Item 1. Business
Information contained throughout this Annual Report 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 this Annual Report and elsewhere in this Annual Report constitute cautionary statements identifying factors with respect to such forward-looking statements, including certain risks and uncertainties, that could cause 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.
Company Overview
Osteotech, Inc., or Osteotech, provides services and products primarily focused in the repair and healing of the musculoskeletal system. These products and services are marketed primarily to the orthopaedic, spinal, neurological, oral/maxillofacial, dental and general surgery markets in the United States and Europe. Based on our knowledge of the allograft bone tissue industry, we believe that we are the world's largest processor and developer of human bone and bone connective tissue, or allograft bone tissue, forms. The allograft bone tissue we process is procured by independent tissue banks or other Tissue Recovery Organizations, or TRO's, primarily through the donation of tissue from deceased human donors and is used for transplantation. We have two primary operating segments:
o the Grafton(R)Demineralized Bone Matrix (DBM) Segment, or the Grafton(R)DBM Segment; and
o the Base Allograft Bone Tissue Segment, or the Base Tissue Segment.
All of our other products and services which do not meet the criteria to be separately identified as a segment are aggregated under the category of "other."
In the Grafton(R) DBM Segment we process and market Grafton(R) DBM which is generally distributed by our clients. To the extent that allograft bone tissue is recovered by TRO's on our behalf, we will process and distribute such tissue under our own label. Grafton(R) DBM is processed using our validated, advanced, proprietary demineralization process. When applied to cortical bone, this process yields allograft bone tissue which has osteoinductive (the process by which bone is induced to grow) and osteoconductive (the matrix provided by allograft bone tissue into which the host bone can grow) capabilities greater than currently available forms of mineralized allograft bone tissue.
In the Base Tissue Segment we process primarily mineralized weight-bearing allograft bone tissue which our clients generally market and distribute. To the extent that TRO's recover
allograft bone tissue on our behalf, we will process and distribute such tissue under our own label. We also process the bio-d(TM) Threaded Cortical Bone Dowel for posterior and anterior spinal fusion procedures, the Graftech(TM) Bio-implant spacers and ramps for posterior and anterior spinal fusion procedures and OsteoPure(TM) Femoral head bone tissue in the Base Tissue Segment. We market these allograft bone tissue forms which are generally distributed by our clients, unlike other tissue forms processed in this segment, which are generally marketed and distributed by our clients.
We have leveraged our expertise in musculoskeletal tissue technology to develop innovative processes and proprietary products that are widely used by orthopaedic, spinal, neurological and oral/maxillofacial surgeons for spinal fusion procedures; to repair and replace bone loss caused by trauma or certain disease states; to augment prosthetic implant procedures; and to replace damaged ligaments and tendons.
In addition to our Grafton(R) DBM Segment and Base Tissue Segment, we provide ceramic and titanium plasma spray coating services and ceramic products which are used as bone graft substitutes, to orthopaedic and dental implant manufacturers. We distribute these products in Europe and the Middle East through our operations based in Leiden, The Netherlands. In the United States, we also market and distribute metal spinal implant products, including the Versalok(R) Low Back Fixation System, or Versalok(R) System, a lumbosacral spine fixation system with an innovative polyaxial screw. In January, 2001, we began marketing the Vertebral Body Replacement, or VBR(TM), a patented device approved as a vertebral body replacement device intended for use in the thoracolumbar spine (T1 - L5) to replace a collapsed, damaged or unstable vertebral body due to tumor or trauma. To our knowledge, this is the first time the Food and Drug Administration, or the FDA, has specifically cleared any single device for either of these indications, which establishes a new standard for this class of device. In January, 2001, we also began marketing the Ovation(TM) Low Back Fixation System, or Ovation(TM), a titanium, lumbosacral spine fixation system with an innovative polyaxial screw.
In February, 2001, we entered into a distribution agreement to market a pedicle screw system and a cervical plating system in the United States and Canada, which are manufactured by Alphatec Manufacturing, Inc. Under the terms of the agreement, which is for an initial term of two (2) years from the date that the first order for the systems is completed (expected to be in August, 2001), we are required to purchase a minimum of $6 million of the two systems. The agreement is automatically renewed for two (2) year periods unless either party cancels it upon six months prior written notice. If the original agreement is renewed, we are required to purchase a minimum of $8 million in the next two years. Thereafter, minimums are to be negotiated in advance of each renewal.
Through our acquisition of 90% of OST Developpement, SA, or OST, which was completed in January, 1999, we also process, market and distribute both bovine bone tissue products which are utilized as bone graft substitutes by surgeons and OsteoPure(TM) Femoral head processed human allograft bone tissue grafts, primarily in Europe, Asia and the Middle East. We also market and distribute Grafton(R) DBM through OST in these same markets.
We estimate that the total bone graft market in the U.S. for 2000 was approximately $517 million, which includes allograft bone tissue procedures, synthetic graft substitutes and autograft bone tissue procedures (transplant tissue harvested from the patient). We estimate that the allograft bone tissue portion of the total bone graft market in the U.S. in 2000 was approximately $257 million. The allograft bone tissue market is growing at a substantially faster rate than the general bone grafting market, as allograft bone tissue is increasingly becoming accepted as either an augment to, or a surgical alternative to autograft procedures. Autograft bone tissue often requires a second surgical procedure to harvest bone from the patient's own body and, therefore, exposes the patient to increased risk associated with blood loss, infection and chronic pain. Increased use of allograft bone tissue is expected to continue as physicians become increasingly educated about the benefits of allograft bone tissue and concerns over disease transmission are diminished. Moreover, allograft bone tissue is increasingly preferred for use in elderly patients, who often lack sufficient harvestable bone.
Based upon our knowledge of the allograft bone tissue industry, we estimate that we process about 40% of the allograft bone tissue donors in the U.S. We believe that our strong market position is attributable to our proprietary product line; our clients' national donor recovery programs; our large national sales and marketing organization; and the substantial investment we have made in processing technology to ensure stringent standards and high quality control which, combined with extensive donor screening and testing performed by our clients, has virtually eliminated the risk of transmission of infectious agents.
Our clients pay us fees for our processing of the allograft bone tissue that they provide to us. In the Grafton(R) DBM Segment, our clients pay fees on a per unit basis for the Grafton(R) DBM products we process. In the Base Tissue Segment, our clients pay fees on a per donor basis, except in the case of bio-implants, for which fees are paid on a per unit basis.
In the United States we process allograft bone tissue pursuant to contracts with a number of clients, including two large not-for-profit organizations, American Red Cross Tissue Services, or ARC, and Musculoskeletal Transplant Foundation, or MTF. Our clients are responsible for donor procurement and generally for the distribution of the allograft bone tissue we process for them. Our contract with ARC expires in December, 2006 and our contract with MTF expires in August, 2005. However, the MTF contract may be canceled effective March 31, 2002 and thereafter upon either party giving six months prior written notice. We also are currently in litigation with MTF related to our Grafton(R) DBM patents and other matters. See Item 3 "Legal Proceedings." We also process allograft bone tissue for several smaller tissue banks in the United States and Europe.
We market our proprietary allograft bone tissue products such as Grafton(R) DBM and our line of bio-implants through independent agents and direct field sales personnel. Generally, our clients market the non-proprietary products we process in our Base Tissue Segment, primarily using direct field personnel. Our products are gaining wide acceptance among surgeons in a broad spectrum of orthopaedic procedures due to their flexibility, unique handling characteristics and ability to enhance bone growth.
Revenue in our Grafton(R) DBM Segment increased to $45,226,000 in 2000 from $45,136,000 in 1999 and 2000 revenue in our Base Tissue Segment of $26,204,000 was about 2% above 1999's revenue of $25,751,000. We expect that both our Grafton(R) DBM and Base Tissue Segments will continue to be important contributors to the growth of our consolidated revenues and profits in 2001, as processed allograft bone tissue forms continue to gain increased acceptance.
Strategy
Overview
We intend to expand our business as follows:
o We intend to use our position as the leader in allograft bone tissue processing and marketing to become a leading orthopaedic/musculoskeletal company by bringing to market innovative and cost-effective allograft bone tissue forms and non-allograft products. We also will expand into new markets globally.
o We will continue to educate the medical community and the general public concerning the benefits of allograft bone tissue.
o We intend to use our strong research and development capabilities and expertise in musculoskeletal science to:
* enhance the performance of our existing allograft bone tissue forms;
* expand the safety claims of these tissue forms using proprietary processes; and
* continue to introduce new tissue forms with enhanced performance profiles.
o We intend to add additional metal spinal implant systems to our product line in order to provide the spinal surgeon with a greater depth of products.
o We intend to utilize our marketing and distribution network to enhance the market share of both our allograft bone tissue forms and non-allograft product lines.
o To ensure that we have an adequate supply of allograft bone tissue to meet the market demand for existing tissue forms that we process and for any new tissue forms that we may process, we intend to work with existing clients to expand the amount of tissue they recover, obtain additional tissue bank clients and contract directly with TRO's to obtain tissue on our behalf.
Grafton(R) DBM Segment
In the near term, we will continue to focus on marketing Grafton(R) DBM through our direct marketing organization, our national agent network and medical education programs. We will support these programs through prospective clinical and outcome studies to further validate the performance, utility and safety of our processed tissue. We also will continue to expand the Grafton(R) DBM tissue line by adding additional forms and continue our expansion globally.
We expect to continue expansion of sales of Grafton(R) DBM through:
o the recently completed reorganization of our sales force to allow for expanded market coverage and selling time with surgeons;
o providing the surgeon an expanded line of metal implant products and allograft bone tissue forms which are usable with Grafton(R) DBM so that we can better meet the needs of the surgeon;
o surgeon identified new procedures;
o surgeon oriented medical education programs;
o in-depth sales agent training programs;
o published clinical support;
o product line extensions;
o global expansion with an initial European focus; and
o continued expansion of the allograft bone tissue market in both the United States and globally.
Base Tissue Segment
We expect to achieve continued growth in the Base Tissue Segment through:
o introduction of additional allograft bone tissue grafts with application in spinal and other surgical procedures;
o use of our new packaging system and, a new validated viral inactivation claim, when available;
o global expansion of base allograft bone tissue grafts and the tissue processing business in selected countries, initially in Europe;
o development of proprietary tissue processing technology through internal research;
o introduction of new allograft bone tissue forms with enhanced performance profiles; and
o obtaining additional bone tissue processing clients and sources of bone tissue.
Other
Non-Allograft Bone Tissue Spinal Implant Products
Our strategy in the non-allograft bone tissue spinal implant product lines of business is to:
o continue focusing our European non-allograft bone tissue operations to capture available opportunities for ceramic coating services and ceramic products;
o capitalize on high-growth opportunities in the U.S. spinal products market with innovative non-allograft bone tissue products;
o enter into agreements with other health care product companies to utilize our technology and expertise in the non-allograft bone tissue area for the development and manufacture of proprietary product components; and
o expand our metal implant product line, either through internal development, acquisition or licensing of products from other companies, in order to increase our market share and provide the surgeon with a more comprehensive product line so that we will be able to meet all the surgical implant needs of the surgeon.
Spinal Strategy
Our strategy consists of two primary components involving our Grafton(R) DBM and Base Tissue Segments and our non-allograft bone tissue spinal implant product line of business:
o continue the U.S. market penetration of our non-allograft bone tissue spinal implant products, including the Versalok(R) System, the Ovation(TM) System, the introduction of VBR(TM) and the market introduction of the pedicle screw system and cervical plating system obtained under a distribution agreement with Alphatec Manufacturing, Inc.;
o market our allograft bone tissue bio-implants and our non-allograft bone tissue spinal implant products together with Grafton(R) DBM through our extensive sales agency network.
Our intention is to educate surgeons to use Grafton(R) DBM, our allograft bone tissue bio-implants and our metal spinal systems, either alone or in conjunction with each other. Spinal implant products, both allograft and non-allograft, which we add to our product mix in the future will be included in this strategy.
Business Summary
Bone and related tissue transplants are often necessary to correct deformities and repair and reconstruct defects caused by congenital malformations, trauma, infections, cancer and other disease conditions. For certain procedures, autograft bone tissue can be acquired from another part of the patient's skeleton by an additional operative procedure. For a large number of procedures for which autograft bone tissue is not feasible or desirable, allograft bone tissue previously obtained from cadavers or surgical patient donors can be utilized. Allograft bone tissue is procured primarily from cadavers by a network of organ procurement organizations and/or directly by tissue banks.
We process allograft bone tissue for our clients and bone tissue recovered by TRO's for us in both our Grafton(R) DBM and Base Tissue Segments. Once processed, we typically return the allograft bone tissue to our clients for distribution to surgeons and medical institutions, or if recovered by TRO's on our behalf, we distribute it directly to surgeons and medical institutions. The surgeons and medical institutions pay the fees established and charged by our clients or us. The surgeons and medical institutions in turn charge their patients for the various aspects of transplant surgery performed by them, including standard charges established by the surgeon or institution for each unit of processed allograft bone tissue used. The cost to the patient for the processed allograft bone tissue is generally reimbursable by medical insurance carriers as part of the overall cost of the procedure.
In both our Grafton(R) DBM and Base Tissue Segments, our processing yields a wide array of freeze-dried, frozen and demineralized allograft bone tissue forms that are used by orthopaedic, neurological, plastic, dental, periodontal and oral/maxillofacial surgeons for:
o spinal fusion procedures;
o repair and replacement of bone loss caused by trauma or certain disease states;
o augmentation of prosthetic implant procedures; and
o replacement of damaged ligaments and tendons.
We believe our processing methods, our clients' tissue recovery techniques and the multiple screening and testing procedures employed, virtually eliminate the risk of transmission of infectious agents by the allograft bone tissue we process.
In our Grafton(R) DBM Segment, we have a validated viral inactivation process for our demineralized bone tissue. Studies completed by an independent testing laboratory specializing in viral inactivation studies demonstrated that this proprietary demineralization process virtually inactivates and eliminates viruses such as HIV, hepatitis B, hepatitis C, cytomeglia and polio.
We are in the process of implementing additional proprietary processing technologies that, once fully implemented, will enable us to expand our viral inactivation claims to include the mineralized weight-bearing allograft bone tissue processed in our Base Tissue Segment.
We believe that allograft bone tissue transplantation is one of the fastest growing areas of transplant medicine. We estimate that in 2000 there were approximately 550,000 grafting procedures in the U.S. for which allograft bone tissue could have been utilized, representing an estimated available allograft bone tissue market of approximately $517 million. We estimate that the allograft bone tissue portion of the total bone graft market in the U.S. in 2000 was approximately $257 million. Industry data indicates that the musculoskeletal surgical market is growing. We believe this will expand the potential market for allograft bone tissue in both our Grafton(R) DBM and Base Tissue Segments, due to a number of factors, including:
o increasing frequency of surgical procedures that incorporate bone grafting techniques;
o the desire by surgeons to avoid the additional procedure needed to acquire autograft bone tissue, which often increases operating time and risks such as excessive blood loss, infection and chronic pain;
o a reduction in the possibility of transmission of infectious agents and toxicity because of improved allograft bone tissue processing techniques and donor screening;
o increased awareness by, and training of, the medical community with respect to the use of allograft bone tissue;
o an increasing number of musculoskeletal surgical procedures which require more bone tissue than can be obtained through autograft procedures;
o an increase in the number of patients who do not possess the quality of bone tissue required for autograft procedures as a result of the general aging of the population; and
o an increase in the availability of allograft bone tissue due to an increase in bone tissue donations and improved recovery and processing techniques.
Allograft bone tissue is employed in surgical procedures because of its biologic and biomechanical properties. Bone from various locations in the body can be processed to yield either dense cortical bone, porous cancellous bone or units comprised of both cortical and cancellous bone. Cortical bone, the thick outer portion of bone, provides biomechanical strength which allows the bone to be weight-bearing, and therefore, is commonly used in surgery in the spine and in the extremities and in other procedures requiring strong transplant material. Cancellous bone, the spongy portion of bone tissue, is preferable for surgical procedures, or aspects thereof, in which rapid penetration of new bone into the pores of the transplant, a process known as osteoconduction, is desirable but where weight-bearing strength is not paramount. Therefore, cancellous bone is often used to fill smaller areas of bone loss and to augment more extensive reconstructive procedures including knee and hip replacements. Most procedures using
allograft bone tissue, however, employ a combination of cortical and cancellous bone in a variety of forms, shapes and sizes.
Allograft Bone Tissue Processing
Grafton(R) DBM Segment
In addition to the proprietary procedures which are particular to the processing of Grafton(R) DBM, the technologies used in processing allograft bone tissue in the Base Tissue Segment are also used in processing Grafton(R) DBM. The methods used to process Grafton(R) DBM have been validated as a viral inactivation process. This proprietary process virtually inactivates and eliminates viruses such as HIV, hepatitis B, hepatitis C, cytomeglia and polio.
We have developed an advanced proprietary demineralization process for cortical bone which yields Grafton(R) DBM -- a form of allograft bone tissue which can be used to aid in the formation of new bone through the processes of osteoconduction and osteoinduction. Osteoconduction is the process of providing the matrix into which bone will grow and osteoinduction is the process by which bone is induced to grow. Cortical bone is believed to be the principal reservoir for various factors which are instrumental in osteoinduction. These biological properties of cortical bone, however, are inhibited by the bone's structure and various minerals, lipids and other substances comprising the bone. Our process removes these inhibiting factors.
In our Grafton(R) DBM Segment we currently process five forms of Grafton(R) DBM:
o Grafton(R) DBM Gel - a gel-like substance with unique handling characteristics which are useful in performing bone graft procedures as part of spinal fusions, joint replacements and repairs of osseous defects;
o Grafton(R) DBM Putty - a moldable putty-like graft of entangled fibers of demineralized bone, which is mixed easily with marrow and other grafts, minimizes migration, can be molded easily and retains its shape even in larger defects;
o Grafton(R) DBM Flex - a flexible "pressed fiber" form of demineralized bone processed by utilizing a pressed fiber technique, providing surgeons a pliable form of bone graft. It is available in square or strip forms, conforms to the body's natural anatomy and can be easily cut for precise adaptation to host bone;
o Grafton(R) DBF Matrix - a flexible "pressed fiber" form of demineralized bone processed by utilizing a pressed fiber technique, providing the surgeon with a pliable form of bone graft. It also contains a "trough" into which the surgeon can place autologous bone and bone marrow to aid in the osteoinduction process; and
o Grafton(R) DBM Crunch - a ready to use mixture of demineralized bone fibers and demineralized cortical cubes which packs and locks into bone defects, providing structure and support to the graft site.
We expect that wider distribution and deeper market penetration of Grafton(R) DBM utilizing our national network of independent agents in combination with our direct marketing force, our expansion into European markets and our marketing of metal spinal implant systems will drive the further growth in the use of Grafton(R) DBM processed allograft bone tissue. Through December 31, 2000, Grafton(R) DBM forms had been utilized in over 410,000 procedures domestically.
Base Tissue Segment
Unlike organs which require transplantation within hours of recovery, allograft bone tissue generally goes through a processing phase in which it is cleaned, cut into different sizes and forms for specific surgical procedures, preserved, packaged and labeled. We process the allograft bone tissue utilizing technology we have developed which yields a wide array of freeze-dried, frozen, demineralized bone and connective tissue products. Frozen tissues include whole bones and major sections thereof, bone segments, tendons and ligaments. Freeze-dried bone tissues include various wedges, strips, struts, dowels, cancellous cortical chips, blocks, strips and ribs.
The suitability of an allograft bone tissue is partly dependent on the methods used in the processing of the tissue. Processing includes the removal of certain portions of the allograft bone tissue in a manner which enables the tissue to maintain as much of the native biological characteristics relating to the use of such tissue in bone grafting procedures as possible. To provide suitable allografts, we have developed techniques that minimize the use of chemicals and procedures that might render the allograft bone tissue less suitable for use as a graft. We process allograft bone tissue in a microbially-controlled environment, substantially cleaner than that of a typical hospital operating room, created through the use of advanced air filtration, water distillation and mineral control systems and other "clean room" techniques. We believe that our use of such clean room techniques, a controlled environment, in-line disinfection and other technologies preserve the properties of the tissues that make them suitable as grafts and address the medical community's and the general public's perceptions and concerns regarding the possible transmission of infectious disease and toxicity. Once processed using our current processing methods, freeze-dried bone tissues may be stored for up to three years and frozen bone tissues may be stored for up to five years before they must be used or discarded.
In December, 1998 we began to process the bio-d(TM) Threaded Cortical Bone Dowel for spinal fusion. In late 2000, we began to introduce the Graftech(TM) Bio-implants, including the Graftech(TM) Posterior Ramp, Graftech(TM) Anterior Ramp, Graftech(TM) Cervical spacer and the Graftech(TM) Cervical dowel. In addition to our normal processing techniques, the Graftech(TM) Bio-implants are processed using our OsteoActive(TM) Process which transforms the typically non-osteoinductive weight bearing graft into an osteoinductive graft, thus allowing for faster incorporation of the graft into the host bone. Additionally, the graft is processed using a new technology which allows it to be available in a non-frozen form. Previously, these types of grafts
were available only in a frozen form, often resulting in the surgeon using more of the grafts to successfully perform a procedure than is necessary when a non-frozen graft is used. It is expected that the use of our new non-frozen grafts will thus significantly reduce the cost of the surgery. All of our bio-implant grafts have been tested and shown to withstand loads comparable to those reported in the lumbar spine, and their inherent natural properties, enhanced by our new processing technologies, will permit faster incorporation and remodeling. Additionally, these bio-implant grafts can be used with Grafton(R) DBM. Therefore, the bio-implants will provide structural support and with Grafton(R) DBM added, will also aid in the fusion process by inducing bone growth.
Expansion of Allograft Bone Tissue Business in Europe
In January, 1999, we completed the acquisition of 90% of OST, which is located in Clermont-Ferrand, France. OST manufactures and markets bovine tissue products for use as bone grafts in orthopaedic and dental surgery. These products, marketed under the trade names of LUBBOC(R) and LADDEC(R), were developed to address the shortage of safe and effective human allograft bone grafts in France and other countries outside the United States. In the future, as a complement to our human allograft tissue products, OST will continue to market these products in certain markets.
We are expanding operations and staff at OST as we begin to use it as a base for developing our human allograft tissue graft and tissue processing business in Europe. OST has adapted its proprietary LUBBOC(R) and LADDEC(R) processing technology to develop the OsteoPure(TM) Process for the processing of human femoral heads recovered during hip replacement surgery. OST has concluded an agreement with OsteoBanque D'Auvergne and five other European based tissue banks. OST expects to enter into similar agreements with other European tissue banks for the provision of tissue for the OsteoPure(TM) Process in the future. Additionally, we are expanding the range of human allograft bone tissue grafts available to orthopaedic and other surgeons in various countries in Europe by supplying Grafton(R) DBM and other allograft bone tissue grafts processed in the U.S.
In conjunction with OsteoBanque D'Auvergne and other European tissue banks, we plan to help establish a cadaveric tissue recovery network in medical centers throughout France and other European countries in order to meet the growing demands by European surgeons for safe human allograft bone tissue forms. France will continue to be the prime base of operation in our efforts to expand the distribution of our human allograft bone tissue grafts throughout Europe on a country-by-country basis. Facilities and staff will be added to our current operations, as required, to support this expansion.
We believe the advantages of locating our European operations in France are significant. The French market is one of the larger and more sophisticated European markets for bone grafts. Also, French laws and regulations governing tissue banking are well defined and the most advanced of all the major European countries. Although tissue banking operations in France are generally restricted to non-profit public health organizations approved by the government, French
regulations also provide for governmental approval of for-profit organizations as tissue banks if these organizations are able to provide haute technicite (high technology) unavailable in the non-profit sector. We believe that our tissue processing technology meets this requirement and, therefore, OST has filed a dossier with the French government to operate as a tissue bank. As a result, during the course of 2001, we expect to receive approval from the French government which will enable us to operate independently as an approved tissue bank in addition to providing contract processing, marketing and management services to non-profit tissue banks.
Other
Ceramic and Titanium Plasma Spray Coating Services and Products
We are providing ceramic hydroxyapatite, or HA, and titanium plasma spray coating services to orthopaedic and dental implant companies in Europe. The primary advantage of coating orthopaedic and dental prosthetic devices with HA or titanium, is that it enables bone to grow onto the implanted device. This enhances the stability of the device, which, in turn, lowers the amount of bone loss and reduces pain caused by micro motion. We manufacture HA powder which we use in our plasma spray coating operations from raw materials which are readily available from several sources. We also supply HA powder to various companies for use in their in-house plasma spray coating operations. Additionally, we produce CE marked HA products that are used as grafting material to provide a matrix into which bone will grow as part of the process of the repair of bone defects.
Non-Allograft Bone Tissue Spinal Implants and Instruments
The human spine is subjected to various loading conditions including tension, compression, torsion, bending and combinations of all four. When the spine has been injured by tumors, fractures, degenerative conditions or deformities, stabilizing instrumentation is required to maintain surgical correction of the condition during the healing and fusion process. We offer several metal spinal implant systems to achieve these results.
The Versalok(R) System, which is marketed by our national network of direct and independent agency representatives in combination with our allograft and other non-allograft spinal products, is a lumbo-sacral spine fixation system with innovative polyaxial screw. The Versalok(R) System is designed in a manner to allow the sharing of the forces to which the spine are subjected with the system, which in turn is thought to provide improved results in spinal fusion procedures.
Beginning in the first quarter 2001, we will market the VBR(TM). This patented device, which we will distribute under an exclusive distribution agreement with Heinrich C. Ulrich, K.G., or Ulrich, of Ulm, Germany, the manufacturer of the product, has been cleared for sale by the FDA to replace a collapsed, damaged or unstable vertebre due to a tumor or trauma.
In February, 2001, we entered into a distribution agreement to market a pedicle screw system and a cervical plating system in the United States and Canada, which are manufactured by
Alphatec Manufacturing, Inc. Under the terms of the agreement, which is for an initial term of two (2) years from the date that the first order for the systems is completed (expected to be in August, 2001), we are required to purchase a minimum of $6 million of the two systems. The agreement is automatically renewed for two (2) year periods unless either party cancels it upon six months prior written notice. If the original agreement is renewed, we are required to purchase a minimum of $8 million in the next two years. Thereafter, minimums are to be negotiated in advance of each renewal.
We expect to continue to expand our metal spinal implant product line so that we are able to offer surgeons implant systems capable of solving a variety of spinal problems.
Quality Assurance
We have stringent quality assurance programs in place covering all of our lines of business, including our Grafton(R) DBM and Base Tissue Segments, our HA-titanium plasma spray coating services, and our non-allograft bone tissue spinal implants and instruments. Our facilities in Clermont-Ferrand, France and Leiden, The Netherlands have received International Standardization Organization, or ISO, certification for their quality systems.
In both the Grafton(R) DBM and Base Tissue Segments, our allograft bone tissue quality assurance program commences with the recovery of allograft bone tissue which is procured under strict aseptic conditions. The tissue is recovered primarily in hospitals and, to a lesser extent, coroners' facilities which have been prepared for recovery. Recovered allograft bone tissue is also required to be sterilely wrapped and shipped in special containers. Upon receipt of this tissue, a quarantine period is imposed to permit serologic and microbiologic testing prior to release of allograft bone tissue for processing. Upon satisfactory completion of all testing, the allograft bone tissue is processed in a microbially-controlled environment. Under constant monitoring, the allograft bone tissue is cleaned, soaked in antibiotics and then cut and shaped in accordance with client specifications. Before being released to our clients, our quality assurance team inspects and again tests all processed bone tissue for microbiological contaminants.
We believe that the serologic screening of donors, the extensive screening of donor profiles and medical histories performed by our clients and TRO's and our processing technologies virtually eliminate the likelihood of the presence of infectious agents, including HIV and hepatitis viruses, in our processed allograft bone tissue. Studies completed by an independent testing laboratory specializing in viral inactivation studies demonstrated that our proprietary demineralization process used in our Grafton(R) DBM Segment can virtually inactivate and eliminate viruses such as HIV, hepatitis B, hepatitis C, cytomeglia and polio.
In addition to the proprietary demineralization process used in our Grafton(R) DBM Segment, we have begun to implement additional processing technologies that once fully implemented will enable us to expand our viral inactivation claims to include virtually all of the allograft bone tissue we process in our Base Tissue Segment. These proprietary, tissue-specific technologies are expected to further enhance graft safety while maintaining the tissue's biologic and physical properties.
To our knowledge, none of the approximately 2.3 million transplanted grafts we have processed in our Grafton(R) DBM and Base Tissue Segments have caused a confirmed transmission of infectious diseases. This record is due to the rigorous donor screening and tissue recovery techniques used by our clients, extensive donor testing, as well as our demanding quality assurance and processing protocols.
Clients
We are the processor of allograft bone tissue for two large United States clients. In the Base Tissue Segment, with the exception of the bio-d(TM) Threaded Cortical Bone Dowel and Graftech(TM) Bio-implants for which we are paid on a per unit basis, we are paid fees on a per donor basis for processing, finishing and packaging our clients' mineralized, weight-bearing allograft bone tissue. In the Grafton(R) DBM Segment our clients pay us fees on a per unit basis. During 2000, MTF and ARC accounted for approximately 50% and 40%, respectively, of our consolidated revenues. We receive revenues in both our Grafton(R) DBM and Base Tissue Segments from each of these clients. We have processing agreements with MTF and ARC which run through August 31, 2005 and December 31, 2006, respectively. The agreement with MTF may be terminated, effective March 31, 2001 and thereafter, by either party upon giving six (6) months prior written notice. We also are currently in litigation with MTF related to our Grafton(R) DBM patents and other matters. See Item 3 "Legal Proceedings."
In June, 2000, we entered into a five year agreement with Bone Bank Allografts, or BBA, to process donor allograft bone tissue procured by BBA. This tissue is processed in our Grafton(R) DBM and Base Tissue Segments.
We generally rely on our clients to obtain the donor allograft bone tissue which we process and, generally, to distribute the processed allograft bone tissue to hospitals and physicians for transplantation. We perform marketing services which generate demand for our products. See "Education and Marketing."
In the fourth quarter of 1999, we commenced using the OsteoPure(TM) System for processing allograft bone tissue grafts for French tissue bank clients and we also concluded a contract with BioImplant Services of The Netherlands for expanded distribution of Grafton(R) DBM in Europe, which we began doing in the first quarter of 2000.
Our plasma spray coating customers and non-allograft bone tissue spinal implant product customers generally purchase our services and products pursuant to purchase orders or non-exclusive supply agreements which are cancelable at any time by either party.
Education and Marketing
We believe the markets for processed allograft bone tissue will continue to be general orthopaedic, spinal, neurological, and oral/maxillofacial surgical specialties. Our future growth in these areas will depend upon availability of adequate supplies of allograft bone tissue and a wider
acceptance by these specialties of the use of allograft bone tissue as an alternative to autograft bone tissue and other available materials and treatments.
As of December 31, 2000, in the United States, we employed 16 persons engaged directly in efforts to educate surgeons as to the benefits and applications of processed allograft bone tissue and nine employees engaged in training our independent sales agents. We complement our direct sales organization with a national network of independent sales agents who market Grafton(R) DBM, our bio-implant allograft bone tissue spinal implants and our non-allograft bone tissue spinal implant products. These agents also educate the medical community about processed allograft bone tissue. At December 31, 2000, we had appointed 42 agencies which employ over 195 sales representatives.
Currently, a small group of marketing and sales employees located in Clermont-Ferrand, France markets and sells our LUBBOC(R) and LADDEC(R) Bovine bone grafts to orthopaedic surgeons and dentists. This staff is being retrained to market our OsteoPure(TM) Human femoral head and cancellous bone grafts, Grafton(R) DBM and other human allograft tissue products in connection with a network of agents and distributors we have retained.
A small in-house marketing staff located at our Leiden facility markets our plasma spray coating services. These marketing activities consist primarily of attendance at trade shows, placement of advertisements in trade journals and direct mailings to orthopaedic and dental implant companies. We market our HA powders and ceramic products directly and through a small number of independent contract representatives in Europe.
Government Regulations
Both of our Grafton(R) DBM and Base Tissue Segments involve the processing of human tissue intended for transplantation and are subject to the same regulations in the U.S.
The procurement and transplantation of allograft bone tissue is subject to federal law pursuant to the National Organ Transplant Act, or NOTA, a criminal statute which prohibits the purchase and sale of human organs, including bone and related tissue, for "valuable consideration." NOTA permits the payment of reasonable expenses associated with the removal, transportation, processing, preservation, quality control, implantation and storage of human bone tissue. We provide services in all of these areas, with the exception of removal and implantation.
The FDA currently regulates human tissue-based products such as the allograft bone tissue that we process, including Grafton(R) DBM, under certain provisions (Section 361) of the Public Health Services Act. Such products are not regulated as drugs, medical devices or blood products, but as "human tissue for transplantation." FDA regulations do not require a premarket clearance for such products, though these products are subject to regulations concerning tissue donor screening and testing, processing and record keeping, and other controls. Tissue-based and cellular products that are not classified as human tissue intended for transplantation will be regulated under different regulations as either drugs, devices or biologics.
In August 1995, the FDA designated Grafton(R) DBM as within the scope of human tissue intended for transplantation. Human tissue such as demineralized bone matrix has been considered, and still is considered, exempt from FDA premarketing clearance requirements imposed upon medical products such as drugs, devices and biologics. Grafton(R) DBM is a demineralized bone matrix that is mixed with glycerol, a basically inactive substance, to provide desirable physical handling characteristics to the demineralized bone matrix.
The FDA has proposed a more comprehensive regulatory framework that will, if adopted, build upon and supersede the existing regulations for human tissue-based products. Implementation of this proposed regulatory approach would lead to new regulations for the allograft bone tissue we process. One set of new regulations requiring facility registration and listing of products has been published in the Federal Register and is currently effective. In January, 2001, the FDA also published in the Federal Register a proposed rule, Good Tissue Practices, or GTP, which proposes to further regulate tissue processing and quality. This rule is not expected to become effective for another two years. We believe that we will be able to fully comply with the regulation requiring facility registration and listing of products, and with the GTP regulation once it becomes effective.
The allograft bone tissue bio-implants we process are currently regulated as human tissue for transplantation. If these implants were to be regulated by the FDA as a medical device in the future, we may be required to halt or to limit the marketing of these products until we conduct clinical trials to support an application to receive marketing clearance from the FDA.
Allograft bone tissue and tissue processing operations are regulated in most major countries, though with different regulations and standards in each country. We believe that we and our subsidiaries comply with the national regulations of the various countries in which we currently, or plan to operate, although there can be no assurances that we will be able to in the future.
The metal spinal implant products that we distribute in the U.S., are regulated as Class II medical devices under Section 510-K of the Federal Food, Drug and Cosmetic Act. The Versalok(R) System, the Ovation(TM) System and the VBR(TM) System are being marketed pursuant to 510-k marketing approval issued by the FDA. Additionally, the new pedicle screw and cervical plate system that we will market under an agreement with Alphatec Manufacturing, Inc. will be marketed pursuant to 510-k marketing approval which has been issued by the FDA.
ISO certification for production facilities was made mandatory in 1998 for companies that market or distribute products within the European Union. Our facility located in Clermont-Ferrand, France has received ISO 9002 certification for the quality systems used in the manufacture of bovine tissue products. The LUBBOC(R) and LADDEC(R) Bovine Grafts produced and marketed by OST are regulated as medical devices in Europe and most other international markets in which these products are marketed.
Our European HA plasma spray coating services meet existing regulatory requirements in the specific countries where they are marketed. Our facility in Leiden, The Netherlands has
received ISO 9001 certification for its quality systems used in the development and manufacture of ceramic products and ceramic and titanium spray coatings. The certification was awarded by Tuv Product Service, GmbH of Munich, Germany, a leading Notified Body in medical devices. Notified Bodies are independent organizations authorized by the European Union member countries to administer the ISO certification process. Upon certification, a company may then affix a CE Mark to its device products, thus allowing for the sale of the products throughout the European Union.
Ceramic products produced by us in The Netherlands are currently distributed only in Europe. These products meet existing regulatory requirements in the specific countries where they are produced and marketed. We do not currently intend to market these products in the U.S.; however, if we decide to do so, these products would require premarket clearance by the FDA as medical devices.
HA powder produced and sold in bulk by us in the U.S. and Europe is considered to be a component product and, as such, is not currently subject to regulation by the FDA and similar agencies in Europe.
Research and Development
During 2000, 1999 and 1998, we spent approximately $5,772,000, $5,506,000, and $4,610,000, respectively, on research and development activities. The majority of these expenditures were made in our Grafton(R) DBM and Base Tissue Segments. We are engaged in continuing research and development efforts in the allograft bone tissue processing field which include our continuing efforts to improve upon and maintain the safety and performance of the processed allograft bone tissue, increase the amount of transplantable allograft bone tissue derived from each donor, reduce processing costs through efficiency advances and develop new forms of allograft bone tissue.
Competition
Market Overview
The bone grafting market is an extension of the general orthopaedic surgery market, as bone grafts are used adjunctively in a broad range of reconstructive orthopaedic surgical procedures such as the repair of fractures and skeletal defects, spinal and joint arthrodeses, and revision arthroplasties. These procedures are performed by virtually all orthopaedic subspecialties and by neurosurgeons, some plastic surgeons and certain other surgical specialties. Dental and other oral maxillofacial procedures are not considered to be a primary portion of the bone graft market, but are instead considered to constitute a secondary market. Three basic categories of products or alternatives currently compete in the bone graft market:
o autograft bone tissue; o allograft bone tissue; and o synthetic bone void fillers.
A potential fourth product category, growth factor products, is still in the investigational stage.
We estimate that total domestic allograft bone tissue sales in 2000 was $257 million, comprising approximately 50% of the U.S. bone graft market.
(1) Source: Datamonitor, "US Bone Substitutes" (2) Source: Osteotech estimate
The number of bone graft procedures is forecast to increase during the next five years due to an expected increase in the number of reconstructive orthopaedic surgical procedures utilizing bone grafts, particularly in spinal procedures using bio-implants, pedicle screw implants and spinal cages.
Factors producing the continued growth in the number of reconstructive orthopaedic surgical procedures that incorporate a bone graft include the following:
o the aging of the U.S. population;
o improving success rates for surgical procedures that involve a bone graft procedure;
o development of less invasive reconstructive orthopaedic surgical procedures that will be used in a wider patient population; and
o the increasing number of revision, spinal fusion and joint arthroplasty procedures resulting from a more active and longer living U.S. population.
While the general bone graft market has experienced low-single-digit growth in recent years, we estimate that allograft bone tissue sales have increased at an average annual rate of approximately 16% since 1994. This displacement trend is expected to continue as physicians gain confidence in, and experience with, allograft bone tissue. Some of the factors contributing to the increased use of allograft bone tissue include:
o the desire by surgeons to avoid the additional procedure needed to acquire autograft bone tissue, which often increases costs due to additional operating time, medical supplies and extended hospital stay, and patient risks due to excessive blood loss, infection, chronic pain and morbidity;
o increased awareness by, and training of, the medical community with respect to the use and safety of processed allograft bone tissue;
o an increase in the number of patients who do not possess the quality of bone tissue required for autograft procedures as a result of the general aging of the population; and
o an increase in the availability of allograft bone tissue due to an increase in bone tissue donations and to improved recovery and processing techniques.
Competitive Overview
In both our Grafton(R) DBM and Base Tissue Segments we compete in the bone graft market with autograft bone tissue, synthetic bone void fillers and allograft bone tissue processed by others. Autograft bone tissue has traditionally been the primary choice for surgeons and we believe it still maintains an approximate 50% share of the U.S. bone graft market. Due to factors such as the increased cost and potential complications associated with an additional procedure needed to acquire autograft bone tissue, more surgeons are beginning to choose allograft bone tissue over autograft bone tissue for their bone grafting needs.
Grafton(R) DBM Segment
We have been successful in persuading many surgeons to switch to Osteotech processed allograft bone tissue through the introduction of our proprietary tissue processing technology. We have expanded the applications of allograft bone tissue through Grafton(R) DBM, a proprietary form of allograft bone tissue. The demineralization process used in Grafton(R) DBM removes most of the minerals, thus exposing the proteins that promote bone growth (osteoinduction) and creating a lattice work for new bone (osteoconduction). Grafton(R) DBM has a validated viral inactivation process for HIV, hepatitis B and C, cytomeglia and polio. Grafton(R) DBM is produced in five forms - gel, flex, putty, crunch, and DBF Matrix - and is packaged in sterile, single patient delivery systems. We introduced Grafton(R) DBM Crunch, a mixture of demineralized bone fibers and demineralized cortical cubes, into the market in December, 1999 and Grafton(R) DBF Matrix in January, 2001. With the varying textural and handling characteristics of its five forms, Grafton(R) DBM can be used in virtually all non-weight-bearing bone graft procedures and has been used in over 410,000 procedures through December 31, 2000.
Given its osteoinductive and osteoconductive properties, Grafton(R) DBM has a distinct advantage over synthetic bone void fillers, all of which are exclusively osteoconductive.
Grafton(R) DBM's advantages over synthetic grafting materials in the market for non-weight-bearing applications include:
o superior handling and performance qualities, including providing a matrix for bone to grow into and inducing bone to grow; and
o the suitability of Grafton(R) DBM for all non-weight-bearing bone graft procedures versus the limited applications of competitive products.
GRAFTON(R) DBM VERSUS COMPETITIVE ALLOGRAFT PRODUCTS(1)
(1) Source: Based upon Osteotech's Survey of Competition (2) As a result of a patent lawsuit settlement with Osteotech, DePuy ceased to market DynaGraft in February, 2001. (3) GenSci claims that its DynaGraft Products are osteoinductive.
Although it already occupies a leading position in the U.S. market for non-weight-bearing grafting materials, in recent years, our Grafton(R) DBM products have faced increasing competitive pressures as more companies have developed, or have announced they are developing, products with characteristics similar to Grafton(R) DBM. We expect that this competition will continue to increase in the future. Many of these competitors have research and development, marketing and other resources that are significantly greater than ours. Certain of our competitors also offer a full line of metal implants and other products used in spinal surgeries. This could give them a competitive advantage over us since they can offer surgeons a more complete line of products than we currently can.
Notwithstanding the increasing competition, Grafton(R) DBM has significant opportunities for growth. Currently, Grafton(R) DBM sales are primarily domestic. We estimate that Grafton(R) DBM was used in only 19% of the total bone graft procedures performed in the U.S. during 2000.
We estimate the potential non-domestic bone graft market to be at least as large as that of the U.S. market. The European market, in particular, provides us with an opportunity in an area where we already have a sales presence, and, therefore, we began marketing Grafton(R) DBM in nine European countries during 2000.
Grafton(R) DBM U.S. Procedure Penetration
------------------------------------------ Grafton(R) DBM ------------------------------------------
(1) Source: Data monitor, "US Bone Substitutes" (2) Source: Osteotech estimate
Base Tissue Segment
Allograft bone tissue is still the only alternative to autograft bone tissue for bone grafting procedures which require weight-bearing tissue. Our primary competition in this segment is surgeons who use autograft bone tissue instead of allograft bone tissue. We plan to continue to differentiate our Base Tissue Segment operations from those of other allograft bone tissue processors by expanding our viral inactivation claim to include our mineralized weight-bearing bone tissue. In late 2000, we introduced our Allogard(R) Packaging plastic tray for most of the base allograft bone tissue processed in our Base Tissue Segment. This packaging will be easier for operating room nurses to work with. In addition, this will allow us to differentiate our "Osteotech processed bone" from most competitive allograft processed bone which is usually packaged in glass bottles.
In this segment, we process both our base allograft bone tissue and bio-implants. In December, 1998, we introduced the bio-d(TM) Threaded Cortical Bone Dowel for posterior and anterior spinal fusion procedures. In the fourth quarter 2000, we began the limited market introduction of the Graftech(TM) Bio-implant line of spacers and ramps for posterior and anterior lumbar spinal fusion procedures and for cervical spinal fusion procedures. In the first quarter 2001, two of the Graftech(TM) Bio-implant tissue forms became available nationally and the others are expected to be available nationally by the fourth quarter 2001. We market these bio-implants and our clients generally distribute them.
In order to maintain our leading position in the allograft bone tissue processing market and to encourage more surgeons to switch from autograft bone tissue to our processed allograft bone tissue, we plan to:
o leverage our knowledge of allograft bone tissue processing to expand our proprietary tissue safety claims to our weight-bearing mineralized allograft bone tissue;
o expand our external scientific presence through publication and presentation of clinical research and outcome studies;
o expand our market differentiation through tissue performance improvements, including line extensions of existing base allograft bone tissue products and new product introductions; and
o increase education of surgeons regarding the use of allograft bone tissue through expanded grand rounds, seminars and workshops.
The various national markets in Europe for bone grafts are currently dominated by the use of autograft and synthetic bone graft substitutes. Autograft remains the bone graft of choice due to surgeons' attitudes and concerns about bone graft safety and performance. There is also a significant number of surgeons who have not yet become aware of the safety and performance advantages of processed allografts and who continue to use unprocessed autografts. Our OsteoPure(TM) Process, Grafton(R) DBM and base allograft bone tissue are designed to address these needs. However, other firms have developed or are developing allograft bone tissue grafts and allograft bone tissue-based products to also address these needs. Tissue Bank of France, a unit of Groupe Lepine of France and Tutogen, Inc. of Germany offer allograft bone tissue grafts which directly compete with the OsteoPure(TM) Processed human femoral head tissue grafts in certain European countries. Also, several U.S. tissue bank organizations have formed strategic alliances with orthopaedic device firms to market allograft bone tissue grafts in European markets.
Other
Our ceramic and titanium plasma spray coating and HA product operations face competition in Europe from divisions and subsidiaries of several large corporations engaged in providing such services and products to others and from several smaller independent companies. In addition, we also face competition from medical implant companies which have in-house plasma spray coating operations. We compete primarily on the quality of our coatings and price. We believe that the spraying technology we use, which is computer controlled and utilizes robotics enables us to provide high quality coatings at competitive prices. It should be noted, however, that the ceramic and titanium coating industry is highly competitive.
Although we have not been a significant competitor in the metal spinal implant market to date, we are expanding into this market, which is highly competitive.
Environmental Matters
Our allograft bone tissue processing in both the United States and Europe generates waste which, in the United States, is classified as medical hazardous waste by the United States Environmental Protection Agency and the New Jersey Department of Environmental Protection. We segregate this waste and dispose of it through a licensed hazardous waste transporter in compliance with applicable regulations in both the United States and Europe. The production of HA powder at our facility in The Netherlands generates small amounts of hazardous waste, which we segregate and dispose of through a licensed hazardous waste transporter. Although we believe we are in compliance with applicable environmental regulations, the failure to fully comply with any such regulations could result in the imposition of penalties, fines and/or sanctions which could have a material adverse effect on our business.
Patents and Proprietary Rights
We consider our processing technology and procedures proprietary and rely primarily on trade secrets to protect our technology and innovations. Significant research and development activities have been conducted on our behalf by consultants employed by third parties or in conjunction with unaffiliated medical institutions. Accordingly, disputes could arise in the future concerning the proprietary rights to information applied to our projects which have been independently developed by the consultants or researchers at the medical institutions.
At February 28, 2001, we held an aggregate of 101 United States patents and patent applications and 112 foreign patent and patent applications consisting of: (i) 34 United States patents and 13 foreign patents relating to our aseptic processing technology and our transplant support products, including 15 United States Grafton(R) DBM patents and 3 foreign Grafton(R) DBM patents, (ii) 5 United States and 26 foreign patents relating to our biomaterials technology, (iii) 54 United States and 56 foreign patent applications relating to aspects of our processing technology and our osteogenic and other products under development, (iv) 1 United States patent related to instrumentation, (v) 4 United States patent applications and 16 foreign patent applications relating to our biomaterials technology and (vi) 3 United States patent applications and 1 foreign patent application relating to instrumentation. We believe that our Grafton(R) DBM patents are significant in maintaining our competitive position. These patents expire on various dates ranging from 2009 to 2020. Our other patents expire at various dates ranging from 2007 to 2020.
There can be no assurance that any pending patent applications will result in issued patents or that any currently issued patents, or patents which may be issued, will provide us with sufficient protection in the case of an infringement of our technology or that others will not independently develop technology comparable or superior to ours. We are currently involved in four patent-related lawsuits. See Item 3. "Legal Proceedings."
Product Liability and Insurance
The testing and use of allograft bone tissue and the implantation of medical devices coated with our HA powder, medical devices developed with our biomaterials technology and medical devices manufactured by others and distributed by us entail inherent risks of medical complications for patients, and therefore may result in product liability claims against us. Further, our agreements with our bone tissue processing clients provide them with indemnification by us for liabilities arising out of defects in allograft bone tissue caused as a result of processing performed by us.
We presently maintain product liability insurance in the amount of $102 million per occurrence and per year in the aggregate. We cannot assure you that we will be able to maintain such insurance in the future or that such insurance will be sufficient to cover the amount of claims asserted against us on all types of liabilities.
Employees
At December 31, 2000, we had 350 employees, of whom 214 were engaged in allograft bone tissue processing, ceramic plasma spray coating and the manufacture of products; 27 were engaged in research and development; 51 were engaged in education, sales and marketing; and 58 were engaged in regulatory, finance and administration. Our employees are not covered by any collective bargaining agreement. We consider relations with our employees to be good.
Item 2.
Item 2. Properties
Our principal executive offices are located in approximately 38,000 square feet in Eatontown, New Jersey, which is occupied pursuant to a lease which expires in December, 2004 and provides for a base annual rental of approximately $264,000. This facility is occupied by our corporate, financial, administration, marketing, research and development, regulatory and clinical affairs staff.
Our processing facility is located in approximately 45,000 square feet of space in Shrewsbury, New Jersey, which is occupied pursuant to a lease which expires in October, 2008 and provides for a base annual rental of approximately $247,000 through October 2003 and $309,000 for the remaining term of the lease. The lease is renewable at our option for an additional five year term. Both the Grafton(R) DBM and Base Tissue Segments utilize this facility. In addition, we rent 4,600 square feet of space in Eatontown, New Jersey principally as warehouse space for our non-allograft bone tissue spinal implant products. The lease expires in January 2005 and provides for base annual rental of approximately $27,000.
Our subsidiary in Leiden, the Netherlands, which is engaged in the biomaterial business line, occupies a 21,000 square foot facility. The lease for this facility expires in May, 2008 and the annual rent is dfl 626,000 (approximately $268,000 at the December 31, 2000 exchange rate). We are subleasing 6,400 square feet of this facility to an unrelated third party at an annual rent of dfl
234,000 (approximately $100,000 at the December 31, 2000 exchange rate). The sublease agreement expires in March, 2004.
Our subsidiary in France, OST Developpement SA, which is engaged in the production, processing and distribution of bovine bone graft substitute products and human allograft tissue products, occupies an 11,000 square foot facility in Clermont-Ferrand, France. The lease for this facility expires in June, 2002 and has an annual rent of FRF 556,000 (approximately $80,000 at the December 31, 2000 exchange rate). We have the option to acquire the building and related land for the fair market value of the property at the time of purchase as determined by an independent appraisal.
In 1997, we purchased approximately 13 acres of land surrounding our Eatontown, New Jersey facility. We plan to utilize this land for future expansion to meet our anticipated facilities requirements. In connection with the first stage of this expansion, we have engaged a developer to build an additional 74,000 square foot processing facility to our specifications. We expect to occupy this facility in the second half of 2001. We are financing the construction of this facility with a $4.5 million loan from our bank which will be secured by a mortgage on the real property, building and fixtures, proceeds from a $17 million equipment line of credit from our bank which will be secured by the equipment purchased with the proceeds from this loan facility, through our current cash reserves and from cash generated by operations.
Item 3.
Item 3. Legal Proceedings
GenSci Regeneration Laboratories, Inc. v. Osteotech, Inc.; Osteotech, Inc. v. GenSci Regeneration Sciences, Inc., 10111-MRP (Eex) (C.D. Cal.) - - ----------------------------------------------------------
In January, 1998, we filed a patent infringement action against GenSci Regeneration Laboratories, Inc., or GenSci Labs, and GenSci Regeneration Sciences, Inc., or GenSci Sciences, alleging that the GenSci parties violated claims of one of our patents involving the Grafton(R) Demineralized Bone Matrix (DBM) process. Approximately two weeks after our filing, GenSci Labs filed a suit against us alleging that our Grafton(R) DBM Flex tissue form infringes two patents assigned to GenSci Labs in addition to allegations against us for 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 our 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.
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, we served our answer to this amended complaint, asserted counterclaims against GenSci Labs and served a third-party complaint against GenSci Sciences, and DePuy AcroMed, Inc., or DePuy. Our counterclaims and third party complaint accused the GenSci parties of infringing a second patent of ours, in addition to the patent referred to above, and
accused the DePuy and GenSci parties 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 our Grafton(R) DBM Flex tissue form, our Grafton(R) DBM Gel and Putty tissue forms infringe on the GenSci Lab's patents at issue. GenSci Labs also amended its complaint to modify its false advertising claim, alleging that in addition to Osteotech, individuals acting on our behalf engaged in false advertising. We filed and served our answer and counterclaims to the amended complaint in May, 1999.
In November, 1999, we settled all claims which we had filed against DePuy. As part of the settlement, DePuy has agreed to stop selling the GenSci products accused of infringing our patents, no later than February 4, 2001 and to pay us $3,000,000. Payments of $1,000,000 and $2,000,000 were received in 2000 and 1999, respectively.
In April, 2000, we, GenSci Labs and GenSci Sciences reached an agreement to dismiss with prejudice all of GenSci's patent infringement claims against our proprietary Grafton(R) DBM allograft bone tissue forms and to stay any action in GenSci's anti-trust suit, which it had filed against us on March 6, 2000, until the completion of the trial of our patent infringement claims against GenSci. GenSci also agreed to dismiss all of the tort claims that it had brought against us 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 us in the patent action. This agreement was subject to court approval, which approval has been received. The only remaining claims in the patent action involve our allegations that GenSci has infringed certain of our patents through the sale of the Dynagraft(TM) Gel and Dynagraft(TM) Putty products.
In July, 2000, we filed a motion seeking summary judgment in our favor on GenSci Labs' and GenSci Sciences' reverse doctrine of equivalents defense on the basis that the GenSci parties failed to assert that defense in a timely manner and that the defense is otherwise meritless. We also filed a motion seeking judgment that the portion of the case GenSci dismissed with prejudice be ruled as exceptional based on GenSci Labs having asserted and maintained baseless allegations that we infringed GenSci Labs' patents, thus warranting an award of attorneys' fees and costs to us.
Also, in July, 2000, GenSci filed various motions for summary judgment seeking orders that GenSci does not infringe on our patents and/or that such patents are invalid.
In October, 2000, the court held a claims construction hearing, also known as a Markman hearing, to construe the scope of the claims of the patents-in-suit. In December, 2000, the court issued its ruling adopting our interpretation of the claims.
In January, 2001, we filed a motion for summary judgment of infringement of U.S. Patent No. 5,290,558. Also in January, 2001, GenSci filed a second motion for summary judgment of noninfringement of U.S. Patent No. 5,284,655, and stated to the court that there no longer was a
need for the court to rule on GenSci's first motion for summary judgment of noninfringement of U.S. Patent No. 5,284,655.
In March, 2001, the court rejected GenSci's various motions for summary judgment. Osteotech's motion for summary judgment of infringement of U.S. Patent No. 5,290,558 has not as yet been ruled on.
We will continue to vigorously defend any claims against us, prosecute the claims we have asserted in this action, and vigorously and affirmatively protect our products and intellectual property to the fullest extent possible under the law.
GenSci Orthobiologics, Inc. v. Osteotech, Inc., Civil Action No. 02313-LGB (C.D. Cal.) - - ------------------------------------------------------------
On March 6, 2000, GenSci Orthobiologics, Inc., or GenSci, filed a complaint in the United States District Court for the Central District of California against us, alleging unlawful monopolization, attempt to monopolize the market for demineralized bone matrix and for entering 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 we engaged in unlawful and unfair business practices in violation of Section 17200 of the California Unfair Competition Law. GenSci has alleged that we have monopoly power in the market for demineralized bone matrix products in the United States, and have engaged in anticompetitive conduct by improperly asserting our patents through patent infringement actions, seeking to have the FDA 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 us from restricting the tissue banks for which we process tissue from supplying processed demineralized bone matrix to our competitors and distributing the demineralized bone matrix implant products of our competitors. Certain of these allegations had previously been asserted by GenSci in its patent litigation with us in the Central District of California federal court.
In April, 2000, we 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 our patent infringement claims against GenSci.
We believe the claims made in this lawsuit are without merit and we intend to vigorously defend against these claims.
Osteotech, Inc. v. GenSci Orthobiologics, Inc. CV 00-11342 MRP (EEx) - - --------------------------------------------------------------------
On October 25, 2000, we filed suit against GenSci Orthobiologics, Inc., in the United States District Court for the Central District of California, alleging that GenSci Orthobiologics' demineralized bone matrix materials sold under the name Orthoblast, infringe our U.S. Patent No. 5,290,558 and infringe the reexamined claims of our U.S. Patent No. 5,676,146. Our complaint seeks injunctive relief, treble damages, costs and attorneys fees.
In its second amended answer and counterclaim filed in March, 2001, GenSci Orthobiologics denies infringement, asserts a number of affirmative defenses, and asserts a counterclaim seeking a declaratory judgment that the patents-in-suit are invalid, not infringed and/or unenforceable together with costs and attorneys fees.
We intend to pursue our claims against GenSci Orthobiologics and defend against the counterclaims.
"O" Company, Inc. v. Osteotech, Inc., Case No. Civ. 98-981 BB/LFG (D.N.M.) - - --------------------------------------------------------------------------
In July, 1998, a complaint was filed against us in the Second Judicial District Court, Bernallilo County, New Mexico, which alleges negligence, strict liability, breach of warranties, negligent misrepresentation, fraud, and violation of the New Mexico Unfair Trade Practices Act arising from allegedly defective dental implant coating and coating services provided to plaintiffs by our subsidiary, Cam Implants BV. Plaintiffs have demanded unspecified monetary damages. In August, 1998, we removed this action to the United States District Court for the District of New Mexico and filed and served our answer, denying any and all liability in this action, and moved to dismiss five of the seven claims alleged against us. In March, 1999, the court dismissed with prejudice the plaintiff's negligence and strict liability claims. Remaining are claims for breach of warranties, negligent misrepresentation, fraud, and violation of the New Mexico Unfair Trade Practices Act. As to those claims, we have moved for summary judgment on the basis that all of the remaining claims are barred by their applicable statutes of limitations. At plaintiffs' request, the court permitted limited discovery on the matters related to the statute of limitations issue, which is ongoing.
We believe that the claims made against us in this action are without merit and we will continue to vigorously defend against such claims.
University of Florida Tissue Bank, Inc. v. Osteotech, Inc., Case No. 1:99cv33 MMP (N.D. Fla.) - - -----------------------------------------------------------
In February, 1999, a complaint was filed against us 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 our bio-d(TM)Threaded Cortical Bone Dowel and Endodowel infringe on the claims of U.S. Patent Nos. 5,814,084 and 4,950,296. The plaintiffs have sought injunctive relief and monetary damages in an amount not yet specified. In May, 1999, we filed our answer and counterclaim seeking declaratory judgment that the patents in question in this action are invalid and otherwise not infringed by us. In May, 1999, plaintiffs filed their reply to our counterclaims.
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 patents mentioned above, 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. We believe that the claims made against us in this action are without merit and we will continue to vigorously defend against such claims.
Medtronic Sofamor Danek, Inc., Sofamor Danek L.P. and Sofamor Holdings, Inc. v. Osteotech, Inc., Case No. 99-2656 (W.D. Tenn.) - - ---------------------------------------------------------------
In July, 1999, Medtronic Sofamor Danek Inc., Sofamor Danek L.P. and Sofamor Danek Holdings, Inc., or collectively Danek, sued us in the United States District Court for the Western District of Tennessee alleging that instruments and instrument sets relating to cortical bone dowel products, including the bio-d(TM) Threaded Cortical Bone Dowel and Endodowel, manufactured, sold and/or otherwise distributed by us infringe on certain claims of U.S. Patent Nos. 5,741,253 and 5,484,437 which are owned by Danek. In addition to injunctive relief, plaintiffs seek unspecified monetary damages. In September, 1999, we filed our answer and counterclaims seeking a declaratory judgment that the patents in question in this action are invalid and otherwise not infringed by us. 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 we also 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. We believe that the claims made against us in this action are without merit and we will continue to vigorously defend against such claims.
Regner v. Inland Eye & Tissue Bank of Redlands, SCVS66746 (Superior Ct., San Bernardino County, California) - - ------------------------------------------------------------------------
In May, 2000, Regner brought suit against us 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. Plaintiff claims that we are violating the California Business and Professional Code 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 us, the plaintiffs are seeking damages in an unspecified amount in addition to class certification.
In June, 2000, Regner filed a motion for preliminary injunction and a hearing was held on June 28, 2000. The Court denied the motion. We 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. 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 scheduled a hearing on defendants' demurrers to the plaintiffs' complaint. Plaintiffs subsequently moved to voluntarily dismiss the action without prejudice. The Court granted that motion. In February, 2001, we were served with the action that was refiled in Los Angeles County. The defendants have filed a motion asking the Court to move this action back to San Bernardino County.
We deny that we engaged in the activity complained of and assert that we are licensed by the State of California to do precisely what we are doing, and that our activities are fully in accord with all state and federal laws. Therefore, we believe this suit to be without merit and we will vigorously defend against the claims.
Thacker v. Inland Eye & Tissue Bank, BC241929 (Superior Ct., Los Angeles County, California) - - ------------------------------------------------------------
In February, 2001, Thacker brought suit against us and fifteen or more defendants in the Superior Court for the State of California, Los Angeles County. The suit is substantially identical to the Regner v. Inland Eye & Tissue Bank of Redlands suit discussed above. We are assessing the claims against us and have not yet responded to them. The defendants have filed a motion asking the Court to move this action to the Superior Court for the State of California, San Bernardino County, or in the absence to do so, to consolidate this action with the Regner action.
We deny that we engaged in the activity complained of and assert that we are licensed by the State of California to do precisely what we are doing, and that our activities are fully in accord with all state and federal laws. Therefore, we believe this suit to be without merit and we will vigorously defend against the claims.
Steele v. Inland Eye and Tissue Bank, SCVS59024 (Superior Ct., San Bernardino County, California) - - --------------------------------------------------------------
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. In February, 2001, plaintiffs agreed to dismiss this case with prejudice.
Condos v. Musculoskeletal Transplant Foundation, Civil No. 2:00-CV-0190ST (D. Utah) - - ------------------------------------------------
In June, 2000, we were served with an action brought in the United States District Court for the District of Utah against us and 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 us and MTF which was allegedly implanted into the plaintiff, Chris Condos, during two spinal surgeries. Plaintiffs, which include Mr. Condos' family members, demand monetary damages in an unspecified amount. On July 25, 2000, we answered the complaint, denying any and all liability. Discovery on all of the claims in this action has commenced.
We maintain a general liability insurance policy and have notified the insurance company of this action and the insurance company has agreed to defend us in this action.
Musculoskeletal Transplant Foundation v. Osteotech, Inc., Civil Action No. 00-4869 (JWB) - - ---------------------------------------------------------
In October, 2000, MTF filed a complaint in the United States District Court for the District of New Jersey against us seeking a declaratory judgment that MTF, through its manufacture, use, sale and/or offer for sale of demineralized bone matrix products, does not infringe any claim of our U.S. Patent Nos. 5,284,655 and 5,290,558, and that the claims of those patents are invalid and unenforceable. The complaint was then amended to add Synthes Spine Company, L.P., or Synthes, as a plaintiff. MTF and Synthes seek declaratory and injunctive relief.
We answered the complaint, denying all claims asserted and we have asserted claims against MTF and Synthes for patent infringement, unfair competition, misappropriation of trade secrets, product disparagement, breach of implied covenant of good faith and fair dealing, intentional interference with contractual relations, and for constructive trust, arising from certain wrongful acts committed by MTF and/or Synthes for developing and selling their DBX(R) Products and/or their underlying technology. We seek injunctive relief and monetary damages in an amount to be determined. MTF and Synthes have denied any liability.
Discovery has commenced on all claims. We believe that the claims made against us in this action are without merit and we will vigorously defend against the claims.
Glancy v. Interpore International, Inc., Case No. 2:00-CV-585RL (N.D. Ind.) - - ----------------------------------------
In November, 2000, plaintiffs Bonnie and Ivan Glancy commenced an action in the United States District Court for the Northern District of Indiana against Interpore International, Inc. and Interpore Cross International, Inc., or collectively Interpore, and us. The suit seeks recovery from defendants for alleged personal injuries suffered by plaintiffs as a result of allegedly defective spinal implants, manufactured and/or distributed by Interpore, and/or demineralized bone matrix material, processed by us - both are alleged to have been implanted into plaintiff Bonnie Glancy during a spinal surgery. Plaintiffs have asserted against us a products/strict liability claim relating to the demineralized bone matrix material. Plaintiffs demand monetary damages in an unspecified amount. In January, 2001, we answered the complaint, denying any and all liability. Discovery on all of the claims in this action have commenced.
We maintain a general liability policy and have informed the insurance company of this action. The insurance company has agreed to defend this action.
Criti-Cal, Inc. v. Osteotech, Inc., Case No. OOCC15620 (Superior Ct., Orange County, California) - - ------------------------------------------------------
In December, 2000, Criti-Cal, Inc. commenced an action in the Superior Court for the State of California, Orange County, against us, Second Act Medical, Inc. and Ronald Letner. The plaintiff alleges causes of action for breach of contract, misappropriation of trade secrets, quantum merit and violations of the California Independent Wholesale Sales Representatives Contractual Relations Act of 1990 arising from the termination of an agreement between us and plaintiff. In addition to injunctive relief, plaintiff seeks unspecified monetary damages.
We answered the complaint denying any and all liability and we intend to vigorously defend against all claims.
Medtronic, Inc. v. Osteotech, Inc., Case No. CT-000843-01, Div 7 (Cir. Ct., Shelby County, Tennessee) - - ----------------------------------------------------------
In February, 2001, Medtronic, Inc. and Medtronic Sofamor Danek, Inc., or collectively Medtronic, brought suit against us and Medtronic's former employee, Timothy R. Miller, in the Circuit Court for Shelby County, Tennessee. The plaintiffs seek to enjoin Mr. Miller, whom we recently hired, from using and disclosing any of their trade secrets or other confidential information to any third party, including us, and from working for us for a period of twelve months. The plaintiffs have asserted a claim against us for tortious interference with an employment agreement between Mr. Miller and plaintiffs. In addition to injunctive relief, plaintiffs seek unspecified monetary damages.
Mr. Miller and we have both filed an answer denying any liability. Medtronic has filed a motion for preliminary injunction which remains pending. We intend to vigorously defend against these claims.
Other than the foregoing matters, we are not a party to any material pending legal proceeding. Litigation is subject to many uncertainties and we are 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.
Item 4.
Item 4. Submissions of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters -----------------------------------------
Our Common Stock has been listed on the Nasdaq Stock Market(R) under the trading symbol "OSTE" since our initial public offering in July 1991.
The following table sets forth the high and low sale prices for the Common Stock for each of the fiscal quarters during the years ended December 31, 2000 and 1999 based on transaction data as reported by the Nasdaq Stock Market(R).
On February 11, 1999, our Board of Directors authorized a three-for-two stock split in the form of a 50% stock dividend that was distributed on March 19, 1999 to stockholders of record on March 5, 1999. The high and low sales prices have been restated to give retroactive recognition to the stock split for all periods prior to the effective date of the stock split.
As of March 20, 2001, there were 306 holders of record of Osteotech Common Stock. We believe that there are approximately 5,600 beneficial owners of our Common Stock.
We have never paid a cash dividend and do not anticipate the payment of cash dividends in the foreseeable future as earnings are expected to be retained to finance our growth. Declaration of dividends in the future will remain within the discretion of our Board of Directors, which will review our dividend policy from time to time.
Item 6.
Item 6. Selected Financial Data
Set forth below is the selected financial data for the five fiscal years ended December 31, 2000. The following data should be read in conjunction with our consolidated financial statements and related notes thereto contained elsewhere herein and "Management's Discussion and Analysis of Financial Condition and Results of Operations." All per share data have been adjusted for the three-for-two stock split in the form of a 50% stock dividend in March, 1999.
(a) In 1996, operating expenses include a charge to earnings of $1,350,000 related to the restructuring of our operations located in Leiden, The Netherlands.
Item 7.
Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations
For the Three Years Ended December 31, 2000, 1999 and 1998 Results of Operations
Net Income (Loss)
Consolidated net income decreased to $4,828,000 or $.34 diluted income per share in 2000 compared to net income of $12,351,000 or $.84 diluted income per share in 1999 and $10,304,000 or $.73 diluted income per share in 1998. Net income in 2000 and 1999 included approximately $600,000 or $.04 diluted income per share and $1,200,000 or $.08 diluted income per share, respectively, related to the patent litigation settlement with DePuy. See Part I, Item 3. "Legal Proceedings" and Note 11 of "Notes to Consolidated Financial Statements."
Consolidated income before income taxes decreased to $8,902,000 in 2000 compared to $20,884,000 in 1999 and $17,413,000 in 1998. Income before income taxes in 2000 and 1999 included $1,000,000 and $2,000,000, respectively, related to the patent litigation settlement with DePuy.
The following is a discussion of factors affecting results of operations for the years ended December 31, 2000, 1999, and 1998.
Net Revenues
Consolidated net revenues in 2000 were $75,683,000 as compared to $75,610,000 in 1999. In December 2000, one of our clients purchased $1,000,000 of Grafton(R) DBM in advance of the January 1, 2001 price increase, but we deferred recognition of the revenue until the first quarter of 2001 in accordance with Generally Accepted Accounting Principles, or GAAP, specifically Staff Accounting Bulletin 101. Revenues in 1999 included a $1,500,000 purchase of Grafton(R) DBM in advance of a January 1, 2000 price increase. The 1999 Grafton(R) DBM purchase was not required to be deferred in accordance with GAAP and SEC Staff Accounting Bulletin 101. Domestic net revenues, which consist principally of revenues from the Grafton(R) DBM and Base Tissue Segments, were $71,468,000 in 2000 as compared to $71,517,000 in 1999. Revenues from bio-implants increased 111% in 2000 offsetting the 7% decline in base allograft tissue processing revenues, which resulted from a 16% decline in the number of donors processed, and a 2% decline in domestic Grafton(R) DBM revenues. Foreign net revenues were $4,215,000 in 2000 compared to $4,093,000 in 1999. Revenues associated with the European introduction of Grafton(R) DBM and a 162% increase in OsteoPure(TM) Femoral head processing revenue offset decreased revenues from bovine tissue sales and ceramic and titanium coating services.
Consolidated net revenues increased 28% in 1999 to $75,610,000 from $59,201,000 in 1998. The increase was principally due to higher revenues in both the Grafton(R)
DBM and Base Tissue Segments. Domestic net revenues, which consist principally of revenues from the Grafton(R) DBM and Base Tissue Segments, increased 26% to $71,517,000 from $56,876,000 in 1998. Foreign revenues increased 76% to $4,093,000 from $2,325,000 in 1998. The increase in foreign net revenues resulted primarily from our January 1999 acquisition of OST.
Grafton(R) DBM Segment net revenues in 2000 were $45,226,000 as compared to $45,136,000 in 1999. Grafton(R) DBM Segment revenues were positively affected by the introduction of Grafton(R) DBM in Europe, which offset a 2% decrease in domestic revenues. In addition, 1999 revenues included $1,500,000 of Grafton(R) DBM purchased by our clients in December, 1999 in advance of the January 1, 2000 price increase, while revenue recognition of a similar December, 2000 $1,000,000 purchase of Grafton(R) DBM by one of our clients was deferred until 2001 in accordance with GAAP and SEC Staff Accounting Bulleting 101. In 2000, Grafton(R) DBM faced and we expect it will continue to face, increasing competition as more companies develop products with characteristics similar to Grafton(R) DBM. Base Tissue Segment net revenues increased 2% in 2000 to $26,204,000 from $25,751,000 in 1999. The increase was principally due to a 111% increase in bio-implant processing revenues and a 162% increase in OsteoPure(TM) Femoral head processing revenue. These increases were partially offset by a 7% decline in base allograft tissue processing revenues as a result of a 16% decline in the number of donors processed, due in part to the decline in base tissue needs of surgeons as they shift to using more highly advanced tissues such as our line of Graftech(TM) bio-implants.
Grafton(R) DBM Segment net revenues increased 15% in 1999 to $45,136,000 from $39,128,000 in 1998. The increase resulted from increased demand for Grafton(R) DBM. Base Tissue Segment net revenues increased 49% in 1999 to $25,751,000 from $17,323,000 in 1998. The increase occurred as a result of increased unit volume of allograft bone tissue processed for our clients.
During 2000, 1999, and 1998, two of our clients in the Grafton(R) DBM and Base Tissue Segments accounted for 50% and 40%, 56% and 38%, and 56% and 39%, respectively, of consolidated net revenues. We have processing agreements with each of these clients which expire in August, 2005 and December, 2006, respectively. The agreement which expires in August 2005, may be terminated by either party commencing in March 31, 2002, or any date thereafter upon giving six months prior written notice.
Gross Profit
Gross profit as a percentage of net revenues was 64% in 2000, 68% in 1999, and 70% in 1998. The decline in gross profit as a percentage of net revenues in 2000 resulted primarily from the underabsorption of costs related to: increased capacity, new processing technologies, a 16% decline in the number of donors processed, and allograft bone tissue forms that have not yet achieved revenue levels sufficient to fully absorb production costs while they are in launch mode. The decline in gross profit as a percentage of net revenues in 1999 results from: the absorption of costs associated with additional allograft tissue processing capacity which was added to meet the anticipated growth in our allograft tissue business, and a decline in the percentage of consolidated
revenues coming from the Grafton(R) DBM Segment, which has a higher gross profit than other services and products.
In the fourth quarter of 1998, we commenced construction of a new allograft tissue processing facility in Eatontown, New Jersey which is expected to be in use during the second half of 2001, see Item 2, "Properties" and Note 6 of "Notes to Consolidated Financial Statements." We expect that the incremental expenses associated with this facility will only be partially offset by increased volume in 2001, and therefore consolidated gross profit as a percentage of net revenues in 2001 is expected to decline slightly from the level achieved in 2000.
Marketing, General and Administrative Expenses
Marketing, general and administrative expenses increased 25% in 2000 to $35,545,000 from $28,343,000 in 1999. In 1999, marketing, general and administrative expenses were 37% higher than 1998 expenses of $20,671,000. In 2000, this increase is primarily due to increases in legal fees associated with patent lawsuits, see Part I, Item 3. "Legal Proceedings" and Note 11 of "Notes to Consolidated Financial Statements", and increased costs associated with marketing, selling and promotional activities, especially with respect to new bio-implant tissue forms. The increase in 1999 was primarily attributable to: incremental agent commissions resulting from increased volume in the Grafton(R) DBM Segment, expanded marketing and promotional activities associated with the launch of two new products, the bio-d(TM) Threaded Cortical Bone Dowel which is included in the Base Tissue Segment and the SSCS(TM) system, increased legal fees associated with patent infringement lawsuits, and the inclusion of OST's operating expenses. We are committed to aggressively asserting and defending our technology and related intellectual property. As a result we are currently involved in four patent lawsuits. Prosecuting and defending these lawsuits is expensive and has had, and will likely have, a negative impact on our operating results. However, we believe it is necessary to defend our technology and related intellectual property in which we invest significant amounts of money to develop.
Research and Development Expenses
Consolidated research and development expenses increased 5% in 2000 to $5,772,000 from $5,506,000 in 1999. Research and development expenses in 1999 were 19% higher than 1998 research and development expenses of $4,610,000. These increases were primarily attributable to increased spending in the Grafton(R) DBM and the Base Tissue Segments associated with the continued development of several new processing technologies, development of new allograft bone tissue forms, specifically new bio-implant tissue forms, and ongoing support for existing products and services.
Income From Litigation Settlement
In November, 1999, we settled all claims which we had filed against DePuy in the patent infringement lawsuit against GenSci Labs and GenSci Sciences. As part of the settlement, DePuy has agreed to stop selling the GenSci products accused of infringing our patents no later than February 4, 2001 and to pay us $3,000,000. We received payments and recognized income, of
$250,000 in each quarter of 2000 and a payment of $2,000,000 in the fourth quarter of 1999, of which $1,750,000 and $250,000 was recognized in income in the third and fourth quarters, respectively, of 1999.
Operating Income
Consolidated operating income decreased 60% in 2000 to $7,855,000 from $19,852,000 in 1999 primarily as a result of declines in the Grafton(R) DBM and Base Tissue Segments. In 1999, consolidated operating income was 22% higher than 1998 operating income of $16,281,000. Grafton(R) DBM Segment operating income decreased 33% in 2000 to $11,389,000 from $17,063,000 in 1999 primarily due to: lower gross margins due to underabsorption of costs, increased legal fees associated with patent lawsuits, increased costs associated with marketing, selling and promotional activities, and a decrease of $1,000,000 in patent litigation settlement payments. In 1999 Grafton(R) DBM Segment operating income was 27% higher than 1998 operating income of $13,404,000 principally due to increased revenues and, in 1999, the litigation settlement with DePuy. Base Tissue Segment operating income decreased 89% in 2000 to $694,000 from $6,434,000 in 1999 as a result of lower gross margins due to underabsorption of costs, increased legal fees associated with patent lawsuits, and increased costs associated with marketing, selling and promotional activities, especially with respect to new bio-implant tissue forms. Base Tissue Segment operating income in 1998 was $4,170,000. Other segment operating income declined 16% in 2000 to a loss of $4,228,000 and declined 182% in 1999 to a loss of $3,645,000 from a loss of $1,293,000 in 1998.
Other Income (Expense)
In 2000, other income increased $15,000 to $1,047,000. Other income decreased $100,000 in 1999 principally due to lower interest income resulting from a decline in interest rates.
Income Tax Provision
Our effective income tax rate in 2000 was 46% and was 41% in 1999 and 1998. The effective income tax rate exceeded the federal statutory income tax rate principally due to the non-recognition for tax purposes of foreign operating losses and the impact of domestic state income taxes.
Liquidity and Capital Resources
At December 31, 2000, we had cash and short-term investments of $12,858,000 compared to $20,716,000 at December 31, 1999. We invest our excess cash in U.S. Government-backed securities and investment grade commercial paper of major U.S. corporations. Working capital decreased $7,959,000 to $29,123,000 at December 31, 2000 compared to $37,082,000 at December 31, 1999. The decrease resulted primarily from utilization of cash and short-term investments to partially fund capital expenditures, including construction of the new allograft tissue processing facility, and the purchase and retirement of 330,500 shares of common stock for an aggregate purchase price of $3,124,000.
Net cash provided by operating activities decreased to $10,214,000 in 2000 from $14,459,000 in 1999. The decrease resulted primarily from a reduction of income tax benefits related to stock options, partially offset by increased non-cash charges, principally depreciation and amortization.
Cash used in investing activities increased to $27,167,000 in 2000 from $22,173,000 in 1999. The increase is due to an increase in capital expenditures to $28,382,000 from $18,743,000 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 allograft tissue processing facility in Eatontown, New Jersey. See Item 2. "Properties" and Note 6 of "Notes to Consolidated Financial Statements." The estimated aggregate cost for the construction of the facility, including furniture, fixtures and equipment, is approximately $37,000,000. A portion of the aggregate construction costs have been, and will continue to be, funded through a $4,500,000 building mortgage loan and an equipment line of credit of $17,000,000. The remaining balance will be funded through available cash reserves or anticipated cash flow from operations. Through December 31, 2000, we have incurred $32,197,000 of capital expenditures, including capitalized interest of $761,000, related to the new allograft tissue processing facility, of which $17,883,000 has been funded through bank financing.
Net cash provided by financing activities in 2000 increased to $11,271,000 from $9,388,000 in 1999. The increase results principally from increased borrowings under the credit facility partially offset by a reduction of cash proceeds received from stock option exercises and the purchase and retirement of 330,500 shares of common stock for an aggregate purchase price of $3,124,000.
In June, 1999, we replaced our then existing domestic lines of credit with a credit facility 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 December 31, 2000, $4,500,000 was outstanding under the building mortgage and $15,531,000 was outstanding under the equipment line of credit. No amounts were outstanding under the revolving line of credit.
We also have a line of credit with a Dutch bank, which provides for borrowings of up to dfl 3,000,000, or approximately $1,283,000 at the December 31, 2000 exchange rate. Additionally, we have a line of credit with a French bank which provides for borrowings of up to FRF 1,750,000, or approximately $251,000 at the December 31, 2000 exchange rate. At December 31, 2000, there were no borrowings outstanding under either the Dutch or French credit lines.
At December 31, 2000, certain of our foreign-based subsidiaries have net operating loss carryforwards aggregating $4,415,000 at the December 31, 2000 exchange rate ($525,000 with no expiration date; $3,890,000 expiring 2004 through 2008). See Note 10 of "Notes to Consolidated Financial Statements."
In September, 2000 and February, 2001, we entered into two distribution agreements. We will market pursuant to these agreements, VBR(TM) and, a pedicle screw system and a cervical
plating system, respectively. These agreements require us to make minimum purchase commitments over the next two years of $3,000,000 and $6,000,000, respectively.
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 assurance that such additional funds will be available to us or, if available, that such funds will be available to us on favorable terms.
Recent Developments
In June, 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities," or SFAS No. 133. SFAS No. 133, as amended, is effective for fiscal years beginning after June 15, 2000. We believe adoption of SFAS No. 133 will have no effect on our results of operations or financial condition.
Impact of Inflation and Foreign Currency Exchange Fluctuations
The results of operations for the periods discussed have not been materially affected by inflation or foreign currency fluctuations.
Litigation
We are involved in various legal proceedings involving product liability and patent infringement claims. For a complete discussion of these matters see, Part I, Item 3. "Legal Proceedings" and Note 11 of "Notes to Consolidated Financial Statements." 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.
Risk Factors
We are dependent upon two primary clients who provide the bulk of our revenues.
We are the processor of allograft bone tissue for large national and international not-for-profit organizations. During 2000, MTF and ARC accounted for approximately 50% and 40%, respectively, of our revenues. We entered into a 10-year exclusive processing agreement with ARC in December, 1996 and a five-year processing agreement with MTF in September, 2000. However, the MTF contract may be canceled effective March 31, 2002 and thereafter upon either party giving six months prior written notice. The loss of either MTF or ARC as a client or a substantial reduction in the amount of allograft bone tissue which we process for either entity would have a material adverse effect on our business, financial condition and results of operations. We are currently in litigation with MTF. See Item 3 "Legal Proceedings."
Our dependence upon a limited supply of human donors may curtail business expansion.
Our allograft bone tissue processing business primarily depends upon the availability of bone and related connective tissue from human donors recovered by our clients and TRO's who recover donated human cadaveric tissue for us. We rely on the efforts of not-for-profit donor procurement agencies, including our current clients, to educate the public and foster an increased willingness to donate bone tissue. These organizations may not be able to find a sufficient number of persons to donate, or may not be willing to provide, sufficient amounts of tissue to meet present or future demand for either allograft bone tissue or any allograft bone tissue-based osteogenic materials we are developing. Our ability to secure enough donor tissue to meet our demands could have a material adverse effect on our business, financial condition and results of operations.
We face strong competitive threats from firms with greater financial resources and lower costs.
The allograft bone tissue we process competes in the bone graft market with autograft bone tissue, synthetic bone void fillers and allograft bone tissue processed by others, primarily tissue banks. Autograft bone tissue has traditionally been the primary choice for surgeons and we believe autograft bone tissue still maintains approximately a 50% share of the United States bone graft market. In Europe, bone graft substitutes, such as bovine bone tissue and synthetics, currently comprise most of the bone grafting market. Certain of our competitors have greater financial resources than we do. For numerous circumstances and procedures for which autograft bone tissue transplantation is either not feasible or not desirable, there are a number of competing alternatives available, including allograft bone tissue processed by others and bone graft substitutes.
In recent years, our Grafton(R) DBM products have faced increasing competitive pressures as more companies have developed, or have announced they are developing, products with characteristics similar to Grafton(R) DBM. We expect that this competition will continue in the future. Many of these competitors have research and development, marketing and other resources that are significantly greater than ours. They also offer a full line of metal implants and other products used in spinal surgeries. This could give them a competitive advantage over us since they can offer surgeons a more complete line of products than we currently can.
We believe that a majority of the cadaveric bone banks operating in the United States are engaged in processing allograft bone tissue for transplantation. Substantially all of these bone tissue banks are not-for-profit organizations, and, as such, they may be able to supply processing services at a lower cost than we can. We compete with such entities on the basis of our advanced processing technology and the quality and quantity of the bone tissue our processing yields. Since we introduced our allograft bone tissue processing technology in 1987, certain competing processors have claimed to have developed technology similar to that which we use. Although we believe, based upon our knowledge of the industry, that we process bone tissue from more donors than any other processor in the world, we can not assure you that we will continue to compete successfully in the area of allograft bone tissue processing.
We are currently involved in patent litigation which could have a significant adverse impact on our business. We may become involved in additional patent litigation in the future.
We are currently involved in four litigations involving our patents and patents held by certain of our competitors. Prosecuting and defending these lawsuits is very expensive and these expenses have had, and are likely to have, an adverse affect on our results of operations. We are committed to aggressively asserting and defending our technology and related intellectual property which we have spent a significant amount of money to develop. In addition, the industry in which we compete is known for having a great deal of litigation involving patents. These factors could cause us to become involved in additional patent litigations in the future. The expense of prosecuting or defending these future lawsuits could also have a material adverse effect on our business, financial condition and results of operations.
If we were to lose those litigations in which another party is asserting that our products infringe its patents, we would likely be prohibited from marketing those products and could also be liable for significant damages. Either or both of these results may have a material adverse effect on our business, financial condition and results of operations. If we lose those litigations in which we are claiming that another party's products are infringing our patents and thus, are unable to enforce our patents, it may have a material adverse effect on our business, financial condition and results of operations.
During the course of the patent litigations in which we are involved, interim information about the status of each of these litigations may be released. Although these interim releases may differ from the final determinations in these litigations, such information may have a material adverse effect on the market price of our common stock.
Our revenues will depend upon reimbursement from public and private insurers and national health systems.
The continued ability of our clients to pay our processing charges for the processing of allograft bone tissue, depends upon our clients' ability to distribute processed allograft bone tissue and collect fees from their clients, which are typically medical institutions. The ability of medical institutions to pay fees to our clients, or directly to us for allograft bone tissue or non-allograft spinal implant systems distributed directly by us to the medical institutions, depends in part on the extent to which reimbursement for the costs of such materials and related treatments will continue to be available from government health administration authorities, private health coverage insurers and other organizations. We may have difficulty gaining market acceptance for our products and services if government and third-party payors do not provide adequate coverage and reimbursement.
The medical community could choose not to use our allograft bone tissue products.
We believe the market for allograft bone tissue will continue to be based primarily upon the use of such products by physicians specializing in the orthopaedic, neurological and oral/maxillofacial surgical areas. Our future growth depends in part upon such physicians' wider
use of allograft bone tissue as an alternative to autograft bone tissue and other available materials and treatments. We have tried to educate physicians through our marketing activities. Although our education and marketing efforts to date have enabled us to expand our business, our future efforts in this regard may fail to generate additional demand.
Governmental regulation of organ transplantation could restrict the use of our products.
In the United States the procurement and transplantation of allograft bone tissue are subject to federal regulation pursuant to NOTA, a criminal statute which prohibits the purchase and sale of human organs, including bone and related tissue, for "valuable consideration." NOTA permits the payment of reasonable expenses associated with the removal, transportation, processing, preservation, quality control, implantation and storage of human bone tissue. We provide services in all of these areas, with the exception of removal and implantation. We and other allograft bone tissue processors are engaged in ongoing efforts designed to educate the medical community as to the benefits of processed allograft bone tissue and we will continue to expand our educational activities. Although we believe that NOTA permits reimbursement of these costs as costs associated with the processing, transportation and implantation of our allograft bone tissue products, our inability to be reimbursed for our education efforts in the future could adversely affect our business and prospects. No federal agency or court has determined whether NOTA is, or will be, applicable to every allograft bone tissue-based material which our processing technologies may generate. Assuming that NOTA applies to our processing of allograft bone tissue, we believe that we comply with NOTA, but there can be no assurance that more restrictive interpretations of, or amendments to, NOTA will not be adopted in the future which would call into question one or more aspects of our method of operations.
In various countries outside the United States, national laws and regulations restrict or control the availability and/or use of tissues. There can be no assurance that more restrictive laws, regulations or interpretations will not be adopted in the future which would call into question one or more aspects of our method of operations in those countries.
Loss of key persons could limit our success.
Our success depends upon the continued contributions of our executive officers and scientific and technical personnel. The competition for qualified personnel is intense, and the loss of services of our key personnel, particularly members of senior management, could adversely affect our business.
If we are unable to enforce our patents or if it is determined that we infringe patents held by others it could damage our business.
We consider our allograft bone tissue processing technology and procedures proprietary and rely primarily on trade secrets and patents to protect our technology and innovations. Consultants employed by third parties and persons working in conjunction with medical institutions unaffiliated with us have conducted significant research and development for our products. Accordingly, disputes may arise concerning the proprietary rights to information applied
to our projects which have been independently developed by such consultants or medical institutions. In addition, you should recognize that although we have attempted to protect our technology with patents, our existing patents may prove invalid or unenforceable as to products or services marketed by our competitors. Our pending patent applications may not result in issued patents. Moreover, our existing or future products and technologies could be found to infringe the patents of others. We are currently involved in four lawsuits in which we are accused of infringing patents held by others. See Part I, Item 3 "Legal Proceedings."
Our products face competitive threats from alternate technologies.
The primary advantage of synthetic bone substitutes as compared to allograft bone tissue is that they do not depend on the availability of donated human tissue. In addition, members of the medical community and the general public may perceive synthetic materials as safer than allograft-based bone tissue. The allograft bone tissue we process may be incapable of competing successfully with synthetic bone substitutes and recombinant bone growth factors which are developed and commercialized by others, which could have a material adverse effect on our business, financial condition and results of operations.
Our spray coating, HA products and bovine tissue products operations face intense competition.
Our plasma spray coatings, HA products and bovine tissue products operations face intense competition in Europe from divisions and subsidiaries of several large corporations engaged in providing such services and products to others and from several smaller independent companies. In addition, we also face competition from medical implant companies which have in-house plasma spray coating operations. We compete primarily on the quality of our coatings, bovine tissue products and our prices. We believe that the spraying technology we use, which is computer-controlled and utilizes robotics, enables us to provide high quality coatings at competitive prices. You should note, however, that the industries in which we compete in Europe are highly competitive, certain of our competitors have greater resources than we do, and we may be unable to compete successfully.
We may incur losses from product liability lawsuits.
The testing and use of human allograft bone tissue, bovine tissue products and the implantation of medical devices coated with our HA powder or titanium and medical devices manufactured by others and which we distribute, entail inherent risks of medical complications for patients and therefore may result in product liability claims against us. Further, our agreements with our allograft bone tissue processing clients provide for indemnification by us for liabilities arising out of defects in allograft bone tissue they distribute which is caused by our processing. See Part I, Item 3 "Legal Proceedings."
We presently maintain product liability insurance in the amount of $102 million per occurrence and per year in the aggregate. We may be unable to maintain such insurance in the
future and such insurance may not be sufficient to cover all claims made against us or all types of liabilities which may be asserted against us.
We face potential lawsuits or governmental enforcement activities based on hazardous waste we generate in our operations.
Our allograft bone tissue processing in both the United States and Europe generates waste, which, in the United States, is classified as medical hazardous waste by the United States Environmental Protection Agency and the New Jersey Department of Environmental Protection. We segregate such waste and dispose of it through a licensed hazardous waste transporter in compliance with applicable regulations in both the United States and Europe. The production of HA powder at our facility in The Netherlands generates small amounts of hazardous waste, which we segregate and dispose of through a licensed hazardous waste transporter
Although we believe we are in compliance with applicable environmental regulations, our failure to fully comply with any such regulations could result in the imposition of penalties, fines and/or sanctions or, in some cases, private lawsuits, which could have a material adverse effect on our business, financial condition and results of operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
The response to this item is submitted as a separate section of this Annual Report commencing on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The section of our 2001 Proxy Statement entitled "Election of Directors" is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The section of our 2001 Proxy Statement entitled "Executive Compensation" is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The section of our 2001 Proxy Statement entitled "Security Ownership of Certain Beneficial Owners and Management" is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The section of our 2001 Proxy Statement entitled "Certain Relationships and Related Transactions" is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) and (2). The response to this portion of Item 14 is submitted as a separate section of this report commencing on page.
(a)(3) and (c). Exhibits (numbered in accordance with Item 601 of Regulation S-K).
* Previously filed as exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 and incorporated herein by reference thereto. ** Previously filed as exhibits to Osteotech's Registration Statement on Form S-1 (File No. 33-40463) and incorporated herein by reference thereto. *** Previously filed as exhibits to Osteotech's Registration Statement on Form S-8 (File No. 33-44547) and incorporated herein by reference thereto. **** Previously filed as exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference thereto. ***** Previously filed as exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference thereto. ****** Previously filed as exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference thereto. ******** Previously filed as exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 and incorporated herein by reference thereto. + Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 and incorporated herein by reference thereto. ++ Previously filed as exhibits to Osteotech's Current Report on Form 8-K filed with the Commission on May 26, 1992. +++ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 and incorporated herein by reference thereto ++++ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 and incorporated herein by reference thereto. +++++ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 and incorporated herein by reference thereto. ++++++ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference thereto. +++++++ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by reference thereto. ^ Management contracts or compensatory plans and arrangements required to be filed pursuant to Item 14(c)
^^ Previously filed as Exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 and incorporated herein by reference thereto. ^^^ Previously filed as Exhibits to Osteotech's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 and incorporated herein by reference thereto. ^^^^ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999 and incorporated herein by reference thereto. ^^^^^ Previously filed as exhibits to Osteotech's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999 and incorporated herein by reference thereto. ^^^^^^ Previously filed exhibit to Osteotech's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and incorporated herein by reference. # Previously filed as exhibits to Osteotech's Report on Form 8-A dated February 2, 1996 and incorporated herein by reference thereto. - - - Copy omits information which is subject to confidential treatment.
(b) Reports on Form 8-K
On December 12, 2000, we announced that the U.S. District Court for the Central District of California, has adopted our interpretation of claims in two patents asserted by us against GenSci Orthobiologics, Inc. In this lawsuit, commenced in January, 1998, we asserted that GenSci's Dynagraft putty and gel products infringe our patents. The ruling was issued on December 8, 2000, following a claims construction hearing, also known as a Markman hearing, held on October 24 through 26, 2000.
On October 18, 2000, we announced that in response to earlier letters from us informing the Musculoskeletal Transplant Foundation, or MTF, that products made by MTF pursuant to the patent issued to MTF in February, 2000 may infringe on the claims of two of our Grafton(R) Demineralized Bone Matrix, or DBM, patents; U.S. Patent No. 5,284,655 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. We believe that this lawsuit is without merit and we intend to vigorously defend against these claims.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 30, 2001 OSTEOTECH, INC.
By: /s/ Richard W. Bauer ------------------------------- Richard W. Bauer Chief Executive Officer (Principal Executive Officer) and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:
Signature Title Date - - -------------------------------------------------------------------------------
/s/DONALD D. JOHNSTON Chairman of the March 30, 2001 - - --------------------- Board of Directors Donald D. Johnston
/s/RICHARD W. BAUER Chief Executive Officer March 30, 2001 - - ------------------- (Principal Executive Richard W. Bauer Officer) and Director
/s/ARTHUR A. ALFARO President, Chief Operating March 30, 2001 - - ------------------- Officer and Director Arthur A. Alfaro
/s/MICHAEL J. JEFFRIES Executive Vice President March 30, 2001 - - ---------------------- Chief Financial Officer Michael J. Jeffries (Principal Financial Accounting Officer), Secretary and Director
/s/KENNETH P. FALLON III Director March 30, 2001 - - ------------------------ Kenneth P. Fallon III
/s/JOHN P. KOSTUIK Director March 30, 2001 - - ------------------ John P. Kostuik
/s/STEPHEN J. SOGIN Director March 30, 2001 - - ------------------- Stephen J. Sogin
OSTEOTECH, INC. AND SUBSIDIARIES
-------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page 1. FINANCIAL STATEMENTS
Report of Independent Accountants...................................F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999 .......F-3
Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998.............F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998.....................F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998.............F-6
Notes to Consolidated Financial Statements..........................F-7
2. SCHEDULE
II. Valuation and Qualifying Accounts for the years ended December 31, 2000, 1999 and 1998 .........S-1
Report of Independent Accountants on Financial Statement Schedule ..S-2
All schedules, except for the one set forth above, have been omitted since the information required is included in the financial statements or accompanying notes or have been omitted as not applicable or not required.
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of Osteotech, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, changes in stockholders' equity and cash flows present fairly, in all material respects, the financial position of Osteotech Inc. and Subsidiaries (the "Company") at December 31, 2000 and December 31, 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Florham Park, New Jersey February 20, 2001, except as to certain information presented in Note 11 for which the date is March 28, 2001.
OSTEOTECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
OSTEOTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
OSTEOTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (dollars in thousands)
Years ended December 31, 2000, 1999 and 1998
The accompanying notes are an integral part of these consolidated financial statements.
OSTEOTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Osteotech, Inc. (the "Company") provides services and develops and markets products to the orthopaedic, neurological, oral/maxillofacial, dental and general surgery markets in the United States and Europe. The Company's current technology, products and services, and those under development, are focused primarily on the repair and healing of the musculoskeletal system. Osteotech is engaged in the processing of human bone and bone connective tissue (collectively, "allograft bone tissue") used for transplantation. The Company has two primary operating segments: the Grafton(R) Demineralized Bone Matrix (DBM) Segment (the "Grafton(R) DBM Segment") and Base Allograft Bone Tissue Segment (the "Base Tissue Segment"). In addition to these two primary segments, the Company markets and distributes metal spinal implant products and processes, markets and distributes bovine bone tissue products outside of the United States. The Company also provides ceramic and titanium plasma spray coating services and ceramic products used as bone graft substitutes to orthopaedic and dental implant manufacturers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidated Financial Statements
The consolidated financial statements include the accounts of Osteotech, Inc., its majority-owned subsidiaries and joint ventures controlled by the Company. Investments in 20% to 50% owned affiliates are accounted for using the equity method. Investments in less than 20% owned affiliates are accounted for on the cost method. All intercompany transactions and balances are eliminated in consolidation.
Revenue Recognition
The Company derives revenue from allograft bone tissue processing services and sales of products. Processing revenues are recognized when processed allograft bone tissue is returned to our clients or when shipped to customers, and when collectability of the related revenue is reasonably assured. Product revenues are recognized when title passes to the customers and when collectability of the related revenue is reasonably assured.
In 2000, the Company adopted the provisions of Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements", the affects of which are immaterial for all periods presented.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with original maturities of three months or less, when purchased, to be cash equivalents. Investments with maturities in excess of three months but less than one year are classified as short-term investments and are stated at cost, net of any unamortized premiums or discounts, which approximates fair value.
Deferred Processing Costs
Costs related to allograft bone tissue processing are deferred until the processed allograft bone tissue is released from final quality assurance testing and shipped to clients.
Inventories
Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out method. Inventories consist of supplies, which principally support the Company's two primary operating segments, and raw materials and finished goods, which principally support the Company's Other Segment.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Major renewals and betterments are capitalized while maintenance and repairs are expensed as incurred. Interest, if any, is capitalized in connection with the construction of major facilities. The capitalized interest is recorded as part of the underlying asset and is amortized over the asset's estimated useful life. The cost of leasehold improvements is amortized on the straight-line method over the shorter of the lease term or the estimated useful life of the asset. Depreciation is computed on the straight-line method over the following estimated useful lives of the assets:
Building 15 years
Machinery and equipment 5 to 10 years
Computer hardware and software 5 years
Office equipment, furniture and fixtures 5 years
Loaner instruments 3 years
When depreciable assets are retired or sold, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in other income (expense) in the statement of operations.
Whenever events and circumstances indicate that the carrying value of an asset may not be recoverable, the Company reviews the asset's carrying value for impairment principally on an analysis of undiscounted cash flows.
Excess of Cost Over Net Assets of Business Acquired
The excess of cost over the net assets of businesses acquired is being amortized on a straight-line basis over 15 years. It is the Company's policy to periodically review and evaluate whether there has been an impairment in the value. Factors considered in the valuation include current operating results, trends, prospects and anticipated undiscounted future cash flows.
Translation of Foreign Currency
Assets and liabilities of foreign subsidiaries are translated at rates of exchange in effect at the close of the period. Revenues and expenses are translated at the weighted average exchange rates during the period. Translation gains and losses are included in other comprehensive income, which is a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in other income.
Concentrations of Credit Risk
The Company invests the majority of its excess cash in U.S. Government-backed securities and investment grade commercial paper of major U.S. corporations. The Company does not believe it is exposed to any significant credit risk on its cash equivalents and short-term investments.
The Company provides credit, in the normal course of business, to tissue banks and hospitals. The Company maintains an allowance for doubtful accounts and charges actual losses to the allowance when incurred. The Company has two customers who account for 90%, 94% and 95% of revenues in 2000, 1999 and 1998, respectively. As of December 31, 2000 and 1999, these two customers accounted for 78% and 91%, respectively, of outstanding accounts receivable.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair Value of Financial Instruments
The carrying value of financial instruments, including accounts receivable, accounts payable and other accrued expenses, approximate their fair values. The carrying value of amounts outstanding under the credit facility approximates fair value because the debt is subject to short-term variable interest rates that were reflective of market rates of interest.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from such estimates.
3. ACQUISITION OF OST DEVELOPPEMENT SA
Effective January 1, 1999, the Company completed the acquisition of a 90% interest in OST Developpement SA ("OST"), a processor of bone tissue products which are marketed and distributed outside of the United States. The aggregate purchase price paid consisted solely of cash consideration of 9,000,000 French Francs ("FRF") or approximately $1,594,700, of which 496,662 FRF or approximately $84,400 was paid in 1998. In addition, the Company incurred approximately $372,600 of transaction costs of which approximately $310,000 was incurred in 1998. The acquisition was accounted for as a purchase and the consolidated financial statements include the accounts of OST beginning January 1, 1999. The acquisition resulted in an excess of cost over the fair value of net assets acquired of $2,073,000 which is being amortized over 15 years. The Company also has the option to purchase the remaining 10% of OST at a price to be determined at the time of purchase.
4. ACQUISITION OF SPINAL FIXATION SYSTEM
In June, 1999, the Company acquired the Versalok(R) Low Back Fixation System (the "Versalok(R) System"), including all patents, from a medical device company for $600,000. Pursuant to the terms of the purchase agreement, the Company also purchased approximately $1,120,000 of inventory, consisting primarily of finished goods. The $600,000 payment to acquire the product rights and patents will be amortized on a straight-line basis over five years.
5. INVENTORIES
Inventories consist of the following at December 31: (in thousands) 2000 1999 - - -------------------------------------------------------------------------------- Supplies $ 202 $ 248 Raw materials 891 664 Finished goods 2,491 2,493 - - -------------------------------------------------------------------------------- $3,584 $3,405 ================================================================================
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at December 31:
(in thousands) 2000 1999 - - -------------------------------------------------------------------------------- Land $2,262 $2,262 Building 279 279 Machinery and equipment 22,139 19,842 Computer hardware and software 4,165 3,191 Office equipment, furniture and fixtures 3,483 3,013 Loaner instruments 2,710 1,308 Leasehold improvements 6,741 6,340 Construction in progress 33,199 10,809 ---------------------- 74,978 47,044 Less accumulated depreciation and amortization 16,688 13,049 - - -------------------------------------------------------------------------------- $58,290 $33,995 ================================================================================
During the fourth quarter of 1998, the Company commenced construction of a new processing facility in Eatontown, New Jersey. At December 31, 2000 and 1999, approximately $32,197,000 and $10,272,000, respectively, had been incurred, of which approximately $761,000 and $51,000, respectively, represents capitalized interest.
7. ACCOUNTS PAYABLE AND accrued LIABILITIES
Accounts payable and accrued liabilities consist of the following at December 31:
(in thousands) 2000 1999 - - -------------------------------------------------------------------------------- Trade accounts payable $2,856 $5,532 Accrued compensation 494 548 Accrued taxes payable 3,110 3,170 Other accrued liabilities 4,885 3,981 - - -------------------------------------------------------------------------------- $11,345 $13,231 ================================================================================
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. LEASING TRANSACTIONS
The Company leases office and production facilities and equipment under various operating lease agreements which have non-cancelable terms through October, 2008. The leases for office and production facilities include renewal provisions at the Company's option. Additionally, certain of the leases contain fair value purchase options.
Future minimum lease commitments as of December 31, 2000 are as follows:
Operating Year Leases -------------------------------------------- (in thousands)
2001 $ 1,040 2002 935 2003 860 2004 870 2005 and thereafter 2,113 ------- Total minimum lease payments $ 5,818 =======
Rental expense was $1,147,000, $1,157,000, and $1,013,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
9. DEBT AND FINANCING ARRANGEMENTS
The Company has a credit facility which includes a $5,000,000 unsecured revolving line of credit, a $4,500,000 building mortgage loan and a $17,000,000 equipment line of credit.
The revolving line of credit is committed through May 31, 2002. Interest is payable monthly on the outstanding amount. In the absence of default, the Company has the option to convert the revolving line of credit to a term loan and the outstanding unpaid balance as of September 10, 2001 will be repayable in forty-eight equal monthly installments of principal together with accrued interest. A facility fee of .25% is payable on the unused portion of the revolving loan. As of December 31, 2000, no amounts were outstanding under this facility, although the full amount of the line is available to the Company.
The mortgage loan was drawn in December, 2000 and is collateralized by the building which will house the Company's new allograft tissue processing facility and the land on which the building is located. The mortgage loan is repayable in 120 equal monthly installments of principal and interest based on a twenty-year mortgage amortization schedule. Upon the 120th payment, the remaining amount of the unpaid principal will be due and payable.
The equipment line of credit is collateralized by equipment and other capital expenditures purchased using the proceeds of such line, with advances of up to 80% of the cost thereof. Upon expiration of an initial drawdown period, which was extended to September 10, 2001, the equipment line of credit will be repayable in equal monthly installments of principal plus interest based on a seven-year amortization schedule. During the drawdown period, interest only will be payable monthly under the equipment line of credit. A facility fee of .25% is payable on the unused portion of the equipment line.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. DEBT AND FINANCING ARRANGEMENTS (continued)
Pursuant to the terms of the loan and security agreement (the "Agreement"), the Company is required to meet certain financial covenants regarding minimum working capital, tangible net worth and interest coverage. In addition, the Agreement contains limitations on sales of assets other than in the ordinary course of business and additional indebtedness.
The effective weighted average interest rate for borrowings under the credit facility in 2000 was 8.20%.
The Company has a line of credit with a Dutch bank which provides for borrowing up to 3,000,000 Dutch Guilders ("DFL"), or approximately $1,283,000 at the December 31, 2000 exchange rate. Borrowings under this credit line bear interest at the bank's prime rate plus a margin of 2.25%. Under certain circumstances the Company may elect to utilize a rate based on the Amsterdam Interbank Offered Rate (AIBOR) plus a margin of .75%.
The Company also has a line of credit with a French bank which provides for borrowings up to FRF 1,750,000 or approximately $251,000 at the December 31, 2000 exchange rate. At December 31, 2000 there were no borrowings under these lines of credit.
Long-term debt consists of the following at December 31:
(in thousands) 2000 1999 - - -------------------------------------------------------------------------------- Domestic revolving line of credit, interest due monthly at the bank prime rate minus .75% (8.75% at December 31, 2000) $4,500
Domestic bank equipment line of credit, interest due monthly at the bank prime rate minus .50% (9.00% at December 31, 2000) $15,531 1,859
Domestic building mortgage loan, repayable in monthly installments of $37, which include interest at 7.38%, through December 2010 with a balloon payment of $3,087 due January 2011. 4,500 - - -------------------------------------------------------------------------------- 20,031 6,359 Less current portion 101 - - -------------------------------------------------------------------------------- $19,930 $6,359 ================================================================================
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES
The income tax provision at December 31 is summarized as follows:
(in thousands) 2000 1999 1998 - - -------------------------------------------------------------------------------- Current: Federal $ 2,897 $ 7,307 $ 5,893 State 402 1,347 1,488 - - -------------------------------------------------------------------------------- 3,299 8,654 7,381 ------------------------------ Deferred: Federal 551 (148) (151) State 224 27 (121) - - -------------------------------------------------------------------------------- 775 (121) (272) ------------------------------ Income tax provision $ 4,074 $ 8,533 $ 7,109 ================================================================================
The difference between income tax expense and the expected tax which would result from the use of the Federal statutory income tax rate is as follows:
(in thousands) 2000 1999 1998 - - -------------------------------------------------------------------------------- Computed tax at statutory Federal rate $ 3,027 $ 7,309 $ 5,920 State income taxes, net of Federal benefit 413 1,129 931 Foreign losses for which no tax benefit is currently available 660 456 235 Other (26) (361) 23 - - -------------------------------------------------------------------------------- Income tax provision $ 4,074 $ 8,533 $ 7,109 ================================================================================
Loss before income taxes from foreign operations was $1,151,000 in 2000, $591,000 in 1999 and $266,000 in 1998. The losses before income taxes from foreign operations negatively impact the Company's effective income tax rate due to the non-recognition of such losses for tax purposes and the need for a valuation allowance in the foreign jurisdictions.
The components of the deferred tax assets and deferred tax liabilities are as follows at December 31:
(in thousands) 2000 1999 - - -------------------------------------------------------------------------------- Deferred Tax Assets: Net operating loss carryforwards Federal $ 275 $ 282 Foreign 1,736 1,408 State 24 25 Tax credits 62 41 Other 674 1,034 - - -------------------------------------------------------------------------------- 2,771 2,790 Less valuation allowance 2,058 1,749 - - -------------------------------------------------------------------------------- Deferred tax assets 713 1,041 - - -------------------------------------------------------------------------------- Deferred Tax Liabilities: Other 951 504 - - -------------------------------------------------------------------------------- Deferred tax liabilities 951 504 - - -------------------------------------------------------------------------------- Net deferred tax asset (liability) $ (238) $ 537 ================================================================================
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES (continued)
The Company's valuation allowance results principally from foreign losses for which the realization of future tax benefits is uncertain.
Foreign net operating loss carryforwards aggregate $4,415,000 ($525,000 with no expiration date; $3,890,000 expiring 2004 through 2008).
At December 31, the Company had prepaid Federal and state taxes of approximately $1,552,000 in 2000 and $2,987,000 in 1999.
11. COMMITMENTS AND CONTINGENCIES
Service Agreements
Osteotech is the processor of allograft bone tissue for national and international clients. The Company provides these processing services pursuant to long-term service agreements. Osteotech's agreements with its clients generally provide for cross-indemnification against liability arising out of performance of the agreements. Effective January 1, 1997 the Company entered into a new exclusive ten-year processing agreement with one of its major allograft bone tissue processing clients, the American Red Cross Tissue Services ("ARC").
In June, 2000, the Company entered into an exclusive five-year processing agreement with Bone Bank Allografts ("BBA") of San Antonio, Texas. BBA, coordinates the procurement and distribution of allograft bone tissue nationally, with a focus in the Southern region of the United States.
In September, 2000, the Company entered into a new five-year agreement with the Musculoskeletal Transplant Foundation ("MTF"). This new agreement replaced the current agreement which would have expired March 31, 2002. Under the new agreement, MTF is no longer 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 effective March 31, 2002 and thereafter upon giving 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. The Company is currently in litigation with MTF. (See "Litigation" - "Musculoskeletal Transplant Foundation v. Osteotech, Inc.").
Customers of the Company's other products and services generally purchase such products and services pursuant to purchase orders or non-exclusive supply agreements which are cancelable at any time by either party.
Purchase Commitments
In September, 2000, the Company entered into a two-year non-cancelable purchase order 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 began marketing in the United States in the first quarter of 2001. The Company purchased $878,000 under the agreement in 2000.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
In February, 2001, the Company entered into an exclusive distribution agreement with Alphatec Manufacturing, Inc. ("Alphatec") to market and distribute a pedicle screw system and a cervical plating system in the United States and Canada. The term of the agreement is two years from the date of completion of the initial order, which is anticipated to be August, 2001. The agreement automatically renews for additional two-year terms unless terminated, in writing, by either party six months prior to expiration of the then current two-year term. The Company has agreed to purchase $6,000,000 of inventory during the first two years of the agreement, and $8,000,000 during the second two-year term, if the agreement renews. Purchase commitments for each successive renewal period would be negotiated prior to those renewals. If the Company fails to make the minimum purchases in any period, the Company will pay Alphatec a penalty payment equal to 50% of the shortfall.
License and Option Agreement
In June, 1997, the Company entered into an exclusive worldwide license agreement for its proprietary PolyActive(TM) polymer biomaterial technology and patents with IsoTis BV, The Netherlands. Additionally, IsoTis BV has an option to acquire the technology for DFL 4,000,000 (approximately $1,711,000 at the December 31, 2000 exchange rate) commencing in the third year of the agreement and extending through the sixth year of the agreement. In accordance with the license agreement, no license fee was received in 2000 and license fee revenue of DFL 250,000, or approximately $118,000, and DFL 250,000, or approximately $124,000, was received in 1999 and 1998, respectively.
Throughout the term of the agreement, which is the longer of ten years from the first commercial sale of product or the life of the patents, the Company will receive a royalty of 5% of net sales, declining to 2% of net sales if the option to purchase the technology is exercised. Further, the agreement requires IsoTis BV to achieve certain milestones during the first three years of the agreement. Failure to do so will result in its loss of exclusive rights to the patents and technology. Through December 31, 2000, IsoTis has achieved all milestones associated with the agreement.
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", collectively, "GenSci") alleging that GenSci 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 that the Company's Grafton(R) DBM Flex tissue form infringes two patents assigned to GenSci Labs in addition to allegations against us for 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.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. 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 GenSci of infringing a second Company patent, in addition to the patent referred to above, and accused DePuy and GenSci 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 tissue form, the Company's Grafton(R) DBM Gel and Putty tissue forms infringe on the 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 $1,000,000 and $2,000,000 were received in 2000 and 1999, respectively.
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 allograft bone tissue forms 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. This agreement was subject to court approval, which approval has been received. 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.
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 judgement that the portion of the case GenSci dismissed with prejudice be ruled as exceptional based on GenSci Labs having asserted and maintained baseless allegations that the Company infringed GenSci Labs' patents, thus warranting an award of attorneys' fees and costs to the Company.
Also, in July, 2000, GenSci filed various motions for summary judgement seeking orders that GenSci does not infringe on the Company's patents and/or that such patents are invalid.
In October, 2000, the court held a claims construction hearing, also known as a Markman hearing, to construe the scope of the claim of the patents-in-suit. In December, 2000, the court issued its ruling adopting the Company's interpretation of the claims.
In January, 2001, the Company filed a motion for summary judgement of infringement of U.S. Patent No. 5,290,558. Also in January, 2001, GenSci filed a second motion for
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
summary judgement of non-infringement of U.S. Patent No. 5,284,655, and stated to the court that there no longer was a need for the court to rule on GenSci's first motion for summary judgement of non-infringement of U.S. Patent No. 5,290,558.
In March, 2001, the court rejected GenSci's various motions for summary judgement. The Company's motion for summary judgement of infringement of U.S. Patent 5,290,558 has not yet been ruled on.
The Company will continue to vigorously defend any claims against it, prosecute the claims it has asserted in this action, and vigorously and affirmatively 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 unlawful monopolization, attempt to monopolize the market for demineralized bone matrix and for entering 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 supplying processed demineralized bone matrix to the Company's competitors and distributing the demineralized bone matrix implant products of the Company's competitors. Certain of these allegations had previously been asserted by GenSci in its patent litigation with the Company 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 intend to vigorously defend against these claims.
Osteotech, Inc. v. GenSci Orthobiologics, Inc.
On October 25, 2000, the Company filed suit against GenSci Orthobiologics, Inc. ("GenSci"), in the United States District Court for the Central District of California, alleging that GenSci's demineralized bone matrix materials sold under the name Orthoblast, infringe the Company's U.S. Patent No. 5,290,558 and infringe the reexamined claims of the Company's U.S. Patent No. 5,676,146. The Company's complaint seeks injunctive relief, treble damages, costs and attorneys fees.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
In its Second Amended Answer and Counterclaim filed in March, 2001, GenSci denies infringement, asserts a number of affirmative defenses, and asserts a counterclaim seeking a declaratory judgement that the patents-in-suit are invalid, not infringed and/or unenforceable, together with costs and attorneys fees.
The Company intends to pursue its claims against GenSci and vigorously defend against the counterclaims.
"O" Company, Inc. v. Osteotech, Inc.
In July, 1998, a complaint was filed against the Company in the Second Judicial District Court, Bernallilo County, New Mexico, which alleges negligence, strict liability, breach of warranties, negligent misrepresentation, fraud, and violation of the New Mexico Unfair Trade Practices Act arising from allegedly defective dental implant coating and coating services provided to plaintiffs by 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 warranties, negligent misrepresentation, fraud, and violation of the New Mexico Unfair Trade Practices Act. As to those claims, the Company has moved for summary judgement on the basis that all of the remaining claims are barred by their applicable statutes of limitations. At plaintiffs' request, the court permitted limited discovery on the matters related to the statute of limitations issue, which 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.
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 Nos. 5,814,084 and 4,950,296. The plaintiffs have sought injunctive relief and monetary damages in an amount not yet specified. 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. 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 patents mentioned above, 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.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
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. (collectively, "Danek") sued the Company in the United States District Court for the Western District of Tennessee alleging that instruments and instrument sets relating to cortical bone dowel products, including the bio-d(TM) Threaded Cortical Bone Dowel and Endodowel, manufactured, sold and/or otherwise distributed by the Company infringe on certain claims of U.S. Patent Nos. 5,741,253 and 5,484,437 which are owned by Danek. In addition to injunctive relief, the plaintiffs seek unspecified monetary damages. In September, 1999, the Company filed its answer and counterclaims seeking a declaratory judgement 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 also 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.
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. Plaintiff claims that the Company is violating the California Business and Professional Code 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 the Company, 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. 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 scheduled a hearing on defendants' demurrers to the plaintiffs' complaint. Plaintiffs subsequently moved to voluntarily dismiss the action without prejudice. The Court granted that motion. In February, 2001, the Company was served with the action that was refiled in Los Angeles County. The defendants have filed a motion asking the Court to move this action back to San Bernardino County.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
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.
Thacker v. Inland Eye & Tissue Bank of Redlands
In February, 2001, Thacker brought suit against the Company and fifteen or more defendants in the Superior Court for the State of California, Los Angeles County. The suit is substantially identical to the Regner v. Inland Eye & Tissue Bank of Redlands suit discussed above. The defendants have filed a motion asking the Court to move this action to the Superior Court for the State of California, San Bernardino County, or in the absence, to consolidate this action with the Regner action.
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.
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. In February, 2001, plaintiffs agreed to dismiss this case with prejudice.
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 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. Discovery on all of the claims in this action has commenced.
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.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Musculoskeletal Transplant Foundation v. Osteotech, Inc.
In October, 2000, MTF filed a complaint in the United States District Court for the District of New Jersey against the Company seeking a declaratory judgment that MTF, through its manufacture, use, sale and/or offer for sale of demineralized bone matrix products, does not infringe any claim of the Company's U.S. Patent Nos. 5,284,655 and 5,290,558, and that the claims of those patents are invalid and unenforceable. The complaint was then amended to add Synthes Spine Company, L.P. ("Synthes") as a plaintiff. MTF and Synthes seek declaratory and injunctive relief.
The Company answered the complaint, denying all claims asserted and the Company has asserted claims against MTF and Synthes for patent infringement, unfair competition, misappropriation of trade secrets, product disparagement, breach of implied covenant of good faith and fair dealing, intentional interference with contractual relations, and for constructive trust, arising from certain wrongful acts committed by MTF and/or Synthes in developing and selling their DBX(R) products and/or their underlying technology. The Company seeks injunctive relief and monetary damages in an amount to be determined. MTF and Synthes have denied any liability.
Discovery has commenced on all claims. The Company believes that the claims made against it in this action are without merit and will vigorously defend against the claims.
Glancy v. Interpore International, Inc.
In November, 2000, plaintiffs Bonnie and Ivan Glancy commenced an action in the United States District Court for the Northern District of Indiana against Interpore International, Inc. and Interpore Cross International, Inc. (collectively, "Interpore") and the Company. The suit seeks recovery from defendants for alleged personal injuries suffered by plaintiffs as a result of allegedly defective spinal implants, manufactured and/or distributed by Interpore, and/or demineralized bone matrix material, processed by the Company - both are alleged to have been implanted into plaintiff Bonnie Glancy during a spinal surgery. With respect to the Company, plaintiffs have asserted a products/strict liability claim relating to the demineralized bone matrix material. Plaintiffs demand monetary damages in an unspecified amount. In January, 2001, the Company answered the complaint, denying any and all liability and the Company intends to vigorously defend against all claims. Discovery on all of the claims in this action has commenced.
The Company maintains a general liability policy and has informed the insurance company of this action. The insurance company has agreed to defend this action.
Criti-Cal, Inc. v. Osteotech, Inc.
In December, 2000, Criti-Cal, Inc. commenced an action in the Superior Court for the State of California, Orange County, against the Company, Second Act Medical, Inc. and Ronald Letner. The plaintiff alleges causes of action for breach of contract, misappropriation of trade secrets, quantum merit and violations of the California Independent Wholesale Sales Representatives Contractual Relations Act of 1990 arising from the termination of an agreement between the Company and plaintiff. In addition to injunctive relief, plaintiff seeks unspecified monetary damages.
The Company answered the complaint denying any and all liability and intends to vigorously defend against all claims.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (continued)
Medtronic, Inc. v. Osteotech, Inc.
In February, 2001, Medtronic, Inc. and Medtronic Sofamor Danek, Inc. (collectively, "Medtronic") brought suit against the Company and Medtronic's former employee, Timothy R. Miller, in the Circuit Court for Shelby County, Tennessee. The plaintiffs seek to enjoin Mr. Miller, whom the Company recently hired, from using and disclosing any of their trade secrets or other confidential information to any third party, including the Company, and from working for the Company for a period of twelve months. The plaintiffs have asserted a claim against the Company for tortious interference with an employment agreement between Mr. Miller and plaintiffs. In addition to injunctive relief, plaintiffs seek unspecified monetary damages.
Mr. Miller and the Company have both filed an answer denying any liability. Medtronic has filed a motion for a preliminary injunction which remains pending. The Company intends to vigorously defend against these claims.
Other than the foregoing matters, the Company is not a party to any material pending legal proceeding. Litigation is subject to many uncertainties and management is unable to predict the outcome of the pending suits and claims. It is possible that the results of operations or liquidity and capital resources of the Company could be adversely affected by the ultimate outcome of the pending litigation or as a result of the costs of contesting such lawsuits. The Company is 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 for services previously rendered) has been made in the consolidated financial statements.
12. STOCKHOLDERS' EQUITY
Common Stock
In June, 1999, the stockholders of the Company approved an amendment to the Certificate of Incorporation increasing the number of authorized shares of Common Stock from 20,000,000 to 70,000,000.
Preferred Stock
The authorized capital of the Company includes 5,675,595 shares of Preferred Stock, the rights and provisions of which will be determined by the Board of Directors at the time any such shares are issued, if at all. No shares of Preferred Stock were issued or outstanding at December 31, 2000 and 1999.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
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 December 31, 2000, the Company had repurchased and retired 330,500 shares of common stock at a cost of approximately $3,124,000.
In June, 1998, the Board of Directors of the Company authorized the repurchase and retirement of up to $5,000,000 of common stock through open market purchases. During August, 1998, the Company completed this program and had repurchased and retired 367,500 shares of common stock at a cost of $4,958,000.
Stock Split
On February 11, 1999, the Board of Directors authorized a three-for-two stock split in the form of a 50% stock dividend that was distributed on March 19, 1999 to stockholders of record on March 5, 1999. Stockholders' equity has been restated to give retroactive recognition to the stock split for all periods presented. In addition, all references in the financial statements to shares, per share data, stock option data and market prices of the Company's common stock have been restated.
Stock Options
The Company has three stock option plans: the 2000 Stock Plan (the "2000 Plan"), the 1991 Stock Option Plan (the "1991 Plan") and the 1991 Independent Directors Stock Option Plan (the "Directors Plan").
The 2000 Plan authorizes the grant of up to 1,000,000 shares of the Company's common stock in the form of incentive stock options, non-qualified stock options or other stock-based awards to employees, directors and consultants. Incentive stock options may be granted at prices not less than 100% of the fair market value on the date of grant. Non-qualified stock options and other stock-based awards may be granted at the discretion of the Compensation Committee of the Board of Directors under terms and conditions as determined by the Compensation Committee. Options will expire ten years from the date of grant and vesting will be determined by the Compensation Committee.
The 1991 Plan, as amended, authorizes the grant of up to 4,220,648 shares of the Company's common stock in the form of incentive stock options or non-qualified stock options to employees and consultants. Commencing in June, 2000, the 2000 Plan replaced the 1991 Plan, and therefore, options will no longer be issued under the 1991 Plan. At June 30, 2000, there were outstanding options for 1,735,895 shares under the 1991 Plan.
The Directors Plan, as amended, authorizes the grant of up to 750,000 shares of the Company's common stock to members of the Board of Directors who are not officers or employees of the Company. Option exercise prices equal 100% of the fair market value on the date of grant. Options issued prior to July 1, 1997 become exercisable in ratable installments over four years with unexercised options expiring five years from the vesting date. Effective July 1, 1997, the Directors Plan was amended to provide for options issued to become 100% exercisable on the first anniversary of the date of grant with unexercised options expiring ten years from the date of grant.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Stock option activity for the years 2000, 1999 and 1998 is as follows:
The following table summarizes the information about stock options outstanding at December 31, 2000:
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
The Company has adopted the "disclosure only" provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation ("SFAS 123") and, accordingly, no compensation cost has been recognized in the Statements of Operations. Pro forma information regarding net income and net income per share is required by SFAS 123, and has been determined as if the Company accounted for its stock options under the Fair Value Method of that Statement. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Pro forma information follows:
(in thousands except per share data) 2000 1999 1998 - - -------------------------------------------------------------------------------- Net income As reported $ 4,828 $ 12,351 $ 10,304 Pro forma 3,699 10,927 9,032
Net income per share As reported Basic $ .34 $ .88 $ .78 Diluted .34 .84 .73
Pro forma Basic $ .26 $ .78 $ .68 Diluted .26 .75 .64 - - --------------------------------------------------------------------------------
The pro forma effect on net income for 2000, 1999, and 1998 is not representative of the pro forma effect on net income in future years because, in accordance with FAS 123, it does not take into consideration pro forma compensation expense related to grants made prior to 1995.
The fair value for the option grants was estimated at the date of grant using the Black-Scholes Option-Pricing Model with the following weighted-average assumptions:
2000 1999 1998 - - -------------------------------------------------------------------------------- Expected life (years) 5 5 8 Risk free interest rate 5.7% 6.1% 5.1% Volatility factor 60.0% 60.0% 50.0% Dividend yield 0.0% 0.0% 50.0% - - --------------------------------------------------------------------------------
Stock Warrants
As part of financing and contract arrangements, the Company has, at certain times, issued warrants to purchase its Convertible Preferred Stock. During 2000, all outstanding Convertible Preferred Stock warrants expired. As of December 31, 1999 and 1998 there were Convertible Preferred Stock warrants to purchase 458 shares of Common Stock at an exercise price of $3.72.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCKHOLDERS' EQUITY (continued)
Stock Purchase Plan
The 1994 Employee Stock Purchase Plan provides for the issuance of up to 375,000 shares of Common Stock. Eligible employees may purchase shares of the Company's Common Stock through payroll deductions of 1% to 7 1/2% of annual compensation. The purchase price for the stock is 85% of the fair market value of the stock on the last day of each calendar quarter. At December 31, 2000, 193,140 shares were available for future offerings under this plan.
Stockholder Rights Agreement
In January, 1996, the Board of Directors of the Company unanimously adopted a stockholder rights agreement (the "Rights Agreement") declaring a dividend of one preferred stock purchase right (the "Right") for each outstanding share of common stock as of February 12, 1996. Upon the occurrence of certain events, each Right entitles the stockholder to purchase from the Company one one-hundredth of a preferred share at a price of $170.00 per one one-hundredth of a preferred share, subject to adjustment. The Rights will not be exercisable or separable from the common shares until ten business days after a person or group acquires or tenders for 20% or more of the Company's outstanding common shares ("triggering event"). The Rights Agreement also provides that, after a triggering event occurs, the Rights convert into a Right to buy common stock and entitle its holder to receive upon exercise that number of common shares having a market value of two times the exercise price of the Right. In the event the Company is acquired in a merger or other business combination transaction, each Right will entitle its holder to receive upon exercise of the Right, at the Right's then current exercise price, that number of the acquiring company's common shares having a market value of two times the exercise price of the Right. The Company is entitled to redeem the Rights at a price of $.01 per Right at any time prior to their becoming exercisable, and the Rights expire on March 31, 2009. The Rights Agreement was adopted to maximize the value of all stockholders' ownership interest in the Company by establishing a deterrent to abusive takeover tactics sometimes used in challenges for corporate control.
13. SUPPLEMENTAL STATEMENT OF OPERATIONS INFORMATION
Maintenance and repairs expense for the years ended December 31, 2000, 1999 and 1998 was $2,551,000, $2,240,000, and $1,344,000, respectively. Depreciation and amortization expense related to property, plant and equipment for the years ended December 31, 2000, 1999 and 1998 was $3,956,000, $2,745,000, and $2,050,000, respectively.
14. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(in thousands) 2000 1999 1998 - - -------------------------------------------------------------------------------- Cash paid during the year for taxes $ 1,895 $4,476 $2,120 Cash paid during the year for interest, excluding amounts capitalized 11 33 50 Acquisition of business: Fair value of assets acquired 2,563 Liabilities assumed 2,669
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net income (loss) per share:
Weighted average shares issuable upon the exercise of stock options which were not included in the calculation were 771,498 in 2000, 48,419 in 1999 and 24,188 in 1998. Such shares were not included because they were antidilutive.
16. OPERATING SEGMENTS
The Company has two reportable business segments: the Grafton(R) DBM Segment and Base Tissue Segment. The Grafton(R) DBM Segment engages in the processing and marketing of Grafton(R) DBM. Grafton(R) DBM is processed using the Company's advanced proprietary demineralization process. The Base Tissue Segment primarily engages in the processing of mineralized weight-bearing allograft bone tissue which is generally marketed by the Company's clients.
The accounting policies of the reportable segments are the same as those described in the Summary of Significant Accounting Policies. The Company evaluates the performance of its operating segments based on revenue performance and operating results. The Company does not produce information about assets for its operating segments, and accordingly no asset information is presented in the table below. All corporate related expenses are allocated to operating segments and geographic areas in determining operating income (loss) of the respective segments.
Summarized financial information concerning the Company's reportable segments is shown in the following table. The "Other" column includes information for other sources of revenue which do not meet the requirements for reporting as a segment. The Company's other business units engage in providing ceramic and titanium plasma spray coating services and ceramic products to orthopaedic and dental implant manufacturers, marketing and distributing metal spinal implant products and processing, marketing and distributing bovine tissue products outside the United States.
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. OPERATING SEGMENTS (continued)
(in thousands)
Grafton(R) Base DBM Tissue Segment Segment Other Consolidated - - -------------------------------------------------------------------------------- Revenues: 2000 $45,226 $26,204 $ 4,253 $75,683 1999 45,136 25,751 4,723 75,610 1998 39,128 17,323 2,750 59,201 - - -------------------------------------------------------------------------------- Operating income (loss): 2000 $11,389 $ 694 $(4,228) $ 7,855 1999 17,063 6,434 (3,645) 19,852 1998 13,404 4,170 (1,293) 16,281 - - -------------------------------------------------------------------------------- Depreciation and amortization: 2000 $ 2,198 $ 1,376 $ 1,023 $ 4,597 1999 1,203 1,153 942 3,298 1998 1,180 742 481 2,403 - - --------------------------------------------------------------------------------
Financial information by geographic area is summarized as follows:
(in thousands) United States Europe Consolidated - - -------------------------------------------------------------------------------- Revenues 2000 $71,468 $4,215 $75,683 1999 71,517 4,093 75,610 1998 56,876 2,325 59,201
Long-lived Assets 2000 $56,618 $1,672 $58,290 1999 32,068 1,927 33,995 1998 15,449 595 16,044
Two of the Company's customers individually comprise 10% or more of the Company's consolidated net revenues. Revenues by customer, which are reported as part of the Company's Grafton(R) DBM and Base Tissue Segments, are as follows:
(in thousands) 2000 1999 1998 - - --------------------------------------------------------------------------------
Revenues MTF $37,743 $42,095 $33,286 ARC 30,469 28,436 23,020 - - -------------------------------------------------------------------------------- $68,212 $70,531 $56,306 ================================================================================
OSTEOTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. RETIREMENT BENEFITS
The Company has a 401(k) plan which covers substantially all full time U.S. employees. The Company has agreed to contribute an amount equal to 25% through December 31, 2000 and 35% effective January 1, 2001 of each participant's contribution. A participant's contribution may not exceed 15% of annual compensation, or the maximum allowed by the Internal Revenue Code, if less than 15% of compensation. Provisions of the plan include graduated vesting over five years of service. Total Company contributions for the years ended December 31, 2000, 1999 and 1998 were $285,000, $287,000, and $221,000, respectively.
Certain of the Company's foreign subsidiaries provide retirement benefits to their employees through the purchase of non-participating annuity contracts. The expenses for these contracts were $70,000, $53,000, and $88,000 for the years ended December 31, 2000, 1999 and 1998.
The Company does not maintain any other pension or post retirement plans.
18. 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 statements of cash flows for the years ended December 31, 1999 and 1998, the Company reclassified $6,542,000 and $3,228,000, respectively, 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.
19. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of the unaudited quarterly results for the years ended December 31, 2000 and 1999:
(a) Net income in 2000 included approximately $150,000, or $.01 net income per share, per quarter from a litigation settlement, while 1999 included approximately $1,050,000, or $.07 net income per share, in the third quarter and approximately $150,000, or $.01 net income per share, in the fourth quarter from the litigation settlement.
SCHEDULE II
OSTEOTECH, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (in thousands)
(a) Represents foreign currency translation adjustments.
(b) Represents the write-off of accounts receivable.
(c) Represents the tax effect of temporary differences.
(d) Represents recognition of a deferred tax asset.
(e) Represents recovery on previously written-off accounts receivable.
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Report of Independent Accountants on Financial Statement Schedule
To the Board of Directors of Osteotech, Inc.
Our audits of the consolidated financial statements referred to in our report dated February 20, 2001, except as to certain information presented in Note 11 for which the date is March 28, 2001, appearing on page of this 2000 Form 10-K also included an audit of the Financial Statement Schedule listed in Item 14(a)(2) of this 2000 Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP Florham Park, New Jersey February 20, 2001, except as to certain information presented in Note 11 for which the date is March 28, 2001.
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EXHIBIT INDEX
Exhibit Page Number Description Number - - ------ ----------- ------
10.37 Mortgage Term Note among Summit Bank, Osteotech, Inc., E-2 Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/CAM Services, B.V. and OST Developpement dated December 8, 2000
10.38 Allonge to Loan and Security Agreement among Summit Bank, E-7 Osteotech, Inc., Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/CAM Services, B.V. and OST Developpement dated December 8, 2000
10.39 Allonge to Equipment Loan Note among Summit Bank, Osteotech, E-10 Inc., Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST Developpement dated December 8, 2000
10.40 Distribution Agreement entered into February, 2001 by E-12 Osteotech, Inc. and Alphatec Manufacturing, Inc. for which Osteotech is requesting confidential treatment pursuant to Rule 24b-2
10.41 Second Allonge to Loan and Security Agreement among Fleet E-34 National Bank, Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST Developpement dated March 8, 2001
10.42 Second Allonge to Equipment Loan Note among Fleet National E-37 Bank, Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST Developpement dated March 8, 2001
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10.43 Allonge to Convertible Revolving Note among Fleet National E-39 Bank, Successor in Interest to Summit Bank, Osteotech, Inc., Osteotech Investment Corp., Cam Implants Inc., Osteotech, B.V., H.C. Implants, B.V., Cam Implants, B.V., Osteotech/Cam Services, B.V. and OST Developpement dated March 8, 2001
21.1 Subsidiaries of Registrant E-41
23.1 Consent of PricewaterhouseCoopers LLP E-42
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