which is a tissue bank accredited by the American Association of Tissue
Banks, coordinates the procurement and distribution of allograft bone
tissue nationally, with a focus in the Southern region of the United
States.
Purchase Commitments
In September 2000, the Company entered into a non-cancelable 2-year
agreement with Heinrich C. Ulrich, K.G. ("Ulrich") for the purchase of
$3,000,000 of inventory of a spinal vertebral body replacement system ("VBR
System"), which the Company expects to begin marketing in the United States
in the first quarter of 2001. An initial order of $875,300 is expected to
be delivered by the end of December 2000.
Litigation
GenSci Regeneration Laboratories, Inc. v. Osteotech, Inc.; Osteotech, Inc.
v. GenSci Regeneration Sciences, Inc.
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 the GenSci
parties violated claims of one of the patents involving the Company's
Grafton(R) Demineralized Bone Matrix (DBM) process. Approximately two weeks
after the Company's filing, GenSci Labs filed a suit against the Company
alleging 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 the Company's patents
U.S. Patent Nos. 5,284,655 and 5,290,558 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. In August 1998, the actions were consolidated into one
case before the United States District Court for the Central District of
California.
6
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies (continued)
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, and DePuy AcroMed,
Inc.("DePuy"). The Company's counterclaims and third party complaint
accused the GenSci parties of infringing a second Company patent, in
addition to the patent referred to above, and accused the GenSci parties
and DePuy of acting jointly and severally in infringing on the claims of
both patents.
In May 1999, GenSci Labs amended its complaint to allege that in addition
to the Company's Grafton(R) DBM Flex product, the Company's Grafton(R) DBM
Gel and Putty products infringe on GenSci Lab's patents at issue. GenSci
Labs also amended its complaint to modify its false advertising claim,
alleging that in addition to the Company, individuals acting on the
Company's behalf engaged in false advertising. The Company filed and served
its answer and counterclaims to the amended complaint in May 1999.
In November 1999, the Company settled all claims which it had filed against
DePuy. As part of the settlement, DePuy has agreed to stop selling the
GenSci products accused of infringing the Company's patents, no later than
February 4, 2001 and to pay the Company $3,000,000. Payments of $2,000,000
were received in the fourth quarter of 1999, of which $1,750,000 and
$250,000 was recognized in income in the third and fourth quarters of 1999,
respectively. Further, the Company has received and recognized in income
payments of $250,000 in each of the first three quarters of 2000. In
accordance with the settlement agreement with DePuy, a final payment of
$250,000 is expected to be made in the fourth quarter of 2000.
In April 2000, the Company, GenSci Labs, and GenSci Sciences reached an
agreement to dismiss with prejudice all of GenSci's patent infringement
claims against the Company's proprietary Grafton(R) DBM products and to
stay any action in GenSci's anti-trust suit, which it had filed against the
Company on March 6, 2000, until the completion of the trial of the
Company's patent infringement claims against GenSci. GenSci also agreed to
dismiss all of the tort claims that it had brought against the Company in
its patent lawsuit without prejudice and to transfer the claims to the
anti-trust action. As a result of these dismissals, GenSci will no longer
have any claims against the Company in the patent action. The only
remaining claims in the patent action involve the Company's allegations
that GenSci has infringed certain of the Company's patents through the sale
of the Dynagraft(TM) Gel and Dynagraft(TM) Putty products. This agreement
was subject to court approval, which approval has been received.
In July 2000, the Company filed a motion seeking summary judgment in its
favor on GenSci Labs' and GenSci Sciences' reverse doctrine of equivalents
defense on the bases that the GenSci parties failed to assert that defense
in a timely manner and that the defense is otherwise meritless. The Company
also filed a motion seeking judgment that the portion of the case that
GenSci dismissed with prejudice be ruled as exceptional based on GenSci
Labs having asserted and maintained baseless allegations that Osteotech
infringed GenSci Labs' patents, thus warranting an award of attorneys' fees
and costs to Osteotech.
7
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies (continued)
Also, in July 2000, GenSci filed various motions for summary judgment
seeking orders that GenSci does not infringe on Osteotech's patents and/or
that such patents are invalid.
The Company will continue to vigorously prosecute the claims it has
asserted in this action to protect its products and intellectual property
to the fullest extent possible under the law.
GenSci Orthobiologics, Inc. v. Osteotech, Inc.
On March 6, 2000, GenSci Orthobiologics, Inc. ("GenSci") filed a complaint
in the United States District Court for the Central District of California
against the Company, alleging that the Company engaged in unlawful
monopolization, attempted to monopolize the market for demineralized bone
matrix and entered into agreements in restraint of trade, in violation of
sections 1 and 2 of the Sherman Antitrust Act and Section 3 of the Clayton
Act; and that the Company engaged in unlawful and unfair business practices
in violation of section 17200 of the California Unfair Competition Law.
GenSci has alleged that the Company has monopoly power in the market for
demineralized bone matrix products in the United States, and has engaged in
anticompetitive conduct by improperly asserting its patents through patent
infringement actions, seeking to have the Food and Drug Administration
remove certain of GenSci's products from the market, restricting
competitors' access to raw materials, interfering with GenSci's
arrangements to manufacture demineralized bone matrix implants, interfering
with GenSci's marketing and distribution arrangements, and disparaging
GenSci's products. GenSci seeks compensatory, incidental, consequential,
and punitive damages in an unspecified amount, and injunctive relief to
stop the Company from restricting the tissue banks for which it processes
tissue from (a) supplying processed demineralized bone matrix to
Osteotech's competitors and (b) distributing the demineralized bone matrix
implant products of Osteotech's competitors. Certain of these allegations
had previously been asserted by GenSci in its patent litigation with
Osteotech in the Central District of California federal court.
In April 2000, the Company reached an agreement with GenSci whereby tort
claims that were dismissed from the patent litigation would be transferred
to this action and this action was stayed until the completion of the trial
of the Company's patent infringement claims against GenSci.
The Company believes the claims made in this lawsuit are without merit and
intends to vigorously defend against these claims.
University of Florida Tissue Bank, Inc. v. Osteotech, Inc.
In February 1999, a complaint was filed against the Company in the United
States District Court for the Northern District of Florida. This action,
which has been brought by plaintiffs, University of Florida Tissue Bank,
Inc., Regeneration Technologies, Inc., Sofamor Danek Group, Inc., and
Sofamor Danek L.P. alleges that the Company's bio-d(TM)Threaded Cortical
Bone Dowel and Endodowel infringe on the claims of U.S. Patent No.
5,814,084, entitled "Diaphysical Cortical Dowel." In April 1999, plaintiffs
filed an amended complaint adding a claim for patent infringement against
the Company with
8
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies (continued)
respect to U.S. Patent No. 5,814,084, entitled "Bone Grafting Units", which
is owned by plaintiff University of Florida Tissue Bank, Inc. In May 1999,
the Company filed its answer and counterclaim seeking declaratory judgment
that the patents in question in this action are invalid and otherwise not
infringed by the Company. Although the plaintiffs seek monetary damages, an
amount has not been specified. In May 1999, plaintiffs filed their reply to
the Company's counterclaims.
In October 2000, the Court granted plaintiffs permission to amend their
complaint to allege that the Company, in addition to infringing on the
claims of the U.S. Patent Nos. 5,814,084 and 4,950,296, infringed upon the
claims of a related patent owned by plaintiffs, U.S. Patent No. 6,096,081.
As with their infringement claims regarding the other patents, plaintiffs
seek injunctive relief and unspecified damages.
Discovery on all of the claims asserted in this litigation is ongoing. The
Company believes that the claims made against it in this action are without
merit and will continue to vigorously defend against such claims.
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings,
Inc. v. Osteotech, Inc.
In July 1999, Medtronic Sofamor Danek Inc., Sofamor Danek L.P. and Sofamor
Danek Holdings, Inc. ("Danek") sued Osteotech in the United States District
Court for the Western District of Tennessee alleging that instruments,
instrument sets and cortical bone dowel products, manufactured, sold and/or
otherwise distributed by the Company infringe on certain claims of U.S.
Patent Nos. 5,741,253, entitled "Method for Inserting Spinal Implants", and
5,484,437, entitled "Apparatus and Method of Inserting Spinal Implants",
which are owned by Danek. In September 1999, the Company filed its answer
and counterclaims seeking a declaratory judgment that the patents in
question in this action are invalid and otherwise not infringed by the
Company. Plaintiffs filed their reply to the counterclaims in October 1999.
In October 2000, the Court granted plaintiffs permission to amend their
complaint to allege that the Company, in addition to infringing on the
claims of the U.S. Patent Nos. 5,741,253 and 5,484,437 infringed upon the
claims of a related patent owned by plaintiffs, U.S. Patent No. 6,096,038.
As with their infringement claims regarding the other patents, plaintiffs
seek injunctive relief and unspecified damages.
Discovery on all of the claims asserted in this litigation is ongoing. The
Company believes that the claims made against it in this action are without
merit and will continue to vigorously defend against such claims.
9
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies (continued)
Condos v. Musculoskeletal Transplant Foundation
In June 2000, the Company was served with an action brought in the United
States District Court for the District of Utah against the Company and
Musculoskeletal Transplant Foundation ("MTF"). The suit alleges causes of
action for strict liability, breach of implied warranty and negligence
arising from allegedly defective allograft bone tissue processed and/or
provided by the Company and MTF which was allegedly implanted into the
plaintiff, Chris Condos, during two spinal surgeries. Plaintiffs, which
include Mr. Condos's family members, demand monetary damages in an
unspecified amount. On July 25, 2000, the Company answered the complaint,
denying any and all liability.
The Company maintains a general liability insurance policy and has notified
the insurance company of this action and the insurance company has agreed
to defend the action.
Regner v. Inland Eye & Tissue Bank of Redlands
In May 2000, Regner brought suit against the Company and fifteen or more
other defendants in the Superior Court for the State of California, San
Bernardino County. The suit seeks class action status and alleges a cause
of action based on a violation of the California Business and Professional
Code, as well as a number of common law causes of action, including
negligence, deceit, and intentional and negligent infliction of emotional
distress. With respect to the Company, plaintiff claims that the Company is
violating California law by engaging in the activity of buying or selling
organs or tissue for valuable consideration or profit. It appears that the
plaintiff is seeking only injunctive relief with respect to its California
Business and Professional Code claim. To the extent any of the other causes
of action exist against Osteotech, the plaintiffs are seeking damages in an
unspecified amount in addition to class certification.
In June 2000, Regner filed a motion for a preliminary injunction and a
hearing was held on June 28, 2000. The Court denied the motion. The Company
also filed a demurrer to the complaint requesting that the complaint be
dismissed.
In September 2000, plaintiffs voluntarily dismissed without prejudice their
claims filed in the Superior Court for the State of California, San
Bernardino County. At or about the time of the dismissal, the plaintiffs
"refiled" the action in the Superior Court for Los Angeles County. The
Company, however, has not been served with that action. In October 2000,
the defendants, including the Company, moved to vacate plaintiffs'
dismissal of the San Bernardino County action and have the action
reinstated. The Court granted that motion and has scheduled a hearing for
December 4, 2000, on defendants' demurrers, filed in June 2000, to the
plaintiffs' complaint requesting that the action be dismissed with
prejudice.
The Company denies that it is engaged in the activity complained of and
asserts that it is licensed by the State of California to do precisely what
it is doing, and that its activities are fully in accord with all state and
federal laws. Therefore, the Company believes this suit to be without merit
and will vigorously defend against the claims.
10
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies (continued)
Musculoskeletal Transplant Foundation v. Osteotech, Inc.
In October 2000, the Musculoskeletal Transplant Foundation ("MTF") filed a
complaint in the United States District Court for the District of New
Jersey against the Company seeking a declaratory judgment (1) that MTF,
through its manufacture and use of certain demineralized bone tissue
products, does not infringe any claim of U.S. Patent Nos. 5,284,655 and
5,290,558, which are owned by the Company; (2) that claims of those patents
are invalid; and (3) that the claims of those patents are unenforceable.
The complaint was then amended to add Synthes Spine Company, L.P. as a
plaintiff. Although plaintiffs seek no specific monetary award they have
requested that the Court award the plaintiff's their attorneys' fees and
costs in this action. The Company is assessing the claims asserted against
it and has not yet responded to them.
Steele v. Inland Eye and Tissue Bank
In October 2000, the Company was served with a summons and second amended
complaint naming the Company as a "Doe" defendant in an action pending in
the Superior Court for the State of California, San Bernardino County.
Plaintiff has asserted claims against defendants for intentional
misrepresentation, negligent misrepresentation and tortious interference in
connection with certain tissue procurement activities allegedly engaged in
by defendants. Plaintiff seeks damages in an unspecified amount. The
Company is currently assessing the claims asserted against it and has not
yet responded to them.
Orthopaedic Bone Screw Products Liability Litigation
The Company remained a defendant in one previously reported state court
products liability action involving orthopaedic bone screws: Ponder v.
Synthes. This action has been dismissed.
"O" Company, Inc. v. Osteotech, Inc.
In July 1998, a complaint was filed against the Company in the Second
Judicial District Court, Bernallilo County, New Mexico, which alleges
negligence, strict liability, breach of 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 unspecified monetary damages. In
August 1998, the Company removed this action to the United States District
Court for the District of New Mexico and 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 March 1999, the court dismissed
with prejudice the plaintiff's negligence and strict liability claims.
Remaining are claims for breach of warranty, negligent misrepresentation,
fraud, and violation of the New Mexico Unfair Trade Practices Act. As to
those claims, the Company has moved for summary judgment on the basis that
all of the remaining claims are barred by their applicable statutes of
limitations. At plaintiff's request, the court permitted limited discovery
on the matters related to the statute of limitations issue, which is
ongoing.
11
<PAGE>
OSTEOTECH, INC. AND SUBSIDIARIES
Notes To Condensed Consolidated Financial Statements
(unaudited)
5. Commitments and Contingencies (continued)
The Company believes that the claims made against it in this action 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
our results of operations or liquidity and capital resources could be
adversely affected by the ultimate outcome of the pending litigation or as
a result of the costs of contesting such lawsuits. We are unable to
estimate the potential liability, if any, that may result from the pending
litigation and, accordingly, no provision for any liability (except for
accrued legal costs) has been made in the consolidated financial
statements.
6. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three-month and nine-month periods ended
September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------
(dollars in thousands
except per share data) 2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 231 $ 3,248 $ 4,724 $ 9,750
--------------------------------------------------------------------------------------------------------------------------
Weighted average common shares 13,960,228 14,174,402 14,085,310 13,969,901
-------------------------------------------------------
Denominator for basic earnings per share 13,960,228 14,174,402 14,085,310 13,969,901
Effect of dilutive securities:
Stock options 288,905 466,479 318,494 669,156
Warrants 378 145 126
-------------------------------------------------------
Denominator for diluted earnings per share 14,249,133 14,641,259 14,403,949 14,639,183
--------------------------------------------------------------------------------------------------------------------------
Basic net income per share $ .02 $ .23 $ .34 $ .70
--------------------------------------------------------------------------------------------------------------------------
Diluted net income per share $ .02 $ .22 $ .33 $ .67
--------------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
OSTEOTECH, INC. AND Subsidiaries
Notes To Condensed Consolidated Financial Statements
(unaudited)
7. Operating Segments
Summarized in the table below is financial information for the Company's
reportable segments for the three-month and nine-month periods ended
September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------------------
(dollars in thousands) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Grafton(R)DBM Segment $ 11,139 $ 9,905 $ 33,433 $ 32,346
Base Tissue Segment 5,872 6,525 20,471 20,043
Other 905 1,039 3,277 3,488
-------------------------------------------------------------------------------------------------------------------------
Consolidated $ 17,916 $ 17,469 $ 57,181 $ 55,877
-------------------------------------------------------------------------------------------------------------------------
Operating income (loss):
Grafton(R)DBM Segment $ 2,158 $ 4,429 $ 8,110 $ 12,509
Base Tissue Segment (415) 1,884 2,547 5,969
Other (1,228) (1,003) (3,109) (2,733)
-------------------------------------------------------------------------------------------------------------------------
Consolidated $ 515 $ 5,310 $ 7,548 $ 15,745
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
8. Reclassifications
In 2000, the Emerging Issues Task Force ("EITF") issued EITF 00-15,
"Classification in the Statement of Cash Flows of the Income Tax Benefit
Received by a Company upon Exercise of a Nonqualified Employee Stock
Option." In accordance with the EITF, in the statement of cash flows for
the nine months ended September 30, 1999, the Company reclassified
$3,365,000 in income tax benefits from the cash flows from financing
activities section to the cash flows from operating activities section.
In addition, certain other prior year amounts within the financial
statements have been reclassified to conform to the 2000 presentation.
13
<PAGE>
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 the Company's Annual Report on Form 10-K for the year ended December
31, 1998, constitute cautionary statements identifying factors with respect to
such forward-looking statements, including certain risks and uncertainties, that
could cause actual results to vary materially from the future results indicated
in such forward-looking statements. Other factors could also cause actual
results to vary materially from the future results indicated in such
forward-looking statements.
FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2000 AND 1999
Results of Operations
Net Income
Consolidated net income in the third quarter of 2000, which includes $150,000 or
$.01 diluted net income per share related to the settlement with DePuy Acromed,
Inc. ("DePuy") in connection with the on-going GenSci patent litigation,
decreased to $231,000 or $.02 diluted net income per share as compared to net
income of $3,248,000 or $.22 diluted net income per share in the third quarter
of 1999, which includes $1,050,000 or $.07 diluted net income per share from the
DePuy settlement. Consolidated net income in the nine months ended September 30,
2000, which includes $450,000 or $.03 diluted net income per share from the
DePuy settlement, decreased to $4,724,000 or $.33 diluted net income per share
as compared to net income of $9,750,000 or $.67 diluted net income per share in
the nine months ended September 30, 1999, which includes $1,050,000 or $.07
diluted net income per share from the DePuy settlement.
The following is a discussion of factors affecting results of operations for the
three-month and nine-month periods ended September 30, 2000 and 1999.
Net Revenues
Consolidated net revenues increased 3% to $17,916,000 from $17,469,000 in the
third quarter of 1999 and increased 2% to $57,181,000 from $55,877,000 in the
nine months ended September 30, 1999. Domestic revenues, which consist
principally of revenues from the Grafton(R) DBM and Base Tissue Segments,
increased 4% to $17,375,000 from $16,672,000 in third quarter of 1999 and
increased 2% to $54,093,000 from $52,810,000 in the nine months ended September
30, 1999. Foreign based revenues decreased 32% to $541,000 from $797,000 in
third quarter of 1999 and increased 1% to $3,088,000 from $3,067,000 in the nine
months ended September 30, 1999. The decrease in foreign based revenues in the
quarter resulted primarily from a decrease in unit volume for ceramic and bovine
products. The increase in the nine months resulted primarily from the initial
distribution of Grafton(R) DBM in Europe offset by decreases in unit volume in
ceramic and bovine products. Both periods were also adversely affected by the
strength of the U.S. dollar compared to the Dutch Guilder and French Franc. The
impact of the exchange rates reduced foreign based revenues by 14% and 13% in
the third quarter and nine months, respectively.
Grafton(R) DBM Segment revenues increased 12% to $11,139,000 from $9,905,000 in
the third quarter of 1999 and increased 3% to $33,433,000 from $32,346,000 in
the nine months ended September 30, 1999. The increases in both periods are a
result of an increase in unit volume and the distribution of Grafton(R) DBM in
Europe. Grafton(R) DBM
14
<PAGE>
was not distributed in Europe during the nine months ended September 30, 1999.
Despite a 7% growth at the hospital/end-user level, our revenues during the
first nine months grew at a slower rate as a result of our clients purchasing
less Grafton(R) DBM products in the first quarter of 2000 than they needed to
meet hospital/end-user demand. This is a result of our clients using $1,500,000
of excess inventory purchased in December 1999 ahead of a 4% price increase
which became effective January 1, 2000. Grafton(R) DBM Segment revenues growth
slowed in the third quarter of 2000 as compared with the prior year same quarter
primarily due to the increasing competition as more companies have developed
products with characteristics similar to Grafton(R) DBM. Although we expect that
this competition will continue in the future, we expect demand for our
Grafton(R) DBM products to grow as we take steps to compete more effectively and
introduce the product line into additional markets in both the United States and
Europe. Additionally, foreign based revenues were negatively impacted by 14% and
13% in the third quarter and nine months ended September 30, 2000, respectively,
due to a decline in the Dutch Guilder and French Franc against the U.S. dollar.
Base Tissue Segment revenues decreased 10% to $5,872,000 from $6,525,000 in the
third quarter of 1999 and increased 2% to $20,471,000 from $20,043,000 in the
nine months ended September 30, 1999. The decrease in the quarter results
principally from a 31% decline in the number of donors processed for our clients
as market demand shifts towards more technically advanced tissue products,
partially offset by a 112% increase in bio-implant revenues. The increase in the
nine months resulted primarily from increases in bio-implant and OsteoPure(TM)
Femoral Head processing revenues and price increases effective January 1, 2000
offset by a decrease in base tissue allograft processing revenue as a result of
a decline in the number of donors processed.
In September 2000, we entered into a new five-year agreement with the
Musculoskeletal Transplant Foundation ("MTF"). This new agreement replaces the
current agreement which would have expired March 31, 2002. Under the new
agreement MTF will no longer be required to exclusively provide all donor tissue
it recovers to us for processing. The new agreement expires on August 31, 2005,
and provides that either party has the right to terminate the agreement
commencing March 31, 2002 upon six months prior written notice. Also, under the
terms of the new agreement, we will have the ability to directly contract with
tissue recovery organizations for the processing of tissue recovered by those
organizations.
During the third quarter and nine months ended September 30, 2000, two of our
clients in the Grafton(R) DBM and Base Tissue Segment accounted for 51% and 41%,
and 50% and 40% of consolidated revenues.
Gross Profit
Gross profit as a percentage of revenues was 61% in the third quarter and 65% in
the nine months ended September 30, 2000, respectively, as compared to 68% and
69% in the same periods last year. The decreases in both periods results from
the underabsorption of fixed costs in the Base Tissue Segment as a result of the
decline in donors processed for our clients. The decrease in the nine months
results from costs associated with additional allograft tissue processing
capacity which was added in the second half of 1999 to meet the expected growth
of our allograft tissue business.
Marketing, General and Administrative
Marketing, general and administrative expenses increased $2,272,000 or 33% in
the third quarter and $5,941,000 or 30% in the nine months ended September 30,
2000 compared to the same periods last year. The increase was primarily
attributable to: (i) increased legal fees associated with patent infringement
lawsuits in both the Grafton(R) DBM and the Base Tissue Segments, and (ii)
expanded marketing and promotional activities associated with the launch of four
new bio-implant products.
15
<PAGE>
Research and Development
Research and development expenses increased $117,000 or 9% in the third quarter
and $226,000 or 5% in the nine months ended September 30, 2000 compared to the
same periods last year. The increase was primarily attributable to increased
spending in the Grafton(R) DBM and Base Tissue Segment associated with the
continued development of several new processing technologies and ongoing
development of new products.
Operating Income
Consolidated operating income decreased 90% to $515,000 in the third quarter and
52% to $7,548,000 in the nine months ended September 30, 2000 compared to
$5,310,000 and $15,745,000 in the same periods last year primarily as a result
of decreased operating income in both the Grafton(R) DBM and Base Tissue
Segments and reduced income from the DePuy patent litigation settlement.
Grafton(R) DBM Segment operating income, decreased 51% to $2,158,000 in the
third quarter and 35% to $8,110,000 in the nine months ended September 30, 2000
compared to $4,429,000 and $12,509,000 in the same periods in 1999. Third
quarter and nine month operating income of 2000 includes income from the DePuy
patent litigation settlement of $250,000 and $750,000, respectively compared to
$1,750,000 in each period in 1999. The decrease results primarily from lower
gross profit margin resulting from increased capacity and increased costs
associated with a patent lawsuit. Base Tissue Segment operating income decreased
122% to a loss of $415,000 in the third quarter and 57% to $2,547,000 in the
nine months ended September 30, 2000 compared to $1,884,000 and $5,969,000 in
the same periods last year. The decrease results primarily from a decrease in
gross profit margin resulting from a decline in donors processed, increased
legal expenses associated with two patent lawsuits and increased marketing and
promotional spending associated with the launch of four new bio-implants.
Income Tax Provision
The effective income tax rate increased to approximately 71% in the third
quarter and to 44% in the nine months ended September 30, 2000 from 41% and 40%
in the same periods last year. The net change in the effective income tax rate
in 2000 is caused by non-deductible foreign losses partly offset by recognition
of tax benefits.
Liquidity and Capital Resources
At September 30, 2000, we had cash and short-term investments of $14,792,000
compared to $20,716,000 at December 31, 1999. We invest excess cash in U.S.
Government-backed securities and investment grade commercial paper of major U.S.
corporations. Working capital decreased $7,062,000 to $30,020,000 at September
30, 2000 compared to $37,082,000 at December 31, 1999. The decrease in working
capital results principally from a decrease in cash, accounts receivable,
prepaid expenses, accounts payable and accrued liabilities.
Net cash provided by operating activities decreased to $9,077,000 in the nine
months ended September 30, 2000, compared to $12,473,000 in the same period of
1999. The decrease resulted primarily from a decrease in net income and income
tax benefits related to stock options.
Cash used in investing activities increased to $19,038,000 in the nine months
ended September 30, 2000 from $16,946,000 in the same period of 1999. The
increase results principally from an increase in capital expenditures to
$20,509,000 from $13,537,000 resulting from our continued investment in
facilities and equipment needed for current and future business requirements. In
the fourth quarter of 1998, we commenced construction of a new processing
facility in Eatontown, New Jersey.
16
<PAGE>
The estimated aggregate cost for the construction of the building, including
furniture, fixtures and equipment is approximately $34,000,000; $21,500,000 of
which we expect will be funded through a building mortgage loan and equipment
line of credit. The remaining balance will be funded through available cash
reserves or anticipated cash flow from operations. Through September 30, 2000,
we have incurred $25,500,000 in building and equipment costs, including
capitalized interest of $487,000, of which $15,019,000 has been funded through
bank financing.
Net cash provided by financing activities decreased to $6,047,000 in the nine
months ended September 30, 2000, from $6,690,000 in the same period of 1999,
principally as a result of cash used to repurchase and retire 330,500 shares of
common stock at a cost of $3,121,000 and a decrease in cash proceeds received
from stock option exercises.
In September 2000, we entered into a non-cancelable 2-year agreement with Ulrich
for the purchase of $3,000,000 of inventory for the VBR System. As a result of
previously outstanding credits with Ulrich in the amount of $1,400,000, the net
cash flow effect of this commitment will be $1,600,000.
We have a credit facility with a U.S. bank, that includes a $5,000,000 revolving
line of credit, a $4,500,000 building mortgage loan, and a $17,000,000 equipment
line of credit. At September 30, 2000, $4,500,000 was outstanding under the
revolving line of credit and $10,519,000 was outstanding under the equipment
line of credit. The revolving line of credit expires May 31, 2000, at which
time, upon written notice to the lender, we have the option to extend the term
for an additional four years. The equipment line of credit automatically
converts to a seven-year term loan on December 10, 2000. We also have a line of
credit with a Dutch bank, which provides for borrowings of up to 5,000,000 Dutch
Guilders ("dfl"), or approximately $2,000,000 at the September 30, 2000 exchange
rate. Analysis of our cash position and anticipated cash flow indicated that it
most likely would not be necessary to utilize a significant portion of this line
of credit and, therefore, we agreed with the bank to limit borrowings, if any,
to no more than dfl 3,000,000 or approximately $1,200,000 at the September 30,
2000 exchange rate. There were no borrowings outstanding under this credit line
as of September 30, 2000. Additionally, we have a line of credit with a French
bank, which provides for borrowing of up to FRF 1,000,000, or approximately
$134,000 at the September 30, 2000 exchange rate. There were no borrowings
outstanding under this credit line as of September 30, 2000.
We believe that our 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 our near-term requirements. From time to
time we may seek additional funds through equity or debt financing. However,
there can be no assurances that such additional funds will be available, or if
available, that such funds will be available on favorable terms.
Impact of Inflation and Foreign Currency Exchange Fluctuations
The results of our operations for the periods discussed above have not been
significantly affected by inflation or foreign currency fluctuations.
17
<PAGE>
Litigation
We are involved in various legal proceedings. For a discussion of these matters
see Note 5 of "Notes to Condensed Consolidated Financial Statements", PART II.,
ITEM 1. LEGAL PROCEEDINGS and our Annual Report on Form 10-K for the year ended
December 31, 1999. It is possible that our results of operations or liquidity
and capital resources could be adversely affected by the ultimate outcome of the
pending litigation or as a result of the costs of contesting such lawsuits.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Update of Previously Reported Legal Proceedings
University of Florida Tissue Bank, Inc. v. Osteotech, Inc.
In October 2000, the Court granted plaintiffs permission to amend their
complaint to allege that we, in addition to infringing on the claims of the
U.S. Patent Nos. 5,814,084 and 4,950,296, infringed upon the claims of a
related patent owned by plaintiffs, U.S. Patent No. 6,096,081. As with
their infringement claims regarding the other patents, plaintiffs seek
injunctive relief and unspecified damages.
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings,
Inc. v. Osteotech, Inc.
In October 2000, the Court granted plaintiffs permission to amend their
complaint to allege that we, in addition to infringing on the claims of the
U.S. Patent Nos. 5,741,253 and 5,484,437 infringed upon the claims of a
related patent owned by plaintiffs, U.S. Patent No. 6,096,038. As with
their infringement claims regarding the other patents, plaintiffs seek
injunctive relief and unspecified damages.
Regner v. Inland Eye & Tissue Bank of Redlands
In September 2000, plaintiffs voluntarily dismissed without prejudice their
claims filed in the Superior Court for the State of California, San
Bernardino County. At or about the time of the dismissal, the plaintiffs
"refiled" the action in the Superior Court for Los Angeles County. We,
however, have not been served with that action. In October 2000, the
defendants, including us, moved to vacate plaintiffs' dismissal of the San
Bernardino County action and have the action reinstated. The Court granted
that motion and has scheduled a hearing for December 4, 2000, on
defendants' demurrers to the plaintiffs' complaint requesting that the
action be dismissed with prejudice.
New Legal Proceedings
Musculoskeletal Transplant Foundation v. Osteotech, Inc.
In October 2000, the Musculoskeletal Transplant Foundation ("MTF") filed a
complaint in the United States District Court for the District of New
Jersey against us seeking a declaratory judgment (1) that MTF, through its
manufacture and use of certain demineralized bone tissue products, does not
infringe any claim of U.S. Patent Nos. 5,284,655 and 5,290,558, which are
owned by us; (2) that claims of those patents are invalid; and (3) that the
claims of those patents are unenforceable. The complaint was then amended
to add Synthes Spine Company, L.P. as a plaintiff. Although plaintiffs seek
no specific monetary award they have requested that the Court award the
18
<PAGE>
plaintiff's their attorneys' fees and costs in this action. We are
assessing the claims asserted against us and have not yet responded to
them.
Steele v. Inland Eye and Tissue Bank
In October 2000, we were served with a summons and second amended complaint
naming us as a "Doe" defendant in an action pending in the Superior Court
for the State of California, San Bernardino County. Plaintiff has asserted
claims against defendants for intentional misrepresentation, negligent
misrepresentation and tortious interference in connection with certain
tissue procurement activities allegedly engaged in by defendants. Plaintiff
seeks damages in an unspecified amount. We are currently assessing the
claims asserted against us and have not yet responded to them.
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
------ ----------- ------
10.36 Amended and Restated Processing Agreement E-1
Entered into September 11, 2000 with
Musculoskeletal Transplant Foundation and
Biocon, Inc. for which the Registrant is
requesting confidential treatment pursuant
to Rule 24b-2.
27.0 Financial Data Schedule E-38
(b) Reports on Form 8-K
On October 18, 2000, we filed with the Commission a Current Report on
Form 8-K to announce that in response to earlier letters from us
informing Musculoskeletal Transplant Foundation ("MTF") that products
made by MTF pursuant to the patent issued to MTF in February, 2000 may
infringe on the claims of two Osteotech Grafton(R) Demineralized Bone
Matrix (DBM) patents; U.S. Patent No. 5,284,665 and U.S. Patent No.
5,290,558, issued in February and March 1994, respectively, MTF had
filed a lawsuit in the United States District Court for the District
of New Jersey asking the court to rule that MTF does not infringe the
claims of our patents. The suit also requests the court to declare our
patents invalid and unenforceable.
On September 11, 2000, we filed with the Commission a Current Report
on Form 8-K to announce that we had entered a new five-year agreement
with MTF which replaces the current five-year agreement which would
have expired April 1, 2002.
19
<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 10, 2000 By: /s/ Richard W. Bauer
-------------------------------
Richard W. Bauer
Chief Executive Officer
Date: November 10, 2000 By: /s/ Michael J. Jeffries
-------------------------------
Michael J. Jeffries
Executive Vice President
Chief Financial Officer
20
