UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 FORM
10-Q (Mark One) xQuarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 for the Period Ended June 30, 2005 or oTransition Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934 for the Transition Period from
________to ________ Commission
File Number 0-19278 OSTEOTECH, INC.(Exact name of registrant as specified in its charter)  Delaware
  
  13-3357370(State or other jurisdiction of 
  incorporation or organization)
  
  (I.R.S. Employer Identification No.)51 James Way, Eatontown, New Jersey
  
  07724(Address of principal executive offices)
  
  (Zip Code)(732) 542-2800(Registrants telephone number, including area code)Not Applicable(Former name, former address and former fiscal year, if changed since
  last report) Indicate by
check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes xNo o Applicable Only to Corporate Issuers Indicate by
check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yesxor Noo The number of
shares of the registrants common stock, $.01 par value, outstanding as of
August 5, 2005 was 17,198,901.    PART I.
  FINANCIAL
  INFORMATIONITEM 1.
  Financial
  StatementsOSTEOTECH,
INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS(unaudited)(dollars
in thousands)

June 30,
  2005
  
  December
  31,
  2004ASSETSCurrent
  assets:Cash and cash equivalents
  
  $
  10,959
  
  $
  13,391Accounts receivable, net of allowance
  of  $1,664 in 2005 and $1,468 in 2004
  
  
  18,764
  
  
  14,795Deferred processing costs
  
  
  34,232
  
  
  36,049Inventories
  
  
  1,524
  
  
  1,202Prepaid expenses and other current
assets
  
  
  6,223
  
  
  5,595Total current assets
  
  
  71,702
  
  
  71,032Property,
  plant and equipment, net
  
  
  35,050
  
  
  37,447Goodwill
  
  
  1,669
  
  
  1,669Other assets
  
  
  5,931
  
  
  6,256Total assets
  
  $
  114,352
  
  $
  116,404LIABILITIES AND STOCKHOLDERS EQUITYCurrent
  liabilities:Accounts payable and accrued
liabilities
  
  $
  13,128
  
  $
  11,532Current maturities of long-term debt
  
  
  2,661
  
  
  2,661Total current liabilities
  
  
  15,789
  
  
  14,193Long-term
  debt
  
  
  8,746
  
  
  10,076Other
  liabilities
  
  
  119
  
  
  740Total liabilities
  
  
  24,654
  
  
  25,009Commitments
  and contingenciesStockholders
  equity:Preferred stock, $.01 par value; 5,000,000
  sharesAuthorized; no shares issued
  or outstandingCommon stock, $.01 par value; 70,000,000
  shares Authorized; issued and
  outstanding 17,198,901 shares in 2005 and 17,175,474 shares in 2004
  
  
  172
  
  
  172Additional paid-in capital
  
  
  64,568
  
  
  64,482Accumulated other comprehensive income
  
  
  1,676
  
  
  750Retained earnings
  
  
  23,282
  
  
  25,991Total stockholders equity
  
  
  89,698
  
  
  91,395Total liabilities and stockholders
equity
  
  $
  114,352
  
  $
  116,404See
accompanying notes to condensed consolidated financial statements.

-2-OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)(dollars
in thousands, except per share data)

Three
  Months Ended June 30,
  
  Six Months
  Ended June 30,2005
  
  2004
  
  2005
  
  2004Net revenues:Service
  
  $
  24,997
  
  $
  21,153
  
  $
  48,435
  
  $
  43,346Product
  
  
  293
  
  
  1,072
  
  
  703
  
  
  2,65625,290
  
  
  22,225
  
  
  49,138
  
  
  46,002Cost of
services
  
  
  15,110
  
  
  11,800
  
  
  28,173
  
  
  22,697Cost of products
  
  
  107
  
  
  468
  
  
  265
  
  
  3,71015,217
  
  
  12,268
  
  
  28,438
  
  
  26,407Gross profit
  
  
  10,073
  
  
  9,957
  
  
  20,700
  
  
  19,595Marketing, selling, general
and
  administrative
  
  
  10,967
  
  
  9,678
  
  
  21,573
  
  
  20,184Research and development
  
  
  1,224
  
  
  1,187
  
  
  2,186
  
  
  2,04312,191
  
  
  10,865
  
  
  23,759
  
  
  22,227Operating loss
  
  
  (2,118
  )
  
  (908
  )
  
  (3,059
  )
  
  (2,632
  )Other, net:Interest expense,
net
  
  
  (41
  )
  
  (101
  )
  
  (152
  )
  
  (222
  )Foreign
currency losses
  
  
  (636
  )
  
  (7
  )
  
  (821
  )
  
  (123
  )(677
  )
  
  (108
  )
  
  (973
  )
  
  (345
  )Loss before income tax
benefit
  
  
  (2,795
  )
  
  (1,016
  )
  
  (4,032
  )
  
  (2,977
  )Income tax benefit
  
  
  (917
  )
  
  (589
  )
  
  (1,323
  )
  
  (1,295
  )Net loss
  
  $
  (1,878
  )
  $
  (427
  )
  $
  (2,709
  )
  $
  (1,682
  )Net loss per share:Basic
  
  $
  (.11
  )
  $
  (.02
  )
  $
  (.16
  )
  $
  (.10
  )Diluted
  
  $
  (.11
  )
  $
  (.02
  )
  $
  (.16
  )
  $
  (.10
  )Shares used in computing net
loss per
  share:Basic
  
  
  17,187,792
  
  
  17,144,280
  
  
  17,182,245
  
  
  17,132,335Diluted
  
  
  17,187,792
  
  
  17,144,280
  
  
  17,182,245
  
  
  17,132,335See
accompanying notes to condensed consolidated financial statements.
-3-


OSTEOTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(dollars
in thousands)
Six
        Months Ended June 30,
    
    2005
    
    2004Cash
        Flow From Operating ActivitiesNet
        loss
    
    $
    (2,709
    )
    $
    (1,682
    )Adjustments
        to reconcile net loss to net cash provided by (used in) operating activities:Depreciation
        and amortization
    
    
    2,799
    
    
    4,078Provision
        for metal spinal implant systems
    
    
    
    
    
    1,998Changes
        in current assets and liabilities:Accounts
        receivable
    
    
    (4,595
    )
    
    (527
    )Deferred
        processing costs
    
    
    1,434
    
    
    (2,855
    )Inventories
    
    
    (368
    )
    
    502Prepaid
        expenses and other current assets
    
    
    (886
    )
    
    356Accounts
        payable and other liabilities
    
    
    3,848
    
    
    216Net
        cash provided by (used in) operating activities
    
    
    (477
    )
    
    2,086Cash
        Flow From Investing ActivitiesCapital
        expenditures
    
    
    (459
    )
    
    (771
    )Other,
        net
    
    
    (139
    )
    
    67Net
        cash used in investing activities
    
    
    (598
    )
    
    (704
    )Cash
        Flow From Financing ActivitiesProceeds
        from issuance of common stock
    
    
    86
    
    
    202Principal
        payments on long-term debt
    
    
    (1,330
    )
    
    (1,331
    )Net
        cash used in financing activities
    
    
    (1,244
    )
    
    (1,129
    )Effect
        of exchange rate changes on cash
    
    
    (113
    )
    
    136Net
        increase (decrease) in cash and cash equivalents
    
    
    (2,432
    )
    
    389Cash
        and cash equivalents at beginning of period
    
    
    13,391
    
    
    15,326Cash
        and cash equivalents at end of period
    
    $
    10,959
    
    $
    15,715Supplementary
        cash flow data:Cash
        paid during the period for interest
    
    $
    321
    
    $
    270Cash
        paid during the period for taxes
    
    
    561
    
    
    1,413See
accompanying notes to condensed consolidated financial statements
-4-


1.
  Basis of
  PresentationThe accompanying unaudited condensed
  consolidated financial statements reflect all adjustments (consisting only of
  normal recurring accruals) considered necessary by management for a fair
  statement of the consolidated financial position as of June 30, 2005, the
  consolidated results of operations for the three months and six months ended
  June 30, 2005 and 2004, and the consolidated cash flows for the six months
  ended June 30, 2005 and 2004. The results of operations and cash flows for
  the respective interim periods are not necessarily indicative of the results
  to be expected for the full year.  The
  December 31, 2004 financial information has been derived from the audited
  financial statements for the year ended December 31, 2004.  The condensed consolidated financial
  statement should be read in conjunction with the audited consolidated
  financial statements, which were included as part of Osteotech, Inc.s (the
  Company) Annual Report on Form 10-K for the year ended December 31, 2004.2.
  Other Intangible
  AssetsThe Companys intangibles, other than
  goodwill, are recorded at an original cost of $2,998,000 and $2,846,000 as of
  June 30, 2005 and December 31, 2004, respectively, and are principally
  represented by patents, patent applications and licenses.  The carrying values of such intangibles
  are $1,792,000 and $1,710,000 as of the same respective dates.  Patents and licenses are amortized over
  their estimated useful lives ranging from five to ten years.  Patent application costs are amortized
  upon grant of the patent or expensed if the application is rejected or
  withdrawn.3.
  Stock OptionsThe Company accounts for stock option
  awards in accordance with Accounting Principles Board Opinion No. 25,
  Accounting for Stock Issued to Employees, and related interpretations (APB
  No. 25). Accordingly, no compensation expense has been recognized for stock
  options, since all options have been granted with an exercise price equal to
  or greater than the market price of the underlying common stock on the date
  of grant.  The Company has adopted the
  disclosure only provisions of Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock Based
  Compensation (SFAS No. 123).  Pro
  forma information regarding net income/loss and net income/loss per share is
  required by SFAS No. 123, and has been determined as if the Company accounted
  for its stock options on a fair value basis. 
  For purposes of the pro forma disclosures, the estimated fair value of
  the options is amortized on a straight-line basis to expense over the
  options vesting period, or such other period to match the vesting period or
  adjusted vesting period determined by the Companys Board of Directors.In December, 2004, the Financial Accounting
  Standards Board (FASB) issued SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No.
  123R).  SFAS No. 123R addresses all
  forms of share-based payment (SBP) awards, including shares issued under
  employee stock purchase plans, stock options, restricted stock and stock
  appreciations rights.  SFAS No. 123R
  will require the Company to expense SBP awards as compensation costs for SBP
  transactions measured at fair value. 
  SFAS No. 123R would have been effective beginning in the Companys
  third quarter of 2005, however, in April, 2005, the Securities and Exchange
  Commission extended the effective date of SFAS No. 123R to January 1, 2006.
  The Company intends to adopt SFAS No. 123R using the modified prospective
  method.  The Company is currently
  evaluating its long-term incentive plan related to the issuance of stock
  options, but no decisions have been made.-5-


In anticipation of the effective date of
  SFAS No. 123 and to provide additional incentive to the Companys employees,
  in June, 2005, the Companys Board of Directors approved the accelerated
  vesting of all unvested stock options with an exercise price greater than
  $3.33, the closing price of the Companys common stock on June 9, 2005.  Stock options representing 435,850 shares
  of the Companys common stock were vested immediately as a result of this
  Board action. In accordance with the provisions of APB No. 25, the Company
  will not recognize any compensation cost in its consolidated statement of
  operations related to this Board action, since the exercise price of the
  options which were accelerated was greater than the market price. However,
  compensation costs, net of tax, associated with the acceleration of these
  stock options and determined in accordance with SFAS No. 123 of approximately
  $748,000 are included in the following table in addition to the amounts that
  would have been reflected had this Board action not occurred in compliance
  with the disclosure only provisions of SFAS No. 123.On June 9, 2005, the Companys Board
  of Directors approved amending all of the option agreements issued to the
  Companys Chief Executive Officer, Richard W. Bauer, to provide that all of
  his options shall remain exercisable through the original expiration date of
  such option agreements, notwithstanding any provisions in such option
  agreements which would have limited the exercise period of such options
  following the termination of Mr. Bauers employment with the Company.
  Originally, the option agreements provided that upon the termination of Mr.
  Bauers employment with the Company, the option granted to Mr. Bauer must be
  exercised no later than the earlier of (i) the original expiration date or
  (ii)(a) the 90th day following the termination of Mr. Bauers employment with
  the Company or (b) the first anniversary of the date Mr. Bauers employment
  with the Company is terminated if his employment is terminated due to his
  death or disability. In accordance with the provisions of APB No. 25, the
  Company will not recognize any compensation cost in its consolidated
  statement of operations related to this change to Mr. Bauers stock options,
  since the exercise price of Mr. Bauers stock options were all greater than
  the market price of the Companys common stock on June 9, 2005. In accordance
  with the provisions of SFAS No. 123, this change to Mr. Bauers stock options
  resulted in a compensation cost, net of tax, of 190,000 which will be
  included in the following table in accordance with the disclosure only
  provisions of SFAS No. 123.The following table shows the estimated
  effect on earnings and per share data as if the Company had applied the fair
  value recognition provisions of SFAS No. 123 to stock-based employee
  compensation.Three
  Months Ended
  June 30,
  
  Six Months
  Ended
  June 30,(in thousands except per share data)
  
  2005
  
  2004
  
  2005
  
  2004Net loss -
  reported
  
  $
  (1,878
  )
  $
  (427
  )
  $
  (2,709
  )
  $
  (1,682
  )Impact on net loss related to stock-based
  employee compensation expense, net of tax
  
  $
  1,003
  
  $
  227
  
  $
  1,057
  
  $
  454Net loss -
  pro forma
  
  $
  (2,881
  )
  $
  (654
  )
  $
  (3,766
  )
  $
  (2,136
  )Net loss per
  shareAs reported:Basic
  
  $
  (.11
  )
  $
  (.02
  )
  $
  (.16
  )
  $
  (.10
  )Diluted
  
  $
  (.11
  )
  $
  (.02
  )
  $
  (.16
  )
  $
  (.10
  )Pro forma:Basic
  
  $
  (.17
  )
  $
  (.04
  )
  $
  (.22
  )
  $
  (.12
  )Diluted
  
  $
  (.17
  )
  $
  (.04
  )
  $
  (.22
  )
  $
  (.12
  )-6-


4.
  Recent Accounting PronouncementsIn March,
  2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional
  Asset Retirement Obligation (FIN 47). The interpretation addresses diverse
  practices, which have developed with respect to the recognition of asset
  retirement obligations when the timing and/or method of settlement of an
  obligation are conditional on a future event. The interpretation requires recognition of a
  liability for the fair value of a conditional asset retirement obligation
   if the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement obligation
  should be recognized when incurred (generally upon acquisition, construction
  or development) and/or through the normal operation of the asset. This
  guidance is effective no later than the end of fiscal years ending after
  December 15, 2005. Retrospective application for interim financial
  information is permitted but is not required. The Company is in the process
  of evaluating the impact, if any, of implementing FIN 47.In May, 2005
  the FASB issued SFAS No. 154, Accounting Changes and Error Corrections
  (SFAS No. 154).  SFAS No. 154
  addresses the requirements for the accounting for and reporting of a change
  in accounting principle.  It requires
  retrospective application to prior periods financial statements of changes in
  accounting principles unless a pronouncement giving rise to a change in
  accounting principle includes specific transition provisions, in which case
  those provisions should be followed. 
  This guidance must be implemented for accounting changes and
  corrections of errors made in fiscal years beginning after December 15, 2005.5.
  2005 and 2004 Charges2005 ChargesReserves for Obsolescence and ExpirationDuring the
  second quarter of 2005, the Company increased its reserves for tissue
  inventories obsolescence and expiration by $790,000, mostly due to the
  previously announced dispute with Bone Bank Allograft (BBA), which prevents
  us from utilizing BBA labeled tissue.2004 ChargesProvision for Metal Spinal Implant SystemsAs a result of an assessment of its metal spinal implant business in
  the first quarter of 2004, the Company ceased marketing and distributing all
  metal spinal implant product lines on June 30, 2004.  The Company recorded a charge to cost of
  sales in the first quarter of 2004 of $1,998,000 to reduce metal spinal
  implant inventory and instrumentation to estimated net realizable value.  The Company ceased distribution of all
  metal spinal implant product lines in June, 2004.Severance  Sales and Marketing ReorganizationIn first
  quarter 2004, the Company reorganized its sales and marketing
  departments.  As a result, the Company
  recorded a charge in marketing, selling, general and administrative expenses
  of $650,000,-7-


principally
  for the severance costs associated with the departure of the executive
  officer responsible for these areas and two other employees.6.
  Deferred Processing CostsDeferred
  processing costs consist of the following:(in thousands)
  
  June 30,
  2005
  
  December
  31, 
  2004Donor tissue
  to be processed
  
  $
  11,015
  
  $
  9,259Tissue in
  process
  
  
  6,249
  
  
  11,740Processed
  implantable donor tissue to be distributed by the Company
  
  
  16,804
  
  
  12,841Processed
  implantable donor tissue held for clients
  
  
  164
  
  
  2,209$
  34,232
  
  $
  36,0497.
  InventoriesInventories
  consist of the following:(in thousands)
  
  June 30,
  2005
  
  December
  31, 
  2004Supplies
  
  $
  297
  
  $
  237Raw
  materials
  
  
  972
  
  
  718Finished
  goods
  
  
  255
  
  
  247$
  1,524
  
  $
  1,2028.
  Debt and Financing ArrangementsThe Company
  has a Credit Facility, as amended, which includes a $5,000,000 line of
  credit, a mortgage loan and an equipment term loan.  As of June 30, 2005, no amounts were outstanding under the
  revolving line of credit and the full amount was available.  The Credit Facility imposes certain
  restrictive operating and financial covenants.  The Company complied with all financial covenants as of June
  30, 2005.On August
8, 2005, the Company entered into the sale and leaseback transaction for the
Companys principal processing facility, which is more fully discussed in
Note 14. A portion of the proceeds from this transaction were utilized to repay
the then outstanding balance of the mortgage and equipment term loan and the
line of credit was cancelled resulting in a termination of the Companys
credit facility.9.
  Commitments and ContingenciesLitigationThe
  following is a description of material developments that occurred during the
  three months ended June 30, 2005 in lawsuits reported in the Companys Annual
  Report on Form 10-K for the year ended December 31, 2004 and the Companys
  Quarterly Report on Form 10-Q for the quarter ended March 31, 2005.  Additionally, from time to time the
  Company is party to other litigation incidental to its business,-8-


none of
  which, individually or in the aggregate, are expected to have a material
  adverse effect on our results of operations or financial condition.Tissue Transplant Technology, Ltd. d/b/a
  Bone Bank Allografts v. Osteotech, Inc.In December,
  2004, the Company was served with a suit filed by Tissue Transplant Technology,
  Ltd. d/b/a Bone Bank Allografts (BBA) alleging, among other things, breach
  of contract in connection with a processing agreement between the two parties
  entered into on June 1, 2000.  BBAs
  complaint, as amended, contains claims for breach of contract, tortious
  interference with existing contract, tortious interference with prospective
  business relationships, negligence, breach of fiduciary duty, unfair
  competition, fraud, and federal unfair competition.  BBA does not allege a specified amount of damages.  On January 31,
2005, the Company filed a
  motion to transfer venue to the District of New Jersey and a motion to
  dismiss some of BBAs claims.  On
  April 26, 2005, the U.S. District Court for the Western District of Texas
  denied the Companys motion to transfer venue and granted the Companys
  motion to dismiss only with respect to the breach of fiduciary duty
  claim.  As a result, litigation with
  respect to BBAs remaining claims will go forward in the Western District of
  Texas.  On May 10, 2005, the Company
  filed its answer, affirmative defenses and two counterclaims for breach of
  contract. Discovery proceedings and depositions are ongoing.  The Company and BBA have participated in
  three mediation sessions, but have been unable to reach a non-litigation
  resolution to the dispute.The Company
  believes that the claims made against it in this action are without merit and
  will vigorously defend against such claims.-9-


10.
  Comprehensive LossComprehensive
  loss for the three months and six months ended June 30, 2005 and 2004
  were as follows:Three Months Ended
  June 30,
  
  Six Months Ended
  June 30,(in thousands)
  
  2005
  
  2004
  
  2005
  
  2004Net loss
  
  $
  (1,878
  )
  $
  (427
  )
  $
  (2,709
  )
  $
  (1,682
  )Currency
  translation adjustments
  
  
  469
  
  
  (96
  )
  
  926
  
  
  (88
  )Comprehensive loss
  
  $
  (1,409
  )
  $
  (523
  )
  $
  (1,783
  )
  $
  (1,770
  )11.
  Loss Per ShareThe
  following table sets forth the computation of basic and diluted net loss per
  share for the three months and six months ended June 30, 2005 and 2004.Three Months Ended
  June 30,
  
  Six Months Ended
  June 30,(dollars
in thousands, except per share data)
  
  2005
  
  2004
  
  2005
  
  2004Net loss available to common shareholders
  
  $
  (1,878
  )
  $
  (427
  )
  $
  (2,709
  )
  $
  (1,682
  )Denominator for basic net loss per share,
  weighted average common shares outstanding
  
  
  17,187,792
  
  
  17,144,280
  
  
  17,182,245
  
  
  17,132,335Effect of dilutive securities, stock
  optionsDenominator for diluted net loss per share
  
  
  17,187,792
  
  
  17,144,280
  
  
  17,182,245
  
  
  17,132,335Net loss per share:Basic
  
  $
  (.11
  )
  $
  (.02
  )
  $
  (.16
  )
  $
  (.10
  )Diluted
  
  $
  (.11
  )
  $
  (.02
  )
  $
  (.16
  )
  $
  (.10
  )As of June
  30, 2005 and 2004, the Company had outstanding options to purchase 2,922,162
  and 2,421,636 shares of common stock, respectively, which were excluded from
  the calculation of diluted net loss per share as the effects are
  antidilutive.-10-


12.
  Operating
  SegmentsSummarized in the table below is financial
  information for our reportable segments for the three months and six months
  ended June 30, 2005 and 2004:Three Months Ended
  June 30,
  
  Six Months Ended
  June 30,(dollars in thousands)
  
  2005
  
  2004
  
  2005
  
  2004Revenues:Demineralized Bone Matrix Segment
  
  $
  14,012
  
  $
  10,862
  
  $
  26,907
  
  $
  22,295Base Tissue Segment
  
  
  10,985
  
  
  10,291
  
  
  21,528
  
  
  21,051Other
  
  
  293
  
  
  1,072
  
  
  703
  
  
  2,656Consolidated
  
  $
  25,290
  
  $
  22,225
  
  $
  49,138
  
  $
  46,002Operating income (loss):Demineralized Bone Matrix Segment
  
  $
  1,237
  
  $
  121
  
  $
  1,883
  
  $
  1,241Base Tissue Segment
  
  
  (3,434
  )
  
  (722
  )
  
  (4,911
  )
  
  (1,064
  )Other
  
  
  79
  
  
  (307
  )
  
  (31
  )
  
  (2,809
  )Consolidated
  
  $
  (2,118
  )
  $
  (908
  )
  $
  (3,059
  )
  $
  (2,632
  )One of our
clients in the DBM and Base Tissue Segments, the Musculoskeletal Transplant
Foundation (MTF), accounted for 30% and 31% of consolidated net
revenues during the three months and six months ended June 30, 2005,
respectively.  In January, 2005, MTF acquired the allograft tissue banking
operations of the American Red Cross (ARC), which previously had
been a major customer of the Company.  For the three months ended June 30,
2005, the Company did not recognize any revenues from ARC. For the six months
ended June 30, 2005, ARC accounted for 2% of consolidated net revenues. 
For the three and six months ended June 30, 2004, MTF and ARC accounted for 20%
and 22% and 19% and 22%, respectively, of consolidated net revenues. As of June
30, 2005 and December 31, 2004, these two clients together accounted for 30% and
32%, respectively, of consolidated outstanding account receivables.13.
  ReclassificationsCertain
  prior year amounts have been reclassified to conform to the 2005
  presentation.14.
  Subsequent EventsSale and Leaseback of Processing FacilityOn August 8,
  2005, the Company completed the sale of its principal processing facility
  located in Eatontown, New Jersey to an unrelated third party for $16.5
  million in cash. The Company also entered into an agreement to leaseback the
  processing facility. The lease agreement is for an initial term of 20 years
  with two five year renewal options at the Companys election.  Lease payments will be $2,326,000 annually
  for the first seven years of the agreement, $1,460,000 for years eight
  through twelve, a rental rate to be determined at the time with a minimum
  rate of $1,460,000 and a maximum rate of $1,533,000 for years thirteen
  through seventeen, and a  rental rate
  to be determined at the time with a minimum rate equal to the actual rental
  rate in year seventeen and a maximum rate of $1,609,650 for years eighteen through
  twenty.  The Company retains all
  property and equipment, including leasehold improvements, directly related to
  the operation of the Companys business. The transaction will be recorded as
  a capital lease,-11-


with the
  resulting gain of approximately $3,600,000 from the sale of the facility deferred
  and amortized in proportion to the amortization of the leased assets. The
  Company has not yet completed an evaluation of the impact of FIN47 and SFAS
  No. 143, Accounting for Asset Retirement Obligations as it relates to this
  transaction.The Company
  utilized a portion of the proceeds from the sale to repay all outstanding
  debt as of August 8, 2005 of $10,963,000. All remaining proceeds arising from
  this transaction will be utilized for general corporate purposes.Intercompany Loans  Permanent StatusOn July 7,
  2005, the Companys Board of Directors declared $5.5 million of intercompany
  loans between the domestic company and OST Developpement S.A., the Companys
  French subsidiary, to be permanent debt, requiring no principal payments on
  such intercompany loans for the foreseeable future. As a result, and pursuant
  to SFAS No. 52, Foreign Currency Translation, from July 7, 2005 forward
  that portion of the intercompany debt will no longer be subject to the
  effects of variations in currency exchange rates between the U.S. dollar and
  the Euro. The remaining outstanding balance under intercompany loans between
  the domestic company and OST Developpement. of $3,141,000 as of June 30, 2005
  will continue to be subject to variations in currency exchange rates between
  the U.S. dollar and the Euro. Historically, the Company has recognized
  cumulative translation gains on its intercompany debt of $105,000 in its
  consolidated statement of operations.Management ChangeOn July 29,
  2005, the Company announced the forthcoming retirement of Michael J. Jeffries,
  its Executive Vice President, Chief Financial Officer and Secretary,
  effective December 31, 2005.  The
  Board of Directors has approved a retirement arrangement for Mr. Jeffries
  with an approximate value of $430,000 that includes the following
  commitments: (i) 15 months of severance payments, (ii) compensation
  corresponding to all unused vacation pay accrued as of the date of
  retirement, (iii) payment of premiums for Mr. Jeffries
  medical, dental and life insurance coverage through March 31, 2007, and (iv)
  payment of all COBRA premiums commencing April 1, 2007 through (a) the
  earlier of such time Mr. Jeffries is eligible to receive Medicare benefits or
  (b) eighteen months after April 1, 2007. Mr. Jeffries will also receive 100% of bonus payouts, if any, that are awarded to Mr. Jeffries for the year ending December 31, 2005 in accordance with the Management Performance Bonus Plan. 
The Company will record the value of the retirement arrangement ratably to the consolidated statement of operations over the remainder of 2005.
  In addition, all outstanding stock options granted to Mr. Jeffries
  shall remain exercisable through the original expiration dates of the option
  agreements pursuant to which they were granted, notwithstanding any
  provisions in such option agreements which would have limited the exercise
  period of such options following the termination of Mr. Jeffries employment
  with the Company.  In accordance with the provisions of APB No. 25, the Company will recognize compensation costs in the third quarter of 2005 of approximately $41,000 related to this change to Mr. Jeffries stock options, for all stock options where the exercise price of Mr. Jeffries stock options are less than the market price of the Companys common stock on August 3, 2005.  In addition, Mr. Jeffries and the Company mutually agree to release each other from any claims
  or liabilities arising out of Mr. Jeffries employment or retirement.  Mr. Jeffries will also be subject to
  certain non-competition covenants through March 31, 2007.On August 1,
  2005 the Company announced that the Board of Directors had appointed Mark H.
  Burroughs, currently the Companys Vice President, Finance and Treasurer, to
  succeed Mr. Jeffries as the Companys Executive Vice President, Chief Financial Officer and Secretary upon the
  retirement of Mr. Jeffries.-12-


Item 2.
  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
  RESULTS OF OPERATIONSInformation
contained herein contains forward-looking statements which can be identified
by the use of forward-looking terminology such as believes, expects, may,
will, should, or anticipates or the negative thereof or variations
thereon or comparable terminology, or by discussions of strategy. No assurance
can be given that the future results covered by the forward-looking statements
will be achieved. Some of the matters set forth in the Risk Factors section
of our Annual Report on Form 10-K for the year ended December 31, 2004
constitute cautionary statements identifying factors with respect to such
forward-looking statements, including certain risks and uncertainties, that
could cause actual results to vary materially from the future results indicated
in such forward-looking statements. Other factors could also cause actual
results to vary materially from the future results indicated in such forward-looking
statements.

FOR THE THREE MONTHS
AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004

Results of Operations

Critical Accounting Policies and Estimates

Critical
accounting policies are those that involve subjective or complex judgments,
often as a result of the need to make estimates. The following areas all
require the use of judgments and estimates: product returns, bad debts,
inventories including purchase commitments, deferred processing costs including
reserves for rework, excess and obsolescence, property, plant and equipment,
intangible assets, current and deferred income taxes, contingencies and
litigation. Estimates in each of these areas are based on historical experience
and various assumptions that we believe are appropriate. Actual results may
differ from these estimates. Our accounting practices are discussed in more
detail in Managements Discussion and Analysis of Financial Condition and
Results of Operations and Note 2 of Notes to Consolidated Financial
Statements in our Annual Report on Form 10-K for the year ended December
31, 2004.

Net Income (Loss)

We incurred a
consolidated net loss for the three months ended June 30, 2005 of $1,878,000 or
$.11 diluted net loss per share compared to a consolidated net loss of $427,000
or $.02 diluted net loss per share for the three months ended June 30, 2004. We
incurred a consolidated net loss for the six months ended June 30, 2005 of
$2,709,000 or $.16 diluted net loss per share compared to a consolidated net
loss of $1,682,000 or $.10 diluted net loss per share for the six months ended
June 30, 2004. The net loss in both periods of 2005 is primarily attributable
to lower gross profit margins, increased operating expenses and foreign
currency translation losses. Gross profit margins were primarily impacted by an
increase in reserves for tissue inventory obsolescence and expiration of $790,000,
mostly due to the previously announced dispute with Bone Bank Allograft
(BBA), which prevents us from utilizing BBA labeled tissue, and negative
production variances of $700,000 related to our Graftech® Bio-implant product
line due to a planned reduction in unit production output to reduce overall
Graftech® Bio-implant inventory levels. Operating expenses increased primarily
due to costs associated with implementation of programs to turn around the
domestic business, expenses associated with our continuing investment in
strengthening and diversifying our tissue sources and increased professional
fees. We incurred translation losses on the outstanding balance of intercompany
debt due to the strengthening of the U.S. dollar against the Euro. The net loss
for the six months ended June 30, 2004 was impacted by the inventory reserves
associated with our exit from the metal spinal implant business of

-13-


$1,998,000 and
the severance costs related to the reorganization of our sales and marketing
functions of $650,000.

The following
is a discussion of factors affecting results of operations for the three months
and six months ended June 30, 2005 and 2004.

Net Revenues

Consolidated
net revenues increased $3,065,000 to $25,290,000 in the second quarter of 2005
compared to consolidated net revenues of $22,225,000 in the corresponding
period in 2004. Domestic net revenues increased 11% to $21,662,000 for the
three months ended June 30, 2005 from $19,446,000 in the same period in 2004.
Foreign-based net revenues increased 31% to $3,628,000 in the second quarter of
2005 from $2,779,000 in the same period in 2004. Consolidated net revenues
increased 7% to $49,138,000 for the six months ended June 30, 2005 compared to
consolidated net revenues of $46,002,000 for the six months ended June 30,
2004. Domestic net revenues increased 4% to $42,019,000 for the six months
ended June 30, 2005 from $40,365,000 in the corresponding period in 2004.
Foreign-based revenues increased 26% to $7,119,000 for the six months ended
June 30, 2005 from $5,637,000 in the same period in 2004. These increases in
revenues are mainly attributable to the continued growth of our international
and private label businesses and improved domestic revenues of Grafton® DBM.
Consolidated revenues for the three months and six months ended June 30, 2004
included revenue of $608,000 and $1,700,000 from metal spinal implant products
that we discontinued distributing in June, 2004.

Revenues in
the Demineralized Bone Matrix (DBM) Segment, or DBM Segment, increased 29% to
$14,012,000 in the second quarter of 2005 from revenues of $10,862,000 in the
corresponding period in 2004. DBM Segment revenues for the six months ended June
30, 2005 of $26,907,000 increased 21% from DBM Segment revenues of $22,295,000
for the six months ended June 30, 2004. Domestic Grafton® DBM revenues
increased 27% to $10,922,000 in second quarter 2005 from revenues of $8,632,000
in second quarter 2004 and increased to $20,818,000 for the six months ended
June 30, 2005 from $17,737,000 for the corresponding period in the prior year.
The increase in domestic Grafton® DBM revenues in the three months and six
months ended June 30, 2004 is primarily related to an 11% increase in the
volume compared to the corresponding periods in the prior year and recognition
of a greater portion of the end user selling price arising from the continued
conversion of unit sales of domestic GraftonÒ
DBM business to direct distribution. Domestic private label revenues increased
to $839,000 in the second quarter 2005 from revenues of $542,000 in second
quarter 2004 and increased to $1,940,000 for the six months ended June 30, 2005
from $1,146,000 for the corresponding period in the prior year. The increase in
revenues in both periods of 2005 relates mainly to shipments under our
arrangement with Smith & Nephew, since we did not commence shipping product
under this arrangement until July, 2004. Foreign-based GraftonÒ
DBM revenues increased 33% to $2,251,000 in the second quarter of 2005 from
revenues of $1,688,000 in the corresponding period in the prior year, and
increased 22% to $4,149,000 for the six months ended June 30, 2005 from
$3,412,000 for the six months ended June 30, 2004. The increase in
foreign-based Grafton® DBM revenues is primarily due to increased unit volume
arising from our increased penetration in existing markets and the expansion
into additional markets.

Base Allograft
Tissue Segment, or Base Tissue Segment, revenues increased 7% to $10,985,000 in
the second quarter of 2005 from $10,291,000 in the corresponding period in
2004. Base Tissue Segment revenues increased 2% to $21,528,000 for the six
months ended June 30, 2005 from revenues of $21,051,000 for the six months
ended June 30, 2004. The increase in Base Tissue Segment revenues in the second
quarter of 2005 is primarily attributable to an increase in unit volumes of
directly distributed traditional tissue partially offset by a decline in
revenues from Graftech® Bio-implants due to lower demand and the processing of
fewer donors for clients. Revenues from, the domestic distribution of

-14-


traditional
tissue increased 297% and 237% in the three months and six months ended June
30, 2005, respectively, compared to the respective corresponding period in
2004, primarily as a result of increased unit volume. Revenues from the
processing of donors for clients declined 17% in the second quarter of 2005 as
compared to the second quarter of 2004, primarily due to an 18% decline in
donors processed for such clients, and declined 20% for the six months ended
June 30, 2005 as compared to the corresponding period in 2004, principally due
to a 20% decline in donors processed for clients. Revenues from Graftech®
Bio-implant, which are distributed domestically, declined 8% to $4,729,000 in
the three months ended June 30, 2005 from $5,147,000 in the three months ended
June 30, 2004, primarily due to a 16% decline in unit volume partially offset
by January 1, 2005 price increases and a shift in mix of units sold to units
with a higher per unit selling price. Graftech® Bio-implant revenues declined
14% in the six months ended June 30, 2005 to $9,271,000 from the $10,815,000 in
the corresponding period in 2004, due primarily to a 16% decline in unit
volume. International traditional tissue processing and distribution revenues
increased 54% to $1,211,000 in the three months ended June 30, 2005 from
$784,000 in the corresponding period in 2004, and increased 65% for the six
months ended June 30, 2005 to $2,607,000 compared to $1,579,000 in the earlier
year period. The increases in both periods resulted primarily from increased
unit sales volume related to increased market penetration.

Revenue from
other product lines, consisting primarily of bovine tissue, declined in the
second quarter of 2005 to $293,000 from $1,072,000 in the same period in 2004
and declined for the six months ended June 30, 2005 to $703,000 from $2,656,000
in the corresponding period in 2004. The decline in revenues in both periods is
due principally to discontinuing our distribution efforts for all metal spinal
implant product lines during 2004. Revenues from metal spinal implant product
lines were $608,000 and $1,700,000 for the three months and six months ended June
30, 2004, respectively.

One of our
clients in the DBM and Base Tissue Segments, the Musculoskeletal Transplant
Foundation (MTF), accounted for 30% of consolidated net revenues during the
three months ended June 30, 2005 and 31% of consolidated net revenues for the
six months ended June 30, 2005. In January, 2005, MTF acquired the allograft
tissue banking operations of the American Red Cross (ARC), which previously
had been a major customer of the Company. For the six months ended June 30,
2005, ARC accounted for 2% of consolidated net revenues. There were no revenues
from ARC for the three months ended June 30, 2005. For the three months ended
June 30, 2004, MTF and ARC accounted for 20% and 22%, respectively, of
consolidated net revenues, and for the six months ended June 30, 2004, MTF and
ARC accounted for 19% and 22%, respectively, of consolidated net revenues. We
have two processing agreements with MTF. The first agreement expires on
December 31, 2008 and the second agreement expires on December 31, 2006, but
may be extended for two additional one-year periods if certain conditions
contained in the agreement are met.

Gross Profit Margin

Consolidated
gross profit margin was 40% in the second quarter of 2005 compared to 45% in
the second quarter of 2004 and consolidated gross profit margin was 42% for the
six months ended June 30, 2005 compared to 43% for the six months ended June
30, 2004. The decline in gross profit margin in both periods was due primarily
to the ongoing shift in our domestic business model to direct distribution of
allograft tissue forms to end users, an increase in reserves for tissue inventory
obsolescence and expiration, in part, because of the previously announced
dispute with BBA and negative production variances of $700,000 related to our Graftech®
Bio-implant product line due to a planned reduction in unit production output
to reduce overall Graftech® Bio-implant inventory levels. The six months ended
June 30, 2004 was impacted negatively by the reserves recorded in the first
quarter of 2004 for costs associated with our exit from the metal spinal
implant business of $1,998,000 to reduce metal spinal implant inventory and
instrumentation to estimated net realizable value. We expect to continue to
incur charges related to negative production variances related

-15-


to our
Graftech® Bio-implant product line throughout the remainder of 2005 as we
continue our planned reduction in unit production output to reduce overall
Graftech® Bio-implant inventory levels.

Marketing, Selling, General and Administrative
Expenses

Consolidated
marketing, selling, general and administrative expenses increased 13% in the
second quarter 2005 to $10,967,000 from $9,678,000 in the corresponding period
in 2004. Consolidated marketing, selling, general and administrative expenses
increased 7% for the six months ended June 30, 2005 to $21,573,000 from
$20,184,000 for the six months ended June 30, 2004. The increased spending in
2005 over the corresponding periods in 2004 is principally due to costs
associated with implementation of programs to turn around the domestic
business, expenses associated with our continuing investment in strengthening
and diversifying our tissue sources and increased professional fees. The six
month period ended June 30, 2004 included a severance charge of $650,000
related to the reorganization of the sales and marketing departments. As we
continue to implement ongoing programs we expect marketing, selling and general
and administrative expenses to continue to increase in the second half of 2005.

Research and Development Expenses

Consolidated
research and development expenses increased 3% in the second quarter of 2005 to
$1,224,000 from $1,187,000 in the corresponding period in 2004, and increased
7% in the six months ended June 30, 2005 to $2,186,000 from $2,043,000 in the
six months ended June 30, 2004. The increase in both periods principally
results from increased activity related to development costs of our new
product, Grafton® DBM Orthoblend, which was launched in April, 2005, continued
development of a new system of PEEK composite material and allograft tissue,
which we expect to launch in the fourth quarter of 2005, and continued
development of our Plexus Technology. We expect that research and development
expenditures will continue to increase in future quarters due to new projects
and programs and increased activity in existing projects, including the
continued development of our Plexus Technology.

Operating Income (Loss)

We incurred a
consolidated operating loss of $2,118,000 and $3,059,000 for the three months
and six months ended June 30, 2005, respectively, compared to a consolidated
operating loss of $908,000 and $2,632,000 in the same respective periods in
2004. The operating losses in both periods in 2005 result principally from lower
gross profit margins and increased operating expenses. Our gross profit margins
were primarily impacted by the aforementioned increase in reserves for tissue
inventory obsolescence and expiration of $790,000 and negative production
variances of $700,000. Operating expenses increased primarily due to costs
associated with implementation of programs to turn around the domestic
business, expenses associated with our continuing investment in strengthening
and diversifying our tissue sources and increased professional fees. The
operating loss arising in the three months ended June 30, 2004 results
principally from a decline in gross profit margin impacted by lower net
revenues and increased per unit processing costs. The operating loss for the
six months ended June 30, 2004 primarily related to the aforementioned charges
to reduce metal spinal implant inventory and instrumentation to estimated net
realizable value and severance related to the reorganization of our sales and
marketing departments, increased sales and commission costs, and lower gross
profit margins resulting from the shift in revenue towards lower margin product
categories.

DBM Segment
operating income increased to $1,237,000 in the three months ended June 30,
2005 from $121,000 in the same period in 2004 and increased to $1,883,000 for
the six months ended June 30, 2005 from $1,241,000 in the corresponding period
in 2004. These increases are attributable to the increase in domestic Grafton®
DBM revenues, a corresponding increase in gross profit margin, partially offset
by an

-16-


increase in
operating expenses. Operating income for the six months ended June 30, 2004 was
adversely impacted by a portion of the severance costs related to the
reorganization of the sales and marketing departments.

We incurred an
operating loss in the Base Tissue Segment of $3,434,000 and $4,911,000 in the
three months and six months ended June 30, 2005, respectively, compared to
operating losses of $722,000 and $1,064,000 in the respective corresponding
periods in 2004. The operating losses in 2005 result principally from the
decreased revenue from Graftech® Bio-implant due to lower demand, the
processing of fewer donors for clients, reserves for tissue inventory obsolescence and
expiration, the charges for negative production variances and increased
operating expenses.

Operating
income associated with other revenues for the quarter ended June 30, 2005 was
$79,000 compared to an operating loss of $307,000 in the corresponding 2004
period. The six months ended June 30, 2005 generated an operating loss of
$31,000 compared to an operating loss of $2,809,000 in the comparable 2004
period. The operating loss for the six months ended June 30, 2004 included a
charge of $1,998,000 due to the decision in the first quarter of 2004 to exit
from the metal spinal implant business.

Other, Net

Other, net,
which primarily represents interest expense, net of interest income, and
foreign currency translation and transaction gains and losses was $677,000 and
$973,000 for the three months and six months ended June 30, 2005, respectively,
compared to $108,000 and $345,000, respectively, for the corresponding periods
during 2004. Interest expense, net of interest income, was $41,000 and $152,000
in the three months and six months ended June 30, 2005, respectively, compared
to $101,000 and $222,000 in the three months and six months
ended June 30, 2004, respectively. Losses related to changes in exchange rates
on foreign transactions denominated in US dollars, primarily related to
intercompany debt, were $636,000 and $821,000 in the three months and six
months ended  June 30, 2005, respectively, compared to $7,000 and $123,000 in
the three months and six months ended June 30, 2004, respectively.

On July 7,
2005, the Board of Directors declared $5.5 million of intercompany loans between
the domestic company and OST Developpement, our French subsidiary, to be
permanent debt, requiring no principal payments on such intercompany loans for
the foreseeable future. As a result, and pursuant to Statement of Financial
Accounting Standard (SFAS) No. 52, Foreign Currency Translation, from July
7, 2005 forward that portion of the intercompany debt will no longer be subject
to the effects of variations in currency exchange rates between the U.S. dollar
and the Euro. The remaining outstanding balance under intercompany loans
between the domestic company and OST Developpement of $3,141,000 as of
June 30, 2005 will continue to be subject to variations in currency exchange
rates between the U.S. dollar and the Euro.

Income Tax Benefit

We recognized
an income tax benefit in the three months and six months ended June 30, 2005
primarily due to losses in our domestic and foreign operations and our
assessment of the recoverability of these benefits. We have not provided any
benefit for domestic state income taxes as we have established a valuation
allowance for such state income tax benefits in accordance with SFAS No. 109,
Accounting for Income Taxes, because we believe that it is more likely than
not that such benefits will not be recoverable. We intend to maintain the
valuation allowance related to domestic state income taxes until sufficient
positive evidence exists to support the reversal of such valuation allowances.
We recognized income tax benefits for the three months and six months ended
June 30, 2004 primarily due to losses incurred in our domestic operation and
our assessment of the recoverability of these benefits and our ability to
utilize previously

-17-


unrecognized
foreign net operating loss carry forwards, which carried a full valuation
allowance, to offset foreign income.

Liquidity and Capital Resources

At June 30,
2005, we had cash and cash equivalents of $10,959,000 compared to $13,391,000
at December 31, 2004. The decline in cash and cash equivalents primarily
relates to increases in accounts receivable as a result of increased revenues,
spending designed to continue the strengthening of our tissue sources and turn
around our domestic business and principal payments on long term debt,
partially offset by the timing of payments to vendors and suppliers. Working
capital decreased to $55,913,000 at June 30, 2005 compared to $56,839,000 at
December 31, 2004.

Net cash
utilized by operating activities was $477,000 for the six months ended June 30,
2005 and net cash provided by operations during the six months ended June 30,
2004 was $2,086,000. In 2005, net cash used by operating activities is
primarily due the net loss for the period and an increase in accounts
receivable due to increased revenues, partially offset by the timing of
payments to vendors and suppliers.

Cash used in
investing activities was $598,000 for the six months ended June 30, 2005
compared to cash used by investing activities of $704,000 for the six months
ended June 30, 2004. Cash used in investing activities in 2005 and 2004
primarily results from capital expenditures of $459,000 and $771,000,
respectively.

Net cash used
in financing activities was $1,244,000 and $1,129,000 for the six months ended
June 30, 2005 and 2004, respectively. Net cash used in financing activities in
both periods primarily results from principal payments on long-term debt,
partially offset by proceeds from the sale of common stock associated with
employee stock option exercises and our employee stock purchase plan.

At June 30,
2005, we had a Credit Facility, as amended, which included a $5,000,000 line of
credit, a mortgage loan and an equipment term loan. As of June 30, 2005, no
amounts were outstanding under the revolving line of credit and the full amount
was available. The Credit Facility imposed certain restrictive operating and
financial covenants. The Company complied with all financial covenants as of
June 30, 2005.

On August 8,
2005, we completed the sale of our principal processing facility located in
Eatontown, New Jersey to an unrelated third party for $16.5 million in cash. We
also entered into an agreement to leaseback the processing facility. The lease
agreement is for an initial term of 20 years with two five year renewal options
at our election. Lease payments will be $2,326,000 annually for the first seven
years of the agreement, a $1,460,000 for years eight through twelve, a rental
rate to be determined at the time with a minimum rate of $1,460,000 and a
maximum rate of $1,533,000 for years thirteen through seventeen, and a rental
rate to be determined at the time with a minimum rate equal to the actual
rental rate in year seventeen and a maximum rate of $1,609,650 eighteen through
twenty. We retain all property and equipment, including leasehold improvements,
directly related to the operation of our business. The transaction will be
recorded as a capital lease, with the resulting gain of approximately $3,600,000
from the sale of the facility deferred and amortized in proportion to the
amortization of the leased assets. We have not yet completed an evaluation of
the impact of FIN47 and SFAS No. 143, Accounting for Asset Retirement
Obligations as it relates to this transaction.

We utilized a
portion of the proceeds from the sale to repay all outstanding debt as of
August 8, 2005 of $10,963,000 and the line of credit was cancelled. All
remaining proceeds arising from this transaction will be utilized for general
corporate purposes.

-18-


We believe
that our cash and cash equivalents, together with anticipated future cash flows
from operations, will be sufficient to meet our forecasted cash needs for the
next twelve months. From time to time we may seek additional funds through
equity or debt financing. However, there can be no assurance that such
additional funds will be available, or if available, that such funds will be
available on favorable terms.

Recent Accounting Pronouncement

In December,
2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123
(Revised 2004), Share-Based Payment (SFAS No. 123R). SFAS No. 123R
addresses all forms of share-based payment (SBP) awards, including shares
issued under employee stock purchase plans, stock options, restricted stock and
stock appreciations rights. SFAS No. 123R will require us to expense SBP awards
as compensation costs for SBP transactions measured at fair value. SFAS No.
123R would have been effective beginning in our third quarter of 2005, however,
in April, 2005, the Securities and Exchange Commission extended the effective
date of SFAS No. 123R to January 1, 2006. We intend to adopt SFAS No. 123R
using the modified prospective method. We are currently evaluating our
long-term incentive plan related to the issuance of stock options, but no
decisions have been made.

In March,
2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional
Asset Retirement Obligation (FIN 47). The interpretation addresses diverse
practices, which have developed with respect to the recognition of asset
retirement obligations when the timing and/or method of settlement of an
obligation are conditional on a future event. The interpretation requires recognition of a
liability for the fair value of a conditional asset retirement obligation if the liability can be reasonably estimated. The fair
value of a liability for the conditional asset retirement obligation should be
recognized when incurred (generally upon acquisition, construction or
development) and/or through the normal operation of the asset. This guidance is
effective no later than the end of fiscal years ending after December 15, 2005.
Retrospective application for interim financial information is permitted but is
not required. We are in the process of evaluating the impact, if any, of
implementing FIN 47.

In May, 2005
the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS
No. 154). SFAS No. 154 addresses the requirements for the accounting for and
reporting of a change in accounting principle. It requires retrospective
application to prior periods financial statements of changes in accounting
principles unless a pronouncement giving rise to a change in accounting
principle includes specific transition provisions, in which case those
provisions should be followed. This guidance must be implemented for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005

As of June 30,
2005, there were no material changes in our contractual obligations or long-term
debt from that disclosed in Item 7, Managements Discussion and
Analysis of Financial Condition and Results of Operations in our Annual
Report on Form 10-K for the year ended December 31, 2004, except as of August 8,
2005, we have repaid the outstanding balance on our long-term debt and have
entered into a new capital lease arrangement, which has the following minimum
lease commitments over the 20 year term of the lease:

(In thousands)
  
  Total
  
  Less Than
  One Year
  
  Years 2-3
  
  After3 YearsCapital
  lease obligations
  
  $
  36,077
  
  
  $
  2,326
  
  
  
  $
  4,652
  
  
  $
  29,099-19-


Impact of Inflation and Foreign Currency
Exchange Fluctuations

Results of
operations for the periods discussed above have not been materially affected by
inflation or foreign currency fluctuations related to the translation of
financial statements denominated in foreign currency to US dollars. Losses
related to changes in exchange rates on foreign transactions denominated in US
dollars, including intercompany debt, were $636,000 and $821,000 in the three
months and six months ended June 30, 2005, respectively, compared to losses of
$7,000 and $123,000 in the three months and six months ended
June 30, 2004, respectively.

Litigation

Osteotech,
Inc. is involved in various legal proceedings. For a discussion of these
matters see, Note 9 of Notes to Condensed Consolidated Financial Statements
included elsewhere herein and PART II. ITEM 1. LEGAL PROCEEDINGS, and our
Annual Report on Form 10-K for the year ended December 31, 2004 and our
Quarterly Report on Form 10-Q for the three months ended March 31, 2005. It is
possible that our results of operations or liquidity and capital resources
could be adversely affected by the ultimate outcome of pending litigation or as
a result of the costs of contesting such lawsuits.

ITEM 3.
  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKFor
information regarding our exposure to certain market risks, see Item 7A,
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, in our Annual
Report on Form 10-K for the year ended December 31, 2004. There have been no
significant changes in our market risk exposures from the fiscal 2004 year-end.

ITEM 4.
  CONTROLS AND PROCEDURESEvaluation of disclosure controls and
procedures

During the
first six months of 2005, our management, including the principal executive
officer and principal financial officer, evaluated our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) related to the recording, processing, summarization and
reporting of information in our reports that we file with the SEC. These
disclosure controls and procedures have been designed to ensure that material
information relating to us, including our subsidiaries, is made known to our
management, including these officers, by other of our employees, and that this
information is recorded, processed, summarized, evaluated and reported, as
applicable, within the time periods specified in the SECs rules and forms. Due
to the inherent limitations of control systems, not all misstatements may be
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. Our controls and procedures can only provide
reasonable, not absolute, assurance that the above objectives have been met.
Based on their evaluation as of June 30, 2005, our principal executive officer
and principal financial officer have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e)

-20-


under the
Securities Exchange Act of 1934) are effective to reasonably ensure that the
information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in SEC rules and
forms.

Changes in internal controls

There were no
changes made in our internal control over financial reporting during the period
covered by this report that have materially affected, or are reasonably likely
to materially affect, these controls subsequent to the date of their last
evaluation.

-21-


PART II.
  OTHER INFORMATIONITEM 1.
  LEGAL PROCEEDINGSThe following
is a description of material developments that occurred during the three months
ended June 30, 2005 in lawsuits reported in our Annual Report on Form 10-K
for the year ended December 31, 2004 and our Quarterly Report on Form 10-Q for
the quarter ended March 31, 2005. Additionally, from time to time we are a
party to other litigation incidental to our business, none of which,
individually or in the aggregate, are expected to have a material adverse
effect on our results of operations or financial condition.

Tissue Transplant Technology, Ltd. d/b/a Bone
Bank Allografts v. Osteotech, Inc.

In December,
2004, we were served with a suit filed by Tissue Transplant Technology, Ltd.
d/b/a Bone Bank Allografts (BBA) alleging, among other things, breach of
contract in connection with a processing agreement between the two parties
entered into on June 1, 2000. BBAs complaint, as amended, contains claims for
breach of contract, tortious interference with existing contract, tortious
interference with prospective business relationships, negligence, breach of
fiduciary duty, unfair competition, fraud, and federal unfair competition. BBA
does not allege a specified amount of damages. On January 31, 2005, we filed a
motion to transfer venue to the District of New Jersey and a motion to dismiss
some of BBAs claims. On April 26, 2005, the U.S. District Court for the
Western District of Texas denied our motion to transfer venue and granted our
motion to dismiss only with respect to the breach of fiduciary duty claim. As a
result, litigation with respect to BBAs remaining claims will go forward in
the Western District of Texas. On May 10, 2005, we filed our answer,
affirmative defenses and two counterclaims for breach of contract. Discovery
proceedings and depositions are ongoing. The parties have participated in three
mediation sessions, but have been unable to reach a non-litigation resolution
to the dispute.

We believe
that the claims made against using this action are without merit and will
vigorously defend against such claims.

-22-


ITEM 4.
  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS(a)
  An annual
  meeting of stockholders of Osteotech, Inc. was held on June 9, 2005.(c)
  The matters
  voted upon at the annual meeting and the results of the voting are set forth
  below:i)
  With respect
  to the election of Directors of Osteotech, the persons named below were
  elected at the annual meeting to serve a term of one year or until the next
  annual meeting of stockholders. They constitute the entire board of directors
  of Osteotech. Each received the following number of votes:Director
  
  
  For
  
  
  WithheldRichard W.
  Bauer
  
  
  
  14,713,374
  
  
  
  
  1,861,833Kenneth P.
  Fallon, III
  
  
  
  16,095,486
  
  
  
  
  479,721Stephen
  Galliker
  
  
  
  16,086,670
  
  
  
  
  488,537Michael J.
  Jeffries
  
  
  
  14,563,228
  
  
  
  
  2,011,979Donald D.
  Johnston
  
  
  
  14,766,534
  
  
  
  
  1,808,673Sam
  Owusu-Akyaw
  
  
  
  16,124,937
  
  
  
  
  450,270Robert J.
  Palmisano
  
  
  
  16,066,388
  
  
  
  
  508,819Thomas M.
  Patton
  
  
  
  16,267,126
  
  
  
  
  308,081Stephen J.
  Sogin, Ph.D.
  
  
  
  16,058,387
  
  
  
  
  516,280ii)
  With respect
  to a proposal to extend the expiration date of Osteotechs 1994 Employee
  Stock Purchase Plan to July 1, 2009, the stockholders voted 9,129,161 shares
  in favor, 676,693 shares against and 10,004 shares abstained. Broker
  non-votes were not applicable. This proposal received the vote required by
  Delaware General Corporation Law and Osteotechs by-laws for approval (i.e.
  the affirmative vote of a majority of the shares of common stock voted on the
  proposal).ITEM 5.
  OTHER INFORMATION(a) On August
8, 2005, the Company entered into a Purchase and Sale Agreement with 201
Industrial Way, Inc., an unrelated third party, whereby the Company completed
the sale of its principal processing facility located in Eatontown, New Jersey
to 201 Industrial Way, Inc. for $16.5 million in cash. On August 8, 2005, the
Company also entered into an agreement to lease the processing facility from 201
Industrial Way, Inc. The lease agreement is for an initial term of 20 years with
two five year renewal options at the Companys election. Lease payments
will be $2,326,000 annually for the first seven years of the agreement,
$1,460,000 for years eight through twelve, a rental rate to be determined at the
time with a minimum rate of $1,460,000 and a maximum rate of $1,533,000 for
years thirteen through seventeen, and a rental rate to be determined at the time
with a minimum rate equal to the actual rental rate in year seventeen and a
maximum rate of $1,609,650 for years eighteen through twenty. The Company
retains all property and equipment, including leasehold improvements, directly
related to the operation of our business. The transaction will be recorded as a
capital lease, with the resulting gain of approximately $3,600,000 from the sale
of the facility deferred and amortized in proportion to the amortization of the
leased assets. The Company has not yet completed an evaluation of the impact of
FIN47 and SFAS No. 143, Accounting for Asset Retirement Obligations
as it relates to this transaction.

-23-


The Company
previously entered into a Credit Facility with Bank of America, N.A. (successor
by merger to Fleet National Bank), as amended, which included a $5,000,000 line
of credit, a mortgage loan and an equipment term loan. Simultaneous to the
closing of the sale and leaseback, the Company utilized a portion of the
proceeds from the sale to repay all outstanding debt under the Credit Facility
as of August 8, 2005 of $10,963,000. As a result, the
mortgage and equipment loan were repaid, the line of credit was cancelled and
the Companys Credit Facility was terminated. All remaining proceeds arising
from the sale and leaseback transaction will be utilized for general corporate
purposes.

ITEM 6.
  EXHIBITS AND REPORTS ON FORM 8-K(a)
  Exhibits
  (numbered in accordance with Item 601 of Regulation S-K)ExhibitNumber
  
  Description
  Page
  Number10.55
  
  1994
  Employee Stock Purchase Plan, as amended
  *10.56
  
  First form
  of option agreement and form of amendment thereto, used to grant options to
  Richard Bauer
  *10.57
  
  Second form
  of option agreement, and amendment thereto, used to grant options to Richard
  Bauer
  *10.58
  
  Third form
  of option agreement, and amendment thereto, used to grant options to Richard
  Bauer
  *10.59
  
  Fourth form
  of option agreement, and amendment thereto, used to grant options to Richard
  Bauer
  *10.60
  
  Fifth form
  of option agreement, and amendment thereto, used to grant options to Richard
  Bauer
  *10.61
   
   Sixth form of option agreement, and amendment thereto, used to grant options to Richard Bauer
   *31.1
  
  Certification
  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
  of 2002
  *31.2
  
  Certification
  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
  of 2002
  *32.1
  
  Certification
  of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
  of 2002
  *32.2
  
  Certification
  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
  of 2002
  **          Filed
herewith.

-24-


SIGNATURES

Pursuant to
the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.



Date: 
  August 9, 2005
  
  
  Osteotech,
  Inc.(Registrant)Date:
   August 9, 2005
  
  By:
  /S/Richard
  W. BauerRichard W.
  BauerChief
  Executive Officer(Principal
  Executive Officer)Date:
   August 9, 2005
  
  By:
  /S/Michael
  J. JeffriesMichael J.
  JeffriesExecutive
  Vice President,Chief
  Financial Officer(Principal
  Financial Officer andChief
  Accounting Officer)-25-